Innovation Tribune eng

Innovation is first and foremost about reducing costs

It is often assumed that innovation is about bringing new offerings or methods to the market. In business, there would be a noble side, that of innovation, and a less noble one, that of managing operations. Nothing could be further from the truth. One of the most fundamental aspects of the free market system lies in its ability to reduce costs, and therefore prices.

In his monumental piece "Capitalism, Socialism and Democracy", still an essential read sixty years later, Schumpeter explains that innovation is not the capitalist system's distinguishing feature: other civilizations or political systems have been innovative in sime areas as well (think of space technologies in the former USSR or Law in ancient Rome). The real distinguishing feature of the system is its inherent ability to democratize innovation by making available new products to the masses. This is achieved both through its ability to organize efficiently but also and more importantly through the ability to decrease costs. In other words, the symbol of capitalism and innovation is not so much the start-up as Wal-Mart, the low-cost supermarket that saves Americans' mostly low-income customers about $50 billion a year. For these customers who struggle to make ends meet, it's something.

Schumpeter thus summarized the argument:"The capitalist engine is first and last an engine of mass production which unavoidably also means production for the masses... It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort. . . . the capitalist process, not by coincidence but by virtue of its mechanism, progressively raises the standard of life of the masses." (source)

Unlike what The Economist explains in their must-read article "The Silence of the Mammon", I don't think defending this system in the name of this formidable wealth creation and affordability is defensive or smacks appeasement. On the contrary, it's a perfectly valid argument as it does not pretend to bestow other responsibilities to this system than it is supposed to have.

The distinction between Radical and Incremental innovation is not relevant

The opposition between radical and incremental innovation is one of the enduring themes of the innovation literature, both academic and managerial. While incremental innovation consists in improving existing products, radical innovation is about inventing completely new product, or more precisely new product categories. They are new to the market, but also to the firm that creates them.

Clayton Christensen's seminal book, the "Innovator's dilemma" shows how incumbent companies take advantage of incremental innovation, which play on their strengths, but are disrupted by radical innovation. Names such as Kodak, NCR, Digital Equipement, for instance, come to mind when evoking the innovator's dilemma syndrome.

Initially, Christensen framed the discussion in terms of technologies, building on the S-curve framework, (introduced by Foster) which describes the non-linear progression of a technology in terms of performance. In the beginning, the new technology - say the automobile - is less performing than the old one - say the horse - on the key dimensions (reliability, speed, simplicity for instance). But it gradually improves, slowly at first, then more quickly until the time it becomes more performing than the old one. At this stage, the new curve breaks past the old one and the old technology is abandoned. However, several counter examples showed that there were incumbent companies able to withstand a disruption by a radical innovation, and sometimes even thrive on it. IBM is a good example, having gone through at least five major radical changes in its environment (mainframes, minis, PCs, product to service, open source). The distinction between radical and incremental is therefore not a relevant categorization to explain why in some cases, incumbents fail and in others incumbents survive and thrive.

Later on, Christensen refined the theory and defined the issue in terms of sustaining versus disruptive innovation. By that he meant that what matters in a disruption is whether the incumbent's business model can leverage the disruption or not. For instance, mobile telephony is really a radical innovation, a completely new category both to the users and to the operators. However, many competencies required to manage a mobile business are very close to those required to manage a fixed line network. In that sense, mobile telephony is not disruptive to the fixed telcos, but sustaining. This is why in most countries, the incumbent mobile operators are also the incumbent fixed line operators.

If, however, the disruption is incompatible with the business model, then the incumbent is in trouble. This is the case, for instance, with SAP. SAP's is in the business of selling very complex IT systems able to manage the complete business of large, global companies in an integrated way. A typical price tag runs in the millions of US dollars. SAP's business model is a combination of license fee for the software and service fees (development, maintenance, training, etc.) In addition, an army of consulting firms live off this business by selling their own services. A few years ago, a disruption started to develop in the form of Web-based IT solutions, a typical leader being Salesfore. Because it is a pure Web solution, Salesforce is sold as a service (subscription) for a few dollars per month. Salesforce is certainly not as sophisticated as SAP, but for small and medium business it is good enough, especially because you can sign up and start using it in less than five minutes, and one doesn't need any infrastructure or service provider. The real problem for SAP is that its market is saturated and it needs to grow, so the untapped market of small to medium business is appealing. So SAP wants to go downmarket. But Salesforce, being established in the low end of the market, also needs to grow, and by tapping the upper side of its existing market, it can get higher margins. So Salesforce improves its product. Hence the collision course between SAP, going down, and Salesforce, going up.

The real problem, as Christensen remarks, is that it's always easy to go up (same cost base, increased margins therefore very beneficial, and shareholders are happy) but very difficult to go down (same cost base, lower margins, reluctant sales people and partners, unhappy shareholders). SAP's way to address the lower end market is to create a cut-down version of its product, but the motivation to sell it is not there. SAP could also create a clone of Salesforce (they actually have a Web version); the problem is not a lack of competencies. But the result would be the same. Put otherwise, SAP's business model is not compatible with a lower end segment: customers are different, its sales force is not adapted to small sales, the distribution network is different, etc.

As a result, SAP is locked into its existing business model, and cruises in a frenetic inertia mode, while Salesforce grows and grows, moving up in terms of segments. It's unlikely that Salesforce will ever target very large, global companies, but it certainly will be very happy with the rest of the market, which probably represents 90% of the total. SAP will have been reduced to a high-end, highly profitable small niche, just like Apple was in the PC sector. Not a bad place to be, but certainly a missed opportunity to reach mass market.

Framing - an important concept for disruptions

The reaction of an organisation to a major disruption in its environment (technological, regulatory, etc.) has long been studied by scholars and consultants. An important concept has recently emerged, that of Frames. The idea is that, when facing a disruption, the organization needs to rethink the way it sees the world. Old concepts don't apply anymore, new competitors emerge seemingly from nowhere, major uncertainties exist in the marketplace, etc. Consider the case of Kodak, struck by the digital revolution, who had to change from a core competence of chemistry to that of electronics and software. The challeng for the organization is to dump old frames and create a new one, which will guide the strategy.

The concept of frames was introduced in the psychology and cognitive litterature, but it applies well to the field of strategy. Ammong the interesting work in this field, let's mention that of Clarke Gilbert, from Harvard, who wrote his PhD thesis on the reaction of traditional newspapersto the rise of the Internet. Gilbert shows how newspapers had to rethink their environment, which some did while other didn't. Unfortunately, the thesis  is only available in paper form (Clarke, a pdf on your page would be cool). Gilbert is also the author of a working paper titled "Can competing frames coexist" (free download) where he shows that the difficulty for an organization to react to a disruption is not always or not necessarily due to a problem of commitment to its value network that hinders change (unlike Clayton Christensen's explanation). On the contrary, the difficulty seems to reside in the way the disruption is perceived by the organization. If the disruption is seen as a threat, the reaction will be one of rigidity (hence the name threat rigidity). If, on the contrary, the disruption is framed as an opportunity, the organization will react more positively and will more easily embrace change. On this notion of frames, the work of Sarah Kaplan, from Wharton, is also worth noting. Kalpan is the author of "Framing contest: micro-mechanism of firm response to technical change". The idea is that when facing a new world, or rather an emergent world where everything is so uncertain, the strategy making process consists in a framing contest within the organization between individuals, departments, groups, etc. If everything goes well, at the end of the process, a common frame emerges that forms the basis of the new strategy. Sarah Kaplan also wrote an interesting article on the cognitive factors influencing an organization's response to a disruption, in the particular case of the pharmaceutical industry: "Discontinuities and senior management - assessing the role of recognition in pharmaceutical firm response to biotech". It can be downloaded for free and is worth reading.