Assessing and Managing Capabilities
Disruptive Innovation
SMaL Case Study
Paxil Case Study
Forced Splits (Innovation Workout)
Innovation = Invention + Commercialization
Innovation
ons
Inventi
Commercial Opportunities
Ideas
Core Competences:
Assessment & Investment
Opportunity
Register
Adaptive
Execution
Market Entrance &
Competitive Strategy
From Chapter 5

capabilities (assets + competences) constrain the space in which we can
effectively compete

radical, progressive, creative, and intermediating industry innovation
trajectories

acquiring capabilities can expand your opportunities for innovation, but are
limited by the money and people at your disposal

successful innovation requires the collaboration of Idea generators,
boundary spanners , evangelists, coaches and project managers

two sources of innovation: functional and circumstantial

innovations are often are procured from a combination of competitors’
laboratories, universities, and government laboratories.
Competences: Your Source of Innovations
What
kinds of sources exist?
Where do you find innovations?
What technological and competence
based forces will influence an innovation
Core Competences

These are the things that the firm does



Firms establish their core competences by:




That they do better than other firms
That are the source of their competitive advantage
Investing in people
Investing in assets, plant and land
Identifying and focusing their mission
The Firm’s core competences are often those of its
CEO and management
Competences



You best
(perhaps your only)
opportunities to
compete are


Your
Competences
Where Product Market
Needs
Cross with
Competences
Competitor A's
Competences
Product Market
Opportunities
Competitor B's
Competences
Competitor C's
Competences
We Look for Competences in
Functions and Circumstances

Functional

(functional relationship through which firms
and individuals derive benefits from
innovation)


Internal; Competitors & related industries;
University, government & private labs
Circumstantial

(under what circumstances will they benefit)



Planned firm activities
Serendipity (fortunate accidents)
Change (creative destruction)
Redifferentiating Gives us New Life
from Old Competences

Innovation involves a dialectic:

On the one-side are arguments about what the
customer wants (demand-side)



Remember that the customer doesn’t care about us or
our products
We have to make them care
On the other-side are arguments about what we
can do (supply-side)


These are determined by our core competences
Which are to some extent determined by Mission and
Vision statements, and our Business Models
Resegmenting and Reconfiguring

Resegmenting


Focusing on and better serving existing market
segment
Reconfiguring



Completely changing the existing basis for
segmentations
By reconfiguring existing value maps
Or introducing entirely new kinds of solutions
Reconfiguring your Market

Reconfiguration is about



Breaking down the Barriers (technological,
regulatory or organizational)
 That set limits on the Attributes you can
offer
 Or on the way that Consumption Chains
can be configured
It builds on your insights from the Consumption
Chain Analysis and Attribute Map
Looking to remove the Limitations imposed by
your existing Core Competences
How to Resegment

Resegmentation addresses the Dynamics of
Customer Usage of a Product



It builds on your insights from the Consumption
Chain Analysis and Attribute Map
Looking for new Segments to market to
Observe behavior



To Uncover existing Customer’s Needs
To find new Customer Groups within your existing
customers
Keep them from moving to competitors’ products
Resource-based view (RBV) of firms
Dominant approach to business strategy today
Basis for Core Competences


The resource-based view suggests that a firm's unique
resources and capabilities provide the basis for a
strategy.
The strategy chosen should allow the firm to best exploit
its core competencies relative to opportunities in the
external environment.
Environment's
Resource Supply Curve
& Constraints
Value
Flow
{valuet , volumet}
Owner of
Strategy
(R-P-V Source
of Competitive
Advantage)
Value Added by Strategy
(difference between two value flows)
Value
Flow
{valuet , volumet}
Environment's Demand
Curve & Constraints
Science & Technology
What are they? How are they related?
Influence / feedback
Verbally
Encoded
Information
Verbally
Encoded
Information
Science
Technology
Influence / feedback
Verbally Encoded
Information
*publications
*patents
Physically & Verbally Encoded
Information
*products & services
*documentatiom
*publications
*patents
Case Studies: Competences and
Management Perspectives on Two
Innovations
Electric Lighting
MS-DOS Operating System
For Example:
Consider the Electric Lighting Innovation
“Systems” provide Functional Benefits
The lightbulb “system”

Thomas Edison, Humphrey Davy, and
Joseph Swan all helped invent a practical
and longer-lasting electric lightbulb in the
19th century

This was Science
Edison’s System

“all parts of the system must be constructed with reference to all
other parts,, since in one sense, all the s form one machine part

1878 - Thomas Alva Edison, referring to an electrical grid in his article on the phonograph in the
North American Review

Edison and his team of engineers in Menlo Park, N.J., spent years
building the entire electric system, from light sockets and safety
fuses to generating facilities and the wiring network.

This was Technology

Edison beat all his predecessors at one crucial task: managing the
whole process of innovation, from light-bulb moment to final
product
Systems Warfare

Edison’s Strategy

Develop the working DC system
 Protect it with patents

When George Westinghouse introduced a superior AC system


He attacked with a smear campaign
Westinghouse / Tesla won with superior
technology


133 Hz (Westinghouse) to 60 Hz (Tesla) at 240 VAC
Edison eventually switched to AC at 110VAC / 60Hz
Microsoft’s O/S Innovation
The most profitable innovation in history

Linking & Leveraging
Strategy




Get the business
Create the standard
Leverage the business
Crush the competition

An Early Competitor
Case Study in MS-DOS

MS purchased Seattle Computer Products' QDOS

for Quick and Dirty Operating System (written by Tim Paterson)

Written as a version of CP/M, with 4000 lines of assembler.

IBM tested Gates’ cleaned up MSDOS 1.0, finding well over 300 bugs, and
decided to rewrite the program


This is why PC-DOS is copyrighted by both IBM and Microsoft.
Gates locked up the IBM deal with the help of his father’s law
firm

est. value of services $250,000
Case Study in DOS

You could order one of three operating systems for
your original IBM PC:

Digital Research's CP/M-86 for $495

UCSD p-System for several hundred dollars


this was a souped-up BASIC operating systems like that
used by the Commodore 64

but portable like Java
DOS 1.0 for $39.95
Case Study in DOS

Microsoft’s OEM brochure touted future
enhancements to DOS:

Unix-compatible pipes, process forks, and multitasking, as
well as graphics and cursor positioning, kanji support,
multi-user and hard disk support, and networking

None of these was ever added

This was neither Science nor Technology

(Innovation = Invention + Commercialization)
Capabilities
What to do with your Opportunity
Register

Assuming you’ve been religiously adding to
your Opportunity Register


Then the question becomes:


You should by this time have a lot of different ideas for
new and marketable products
Which projects should you take on; emphasize;
continue?
The answer depends on your competences
Two Realities

Competitors simply cannot allow you to go
unchallenged



and must try to erode your position
Understanding where to create a competitive
position that cannot easily overcome is thus
essential
You are not only competing with other organizations
in customer markets

You are also competing with them in the capital
markets for critical funds that you need to build future
competitive position
Competences



You best
(perhaps your only)
opportunities to
compete are


Your
Competences
Where Product Market
Needs
Cross with
Competences
Competitor A's
Competences
Product Market
Opportunities
Competitor B's
Competences
Competitor C's
Competences
Your Competence
Creative Tension
Your
Competences
Competitor A's
Competences
Product Market
Opportunities

Innovation = Invention +
Commercialization

Can be



Competitor B's
Competences
Technological, or
Market related
Capabilities = assets + competences

What you can do
Competitor C's
Competences
Dell’s
War on Inventory
FedEx’s Inverts the Post Office
Business Model
Dell’s War on Inventory



In less than 20 years, Michael Dell moved
from cluttered dorm-room operations
to a $25 billion a year company,
outperforming giants such as IBM, HewlettPackard and Compaq in the process.
Hyper-efficient supply chain



Dell is relentless in negotiating the best
prices from suppliers, and
driving those savings through the supplychain.
To do that, Dell replaces inventory with
information.
Materials costs account for about
74% of Dell’s revenues

about $21 billion in 2000


Where other competitors carry one to three months
of inventory,


Lowering materials costs by 0.1% can have a
bigger impact than improving manufacturing
productivity by 10%.
Dell carries 5 days.
Since materials costs in the computer industry fall
by around 1% per weeks,

carrying 5 days versus one month of inventory is
around 6% of materials cost.
Safety stocks are very expensive




But they are very difficult to reduce.

Reduction requires complete and accurate information and
forecasts about production and procurement.
Dell has standardized worldwide on i2 Technologies’ software,

with hourly updates of all information from customers to
suppliers.
five hours’ worth of inventory on hand, including work in progress.

This increases cycle time at Dell’s factories and reduces
warehouse space.
The warehouse space is replaced with more manufacturing lines in
a virtuous cycle

Dell has traded inventory for information.
Customers

Dell’s online customer procurement Website puts
Dell in contact with more than 10,000 customers
daily


– giving them more than 10,000 opportunities to forecast
demand and balance supply.
For example, Dell can alter supply constraints through
promotions and substitutions.


If inventory is low on Sony 17-inch monitors, Dell can offer a
19-inch model at the 17-inch price. This moves a lot of
demand in real-time.
Competitors selling through retail channels
cannot do this!
The bottom-line


Dell writes off less than 0.1% of total
material costs in excess and obsolete
inventory
Their competitors write off 2% to 3%.
FedEx

"The concept is interesting and well-formed,
but in order to earn better than a 'C,' the idea
must be feasible."

A Yale University management professor in response to
Fred Smith's paper proposing reliable overnight delivery
service. (before Smith went on to found Federal Express
Corp.)
Fred’s Idea

Compete for customers

Using new technologies


i.e., the increasing size and speed of jets
That restructure the geography of

space

time

money
Overnight Delivery

Smith realized that he could turn Post
Office economics upside-down

Post Office delivery optimized distance traveled

time was not a critical value,

package handling was cheap.

Smith saw that new air technology could
let him ignore distance traveled

… and instead, optimize speed and
handling to create new market value
Lock-in is not forever

In flat letter overnight delivery, Smith used:





first mover advantage
active management of the business ecology
linking and leveraging (network externalities)
“locked-in” customers
But Group III fax quickly substituted for
overnight flat delivery
Tracking the Dynamics of the
Core Competences
consequences of industrial change on
the capabilities demanded of a
competitive firm

‘Coreness’ and imitability of the firm’s
capabilities determine the profitability of
innovations dependent on those capabilities.
Coreness
Noncore
No Profits
Core
Short-term Profits
High
Imitability
No Profits
Long-term Profits
Low
Why Incumbents Perform




An innovation is incremental (regular) if it conserves the
manufacturers/s existing technological and market capabilities;
niche if it conserves technological capabilities but obsoletes market
capabilities;
radical (revolutionary) if it obsoletes technological capabilities, but
enhances market capabilities; and
architectural if both technological and market capabilities become
obsolete. The point to note is that market knowledge is just as
important as technological knowledge.
Technical Capabilities
Preserved
Incremental
Destroyed
Radical
Preserved
Market Capabilities
Niche
Architectural
Destroyed
Difficulties Competing

Innovations are invariably built up of components, and thus building
them requires two kinds of technical knowledge






technology underlying individual components, and
architectural knowledge about how to link components together.
If the innovation enhances both component and architectural
knowledge, it is incremental;
if it destroys both, it is radical;
if only architectural is destroyed, then the innovation is architectural;
where only component knowledge is destroyed (for one or more
components) the innovation is modular.
Architectural Knowledge
Preserved
Incremental
Destroyed
Architectural
Preserved
Component Knowldge
Modular
Radical
Destroyed
Trajectories





Industries evolve along four distinct trajectories
radical, progressive, creative, and intermediating.
Failure results from obsolescence of the firm’s products
or services arising from two directions:
(1) a threat to the industry's core competences; and
(2) a threat to the industry's core assets—the
resources, knowledge, and brand capital that have
historically made differentiated the firm.
Competences
Preserved
Creative
Obsolete
Radical
Obsolete
Assets
Progressive
Intermediating
Preserved
Trajectories in Practice
Creative, 6%
Radical, 19%
Progressive,
43%
Intermediating,
32%
Markets and Competences
Competences are knowledge assets

By its very definition, you are very
likely to know when you stumble
across an innovation – the fact
that what you have found is new
to you, your customer or your
employer makes it an 'innovation.'


But because of its newness, you
are just as unlikely to know its
value.
Innovations, to be successful,
must align with the competences
and assets of the firm
Your Competence
Your
Competences
Competitor A's
Competences
Product Market
Opportunities
Competitor B's
Competences
Competitor C's
Competences
Understanding Innovation
Types of Knowledge

Four kinds of knowledge underpin an innovation; two are





Technological
Market
Component
Architectural
Incumbents Fail when they Fail to “Get” one or the other type
of Knowledge
Science generates commercial
technologies in three phases


The first 'fluid' phase marks
the prototyping of laboratory
technologies
The second 'transitional'
phase begins standardizing
components, and defining
consumer-producer
relationships
Successful innovation demands the firm be
sensitive to ‘Windows of Opportunity’

The early part of the S-curve is a period of
idiosyncratic development, before standards
or deep understanding of the technology
exist


Many competing theories and trajectories
exist, promoted by strong and volatile egos,
making any investments highly risky.
As understanding evolves, standards are
established, and technology advances
incrementally,

generally through sober research,
investment and hard work.
Physical limits of the S-curve

The physical limits of the
S-curve are constrained
by the limits of scientific
knowledge; often
technology alone cannot
push it back.
Understanding Innovation
Life cycle

Fluid phase


Transitional phase


Mainly lab based or custom applications of technology
Standardization of components, and consumer-producer interaction lead to dominant design
Specific phase

Products built around the dominant design proliferate; innovation is incremental
State of Evolution of Tech
Era of Ferment
High Uncertainty
High influence of
nontechnical factors
Era of Incremental Change
Medium Uncertainty
High influence of
nontechnical factors
High
Complexity
Little Uncertainty
Low influence of
nontechnical factors
Near Certainty
Nontechnical factors
may be ignored
Low
What is an Innovation Worth?
Value ‘Happens’ in the Future

Your ‘Vision’ of the Innovation Firm is the best source of information
about this future value






From the ‘Vision’ you derive your ‘Business Plan’
From your ‘Business Plan’ you derive your ‘Strategies’
‘Strategies’ comprise ‘Real Options’ which are conditional particular
‘Events’ occurring in the future
The feasibility of each ‘Event’ is ultimately ‘Discovered’ at some point in
the future
Finance and accounting are geared towards measuring the past
Strategy is designed to plan and control the future



To select the correct innovations from our opportunity register
We need to assess how good our strategy will be
This is why Strategy Drivers


The basis of our key ratios
Are the basis of value as well
Easy and Difficult Industries

Deciding on investments in core competences for
Where to use Financial Dynamics
the(and
future
is ofeasy
asassets
you
move
to value)
the left on the
what kinds
corporate
or services
generate
line below
Mainly Tangible Assets

Mainly Knowledge-Intangible Assets
DCFnearly
&Traditional impossible as you move
Financial
Dynamics
is right
Necessary 
It is
to
the
Valuation Methods are Accurate
for Accurate Valuation
Property,Mortgages,
Mining & Extractive
Industries
Commodity
Manufacturing
(e.g., paper)
Utilities &
Voice Telephony
Branded-Luxury
Merchandise
Local Services
(e.g., Legal,
Government)
Retailing,
Complex
Education &
Manufacturing
Pure R&D
(e.g., cars, chips)
Data Telephony,
Global Network
Services (e.g.,shipping)
Insurance,
Electronic Markets
& Risk Management
Software,
Videogames,
Cinema, Music,
News
Business Models:
Tying Narrative to Numbers

Factory
Work
Production
Labor
R&D
Customers
g
tin
ke
r
a
M
s
ed
Ne

What activities, operations
and products are within
the ‘scope’ of the valuation
analysis? (Bubbles:
depends on audience)
What are the significant
environmental influences?
(Boxes: major competitive
forces outside
management control)
How does value flow
through the relevant scope
of the analysis? (Arrows:
value metric)
De
sig
ns

Customer
Relationship
Management
Market Entry Strategy Model



What are the major
competitive forces
molding managerial
strategy which add to,
or take away from
‘Value’?
What ‘levers’ (strategy
drivers) can
management pull to
influence value
added?
What is the functional
relationship between
value and the strategy
drivers? (Define the
‘Strategy Model’)
Technology Choice

Technology is shared across all competitors. It offers:








Efficiency (improved performance at the same cost)
Quality
Novelty
Substitutes
What are the major technologies relevant to managerial strategy
which add to, or take away from ‘Value’?
What ‘levers’ (strategy drivers) can management pull to
incorporate technology or react to the threat of technology?
What is the functional relationship over time of technological
trends on value? (Define the ‘Technology Choice Model’)
Technology Choice Models will be implemented in the same
manner as strategy models.
Cisco’s Innovation Strategy
Cisco




Cisco Systems has a reputation for expanding its
capabilities through acquisitions.
Shortly after going public in 1990
went on a buying spree, acquiring 73 firms from
1993 to 2000.
By late March 2000, at the height of the dot-com
boom,

Cisco was the most valuable company in the world, with a
market capitalization of more than $US 500 billion.
Early years




This had not always been the case.
During its first decade after it was founded in 1984 the
company acquired no businesses at all,
sticking to selling routers and only routers.
Cisco went public in 1990.


three years later, a faster and cheaper piece of hardware – the
switch – threatened its business.
Cisco engineers scrambled to produce their own switch,
but realized that they could not acquire the capabilities
to produce one anytime soon.
Buying the ‘Switch’

In 1993 of Crescendo Communications for
$95 million which got them into switches –
fast.



Cisco's engineers grumbled that they could have
produced their own switch in time.
Most of Crescendo's executives stayed with
the company, and switches became a core
Cisco business.
The switching unit today generates nearly
$10 billion in annual revenues.
Acquisitions

Since then, using acquisitions



where they are unable to develop internal capabilities
quickly enough to be competitive,
Acquisitions and partnering with other companies
have enabled Cisco to retain its market dominance.
Cisco has made inroads into many network
equipment markets outside of routing, including
Ethernet switching, remote access, branch office
routers, ATM networking, security, IP telephony and
others.
Acquisitions



What began as a one-off response in an emergency soon
evolved into a long-term strategy, an essential part of the
Cisco culture.
While most big tech companies rely heavily on R&D to create
products and business lines,
Cisco, after Crescendo, decided to strategically use
acquisition to expand its capabilities:




In 1995, Cisco acquired its way into firewalls and cache engines.
In 1998, Internet telephony.
In 2003, with the acquisition of Linksys, a home-networking
company,
In 2006 by acquiring Scientific Atlanta, a set-top-box
manufacturer.
People



The vast majority of Cisco’s acquisitions have
been targeted technology buys:
small start-ups with 50 or less engineers whose
products link back to Cisco’s core
competencies, routers and
Cisco has come to realize that the acquisition
of technology really isn't just about technology.
Cisco’s People

"The people are the most strategic asset.“


If, after the acquisition, Cisco loses the technologists and
product managers who created, say, the Linksys router,


Ned Hooper, vice president of business development, whose former
company LightSpeed was acquired by Cisco in 1998.
then it has lost the second and third generations of the product
that existed only in those employees' heads.
That, is where the billion-dollar markets lie. And that is where
Cisco's acquisitions are aimed. "We need the expertise,"
Five sorts of People (Manpower Assets)
Are needed for Innovation

Idea Generators


Gatekeepers & Boundary Spanners


Sell the innovation to the firm
Sponsors (Coach, Mentor)


Conduits for knowledge from other firms and labs
Champions (Entrepreneurs, Evangelists)


Can sift through large quantities of technological and market data
to identify ‘innovations’
Senior level manager who provides behind the scenes support,
access to resources, and protection from political foes
Project Managers

Planners with discipline; one-stop decision making shop
Case Study in Disruptive Innovation:
SMal Camera
SMaL’s Challenge in 2003




SMaL has experienced initial success by targeting a
market where competition was sparse.
But now competitors like Casio are arising. What is
SMaL’s main competitive challenge circa 2003
SMaL is suffering from ‘disruptive innovation’
Sometimes the best strategy can’t save you
from progress and new technology
The Challenge
Innovation on the Demand Side

It is important to get the differentiation large
enough to make the investment in the
technology worthwhile, yet small enough so
it doesn’t take six years to develop a market


Charles Sodini, Chairman of SMaL
Q: How do you develop successful new
technology or innovations?
Forced Market Reconfiguration:
Digital Cameras
Forced Market Reconfiguration: Digital
Cameras
Three potential market segments

Digital Still Cameras

Security-surveillance

Automotive (cruise control, etc.)


Currently 10%-15% of US cars have this technology
How do you “Sell” the product?


Hardware (CCD, CMOS, X3)?
Software (applications)?
Autobrite®
How you manipulate demand with Software


Images on the left, the inability of conventional cameras to adapt to
varying lighting conditions creates a significant safety risk.
Images on the right demonstrate how accurately SMaL's ACM100
with proprietary Autobrite technology capture what the eye sees.
Camera Imaging Technologies



CCD (Sony, Kodak;
industry standard)
CMOS (Kodak, Canon,
SMaL; used in phones,
Canon in some EOS)
X3 (Foveon; used in
Sigma SD10)
Focus
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Having a screen between you and the
consumer at this size company is important
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
(you don’t want a large company at this stage)
Manufacturing is a high fixed cost, low
margin game
Product definition is the key technological
component that allows us to capture value

Sodini
Six Strategies for SMaL






S#1: Move on up
S#2: Focus on Security and Surveillance
S#3: Focus on Automotive
S#4: Focus on Phone Cameras
S#5: Search for new markets that fit SMaL
technology’s strengths (Making a left turn)
S#X: Mix and match any two or three of the
above five
Case Study: Paxil