CHAPTER
7
Business Strategy:
Innovation and Strategic
Entrepreneurship
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Part 2 Strategy Formulation
7–2
LO 7-1
Define innovation and describe its role in the competitive process.
LO 7-2
Describe the competitive implications of different stages in the
industry life cycle.
LO 7-3
Apply strategic management concepts to entrepreneurship and
innovation.
LO 7-4
Evaluate different types of innovation and derive their strategic
implications.
LO 7-5
Describe the long-tail concept and derive strategic implications.
LO 7-6
Evaluate discontinuities and describe the dynamics of paradigm changes.
LO 7-7
Identify the process leading to hypercompetition, and explain why
competitive advantage can often be sustained through continuous
innovation.
7–3
Innovation Funnel
7–4
The
The Development
Development of
of Technology:
Technology: From
From
Knowledge
Knowledge Generation
Generation to
to Diffusion
Diffusion
IMITATION
Supply side
Basic
Knowledge
Invention
Innovation
Diffusion
Demand side
ADOPTION
7–5
The
TheDevelopment
Development of
of Technology:
Technology:Lags
LagsBetween
Between
Knowledge
KnowledgeGeneration
Generation and
andCommercialization
Commercialization
BASIC
KNOWLEDGE
FIRST
PATENTS
PRODUCT
LAUNCH
IMITATION
Xerography
late 19th and
early 20th
centuries
1940
1958
1974
Jet Engines
17th-- early
20th centuries
1930
1957
1959
Fuzzy logic
controllers
1960’s
1981
1987
1988
Appropriation
Appropriation of
of Value:Value:- How
How are
are the
the
Benefits
Benefits from
from Innovation
Innovation Distributed?
Distributed?
Customers
Suppliers
Innovator
Imitators and
other
“followers”
7–7
The
The Profitability
Profitability of
of Innovation
Innovation
Profits
from
Innovation
Value of the
innovation
Innovator’s
ability to
appropriate the
value of the
innovation
• Legal protection
• Complementary
resources
• Imitability of the
technology
•Lead time
7–8
Legal
Legal Protection
Protection of
of Intellectual
Intellectual Property
Property
•
Patents
•
Copyrights
•
Trademarks
•
Trade Secrets
—exclusive rights to a new product,
process, substance or design.
—exclusive rights to artistic, dramatic,
and musical works.
— exclusive rights to words, symbols
or other marks to distinguish goods
and services; trademarks are
registered with the Patent Office.
— protection of chemical formulae,
recipes, and industrial processes.
Also, private contracts between firms and between a firm and its
iemployees can restrict the transfer of technology and know how.
7–9
U.S.
U.S. Managers’
Managers’ Perceptions
Perceptions of
of the
the Effectiveness
Effectiveness of
of
Different
Different Mechanisms
Mechanisms for
for Protecting
Protecting Innovation
Innovation
Processes
Patents to prevent duplication
3.52
Patents to secure royalty income
3.31
Secrecy
4.31
Lead time
5.11
Moving quickly down the learning
5.02
curve
Sales or service efforts
4.55
1 = not at all effective
Products
4.33
3.75
3.57
5.41
5.09
5.59
7 = very effective
Source: Levin, Klevorick, Nelson & Winter. Brookings Papers on Economic Activity, 1987.
The Technology Transfer Process
Research
$29.5
billion
Disclosure
IP Decision
13,039
disclosures
6,375 patent
applications
IP Protection
3,764 issued
patents
Commercialization Strategy
4,362 licenses
454 new companies
Licensing
Source: AUTM
Licensing Survey:
FY 2000
7-11
Alternative
AlternativeStrategies
Strategiesfor
forExploiting
ExploitingInnovation
Innovation
Licensing
Risk &
Return
Strategic
Alliance
Joint
Venture
Shares
investment &
risk. Risk of
partner
conflict &
culture clash
Small risk, but
limited returns
also (unless
patent position
very strong
Limits
investment, but
dependence on
suppliers &
partners
Benefits of
flexibility;
risks of
informal
structure
Few
Allows outside
resources &
capabilities
To be accessed
Permits pooling of the
resources/capabilities of
more than one firm
Konica
licensing its
digital
camera to
HP
Pixar’s movies (e.g.
“Toy Story”)
marketed &
distributed by
Disney.
Competing
Resources
Examples
Outsourcing
certain
functions
Apple and
Sharp build
the
“Newton”
PDA
Microsoft
and NBC
formed
MSNBC
Internal
Commercialization
Biggest risks &
benefits.
Allows complete
control
Substantial
resource
requirements
TI’s
development of
Digital Signal
Processing
Chips
7–12
The
TheComparative
ComparativeSuccess
Successof
of Leaders
Leadersand
and
Followers
Followers
PRODUCT
Jet Airliners
Float glass
X-Ray Scanner
Office P.C.
VCRs
Diet Cola
Instant Cameras
Pocket Calculator
Microwave Oven
Plain Paper Copiers
Fiber Optic Cable
Video Games Players
Disposable Diapers
Web browser
PDA
MP3 music players
INNOVATOR
De Havilland (Comet)
Pilkington
EMI
Xerox
Ampex/Sony
R.C. Cola
Polaroid
Bowmar
Raytheon
Xerox
Corning
Atari
Proctor & Gamble
Netscape
Psion, Apple
Diamond Multimedia
FOLLOWER
Boeing (707)
Corning
General Electric
IBM
Matsushita
Coca Cola
Kodak
Texas Instruments
Samsung
Canon
many companies
Nintendo/Sega/Sony
Kimberly-Clark
Microsoft
Palm
Sony (&others)
WINNER
Follower
Leader
Follower
Follower
Follower
Follower
Leader
Follower
Follower
Not clear
Leader
Followers
Leader
Follower
Follower
Followers
7–13
Uncertainty
Uncertainty&&Risk
RiskManagement
Managementin
inTech-based
Tech-basedIndustries
Industries
Technological
uncertainty
Sources of
uncertainty
Market
uncertainty
Selection process for standards and
dominant designs emerge is complex
and diifficult to predict, e.g. future of 3G
Customer acceptance and adoption rates
of innovations notoriously difficult to
predict, e.g. PC, Xerox copier, Walkman
Cooperating with lead users
early identification of customer requirements
–assistance in new product development
Strategies for
managing risk
Flexibilility
—keep options open
—use speed of response to adapt
quickly to new information
—learn from mistakes
Limiting risk exposure
—avoid major capital commitments
(e.g. lease don’t buy)
—outsource
—alliances to access other firms’
resources & capabilities
—keep debt low
7–14
Sources
Sources of
of Network
Network Externalities
Externalities
•
User linkages, e.g.
– Telephone systems—only value of telephone is connection to
other users
– Video game consoles—same platform allows users to
exchange games and play interactively
– On-line auction—value of auction depends on number of
buyers and sellers participating
Also, social identification—listening to same music, watching
same TV shows, wearing same clothes in order to conform
•
Availability of complementary products, e.g.
– Most PC applications software written for Windows, not Mac.
– In economy autos, easier to get parts and repair for a Ford
Focus than for a Maruti or Proton
•
Economizing on switching costs, e.g.
– In suites of office software, users of Microsoft Office more
likely to avoid switching costs that users of Lotus SmartSuite
when they move jobs
7–15
Competing
Competing for
for Standards:
Standards:
Value
Value Appropriation
Appropriation vs.
vs. Market
Market Acceptance
Acceptance
Maximize
market
acceptance
VHS
Betamax
LOOSE
Maximize
value
appropriation
TIGHT
IBM-PC
Mac
The
TheConditions
Conditionsfor
forCreativity:
Creativity:
“Operating”
“Operating” and
and “Innovating”
“Innovating” Organizations
Organizations
Structure
Processes
Reward
Systems
People
Operating Organization
Innovating Organization
Bureaucratic. Specialization and
division of labor. Hierarchical
control
Operating units controlled and
coordinated by top management
which undertakes strategic
planning, capital allocation and
operational planning.
Financial compensation, promotion
up the hierarchy, power and status
symbols.
Recruitment and selection based
upon the needs of the organization
structure for specific skills:
functional and staff specialists,
general managers, and operatives.
Flat organization without
hierarchical control. Task-oriented
project teams.
Processes directed toward
generation, selection, funding and
development of ideas. Strategic
planning flexible, financial and
operating controls loose.
Autonomy, recognition, equity
participation in new ventures
Key need is for idea generators
which combine required technical
knowledge with creative
personality traits. Managers must
act as sponsors and orchestrators.
7–17
Strategy
Strategy Implementation:
Implementation:
Invention
Invention to
to Innovation
Innovation
•
•
•
•
While invention depends upon creativity, successful
innovation requires integrating new knowledge with
multiple business functions.
Need to link R&D departments with other functions (the
problem of Xerox’s PARC)
The role of cross-functional new product development
teams as vehicles for integration
The role of product champions--in achieving integration
and counteracting organizational inertia.
Chapter Case 7
From Encyclopedia Britannica to
Encarta to Wikipedia
• 18th century Scottish Enlightenment creates
Encyclopedia Britannica (E.B.)
 65,000 topics by 4,000 scholars
 In 1991, E. B. sales $650M (market was $1.2 billion annually)

Price ~$2,000 per set of books
• Microsoft launches Encarta in 1993 for $99 ea.
 By 1996 Encarta U.S. sales over $100M & E.B. ~$300M
• Mr. Wales launches Wikipedia in 2001 for $0 ea.
 3.6 million articles in English ( 40X E.B. !)

18 million total in 281 languages
 In ‘09 Microsoft shut down Encarta
 Peer-reviewed study of 42 topics found 4 errors in Wiki…3 in E.B.
7–19
Chapter Case 7
From Encyclopedia Britannica to
Encarta to Wikipedia
• The innovation of CD-based encyclopedia
 Destroyed more than ½ the revenue of encyclopedias
• Technology allowed Wikipedia to increase value
and decrease costs
• The innovative business model:
 "Crowd wisdom" for big value

But NO revenue

Wikipedia is funded by donations of time and money
7–20
Competition Driven by Innovation
• Invention is discovery of new ideas/products
 Wright brothers – airplane flight
• Innovation is the commercialization of invention
 Boeing & Airbus – selling the airplanes
• Schumpeter’s “gale of creative destruction”
 Encyclopedias to Wikipedia…
 Typewriters to PCs to ???
 Pharmaceuticals to custom treatments
(individualized medicine)
7–21
EXHIBIT 7.1
Innovation: A Novel and Useful Idea
that is Successfully Implemented
Innovation is an invention that is implemented in the marketplace
7–22
Innovation and the Industry Life Cycle
• Innovations create new industries
 Big box retailing
 Express delivery
 Nanotechnology still evolving
• Four stages of industry development
1. Introduction
Early adopters will pay a premium
 Only a few innovators in the market – differentiated
 Strategy here — market acceptance & seeds for growth
– Network effects helpful

• Positive effects ONE user has for other users
7–23
EXHIBIT 7.2
The Industry Life Cycle and ConsumerAdoption Categories
STRATEGY HIGHLIGHT 7.1
Apple Leverages Network
Effects to Propel Growth
• Apple launched iPhone in summer ‘07
 Launched app store a year later

Small programs but BIG business!
-
Over $4 billion in 2012
 Virtuous cycle of 10 billion Apple apps downloaded by 2011

Apps increase value of the iPhone (& iPad too!)

More devices sold, incentivizes software developers

Recent iBook store likely to grow the network effects still more
1–25
7–25
EXHIBIT 7.3
Leveraging Network Economics: Apple’s iPhone
Virtuous Cycle for iPhone (& iPad)
7–26
Innovation and the Industry Life Cycle
• Four stages of industry development (cont'd)
2. Growth Stage
Early majority buyers increase growth rapidly
 Dominant design is set
– IBM PC: Wintel
– Government influence – GSM standard for mobile phones
– QWERTY keyboards
 Core competencies move to manufacturing & marketing

 An example of growth stage

Women’s shapeware industry
– Spanx started in 1998
• Sold over 5M units & over $750 million in sales by 2008
– Maidenform, Body Wrap, & Miraclesuit are competitors
7–27
EXHIBIT 7.4
Product and Process Innovation and the
Emergence of an Industry Standard
After an industry standard is established, process innovations become more important.
7–28
STRATEGY HIGHLIGHT 7.2
Some Standards Die Hard:
QWERTY vs. DSK
• QWERTY introduced in 1870s
 Slowed down typing to avoid jamming keys
• Dvorak introduced in 1930s
 Minimized finger reach to speed up typing
7–29
Innovation and the Industry Life-Cycle
• Four stages of industry development (cont'd)
3. Maturity
Late majority buyers & more limited market growth
– Increased competitive rivalry
 Cost leadership firms tend to drive industry
– Weaker firms will exit
 Oligopoly is dominant industry structure in this stage

4. Decline


Laggards are buyers and market size shrinks
Four strategic options:
– Exit – get out of the industry
– Harvest – stay with limited investments (Olivetti)
– Maintain – stay & continue marketing (Marlboro)
– Consolidate – buy rivals, near monopoly (IBM mainframes)
7–30
EXHIBIT 7.5
Features of the Industry Life Cycle
Not all industries emerge through these stages and some can rejuvenate
such as the steel industry with mini-mills.
7–31
LO 7-1 Define innovation and describe its role in the competitive process.
LO 7-2 Describe the competitive implications of different stages in the
industry life cycle.
LO 7-3 Apply strategic management concepts to entrepreneurship
and innovation.
LO 7-4 Evaluate different types of innovation and derive their
strategic implications.
LO 7-5 Describe the long-tail concept and derive strategic implications.
LO 7-6 Evaluate discontinuities and describe the dynamics of paradigm
changes.
LO 7-7 Identify the process leading to hypercompetition, and explain why
competitive advantage can often be sustained through continuous
innovation.
7–32
Strategic Entrepreneurship
• Entrepreneurs are the change agents for
creative destruction.
 Create new opportunities and exploit them
Jeff Bezos – Amazon.com
– Saw growth of Internet in 1994
– Chose books as the first product for online sales
 Oprah Winfrey – Harpo Productions
– Rose from abuse & poverty to over $2 billion net worth
– Ended talk show to devote time to OWN TV channel
 Jeff Hawkins – Palm Computing (founded in 1992)
– PalmPilot and Treo products

 How to combine entrepreneurial with strategic actions?
 Example: P&G continued innovations in detergent
7–33
EXHIBIT 7.6
Types of Innovation:
Combining Markets and Technologies
GPS to handheld
consumer devices
MRI radiology
Intel 386 to 486 processors
Digital photography
Categorizing according to technology and markets yields 4 quadrants
7–34
STRATEGY HIGHLIGHT 7.3
1930s
From King Gillette to King
of Incremental Innovation
2011
1–35
7–35
STRATEGY HIGHLIGHT 7.3
From King Gillette to King
of Incremental Innovation
• Gillette invented the safety razor in 1903
 A radical innovation at the start
 Innovative business model

Make money from the blades NOT the razors
 Incremental innovation

Moved from 1 to six blades (so far…)
 Top selling blades today! Over $1 billion in sales

Prices steady to higher for the blades!
1–36
7–36
EXHIBIT 7.7
Disruptive Innovation Invading Different
Market Segments from the Bottom Up
Google’s Chrome OS could be a disruptor of traditional
Microsoft operating systems for computers…
7–37
STRATEGY HIGHLIGHT 7.4
GE’s Reverse Innovation:
Disrupt Yourself!
• GE Healthcare – global leader in diagnostics
 Ultrasound machine for research hospitals – $230,000

Limited market for these in developing countries
 2002 local team at GE China – developed portable US

Laptop-based technology – Under $30,000 for U.S. rollout
 2009 introduced a handheld US – about $10,000

Vscan - large cell phone – shaped device
GE Vscan Video
1–38
7–38
LO 7-1
Define innovation and describe its role in the competitive process.
LO 7-2
Describe the competitive implications of different stages in the industry
life cycle.
LO 7-3
Apply strategic management concepts to entrepreneurship and
innovation.
LO 7-4
Evaluate different types of innovation and derive their strategic
implications.
LO 7-5
Describe the long-tail concept and derive strategic implications.
LO 7-6
Evaluate discontinuities and describe the dynamics of paradigm changes.
LO 7-7
Identify the process leading to hypercompetition, and explain why
competitive advantage can often be sustained through continuous
innovation.
7–39
The Internet as Disruptive Force: The Long Tail
• Long tail in a digital world
 Both opportunity and threat
 80% sales in a given category are NOT “hits”

Pareto principle
 Technology enables easier access to the ‘tail’
Selling “less of more”
 Online firms can gain a large share of revenue from
selling a small number of nearly unlimited choices

• Short head is the mainstream
 Available at brick & mortar stores

Significant inventory costs
Ray Kurzwiel Video
7–40
EXHIBIT 7.8
The Short Head and the Long Tail
The Internet and inventory management software drive down costs to
match customer demand, increasing the tail to the black dotted line.
7–41
EXHIBIT 7.9
The Long-Tail Consequences: Selling Less of More
25% to 45% of sales for online retailers is from products
NOT available in traditional retail stores.
7–42
LO 7-1 Define innovation and describe its role in the competitive process.
LO 7-2 Describe the competitive implications of different stages in the
industry life cycle.
LO 7-3 Apply strategic management concepts to entrepreneurship and
innovation.
LO 7-4 Evaluate different types of innovation and derive their strategic
implications.
LO 7-5 Describe the long-tail concept and derive strategic implications.
LO 7-6 Evaluate discontinuities and describe the dynamics of
paradigm changes.
LO 7-7 Identify the process leading to hypercompetition, and explain
why competitive advantage can often be sustained through
continuous innovation.
7–43
Discontinuities: Periods of Paradigm Change
• Periods when underlying standard changes
 Paradigm shift
New technology revolutionizes existing industries
– New standard is established
 Technology “S-curve”
– Physical limits nearing or reached

 Incumbents need absorptive capacity

Existing firms must place “good bets” on new
technologies
 Examples of Discontinuities
Airplanes: propellers to jets
 Cameras: film to digital
 TV screens: vacuum tube to flat panel
 Music storage: vinyl to CDs to MP3 storage

EXHIBIT 7.10
Likelihood of Discontinuity Increases as
Technology Approaches Physical Limit
The Internet and inventory management software drive down costs to
match customer demand, increasing the tail to the black dotted line.
7–46
Rate of Technological Progress
(reduction in emissions)
Ex: Hybrid as Intermediate Step for Autos
Electric
Hybrid
Combustion
Time
Combustion has been automobile standard for over 100 years…
Is it time for a new standard? This is one scenario from the “swarm”
(for more discussion, see MiniCase 7).
7–47
EXHIBIT 7.11
Hypercompetition Driven by
Continuous Innovation
Subsequent innovations sustain competitive advantage
for a shorter time frame.
7–48