Managing Innovation

As a consequence, internal corporate powers and weaknesses are often difficult to recognize before the benefit of practical experience, especially in new and fast-changing technological fields. For instance:

• In the 1960s, the oil company Gulf established its distinctive competencies as providing energy, and so decided to purchase a nuclear energy firm. The venture was failing, in part because the strengths of an oil company in decision, extracting, refining and distributing oil-based products, that is, geology and chemical-processing technologies, logistics, and consumer marketing, were mostly irrelevant to the design, construction, and sale of nuclear reactors, where the critical works are in electromechanical technologies and in failing to relatively few, but often politicized, electrical utilities.6

• In the 1960s and 1970s, many firms in the electrical industry bet heavily on the future of nuclear technology as an innovative breakthrough that would provide virtually cost lessened Atomic clear energy failed to fulfill its promise, and firms only recognized later that principal novel nary opportunities and threats for them came from the virtually costless storage and manipulation of knowledge provided by improvements in semiconductor and related technologies.7

• In the 1980s, analysts and practitioners predicted that the ‘convergence’ of computer and information technologies through digitalization would lower the barriers to entry of mainframe computer firms into telecommunications equipment, and vice versa. Many firms tried to diversify into the other market, often through donations or alliances, for example, IBM bought Rohm, AT&T bought NCR. Most proved unsuccessful, in part because the software requirements in the telecommunications and office markets were so different.8

• The 1990s similarly saw commitments in the fast-moving fields of ICT (information and communication technology) where original expectations about opportunities and complementary have been disappointed. For example, the investments of major media companies on the Internet in the late 1990s took more than a decade to establish profitably: problems persist in delivering products to customers and in getting paid for them, and advertising remains ineffective.9 There have been similar disappointments so far in the development of ‘e-entertainment’.10

The Internet bubble, which started in the late 1990s but had burst by 2000, placed wildly optimistic and unrealistic valuations on new experiments using e-commerce. In special, most of the new e-commerce businesses selling to customers which hovered on the US and UK stock exchanges between 1998 and 2000 consequently lost around 90% of their value or were made bankrupt. Notorious failures of that period include Boo.com in the UK, which endeavored to sell sports clothing via the Internet, and Pets.com in the USA, which tried to sell pet food and accessories

1   Implications for management

This debate has two sets of implications for managers. The first concerns the practice of the corporate state, which should be seen as a form of organizational learning, from analysis and experience, how to cope more efficiently with complexity and change. The implications for the processes of strategy formation are the following:

·         Given the uncertainty, explore the consequences of a range of possible future courses.

·         Ensure broad participation and natural channels of communication.

·         Encourage the use of multiple reservoirs of information, debate, and skepticism.

·         Expect to change strategies in the light of new (and often unexpected) evidence.

The second implication is that successful management practice is never fully reproducible. In a complex world, neither the most scrupulous practicing manager nor the most rigorous management scholar can be sure of identifying – let alone evaluating – all the necessary ingredients in real examples of successful management practice. Also, the conditions of any (inevitably imperfect) reproduction of successful management practice will differ from the original, whether regarding firm, country, sector, physical conditions, state of technical knowledge, or organizational skills and cultural norms.

Thus, in conditions of complexity and change – in other words, the requirements for managing innovation – there are no readily applicable recipes for successful management practice. This is one of the reasons why there are continuous swings in management fashion (see Box 4.2). Useful learning from the experience and analysis of others necessarily requires the following:

A critical reading of the evidence underlying any claims to have identified the factors associated with management success. Compare, for example, the explanations for the success of Honda in penetrating the US motorcycle market in the 1960s, given (i) by the Boston Consulting Group: exploitation of cost reductions through manufacturing investment and production learning in deliberately targeted and specific market segments;13 and (ii) by Richard Pascale: flexibility in product–market strategy in response to unplanned market signals, high-quality product design, manufacturing investment in response to market success.14 The debate has recently been revived, although not resolved, in the California Management Review.15

A careful comparison of the context of successful management practice, with the context of the firm, industry, technology, and country in which the method might be reused. For example, one robust conclusion from management research and experience is that major ingredients in the successful implementation of innovation are effective linkages amongst functions within the firm and with outside sources of relevant scientific and marketing knowledge. Although very useful to management, this knowledge has its limits. Conclusions from a drug firm that the key linkages are between university research and product development are profoundly misleading for an automobile firm, where the critical linkages are amongst product development, manufacturing, and the supply chain. And even within each of these industries, essential ties may change over time. In the drug industry, the critical academic disciplines are shifting from chemistry to include more biology. And in automobiles, computing and associated skills have become essential for the development of ‘virtual prototypes,’ and for linkages between product development, manufacturing, and the supply chain.16

2  Innovation leadership versus Follower Ship

Finally, according to Porter, firms must also decide between two market strategies:17

1.      Innovation ‘leadership’ – where firms aim at being first to market, based on technological leadership. This requires a strong corporate commitment to creativity and risk taking, with close linkages both to significant sources of relevant new knowledge and to the needs and responses of customers.

2.      Innovation ‘followership’ – where firms aim at being late to market, based on imitating (learning) from the experience of technological leaders. This requires a strong commitment to competitor analysis and intelligence, to reverse engineering (i.e., testing, evaluating and taking to pieces competitors’ products, to understand how they work, how they are made and why they appeal to customers), and to cost-cutting and learning in manufacturing.

However, in practice, the distinction between ‘innovator’ and ‘follower’ is much less clear. For example, a study of the product strategies of 2273 firms found that market pioneers continue to have high expenditures on R&D, but that this subsequent R&D is most likely to be aimed at minor, incremental innovations. A pattern emerges where pioneer firms do not maintain their traditional strategy of innovation leadership, but instead focus on leveraging their competencies in minor incremental changes. Conversely, late entrant firms appear to pursue one of two very different strategies. The first is based on skills other than R&D and new product development – for example, superior distribution or greater promotion or support. The second, more exciting strategy, is to focus on significant new product development projects to compete with the pioneer firm.18

However, this example also reveals the essential weaknesses of Porter's framework for analysis and action. As Martin Fransman has pointed out, technical personnel in firms like IBM in the 1970s were well aware of trends in semiconductor technology, and their possible effects on the competitive position of mainframe producers.19 IBM in fact made at least one major contribution to developments in the revolutionary new technology: RISC microprocessors. In spite of this knowledge, none of the established firms proved capable over the next 20 years of achieving the primary objective of strategy, as defined by Porter: ‘… to find a position … where a company can best defend itself against these competitive forces or can influence them in its favor’.

Like much mainstream industrial economics, Porter's framework underestimates the power of technological change to transform industrial structures and overestimates the ability of managers to decide and implement innovation strategies. Or, to put it another way, it underestimates the importance of technological trajectories, and of the firm-specific technological and organizational competencies to exploit them. Large firms in mainframe computers could not control the semiconductor trajectory. Although they had the necessary technical competencies, their organizational skills were geared to selling expensive products in a focused market, rather than a proliferating range of cheap products in an increasing range of (as yet) unfocused markets.

These shortcomings of Porter's framework in its treatment of corporate technology and organization led it to underestimate the constraints on individual firms in choosing their innovation strategies. In particular, a firm's established product base and related technological competencies will influence the range of technical fields and industrial sectors in which it can hope to compete in future. Chemical-based firms do not diversify into making electronic products, and vice versa. It is challenging (but not impossible, see, for example, the case of Nokia in Case Study 9.2) for a firm manufacturing traditional textiles to have an innovation strategy to develop and make computers.20

Also, opportunities are always emerging from advances in knowledge, so that:

Firms and technologies do not fit tidily into preordained and static industrial structures. In particular, firms in the chemical and electrical-electronic industries are typically active in some product markets, and also create new ones, like personal computers. Indeed innovations (as distinct from radical or incremental), which involve some discontinuity in the technological or marketing base of a firm are very common.21

Technological advances can increase opportunities for profitable innovation in so-called mature sectors. See, for example, the chances generated over the past 15 years by applications of IT in marketing, distribution, and coordination in such firms as Benetton.22 See also the increasing opportunities for technology-based innovation in traditional service activities like banking, following massive investments in IT equipment and related software competencies.23

Firms do not become stuck in the middle as Porter predicted. John Kay has shown that firms with average costs and medium quality compared to the competition achieve higher returns on investment than those with either low–low or high–high strategies.24 Furthermore, some firms accomplish a combination of high quality and low cost compared to competitors, and this reaps high financial returns. These and related issues of product strategy will be discussed in Chapter 9.

There is also the little place in Porter's framework for the problems of implementing a strategy:

Organizations which are extensive and specialized must be capable of learning and changing in response to new and often unforeseen opportunities and threats. This does not appear automatically, but must be consciously managed. In particular, the continuous transfer of knowledge and information across functional and divisional boundaries is essential for successful innovation. Studies confirm that the explicit management of competencies across different business divisions can help to create radical changes, but that such interactions demand attention to leadership roles, team composition and informal networks.25

Elements of Porter's framework have been contradicted as a result of organizational and related technological changes. The benefits of non-adversarial relations with both suppliers and customers have become apparent. Instead of bargaining in what appears to be a zero-sum game, cooperative links with customers and suppliers can increase competitiveness, by improving both the value of innovations to customers and the efficiency with which they are supplied.26

According to a survey of innovation strategies in Europe's largest firms, just over 35% replied that the technical knowledge they obtain from their suppliers and customers is essential for their own innovative activities.27

Christensen and Raynor provide a recent and balanced summary of the relative merits of the rational versus incremental approaches to strategy:

… core competence, as used by many managers, is a dangerously inward-looking notion. Competitiveness is far more about doing what customers value than doing what you think you're good at … the difficulty with the core competence/not your core competence categorization is that what might appear to be a non-core activity today might become an absolutely crucial skill to have mastered in a proprietary way in the future and vice versa … emergent methods should dominate in circumstances in which the future is difficult to read, and it is not very clear what the right strategy should be…the deliberate strategy process should dominate once a winning strategy has become clear because in those conditions effective execution often spells the difference between success and failure.28

3  4.2 The dynamic capabilities of firms

Teece and Pisano29 integrate the various dimensions of innovation strategy identified previously into what they call the ‘dynamic capabilities’ approach to corporate strategy, which underlines the importance of dynamic change and organizational learning:

This source of competitive advantage, dynamic capabilities, emphasizes two aspects. First, it refers to the shifting character of the environment; second, it highlights the critical role of strategic management in appropriately adapting, integrating and re-configuring internal and external organizational skills, resources and functional competencies towards a changing environment (p. 537).

To be strategic, a capability must be honed to a user need (so that there are customers), unique (so that the products/services can be priced without too much regard for the competition), and difficult to replicate (so that profits will not compete away) (p. 539).

We advance the argument that the strategic dimensions of the firm are its managerial and organizational methods, its present position, and the paths available to it. By administrative procedures, we refer to the way things are done in the firm, or what might be referred to as its ‘routines,’ or patterns of current practice and learning. By position, we refer to its current endowment of technology and intellectual property, as well as its customer base and upstream relations with suppliers. Bypaths, we see to the strategic alternatives available to the firm, and the attractiveness of the opportunities which lie ahead (pp. 537–541, our italics).

4  Institutions: finance, management and corporate governance

Ways in which their performance is judged and rewarded (and punished). Methods of judgment and reward vary considerably amongst countries, according to their national systems of corporate governance: in other words, the operations for exercising and changing corporate ownership and control. In broad terms, we can distinguish two methods: one practiced in the USA and UK; and the other in Japan, Germany and its neighbors, such as Sweden and Switzerland. In his book Capitalism against Capitalism, Michel Albert calls the first the ‘Anglo-Saxon ‘and the second the ‘Nippon-Rhineland ‘Varity. A lively debate continues about the essential characteristics and performance of the two systems, regarding innovation and other show variables. Table 4.1 is based on a type of sources and tries to identify the main differences that affect innovative performance.

In the UK and the USA, corporate ownership (shareholders) is separated from corporate control (managers), and the two are reconciled through an actual stock market. Investors can be persuaded to hold shares only if there is an expectation of increasing profits and share values. They can shift their investments relatively easily. On the other hand, in countries with governance structures like those of Germany or Japan, banks, suppliers, and customers are more heavily locked into the firms in which they invest. Until the 1990s countries strongly influenced by German and Japanese traditions persisted in investing heavily in R&D in established firms and technologies, while the US system has since been more effective in generating resources to exploit radically new opportunities in IT and biotechnology.

During the 1980s, the Nippon-Rhineland model seemed to be performing better. Aggregate R&D expenditures were on a healthy upward trend, and so were indicators of total economic performance. Since then, there have been growing doubts. The aggregate technological and economic indicators have been performing less well. Japanese firms have proved unable to repeat in telecommunications, software, microprocessors and computing their technological and competitive successes in consumer electronics German firms have been slow to exploit radically new possibilities in IT and biotechnology and there have been criticisms of expensive and unrewarding choices in corporate strategy like the entry of Daimler Benz into aerospace At the same time, US firms appear to have learned valuable lessons, mainly from the Japanese in manufacturing technology, and to have reasserted their eminence in IT and biotechnology.

The 1990s also saw sustained increases in productivity in US industry. According to The Economist in 1995, in a report entitled ‘Back on top?’, one professor at the Harvard Business School believed that people would look back at this period as ‘a golden age of entrepreneurial management in the USA

5 Table 4.1 the effects of corporate governance on innovation

However, some observers have concluded that the strong US performance in innovation cannot be satisfactorily explained simply by the combination of entrepreneurial management, a flexible labor force, and a well-developed stock exchange. The US experience has not been repeated in the other Anglo-Saxon country with apparently similar characteristics -the UK. They argue that the groundwork for US corporate success in exploiting IT and biotechnology was laid initially by the US Federal.

A government, with the large-scale investments by the Defense Department in California in electronics, and by the National Institutes of Health in the scientific fields underlying biotechnology. Also, we should not write off Germany and Japan too soon. The former is now dealing with the dirt and inefficiency of former East Germany (the inclusion of which in official statistics is one reason for the German decline in the 1990s in industry R&D as a share of GDP). Japanese firms like Sony are world leaders in exploiting in home electronics the opportunities opened up by advances in digital technology, And Scandinavian countries are now well ahead of the rest of the world (including the USA) in mobile telephony as well as in more general indicators of skills and knowledge. The jury is still out.

6  Learning from foreign systems of innovation

National systems of innovation influence the rate and direction of innovation of domestic firms, and vice versa, but more important firms also learn and exploit change from other countries (Table 4.2).

Firms have at least three reasons for monitoring and learning from the development of technological, production and organizational competencies of national systems of change, and especially from those that are growing and healthy: 

They will be the references of firms with substantial capacity to compete through innovation. For example, beyond Japan, other East Asian countries are developing robust innovation systems. In particular, business firms in South Korea and Taiwan. Following the destruction of the Russian Empire, we can also expect the re-emergence of robust systems of innovation in the Czech Republic and Hungary

2   They are also potential sources of improvement in the corporate management of innovation, and in national systems of innovation. However, as we shall see below, understanding, interpreting and learning general lessons from foreign operations of innovation is a difficult task. Effectiveness in change has become bound up with broader national and ideological interests, which makes it more difficult to separate fact from belief. Both the business press and business education are dominated by the English language and Anglo-Saxon examples.

Finally, firms can benefit more specifically from the technology generated in foreign systems of innovation. A high proportion of large European firms attach great importance to foreign sources of technical knowledge, whether obtained through affiliated firms (i.e., direct foreign investment) and joint ventures, links with suppliers and customers, or reverse engineering. In general, they find it is more difficult to learn from Japan than from North America and elsewhere in Europe, probably because of greater distances – physical, linguistic and cultural. Conversely, East Asian firms have been very effective over the past 25 years in making these channels an essential feature of their rapid technological learning (see Case Study 4.2).

The slow but significant internationalization of R&D is also a means by which firms can learn from foreign systems of innovation. There are many reasons why multinational companies choose to locate R&D outside their home country, including regulatory regime and incentives, lower cost or more specialist human resources, proximity to leading suppliers or customers, but in many cases, a significant motive is to gain access to national or regional innovation networks. Overall, the proportion of R&D expense made outside the home nation has grown from less than 15% in 1995, to more than 25% by 2009. However, some countries are more advanced in internationalizing their R&D than others (Figure 4.1). In this respect, European firms are the most increased, and the Japanese the least

7  Learning and imitating

While information on competitors' innovations is relatively cheap and easy to obtain, corporate experience shows that knowledge of how to replicate competitors' product and process innovations is much more costly and time-consuming to acquire. Such imitation typically costs between 60 and 70% of the original and usually takes three years to achieve.34

These conclusions are illustrated by the examples of Japanese and Korean firms, where very effective imitation has been sustained by heavy and firm-specific investments in education, training and R&D.35As Table 4.3 shows, R&D managers' report that the most important methods of learning about competitors' innovations were independent R&D, reverse engineering and licensing, all of which are expensive compared to reading publications and the patent literature. Useful and usable knowledge does not come cheap. A similar and more recent survey of innovation strategy in more than 500 large European firms also found that nearly half reported the great importance of the technical knowledge they accumulated through the reverse engineering of competitors' products.36 For example, Book pages, a UK Internet business, was developed in response to the success of Amazon in the USA, and based upon the founder's previous experience of the book trade in the UK and deep knowledge of IT systems. However, to raise sufficient resources to continue to grow, the business was later sold to Amazon

More formal approaches to technology intelligence gathering are less widespread, and the use of different approaches varies by company and sector (Figure 4.2). For example, in the pharmaceutical sector, where much of the knowledge is highly codified in publications and patents, these sources of information are scanned routinely, and the proximity to the science base is reflected in the widespread use of expert panels. In electronics, product technology roadmaps are commonly used, along with the lead users. Surprisingly (according to this study of 26 large firms), long-established and proven methods such as Delphi studies, S-curve analysis, and patent citations are not in widespread use