Innovation Management
(ISMT 302)
Week # 2








Instructor:
J. Christopher Westland, Professor, ISMT
Time:
Tue & Thu 1:30pm-2:50pmVenue: Rm. 4333Duration: 5 Sep – 7 Dec
Text.
McGrath & MacMillan, The Entrepreneurial Mindset, HBS Press 2000
Contact:
Office: 852 2358 7643
Email: westland@ust.hk
Fax: 852 2358 2421
URL: http://teaching.ust.hk/~ismt302/
The Innovator’s Challenge

A firm makes profits



by offering products or services
at a lower cost than is competitors
Or



by offering differentiated products
at premium prices
that more than compensate for the extra cost of
differentiation
Who?
Ho
w?
Two Questions
?
What
Why?
n?
he
W
W
he
re
?

How do low-cost and differentiated
products come about?

Why is it that some firms can offer
them better than others?
The Innovator’s Value Map
Nature of innovation:
Incremental, radical
architectural
Complexity, tacitness
Life cycle phase
Competences:
Ability to design
engines, integrate
different functions, build
logistics, market new
ideas, manufacture
Environment:
Competitive
Macro
Value:
Internals:
Strategy
from low-cost,
differentiated products
Knowledge
Structure
Systems
People
Nature of innovation:
Incremental, radical
architectural
Complexity, tacitness
Life cycle phase
Assets:
Size, patents,
copyrights, location,
skilled scientists,
reputation, sponsor,
licenses
Elements of Product Innovation
Innovation
New Product:
Core Competences:
Assessment & Investment
Ideas
ons
Inventi
Competences
and
Assets
Commercial Opportunities
Low cost
Improved qualities
New qualities
Opportunity
Register
Adaptive
Execution
Market Entrance &
Competitive Strategy
New
Technological
knowledge
New Market
Knowledge
Sources of Innovation

How innovation arises

Functional:

Innovations arise from thinking about the functional relationships between
groups and individuals



Attribute Maps and Quizzing help identify Innovations arising functional
relationships
Circumstantial:

Innovations arise from thinking about the circumstances in which a product
(innovation) will be encountered



e.g., customer or manufacturer
e.g., a cooking innovation when it is consumed in a restaurant
Consumption Chain Analysis helps identify circumstantial Innovations
Where innovations arise





Internal R&D
External Markets (Customers)
Competitors & related industries
University, government & private labs
Other nations / regions
The last two sources are strongly influenced by society and governments
What sort of people are Innovators?

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
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
An Example of a Successful Business Model
Mad Catz, Inc.
From Global Electronic Commerce
(Westland & Clark)
Mad Catz’s Products

Controllers, Joysticks, memory chips, cables,
power supplies, etc.


Anything you could add onto a game console
Question: How do you make money on this
market?
cycle: 2 weeks
Mad Catz’ Value
Map
Packaging Mtl
Package
Design,
Graphics
10% of Costs, in house
50% of Demand Value
60% of Cost, outsourced
HW Vendors Specs
Electronics
Design
0%
co
st
(cycle:
Retailers
(Toys 'R Us;
Wal-Mart)
Electronics
Build
10
Electronic Parts
25% of Demand
Value
cycle: 4-6 months
Plastic Parts
%
25
10% of Costs
Plastic Design:
Main
component of
human interface
cycle: 3:months
e
alu
V
d
an
m
e
D
of
Plastics
Molding
20% of Costs, outsourced
Assembly,
Packaging and
Shipping
10% of costs, in
house for quality
control
cycle: 1 week
Points to Note
about Mad Catz’s Business Model



Sources of costs and revenues are different
Cycle time influences revenue
The product is 100% ‘human interface’





Visual
Mental
Tactile
Their market is driven by other vendors
 What does this imply about market and growth strategies
Many components of this case are typical of Pearl River Delta
companies
Worldwide video game
industry
Mad Catz’s Future Market Potential



Revenues of $25 billion last year
 overtook movie box-office receipts
Sales are expected to climb to $55 billion by 2008
While broadcast TV audiences dwindle and moviegoing
stagnates,
 gaming is emerging as the newest and perhaps strongest
pillar of the media world.
Videogame Economics

Costs for developing games are going sky-high.
 Five years ago, it cost about $3 million to develop a high-end game;
 now it's $20 million as games become more complex and require more
artists and programmers.

Microsoft spent $40 million to create and market Halo 2;
 around $160 million for Halo 3
 Vs. $80 million average cost of a Hollywood movie,


but it prices most small and midsize game makers out of the top of the
market.
The top five game developers last year accounted for 56% of the industry's
more than $10.5 billion in U.S. sales (around $40 billion worldwide)
Economics;



Only 5% of all games reaching the 1 million "hit" mark,
It's vital for game makers to build up a portfolio of winning
franchises
EA has Madden and Sims, NASCAR, James Bond, and the
Medal of Honor shooter series

totaling 27 game titles last year that sold more than 1 million
copies.

It found out early on that sports fans are willing to plunk down
$50 every year for essentially the same game but with updated
team rosters.
Deals

EA on Jan. 18 spent $800 million



Microsoft is producing the movie version of its Halo
video games,



to lock up ESPN content such as X-Game sports
competition
for use in games for the next 15 years
which have raked in $1 billion since 2001,
rather than handing the job to a studio
Sony and Nintendo are racing to be out with new
consoles by Christmas 2006

Microsoft beat them by one year
Market Trends

These days
 more adults play games than kids
 and 39% of gamers are women

On Web sites such as Microsoft's Xbox Live
 2.4 million hard-core gamers match up their reflexes in multiplayer
shoot-'em-up games

China and South Korea are packing Internet cafés to play online
games for as little as pennies per minute

The tiny screen is grabbing attention,
 as cell-phone titles take gaming anytime, anywhere.
 By 2008, the markets for online and mobile-phone gaming are
expected to top $15 billion and $13 billion, respectively
Market Trends
There's money to be made in new ways

eBay runs multi million dollar markets in games weapons and characters

Sony and Shanda (China) are introducing their own eBay style markets for
game weapons, characters, and services


Especially big in China are the rental of services for professional game players
With game demographics trending older

advertisers are getting their messages across through




product placements,
billboards within games, and
sponsorships
The ad angle is so promising that Nielsen Entertainment is setting up a new
service for tracking gamers' likes and dislikes.
Games and the 18-34 Male

Games are siphoning off TV and Hollywood’s best customers:
18- to 34-year-old males.

Madden is a game, not a football coach.

Payoff goes straight to the game makers:



These days, the studios' operating profit margins average just
10%,
while game makers average 15% and the best reap as much as
25%.
When studios license a movie to a game maker, they typically get
$3 million to $5 million up front against about 9% of the take.
Payoffs and Threats

The real payoff for Sony comes in game software sales.

Microsoft, Nintendo and Sony sell their hardware for a loss
 they typically make $5 to $10 in royalties for every game
sold on their platform.
 PS2 has had more than 2,000 software titles, with more
than 775 million total game copies sold.

Sony's game business has for years propped up its consumerelectronics division, which accounts for two-thirds of the company's
profits.

Market shares (subject to change):



Sony ~50%
Microsoft ~30%
Nintendo ~20%
Back to Mad Catz

By outsourcing much of its production, and coordinating the
entire production process
 Mad Catz Controlled its profitability by being a Value Chain
Integrator

It was looking for new opportunities to
 Control costs



Speed up time to market
Improve quality
By innovations in both logistics and information networks
Mad Catz: Take Aways
Look for cost – revenue spreads in the Business
Model



Cut costs where revenues are small
Spend more if you can influence revenues with small
additional cost
Cycle time influences revenue



Look for possibilities for ‘Geographical Scaling’
Through improvements in Information and Logistics
networks
Mad Catz:
Take Aways

Market is driven by other vendors (not by your
decisions)


Bet that Sony and Microsoft will be leaders, and
pander to them
Consider game specific software for powerful
software companies like EA
 E.g., branded controllers
Mad Catz: Take Aways

Because the product is 100% ‘human
interface’


Consider the costs and benefits of professional
industrial design
What is Industrial Design?
Why Business
Models Matter
“During the dot-com boom, ‘Business
Model’ was a buzzword routinely
invoked to glorify all manner of halfbaked plans”
-- Michael Lewis
Why Business Models Matter

Telling a good story


Tying Narrative to Numbers




Part of selling your strategy / investment
Strategy becomes less philosophy
More performance and outcome
When business models don’t work
It’s because the fail either


The ‘Narrative’ test
Or the ‘Story’ test
A business model is not
strategy
It doesn’t describe external forces:
 Competition
Labor
Work
R&D
 Environment
 Scaling
It only depicts the systems that will be put into place
to achieve a strategic objective
Des
igns

Factory
Production
ng
keti
r
a
M
eds
Ne


A good model is not enough
 The boxes on the value map need to be
understood in depth
 In order to develop a good strategy
Customers
Customer
Relationship
Management
Graphing the Value Map

External competitive environment
(supply & demand curves)

Internal strategies, competencies,
knowledge, assets ‘owned’

Value flows between owners and/or
the external environment
E n v ir o n m e n t
S tr a te g y - O w n e r
V
al
ue
Fl
ow
(c
o
t
,e
e
u
en
v
e
,r
st
c.
)
Mad Catz is an example of
A Network Business Models

SelfOrganizing
Alliance
Agora
Distributive
Network
Control
Aggregation
Value Chain
Hierarchical
Low
value integration
High
Taxonomy of
Network Business
Models
Business Models
Value Chain Integrator
Uses both Electronic and Logistic Networks
SelfOrganizing
Alliance
Agora
Distributive
Network
Control
Aggregation
Value Chain
Hierarchical
Low
value integration
High
Integrator
Producers
Customers
Business Models
Aggregator (e-Tailor)
SelfOrganizing
Alliance
Agora
Producer
Distributive
Network
Control
Aggregation
Cust
omer
Value Chain
Hierarchical
Low
value integration
High
Aggregator
Cust
omer
Producer
Producer
Cust
omer
Business Models
SelfOrganizing
Alliance
Agora
Distributive Net, Agora &
Alliance
Distributive
Network
Control
Aggregation
Value Chain
Hierarchical
Low
value integration
Seller
Buyer
Buyer
Price Discovery
Mechanism
Seller
Buyer
Prosu
mer
Buyer
Prosu
mer
Seller
Seller
Prosu
mer
Customers
Producers
Value Space
Distributive Network
Producers
Customers
Prosu
mer
High
What is the “Strategy” in
Innovation Strategy?
Business Model vs. Strategies
Business Models

Telling a good story


Tying Narrative to Numbers




Part of selling your strategy / investment
Strategy becomes less philosophy
More performance and outcome
When business models don’t work
It’s because the fail either


The ‘Narrative’ test
Or the ‘Story’ test
Evolution
of ‘Strategy’
Outcomes
y
g
e
t
a
r
t
S
y
r
a
ilit
Classical M
Profit-maximizing
Evolutionary
Classical
rocesses
eliberate
19
70
Systemic
1980 s
19
s
0
9
s
Processual
Plural
Emergent
Outcomes and Processes
Differing perspectives on Strategy
Profit-maximizing
Outcomes
CLASSICAL
SYSTEMIC
EVOLUTIONARY
PROCESSUAL
Pluralistic
Deliberate
Emergent
Processes
Classical Perspective on Strategy
Inside the Firm (Operations)
Information
Manager
Environmental
Competitive
Internal Financial
Internal
Non-financial
Action
Inputs
Plan
Organize
Actuate
Control
Manpow er
Money
Machines
Methods
Materials
Information System
Information Systems
Information System
Information System
Outputs
Objectives
Quantity
Quality
Cost
Time
Profitability
Efficiency
Grow th
Survival
Porter Perspective on Strategy
Outside the Firm (Markets)
Who?
Ho
w?
Two Questions
?
What
Why?
n?
he
W
W
he
re
?

How do low-cost and differentiated
products come about?

Why is it that some firms can offer
them better than others?
Capabilities

A firm’s assets and competences together


Make up its capabilities
For example,

Intel



Capabilities = integrated circuit design & semiconductor
manufacturing
Assets = patents, copyrights, installed base of PC’s (Intel
inside), reputation, scientific expertise
Competences = protection of intellectual property, fast
product time to market, compatibility of new products with
prior genrations
The Value Map

Firms create that deliver low-cost or differentiated
products


By performing the activities
Of their value configuration


(i.e., value chain, value network, value shop, profit chain)
To perform these activities

A firm needs resources (assets):

Manpower, money, machines, methods, materials

Plants, equipment, patents, scientists, brand name
recognition, geographic location, client relations, distribution
channels, trade secrets
Value Map = The Resource Based View of Strategy
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
Definition: ‘Innovation’

An ‘Innovation’ is:

Invention + Commercialization


A new way of doing things that is commecialized


Freeman, The Economics of Industrial Innovation
Porter
The new knowledge in an innovation can be
either


Technological, or
Market related
Elements
of Product
Innovation
New Product:
Low cost
Improved qualities
New qualities
Competences
and
Assets
New
Technological
knowledge
New Market
Knowledge
Markets:
“The Purpose of a Business is to Create a Customer”
(Peter Drucker)

Even if you create marvelous inventions



Business customers are especially impatient


Your customers won’t care
Unless that is exactly what they need
With any product that doesn’t help them gain competitive
advantage
Yet your firm wants to build products that take
advantage

Of their Core Competences
Framing the Challenge

Task #1: Establish what your business needs
to do to make innovation worthwhile


What do we mean by ‘needs to do’?
What do we mean by ‘worthwhile’?

This is what will drive the Business Model
Facts of Life

There is no checklist!

Incremental improvement of existing products or
business models is insufficient!


You must really make a difference
Will your efforts yield a good return for your
shareholders?

Exactly how?
Targets and Goals

If I were to do something in the next 3-5 years



That I, my boss and my company’s investors would regard as a major win
What would this performance record have to look like?
If I were to do something in the next 3-5 years


That my customers would regard as a major (disruptive) innovation
How would I change their lives?

How would my relation with customers affect my performance?

Are the motivations in Hong Kong different than elsewhere?
What Drives your Strategy?



What’s your Strategy Driver?
What makes your proposed business perform?
What makes your proposed innovation a commercial
success?
E
n
tre
p
re
n
e
u
ria
l
A
ctiv
ity
D
riv
e
s
P
e
rfo
rm
a
n
ce
(cu
sto
m
e
rs, in
v
e
sto
rs,
e
tc.)
Reality Check

Your text suggests a simplistic (but revealing) reality check

For any new business idea

(click for the spreadsheet)
Projections
Goals
Innovation Year +1
+2
+3
+4
+5
+6
Profits
200 220.00 242.00 266.20 292.82 322.10 354.31 10% annual increase
Return on Sales
10%
10%
10%
10%
10%
10%
10%
Return on Assets
15%
15%
15%
15%
15%
15%
15%
Assets
1333 1466.667 1613.333 1774.667 1952.133 2147.347 2362.081
New asset investment at current utilization
133.67 280.33 441.67 619.13 814.35 1029.08
Sales
2000 2200 2420 2662 2928.2 3221.02 3543.122
New Sales
200.00 420.00 662.00 928.20 1221.02 1543.12
Lucent’s Performance Targets

Carly Fiorina set the following targets prior to
Lucent’s IPO:







Sales from 1% growth to the high teens
R&D from 8% to 11% if Sales
Reduce SGA from 27% to 19%
Reduce tax rate 4% points
Lift
ROA from 0% to 1%
What are the Strategy Drivers?
Business
Models
Each of these
companies
looks at their
problems in a
new way
The Opportunity ‘Register’

Concept: Always keep an inventory of possible
opportunities so that you are unlikely to run out of
ideas for making the next competitive move or
capturing the next prospect for growth

Fields:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Business concept
Relevant trends
Key industry data
Obstacles and barriers
Company position
Competition and Substitutes
Sources for your information
What type of opportunity is this?
Timing of proposed actions
Practicum:
Slice and Dice
Discovering the Attributes of a
Product or Service
Innovation and Improvement by
Slicing and Dicing the Attributes
An Example of a Successful Business Model
Mad Catz, Inc.
Mad Catz’s Products

Controllers, Joysticks, memory chips, cables,
power supplies, etc.


Anything you could add onto a game console
Question: How do you make money on this
market?
cycle: 2 weeks
Mad Catz’ Value
Map
Packaging Mtl
Package
Design,
Graphics
10% of Costs, in house
50% of Demand Value
60% of Cost, outsourced
HW Vendors Specs
Electronics
Design
10
0%
co
st
(cycle:
Retailers
(Toys 'R Us;
Wal-Mart)
Electronic Parts
Electronics
Build
25% of Demand V
alue
cycle: 4-6 months
Plastic Parts
%
25
10% of Costs
Plastic Design:
Main
component of
human interface
cycle: 3:months
e
alu
V
nd
ma
e
D
of
Plastics
Molding
20% of Costs, outsourced
Assembly,
Packaging and
Shipping
10% of costs, in
house for quality
control
cycle: 1 week
Points to Note
about Mad Catz’s Business Model



Sources of costs and revenues are different
Cycle time influences revenue
The product is 100% ‘human interface’




Their market is driven by other vendors


Visual
Mental
Tactile
What does this imply about market and growth
strategies
Many components of this case are typical of
Worldwide video game
industry
Mad Catz’s Future Market Potential

Revenues of $25 billion last year

overtook movie box-office receipts

Sales are expected to climb to $55 billion
by 2008

While broadcast TV audiences dwindle
and moviegoing stagnates,

gaming is emerging as the newest and
perhaps strongest pillar of the media world.
Market Trends
There's money to be made in new ways

In China, online leader Shanda Interactive Entertainment Ltd. is
building an eBay-like marketplace



to let players buy and sell game characters
or new colors for that favorite Ferrari racing vehicle -- with Shanda taking a
cut
With game demographics trending older

advertisers are getting their messages across through




product placements,
billboards within games, and
sponsorships
And even hiring developers to build "advergames“
LG Electronics of Seoul has sponsored an online car-chase game in which
players use an LG videophone as they zoom after bad guys modeled on
Fox's 24 TV show

The ad angle is so promising that Nielsen Entertainment is setting up a
new service for tracking gamers' likes and dislikes.
Factors in Mad Catz’s markets

By outsourcing much of its production, and
coordinating the entire production process


It was looking for new opportunities to




Mad Catz Controlled its profitability by being a Value
Chain Integrator
Control costs
Speed up time to market
Improve quality
By innovations in both logistics and information
networks
Mad Catz

Market is driven by other vendors (not by your
decisions)


Bet that Sony and Microsoft will be leaders, and
pander to them
Consider game specific software for powerful
software companies like EA
Mad Catz

Because the product is 100% ‘human
interface’


Consider the costs and benefits of professional
industrial design
What is Industrial Design?
Prac·ti·cum (prăk-tĭ-kəm) noun
Lessons in a specialized field of study designed to give
practical application of theory
Topic
Practicum
Business Needs: Framing the Challenge
False Faces (perceptual reversals)
Building Blockbuster Innovations
Slice and Dice (Attribute Maps pp. 24-35)
Redifferentiating: New Technology / New Uses
Think Bubbles (Quizzing; customers’ experiential context pp. 50-56)
Building Breakthrough Competences
The Idea Box (morphological box)
Selecting Your Competitive Terrain
Hall of Fame (forced connection)
Assembling Your Opportunity Portfolio
Cherry Split (fractionation)
Executing Your Entrance Strategy
Tug-of-War (force-field analysis)
Managing Under Uncertainty
Future Fruit (rationalizing future uncertainty)
Assumption Reversals
(False Faces)

Which line is longer, AB or CD?

Which guy is taller?
Which way is up?
Think outside the box

Connect all the dots with 3 lines
BLUEPRINT






State your challenge.
List your assumptions.
Challenge your fundamental assumptions.
Reverse each assumption. Write down the opposite
of each one.
Record differing viewpoints that might prove useful
to you.
Ask yourself how to accomplish each reversal. List
as many useful viewpoints and ideas as you can.
Benefits / Objectives
Assumption reversal enables you to:


1.
Escape from looking at a challenge in the traditional way.
2.
Free up information so that it can come together in new ways.
3.
Think provocatively. You can take a novel position and then work
out its implications.
4.
Look for a breakthrough.
Assumption reversal helps your imagination escape daily
circumstance, as a bough that has been held down suddenly
straightens itself out.