Chapter 9
Is innovation profitable?
A mixed picture is offered by empirical evidence of R&D intensity, innovation, and profitability, which shows that innovation, does not guarantee fortune. Fundamentally, the profitability of an innovation depends on the value it creates and the share of that value appropriated by the innovator. That created value is distributed among several players in an industry. For example, in the PC industry, innovators such as Apple, MITS, Tandy, and Xerox, appropriate a modest portion of the created value, whereas the industry's suppliers gain a large part of the profit (Intel, Seagate Technology and Quantum Corp, Sharp, and Microsoft). In fact, because of intense competition in this industry, most of the created value was appropriated by customers, who paid less that the derived value for their PCs. Four factors are critical determinants of the size of "the slice of the pie" that innovators will be able to appropriate in regard to the created value: a/ existence of property rights, b/ tacitness and complexity of the technology, c/ lead-time and d/ complementary resources.
How and why should a firm try to win a war over standards?
A standard is a format, interface, or a system that allows interoperability. The establishment and development of standards are sometimes subject to network externalities, which create positive feedback and a tendency for an industry's development to result in a winner-takes-all situation. Once established, a standard is highly resilient and difficult to displace due to learning effects and collective lock-in. Therefore, when network externalities exist, control over a standard provides the basis for a firm's competitive advantage. To win a standard war, several steps must be taken: a/ Determine whether the industry is converging towards a single standard and identify the role of positive feedback, b/ Build a "bigger bandwagon", which implies assembling allies around a firm, to preempt the market by an early entry, by early deals with key customers, through the adoption of penetration pricing, and by the achievement of fast product development, c/ Manage expectations and convince the players that you will win, in hope that this statement will become a self-fulfilling prophecy and d/ Achieve compatibility with existing products. Some critical resources to do so consist of: 1/ control over an existing customer base, 2/ ownership of intellectual property rights to the new technology, 3/ ability to innovate further, 4/ first mover advantage, 5/ strengths in complementary products, and 6/ reputation and brand name.
What role do complementary resources play with regard to innovation?
Complementary resources are resources and capabilities which support the design, the development, and the marketing of an innovation. These resources can be extremely diverse and may be provided to the innovator, or to the industry, by different suppliers. Complementary resources' attributes influence innovation through the appropriation of the innovation's created value, by the different suppliers. Their respective bargaining powers will determine the portion of that value that each supplier can appropriate, and also the development to market and the success of the innovation. For example, the shift of the auto industry to the fuel cell technology depends on the strategy of many suppliers of equipment and infrastructure which are indispensable for the new technology. As long as the "tipping point" is not reached, the development of this innovation will not take place. The degree of specialization of the resource also influences the same variables. If a complementary resource is very specialized, it puts the innovator in a more difficult position for capturing value. However, it creates de facto barriers to imitation.
How can a firm create the conditions for innovation?
Innovation is unpredictable and does not follow identified and "rational" processes like classic routines in an organization. The main determinant of invention resides in creativity. Innovation requires an organizational context that facilitates cooperation and interaction. How does the firm create these conditions? 1/ Creativity. Creativity is a function of personality traits, of the ability to play and to interact, of accidental facts, and of the organizational environment. Therefore, organizational context should facilitate these activities and promote, for example, an egalitarian culture, space, and resources for being spontaneous, open, experience-oriented, experienced and trained, etc. 2/ Cooperation and interaction. Creativity must be linked to technological expertise, with capabilities in different fields. Organizational devices such as cross-functional product development teams, product champions, acquired small pioneers of innovation, and incubators, can foster cooperation and interaction, and ultimately, can increase innovation. The example of 3M illustrates how its organizational context and its HR management contribute to creativity and innovation.
How can a firm manage risks in technology-based industries?
Technology-based industries entail risk. Two main sources of uncertainty generate that risk: a/ technological uncertainty that emerges from the unpredictability of technological evolution, and the complex dynamics of choice and development of an industry's standards and b/ market uncertainty related to the size and growth rates of the market for new products. To limit risk, some actions are possible: 1/ Cooperating with lead users, because they can provide an invaluable insight into the evolution of the market trends and customer needs, 2/ Limiting risk exposure through a sound financial strategy, e.g., by concentrating only on R&D, or economizing on fixed costs and 3/ Being flexible, to allow a fast response to the environment, keeping options open as much as possible, and delaying commitment to specific technology until the evolution of an industry becomes clear.
How do technology-based industries reveal a fundamental dilemma that many firms are facing?
The fundamental dilemma clearly apparent in technology-based industries relies on the fact that innovation is unpredictable, and requires a nurturing organizational context to encourage and foster that innovation, whereas strategy is about resource-allocation decisions. Strategy and management, on one hand, and innovation, on the other, necessitate different and generally antithetical attributes: respectively consensus, control, certainty, and status quo, vs. instinct, uncertainty, freedom, and iconoclasm. Some devices and mechanisms exist to bridge these conflicting requirements, or at least, to make them as compatible as possible. Examples include cross-functional team-based approaches, parallel organizational structures, resource-based approaches, and efficiency-oriented managerial roles. In technology-based industries, technology is the main driver of competition, and innovation the principal source of competitive advantage. Therefore, integrating technology is critical in strategic management, since speed of innovation, international competition, and turbulence of environments are on the rise.
Traditional management of firms does not seem to be "innovation-friendly". Is a new form of management required?
There is a natural tendency for human beings to stay within their comfort zone and to try to establish procedures and processes that function properly, to ensure profitability, and provide peace of mind. Managers are no exception to this general statement. Innovation requires creativity, imagination, entrepreneurial spirit, tolerance for ambiguity and error, openness, and thinking out of the box. Classic management emphasizes more control, certainty, repetition, risk-free and error-free contexts, procedures, etc. Most managers recognize the need for creativity and innovation, especially within technology-based industries, which revolve around inventions and innovations. However, it is very likely that they have few clues about the best way to reconcile these contradictory requirements. Innovation involves uncertainty and, often, change, which is perceived as a "necessary evil" that managers try to avoid or accept when they do not have a better solution. Firms need a form of management that fully understands the necessity of innovation, and the organizational practices that facilitate the challenge of managing innovation. Even in industries that are not strongly based on technology, change is at play and is transforming the environmental context. Innovation is not only technical, but can take place in many other fields, such as administrative practices, organizational devices and behaviors, and strategies, etc.
In fast changing industries, firms have to maintain market share, efficiency, and simultaneously commit to new technologies and standards for their future. How can they achieve this?
They have to simultaneously run their operations very efficiently, which can be achieved through repetition, formalization, certainty, stability, and volume and, at the same time, be flexible, prepare for future, and change their activities, operations, and procedures to adapt to a new situation. This fundamental issue is a common problem for organizational change, and a challenge for the organizational structure and HR management fields. Most of the advice and techniques that the literature offers (flexible structure, diverse coordination devices, managerial roles, adapted culture, etc.) are closely related within the field. In fact, all the variables of the organization must be directed towards addressing this critical dilemma; one of the first, and maybe most difficult challenges, is to convince top managers of the need to adapt their own behavior to deal with it. There is definitively no magic recipe but a set of common-sense recommendations and tools whose wise combination leads to a correct and balanced management of the two dimensions of management: exploitation and exploration. If an industry is accustomed to rapid change, it is very likely that managers have already moved towards these types of tools. However, improvement can still increase the "balance optimality".
