Commercializing and Managing Innovations

© 2004 Leslie Martinich, Competitive Focus

Abstract

Economic growth depends on the successful commercialization and management of innovation. Managers can make better decisions if they understand innovations.  I present a taxonomy of innovation and a capability framework that describes the skills firms need to compete throughout the innovation life cycle.  This research is based on a twenty-year investigation of the practices of the software product industry and a review of the literature to extend its findings to other industries.  The research examines the practices in commercializing innovations and the use of extra-organizational linkages, including alliances, partnerships and developer groups.  The investigation concludes with implications for companies attempting to innovate.

Commercializing and Managing Innovations. 2

1. Characteristics of Innovations. 2

1.1  A Taxonomy of Innovations. 2

Discontinuous and Incremental Innovations. 2

Product, Process and Conceptual Innovations. 3

Replacement and Enhancement Innovations. 3

2.  Patterns and Phases of Innovation. 4

2.1  The Innovation Phase. 5

2.2  Chaos and Commercialization Phase. 5

2.3  Standards Phase. 5

2.4  Market Maturity Phase. 6

3.  Capability Framework. 6

3.1  Early Phase Capabilities. 6

3.2  Late Phase Capability. 8

3.3  The Capability Bridge. 9

4.  Ambidextrous Organizations. 10

End Notes. 11

References. 12

Commercializing and Managing Innovations

Economic growth depends on the successful commercialization and management of innovation and the retention and reinvestment of profits from those innovations.  The ability to produce different kinds of innovations, commercialize them, and manage the various phases of innovation provides a sustained competitive advantage.  Mature firms have the resources to fund research and product introduction, but often fail to capitalize on innovations, sometimes because they are threatened by them.  Entrepreneurial firms are able to get an innovation to market, but often lack (and fail to develop) the capabilities needed to compete in a mature product environment.  The dot com failures exemplify this. 

The research for this paper includes an investigation of the practices of ten software companies between 1980 and 2000.  I have chosen four of these companies for further consideration because their primary focus was delivering innovative software products, rather than system integration, application integration or consulting.  Further research for this paper includes a review of the literature in order to extend the results to other industries.

In this paper I provide a capability framework that describes how firms can compete in both the entrepreneurial and mature stages of an industry.  In order to understand how to successfully manage innovations, we first need to understand the nature and dynamics of innovations.  In the next section, we will consider several different types of innovation and then explore the characteristic patterns of innovation.  With this conceptual model, we will then define the capabilities needed for each phase of innovation.  Finally we will consider ways in which firms can incorporate both sets of capabilities.

1. Characteristics of Innovations

What are the characteristics of innovations?  Since there are many types of innovations and various ways to describe their dynamics, I need to simplify, even oversimplify my description.  But this simplification will help us see some patterns that innovations take.

1.1  A Taxonomy of Innovations 

First, let’s look at the types of innovation.  I have classified innovations along three dimensions: discontinuous and incremental; product, process and conceptual; and replacement and enhancement.

Discontinuous and Incremental Innovations

Discontinuous innovations are not on a continuum with previous technologies; they involve the application of a new technology. The printing press, telegraph, telephone and computers form a series of discontinuous innovations.  Such innovations cause a dramatic shift in the way people or firms perform some activity.  Christensen, who prefers the term “disruptive innovations,” emphasizes the risk that they pose for high-performing incumbent firms. [1]   Each discontinuous innovation disrupts the existing technology.  The printing press, for example, put scribes out of business.

Discontinuous innovations emerge for two primary reasons.  The first reason occurs when a technology exceeds customers’ needs and a simpler, cheaper, less powerful technology is adequate to meet their needs. Mainframe computers provided far more performance and functionality than most people needed, and the personal computer industry disrupted the mainframe industry.  The second reason involves reaching technical limitations.  If a technology is inadequate for customers’ needs, but has reached a technical limitation, [2] then scientists may apply a different technology to replace the current one.   During World War II governments found the power and speed of propeller-driven aircraft to be inadequate; jet engines met their increased needs for air superiority.  For hundreds of years, people communicated with ships at sea using visible mechanisms such as flags and lights and audible mechanisms such as bells and horns. In the nineteenth century, navies found this technology inadequate; it had reached its limits. In the twentieth century, radio replaced the earlier modes of naval communication.  Discontinuous innovations allowed progress.

The commercial use of the Internet provides a clear and obvious example of a discontinuous innovation.  The Internet has fundamentally changed the way that businesses communicate with each other. 

Discontinuous innovations typically disrupt an industry and occasionally disrupt the way consumers engage in some activity.  Despite the fact that an innovation disrupts existing systems and causes chaos, it still follows regular and predictable patterns. [3]   We will explore these patterns in the next section.

On the other side of the spectrum are incremental innovations. Once a technology is commercially accepted, firms compete by incrementally adding functionality and improving performance.  In the late 1980s thousands of people used email.  Some of the incremental innovations added very useful functionality to email, such as compatibility among disparate email systems, the standardization of addressing conventions so that users no longer had to type arcane address symbols including “%” and “$” to delimit address names and to direct one email system to communicate with a different system.

Most innovations are incremental; people and firms continue to perform an activity in a familiar way.  The innovations simply improve performance, functionality or ease of use.

Product, Process and Conceptual Innovations

Another way to classify innovations is to consider whether they are product, process or conceptual innovations.  Product innovations include such things as the personal computer.  Process innovations include Henry Ford’s assembly line, Walmart’s supply chain processes and Dell’s build-to-order manufacturing processes.  Conceptual innovations include Copernicus’s theory of astronomy.

Replacement and Enhancement Innovations

We can also classify innovations by whether they replace or enhance an existing technology.  Sharp and Texas Instruments introduced calculators in the 1960s, Hewlett-Packard improved calculators in the 1970s, and by the mid-1970s, they had almost completely replaced slide rules.  Similarly, personal computers with word processing systems have almost completely replaced typewriters. 

Some innovations enhance the ways in which people perform some activity.  Although Hollywood feared that the introduction of videotapes would mean the end of the movie industry, it in fact enhanced people’s opportunities for entertainment.  Citibank introduced ATMs in the early 1970s enhancing the ways in which people can interact with their banking systems and extending the reach of a given bank worldwide.

Table 1 shows discontinuous and incremental product and process innovations.

Table 1. Partial taxonomy of innovations

2.  Patterns and Phases of Innovation

A successful innovation typically follows a predictable pattern of behavior.  It begins with a discontinuous innovation and proceeds through several phases until the technology is mature when it is once again disrupted by a discontinuous innovation.  Foster introduces the notion of an S-curve comparing performance and effort, a “graph of the relationship between the effort put into improving a product or process and the results one gets back for the investment.” [4]   He is concerned with limits; reaching the limits of the technology spells the flattening out at the top of the S-curve.  It becomes harder and harder to improve the performance of the technology.  At the limit of  technology, no matter how hard you try, you cannot continue to make improvements.

Rogers also looks at an S-curve, but with a difference in the graph’s axes, percent of adoption vs. time. [5]   In his work on the diffusion of innovations, he characterizes innovations according to relative advantage, compatibility, complexity, trialability, and observability.  The characteristics help explain the rate of adoption.

Rogers describes the take-off phase for an innovation as being driven by social forces and “interpersonal network exchanges.” [6]   He describes the dissemination of the use of hybrid corn and the social network effect of farmers learning from each other.

Metcalfe’s Law, named after Robert Metcalfe, the inventor of Ethernet networking technology, says that the value of a network grows in proportion to the square of the number of users.  The network effect plays a significant role in the pattern and dynamics of innovation which involve communication, such as the fax machine, telephones and software.   Once an innovation reaches a critical mass, its acceptance accelerates. 

We can also see the S-curve as a graph of the total number of adopters on the Y-axis and time on the X-axis.   Three inflection points divide the S-curve into four distinct phases.  The first inflection point represents the point in time at which entrepreneurs see the commercial value of the innovation.  The second inflection point occurs when a standard emerges, and the third inflection point occurs when users’ needs are met or exceeded or when no further performance improvements can expected.

Managers face different challenges at different phases of innovation.   In order to understand the challenges, we must first understand the dynamics.  In this section, I present the regular patterns exhibited throughout history.  Each cycle begins with a discontinuous innovation.  If the innovation is successful, it proceeds through subsequent phases and includes later incremental innovations.

2.1  The Innovation Phase

The first phase is the creation of the innovation.   Communities tend to see the innovation as a toy with little or no commercial value and to see the innovators as hobbyists or enthusiasts.   3M managers were skeptical about adhesive that made only intermittent contact when their scientists invented the adhesive for Post-It Notes in the 1970s.

  When Samuel Morse presented the United States Congress with a prototype of his telegraph machine  in 1838, his audience did not take him seriously.  Even after Morse received government funding and set up a telegraph line between Washington D.C. and Baltimore, people still saw little practical use for it.  But Morse and his partners implicitly understood the network effect.  They pushed ahead and built a network of telegraph lines between U.S. cities, hoping that customers would begin to appreciate the value of the telegraph. 

Firms tend to see the innovation as inadequate to meet their customers’ needs.  In the 1970s the mainframe computer industry viewed personal computers as toys for hobbyists who purchased kits to build them.  Few firms saw the personal computer as having any real commercial value.   

2.2  Chaos and Commercialization Phase

The first inflection point on the S-curve occurs when entrepreneurs see the commercial value of the innovation and try to build a business around the innovation. 

As entrepreneurs saw the commercial value of the telegraph, dozens of companies began building telegraph networks, stringing lines haphazardly across the United States.  To avoid patent infringements, companies developed unique telegraph systems, incompatible with each other. [7]   Creating the telegraph infrastructure was expensive, and dozens of companies failed before becoming profitable. In Europe and England, the telegraph systems grew with government sponsorship.  But each country’s system was incompatible with that of its neighbors.  Standards did not yet exist.

As entrepreneurs saw the value of PCs, many companies emerged to give us the KayPro, the Commodore, the Apple Lisa, the DEC Rainbow and the Victor 9000, none of which was compatible with the others.  Software written for one did not work on any others.  And they did not communicate with one another.  This is not surprising.  Just as we have no laws to govern something we have never imagined before, we have no standards to guide discontinuous innovations. 

The characteristics of the Chaos and Commercialization Phase are hype, disappointments, fear, suspicion, many entrants, incompatible systems and no standards. 

An indicator that this phase is coming to a close and the next phase is about to begin is that governments see the innovation as important to national interests.  Both governments and consumers call for standards and interoperability.

2.3  Standards Phase

The Standards Phase has three characteristics: the emergence of a standard or dominant design, rapid growth, and industry consolidation.   The industry as a whole reaches a critical mass, grows rapidly, and all participants aligned with the standard benefit.  During this phase, incremental innovations are important.

The 1865 international conference on the telegraph yielded the International Telegraph Union, still in existence today.  This early standards body worked to unify the many disparate systems and marked a turning point in the telegraph industry.  Its work helped to expand the telegraph throughout the world at a remarkable speed.

The pace of adoption has accelerated since the mid-nineteenth century.  In the computer industry, IBM introduced the IBM PC in 1982. With its strong brand and high level of trust from the business world, it created a standard overnight.  This marked the turning point for the personal computer industry.  Those participating in the standard flourished.   Compaq and Dell began building PCs; Microsoft, Lotus, Borland, Oracle and WordPerfect began building software; Intel’s processor business grew rapidly.  Service providers began offering custom software to run businesses. 

Once a standard emerges, industry consolidation follows quickly.  Almost all the companies building personal computers (other than IBM PC-compatibles) failed in 1983.  In general, at this phase, companies whose products are not aligned with the de facto standard fail; companies whose products are aligned with the standard grow.  Companies compete during this phase by adding functionality through continuous, incremental improvements to their products.

2.4  Market Maturity Phase

The final inflection point on the S-curve comes when products meet or exceed consumers’ needs for functionality, or when the technology has reached its natural limits.   Competition shifts to customer service and to production and distribution efficiencies.  Process innovation is most important at this phase.

The personal computer industry is in this phase now.  Dell, whose strength is in just-in-time production, rather than in enhancing functionality through R&D, has a competitive edge for this phase.

3.  Capability Framework

Different phases and kinds of innovation require different management, engineering, marketing, and operations capabilities.  For our purposes, we will consider the Early Phase to include both the discontinuous innovation itself, and the Chaos and Commercialization Phase.  The Later Phase will include the Standards Phase and the Mature Phase.

3.1  Early Phase Capabilities

What are some of the cultural norms and behaviors that foster discontinuous innovation?  A culture that encourages strong ties with customers, risk taking, experimentation and openness is more likely to foster successful innovation. 

My study of software product companies included two firms that introduced innovative products and gained a large majority of market share. The first firm produced a mainframe financial planning tool in the late 1970s and was among the top 20 software product companies in the world in annual revenues by 1980.

What were the capabilities that contributed to the financial planning software company’s success?  It provided a complete solution for customers, including the installation, configuration, customization, consulting and support of its product.  Employees had strong ties with customers, and the relationships were characterized by trust and involvement.  The scientist who created the product understood the business needs, the customer needs and the delivery dates.  He was ultimately able to handle all the tasks that others had failed to complete on time.

The second firm produced networking operating system software, and held 70% market share of a growing market.  The capabilities that contributed to its success are very similar to those of the financial planning software company.  During the early phase, 1986-1989, this firm provided an end-to-end solution, including hardware, installation, configuration, customization, consulting and support.  Its culture fostered a collaborative relationship with customers.  And the engineer who designed the product understood the business needs, the customer needs, and was able to direct closely the efforts of other engineers to bring the product to completion.

Both of these first two firms had difficulty in designing and scoping their initial products, and in both cases flexibility and the commitment of the principal engineer contributed to success.  During the early phase of an innovation there are a significant number of unknown issues that are only uncovered during development.  So effective scoping is an inherent problem. 

A third firm produced web-based configuration software.  It was able to gain some early success, but failed quickly.  It lacked the close relationship with customers and, although product designers were able to complete the products, they did not understand either business needs or customer needs.

A fourth firm produced web content management software.  It had a far more mature approach to software development than the configuration software provider, but also lacked a close relationship with customers.  It had some early success but is now struggling.

Managing involves using various control systems.  Control systems include both formal control systems and social norms.  What is an effective way to manage or control an innovative organization where work is non-repetitive and not routine?  Change is frequent.  It is a little bit like ordering Rumplestiltskin to spin straw into gold.  You give him the goal, but you don’t tell him how to do it.   Formal control systems are inappropriate here.  Formal control systems involve instructing employees in what to do and how to do it, and monitoring their behavior. [8]   Instead, managers in departments responsible for innovation need to be clear about the firm’s vision and objectives and rely on employees’ judgment. This held true for both the successful software firms.

In departments with predictable, regular and repeated activities such as IS,  inventory management, cash flow management and human resources, managers can rely on formal control systems.  This organizational behavior is in tension with that in the R&D departments.  We’ll address this tension in the section on Ambidextrous Organizations.

Kanter, et. al., suggest “routinizing the unpredictable” in their study of Raytheon’s New Product Center, where the goal is to aid the company’s growth and profits by developing new products. [9]    They found that characteristics such as having modest goals, a patient sponsor, good coordination with the rest of the company, client involvement, product champions and prototypes led to the Center’s success.  They found that the relationship with clients, including trust and  good channels of communication so that the innovators could understand the client business, was the “make-or-break” issue. [10]

3M is well known for its approach to innovation.  Employees are encouraged to spend 15 percent of their time engaged in exploration and innovation.  The 3M lab system includes three levels of labs, more closely or loosely aligned with a given business unit.  And 3M’s stated goal is to have 30 percent of revenues come from products introduced in the last four years. A discontinuous innovation is typically designed for functionality, rather than designed for manufacturing.  Companies such as 3M understand the need to move quickly to design for manufacturing.

Let’s summarize the capabilities needed during the early phase.  When an innovative product is first introduced, firms need skills and capabilities to cope with fear and chaos in the marketplace. Companies need to provide an end-to-end solution.   This serves two purposes.  First, it mitigates the fear that accompanies the innovative phase.  And second, during the early phase of an innovation, there are typically no available partners.  When an invention first comes to market, there is no industry to install or service that product.  Innovative products are usually proprietary, lacking compatibility or interoperability. 

A second capability that differentiated the successful firms from the less successful ones is the relationship of trust and collaboration with initial customers.  In addition to helping to mitigate customer fears, it also provides the innovators with a better sense of what is valuable to the customers.

All four of the software firms in this study understood that the initial product development teams would have difficulty in designing and scoping their products.  All exhibited flexibility and planned for buffers to accommodate this difficulty.

3.2  Late Phase Capability

What are the capabilities that firms need to manage during the Standards and Mature Phases of a innovation cycle?  Once a standard emerges, competition shifts to incremental innovations and product enhancement.  The firm’s focus moves to operational efficiency.  Process innovations can help a firm compete with more operational efficiency.  Additionally interoperability and alliances play a significant role.

The financial planning software firm developed processes for source control, managing the software build process, regression testing, planning, designing and scoping. These were repeatable, optimized processes.  The relationship with customers continued to be important, but the primary engineers were sheltered by intermediaries, typically product managers.  These all contributed to its continued success.

The network operating system firm developed similar processes and disseminated them throughout a geographically dispersed development group.  This firm also divested itself of all activities that were not core to its competitive advantage.  Prior to 1989, 50% of revenues came from hardware sales (approximately $250 million).  In 1989, the firm seeded the market for partners by giving away the hardware designs, and its revenues continued to increase.  It also encouraged the growth of the industry by providing training to potential partners in installation, administration, customization and consulting.  Instead of providing an end-to-end solution, the firm relied on partners to provide all the tangential aspects of the business.

The web content management software firm has made some attempts to build alliances and partnerships.  However, it is caught in a very typical tangle: it relies heavily on the revenues from its consulting business and has been unable to build significant alliances.  It has been successful at improving repeatable processes.

Finally, during the last part of the late phase, firms need to attack and cannibalize themselves. [11] They need to understand limits and when it is time for the next discontinuous innovation.  The financial planning software firm, which had been so successful, failed because it could not move from mainframe to PC software.

Firms in mature industries must shift and replace the quest for efficiency with the quest for competitiveness.  While efficiency is the capability that works during the mature phase, at some point it will be undermined by a new technology. Table 2 summarizes the capability framework.

3.3  The Capability Bridge

How do firms make the leap from innovative and entrepreneurial to mature?  The first two firms in the study successfully made this transition.  They both had good leaders who articulated the vision and goals.

Both the financial planning software firm and the network operating system firm built internal infrastructures which included systems for repeatable, efficient execution, including quality groups, process improvement groups, planning and sophisticated documentation organizations.  The network operating system firm set the standard for its industry, and led the growth of that industry through fostering alliances and partnerships.

Finally, the latter firm divested itself of non-core business and created a strategy based on its competitive advantage and on maintaining control of the platform.  The platform provided the source of value in that industry. [12]

Table 2.  Capability Framework

4.  Ambidextrous Organizations

Why is it so difficult for companies to have both kinds of capabilities?   Clearly the capabilities are in tension with each other.  Tushman, et. al. use the term “ambidextrous organization” to describe the approach managers must take to handle both the entrepreneurial and mature aspects of a firm. [13]

Managers understand that their firm needs innovations in order to grow and they are often supportive of innovative efforts.  But all firms deal with the reality of limited resources, and during the debates on resource allocation, established managers will attempt to control resources even if that means denying them to the entrepreneurial units of the business.

In addition to the inherent tension between capabilities such as flexibility and efficiency, managers often undermine innovation because of what I call the Chronos Syndrome.  In Greek mythology, Chronos feared that his children would overthrow him.  He had himself defeated and overthrown his father.  When Chronos’ son Zeus grew up, he too defeated his father and became the king of the gods.  Managers face this same issue; it is difficult to support the efforts that will lead to your own demise.

Ambidextrous organizations have the capabilities to support simultaneous discontinuous and incremental innovations.  They are inherently unstable,  just as Chronos’ hold on the universe was unstable.  They require leadership that can see the longer term value that the ability to produce different kinds of innovation provides.

Mastering the technology transfer from labs to business units is difficult, but aided by close relations between the innovators and the clients or customers.  Defining workable solutions such as Raytheon or 3M have done provides a long term advantage.

Acquisitions are notoriously perilous, but provide another alternative for firms such as Cisco and IBM.

Doing basic research and coming up with innovations is laudable.  But firms that fail to take the innovation to the next stage lose the VALUE of the innovation. 

End Notes