Strategic management of technological innovation 5th edition schilling

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Strategic Management of Technological Innovation

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Strategic Management of Technological Innovation Fifth Edition

Melissa A. Schilling New York University

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About the Author Melissa A. Schilling, Ph.D. Melissa Schilling is a professor of management and organizations at New York Uni- versity’s Stern School of Business. Professor Schilling teaches courses in strategic management, corporate strategy and technology, and innovation management. Before joining NYU, she was an Assistant Professor at Boston University (1997–2001), and has also served as a Visiting Professor at INSEAD and the Bren School of Environmental Science & Management at the University of California at Santa Barbara. She has also taught strategy and innovation courses at Siemens Corpora- tion, IBM, the Kauffman Foundation Entrepreneurship Fellows program, Sogang University in Korea, and the Alta Scuola Polytecnica, a joint institution of Politecnico di Milano and Politecnico di Torino.

Professor Schilling’s research focuses on technological innovation and knowledge creation. She has studied how technology shocks influence collaboration activ- ity and innovation outcomes, how firms fight technology standards battles, and how firms utilize collaboration, protection, and timing of entry strategies. She also studies how product designs and organizational structures migrate toward or away from modularity. Her most recent work focuses on knowledge creation, including how breadth of knowledge and search influences insight and learning, and how the structure of knowledge networks influences their overall capacity for knowledge creation. Her research in innovation and strategy has appeared in the leading aca- demic journals such as Academy of Management Journal, Academy of Management Review, Management Science, Organization Science, Strategic Management Journal, and Journal of Economics and Management Strategy and Research Policy. She also sits on the editorial review boards of Academy of Management Journal, Academy of Management Discoveries, Organization Science, Strategy Science, and Strategic Organization. Professor Schilling won an NSF CAREER award in 2003, and Boston University’s Broderick Prize for research in 2000.

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vi

Preface Innovation is a beautiful thing. It is a force with both aesthetic and pragmatic appeal: It unleashes our creative spirit, opening our minds to hitherto undreamed of possibilities, while simultaneously accelerating economic growth and providing advances in such crucial human endeavors as medicine, agriculture, and education. For industrial organizations, the primary engines of innovation in the Western world, innovation provides both exceptional opportunities and steep challenges. While innovation is a powerful means of competitive differentiation, enabling firms to penetrate new markets and achieve higher margins, it is also a competitive race that must be run with speed, skill, and precision. It is not enough for a firm to be innovative—to be successful it must innovate better than its competitors.

As scholars and managers have raced to better understand innovation, a wide range of work on the topic has emerged and flourished in disciplines such as strategic management, organization theory, economics, marketing, engineering, and sociology. This work has generated many insights about how innovation affects the competitive dynamics of markets, how firms can strategically manage innovation, and how firms can implement their innovation strategies to maximize their likelihood of success. A great benefit of the dispersion of this literature across such diverse domains of study is that many innovation topics have been examined from different angles. However, this diversity also can pose integration challenges to both instructors and students. This book seeks to integrate this wide body of work into a single coherent strategic framework, attempting to provide coverage that is rigorous, inclusive, and accessible.

Organization of the Book The subject of innovation management is approached here as a strategic process. The outline of the book is designed to mirror the strategic management process used in most strategy textbooks, progressing from assessing the competitive dynamics of the situation, to strategy formulation, and then to strategy implementation. The first part of the book covers the foundations and implications of the dynamics of innovation, helping managers and future managers better interpret their technological environ- ments and identify meaningful trends. The second part of the book begins the pro- cess of crafting the firm’s strategic direction and formulating its innovation strategy, including project selection, collaboration strategies, and strategies for protecting the firm’s property rights. The third part of the book covers the process of implementing innovation, including the implications of organization structure on innovation, the management of new product development processes, the construction and manage- ment of new product development teams, and crafting the firm’s deployment strategy. While the book emphasizes practical applications and examples, it also provides systematic coverage of the existing research and footnotes to guide further reading.

Complete Coverage for Both Business and Engineering Students This book is designed to be a primary text for courses in the strategic management of inno- vation and new product development. Such courses are frequently taught in both business and engineering programs; thus, this book has been written with the needs of business and

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engineering students in mind. For example, Chapter Six (Defining the Organization’s Stra- tegic Direction) provides basic strategic analysis tools with which business students may already be familiar, but which may be unfamiliar to engineering students. Similarly, some of the material in Chapter Eleven (Managing the New Product Development Process) on computer-aided design or quality function deployment may be review material for infor- mation system students or engineering students, while being new to management students. Though the chapters are designed to have an intuitive order to them, they are also designed to be self-standing so instructors can pick and choose from them “buffet style” if they prefer.

New for the Fifth Edition This fifth edition of the text has been comprehensively revised to ensure that the frameworks and tools are rigorous and comprehensive, the examples are fresh and exciting, and the figures and cases represent the most current information available. Some changes of particular note include: Six New Short Cases Tesla Motors. The new opening case for Chapter Three is about Tesla Motors. In 2015, Tesla Motors was a $3.2 billion company on track to set history. It had cre- ated two cars that most people agreed were remarkable. Consumer reports had rated Tesla’s Model S the best car it had ever reviewed. Though it was not yet posting prof- its (see Exhibits 1 and 2), sales were growing rapidly and analysts were hopeful that profits would soon follow. It had repaid its government loans ahead of the major auto conglomerates. Most importantly, it looked like it might survive. Perhaps even thrive. This was astonishing as there had been no other successful auto manufacturing start up in the United States since the 1920s. However, getting the general public to adopt fully electric vehicles still required surmounting several major hurdles. A Battle Emerging in Mobile Payments. Chapter Four now opens with a case describ- ing the mobile payment systems that are emerging and competing around the world. In the developing world, mobile payment systems promise to help bring the unbanked and underbanked access to fast and efficient funds transfer and better opportunities for saving. In the developed world, competing mobile payment standards were battling to achieve dominance, and threatening to obviate the role of the major credit card companies—putting billions of dollars of transaction fees at stake. Reinventing Hotels: citizen M. Chapter Six opens with a case about how Michael Levie, Rattan Chadha, and Robin Chadha set out to create a fundamentally different kind of hotel. Levie and the Chadhas dramatically reduced or eliminated key features typically assumed to be standard at upscale hotels such as large rooms, in-house res- taurants, and a reception desk, while increasing the use of technology at the hotel and maintaining a modern and fresh aesthetic. This enabled them to create a stylish hotel that was significantly less expensive than typical upscale hotels. This case pairs very well with the new Research Brief in Chapter Six on Blue Ocean Strategy. The Mahindra Shaan: Gambling on a Radical Innovation. Chapter Seven opens with a case about the decision of Mahindra & Mahindra to make a very unusual tractor. Mahindra & Mahindra had long made traditional tractors and focused on incremental innovation. However, in the late 1990s, Mahindra’s management decided to try to find the way to meet the needs of smaller farmers, who could not afford a regular tractor. They ended

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up creating the Shaan, a tractor/transporter hybrid that could serve for farming, per- sonal transportation, and for transporting goods (a job small farmers performed in the off season to earn additional income). Developing the tractor was a major break with their traditional innovation choices, and this case details how they were able to get this unusual project approved, and nurture it through the new product development process. Ending HIV? Sangamo Biosciences and Gene Editing. Chapter Eight opens with a case ripped straight from the headlines—the development of ways to alter a living person’s genes to address critical ailments. Sangamo Biosciences has developed a way to edit a person’s genes with Zinc Finger Nucleases (ZFNs). This innovation has the potential to eliminate monogenic diseases such as hemophilia or Huntington’s disease. Even more intriguingly, Sangamo was exploring a way to use ZFNs to cure HIV by giving people a mutation that renders people naturally immune to the disease. In the case, Sangamo must decide how to address this huge—but incredibly risky— opportunity. It already has partnerships with major pharma companies for some of its other projects, but it is unclear whether the pharma companies would want to partici- pate in the HIV project, and whether Sangamo would want to go this route. Managing Innovation Teams at Disney. Chapter Twelve now opens with a case about how Disney creates and manages the teams that develop animated films. Disney, and Pixar (from whom it acquired several of its current innovation practices) are world renown for their ability to develop magically innovative animated films. This opening case highlights the roles of having a small team size, being collocated, and instilling a culture of brutally honest peer feedback. Cases, Data, and Examples from Around the World Careful attention has been paid to ensure that the text is global in its scope. The open- ing cases feature companies from India, Israel, Japan, The Netherlands, Kenya, and the United States, and many examples from other countries are embedded in the chapters themselves. Wherever possible, statistics used in the text are based on worldwide data. More Comprehensive Coverage and Focus on Current Innovation Trends In response to reviewer suggestions, the new edition now provides more extensive discussions of topics such as crowdsourcing and customer co-creation, patenting strategies, patent trolls, Blue-Ocean Strategy, and more. The suggested readings for each chapter have also been updated to identify some of the more recent publications that have gained widespread attention in the topic area of each chapter. Despite these additions, great effort has also been put into ensuring the book remains concise—a feature that has proven popular with both instructors and students. Supplements The teaching package for Strategic Management of Technological Innovation is available online from the book’s Online Learning Center at www.mhhe.com/schilling5e and includes: ∙ An instructor’s manual with suggested class outlines, responses to discussion ques-

tions, and more. ∙ Complete PowerPoint slides with lecture outlines and all major figures from the text. The

slides can also be modified by the instructor to customize them to the instructor’s needs. ∙ A testbank with true/false, multiple choice, and short answer/short essay questions. ∙ A suggested list of cases to pair with chapters from the text.

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Acknowledgments This book arose out of my research and teaching on technological innovation and new product development over the last decade; however, it has been anything but a lone endeavor. I owe much of the original inspiration of the book to Charles Hill, who helped to ignite my initial interest in innovation, guided me in my research agenda, and ultimately encouraged me to write this book. I am also very grateful to colleagues and friends such as Rajshree Agarwal, Juan Alcacer, Rick Alden, William Baumol, Bruno Braga, Gino Cattanni, Tom Davis, Sinziana Dorobantu, Gary Dushnitsky, Douglas Fulop, Raghu Garud, Deepak Hegde, Hla Lifshitz, Tammy Madsen, Rodolfo Martinez, Goncalo Pacheco D’Almeida, Jaspal Singh, Deepak Somaya, Bill Starbuck, and Christopher Tucci for their suggestions, insights, and encouragement. I am grateful to executive brand manager Mike Ablassmeir and marketing manager Casey Keske. I am also thankful to my editors, Laura Hurst Spell and Diana Murphy, who have been so supportive and made this book possible, and to the many reviewers whose sugges- tions have dramatically improved the book:

Joan Adams Baruch Business School (City University of New York)

Shahzad Ansari Erasmus University

B. Rajaram Baliga Wake Forest University

Sandy Becker Rutgers Business School

David Berkowitz University of Alabama in Huntsville

John Bers Vanderbilt University

Paul Bierly James Madison University

Paul Cheney University of Central Florida

Pete Dailey Marshall University

Robert DeFillippi Suffolk University

Deborah Dougherty Rutgers University

Cathy A. Enz Cornell University

Robert Finklestein University of Maryland–University College

Sandra Finklestein Clarkson University School of Business

Jeffrey L. Furman Boston University

Cheryl Gaimon Georgia Institute of Technology

Elie Geisler Illinois Institute of Technology

Sanjay Goel University of Minnesota in Duluth

Andrew Hargadon University of California, Davis

Steven Harper James Madison University

Donald E. Hatfield Virginia Polytechnic Institute and State University

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I am also very grateful to the many students of the Technological Innovation and New Product Development courses I have taught at New York University, INSEAD, Boston University, and University of California at Santa Barbara. Not only did these students read, challenge, and help improve many earlier drafts of the work, but they also contributed numerous examples that have made the text far richer than it would have otherwise been. I thank them wholeheartedly for their patience and generosity.

Melissa A. Schilling

Glenn Hoetker University of Illinois

Sanjay Jain University of Wisconsin–Madison

Theodore Khoury Oregon State University

Rajiv Kohli College of William and Mary

Vince Lutheran University of North Carolina—Wilmington

Steve Markham North Carolina State University

Steven C. Michael University of Illinois

Robert Nash Vanderbilt University

Anthony Paoni Northwestern University

Johannes M. Pennings University of Pennsylvania

Raja Roy Tulane University

Linda F. Tegarden Virginia Tech

Oya Tukel Cleveland State University

Anthony Warren The Pennsylvania State University

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Preface vi 1 Introduction 1

PART ONE Industry Dynamics of Technological Innovation 13 2 Sources of Innovation 15 3 Types and Patterns of Innovation 43 4 Standards Battles and Design Dominance 67 5 Timing of Entry 89

PART TWO Formulating Technological Innovation Strategy 107 6 Defining the Organization’s Strategic Direction 109 7 Choosing Innovation Projects 129 8 Collaboration Strategies 153 9 Protecting Innovation 183

PART THREE Implementing Technological Innovation Strategy 209 10 Organizing for Innovation 211 11 Managing the New Product Development Process 235 12 Managing New Product Development Teams 265 13 Crafting a Deployment Strategy 283

INDEX 311

Brief Contents

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Chapter 1 Introduction 1 The Importance of Technological Innovation 1 The Impact of Technological Innovation on Society 2 Innovation by Industry: The Importance of Strategy 4

The Innovation Funnel 4 The Strategic Management of Technological Innovation 6

Summary of Chapter 9 Discussion Questions 10 Suggested Further Reading 10 Endnotes 10

PART ONE INDUSTRY DYNAMICS OF TECHNOLOGICAL INNOVATION 13

Chapter 2 Sources of Innovation 15 Getting an Inside Look: Given Imaging’s Camera Pill 15 Overview 19 Creativity 20

Individual Creativity 20 Organizational Creativity 20

Translating Creativity Into Innovation 22 The Inventor 22 Innovation by Users 24 Research and Development by Firms 26 Firm Linkages with Customers, Suppliers, Competitors, and Complementors 27

Universities and Government-Funded Research 28 Private Nonprofit Organizations 32

Innovation in Collaborative Networks 32 Technology Clusters 34 Technological Spillovers 37

Summary of Chapter 37 Discussion Questions 38 Suggested Further Reading 39 Endnotes 39

Chapter 3 Types and Patterns of Innovation 43 Tesla Motors 43 History of Tesla 43 The Roadster 44 The Model S 45 The Future of Tesla 46 Overview 47 Types of Innovation 48

Product Innovation versus Process Innovation 48 Radical Innovation versus Incremental Innovation 48 Competence-Enhancing Innovation versus Competence-Destroying Innovation 49 Architectural Innovation versus Component Innovation 50 Using the Dimensions 51

Technology S-Curves 51 S-Curves in Technological Improvement 52 S-Curves in Technology Diffusion 54 S-Curves as a Prescriptive Tool 56 Limitations of S-Curve Model as a Prescriptive Tool 57

Technology Cycles 57 Summary of Chapter 63

Contents

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Discussion Questions 64 Suggested Further Reading 64 Endnotes 65

Chapter 4 Standards Battles and Design Dominance 67 A Battle Emerging in Mobile Payments 67 Overview 70 Why Dominant Designs are Selected 71

Learning Effects 71 Network Externalities 73 Government Regulation 75 The Result: Winner-Take-All Markets 76

Multiple Dimensions of Value 77 A Technology’s Stand-Alone Value 77 Network Externality Value 77 Competing for Design Dominance in Markets with Network Externalities 82 Are Winner-Take-All Markets Good for Consumers? 84

Summary of Chapter 86 Discussion Questions 86 Suggested Further Reading 87 Endnotes 87

Chapter 5 Timing of Entry 89 From SixDegrees.com to Facebook: The Rise of Social Networking Sites 89 Overview 93 First-Mover Advantages 93

Brand Loyalty and Technological Leadership 93 Preemption of Scarce Assets 94 Exploiting Buyer Switching Costs 94 Reaping Increasing Returns Advantages 95

First-Mover Disadvantages 95 Research and Development Expenses 96 Undeveloped Supply and Distribution Channels 96 Immature Enabling Technologies and Complements 96 Uncertainty of Customer Requirements 97

Factors Influencing Optimal Timing of Entry 99 Strategies to Improve Timing Options 103 Summary of Chapter 103 Discussion Questions 104 Suggested Further Reading 104 Endnotes 105

PART TWO FORMULATING TECHNOLOGICAL INNOVATION STRATEGY 107

Chapter 6 Defining the Organization’s Strategic Direction 109 Reinventing Hotels: citizenM 109 Overview 111 Assessing The Firm’s Current Position 111

External Analysis 111 Internal Analysis 115

Identifying Core Competencies and Dynamic Capabilities 119

Core Competencies 119 The Risk of Core Rigidities 120 Dynamic Capabilities 121

Strategic Intent 121 Summary of Chapter 126 Discussion Questions 126 Suggested Further Reading 127 Endnotes 127

Chapter 7 Choosing Innovation Projects 129 The Mahindra Shaan: Gambling on a Radical Innovation 129 Overview 131 The Development Budget 131 Quantitative Methods for Choosing Projects 133

Discounted Cash Flow Methods 133 Real Options 138

Disadvantages of Quantitative Methods 140 Qualitative Methods for Choosing Projects 140

Screening Questions 141 The Aggregate Project Planning Framework 143 Q-Sort 145

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Combining Quantitative and Qualitative Information 145

Conjoint Analysis 145 Data Envelopment Analysis 147

Summary of Chapter 149 Discussion Questions 149 Suggested Further Reading 150 Endnotes 150

Chapter 8 Collaboration Strategies 153 Ending HIV? Sangamo Biosciences and Gene Editing 153 Correcting Monogenic Diseases 153 Drug Development and Clinical Trials 155 Competing Technologies 156 Sangamo’s Partnerships 157 A World-Changing Opportunity: Creating Immunity to HIV 158 The Future . . . 159 Overview 160 Reasons for Going Solo 161

1. Availability of Capabilities 161 2. Protecting Proprietary Technologies 161 3. Controlling Technology Development

and Use 162 4. Building and Renewing Capabilities 162

Advantages of Collaborating 163 Types of Collaborative Arrangements 164

Strategic Alliances 165 Joint Ventures 167 Licensing 167 Outsourcing 168 Collective Research Organizations 170

Choosing a Mode of Collaboration 170 Choosing and Monitoring Partners 173

Partner Selection 173 Partner Monitoring and Governance 174

Summary of Chapter 177 Discussion Questions 178 Suggested Further Reading 179 Endnotes 179

Chapter 9 Protecting Innovation 183 The Digital Music Distribution Revolution 183 Fraunhofer and MP3 183 Napster Takes the Lead 184 iTunes Just in Time 185 Overview 187 Appropriability 188 Patents, trademarks, and copyrights 188

Patents 189 Trademarks and Service Marks 194 Copyright 195

Trade Secrets 196 The Effectiveness and Use of Protection Mechanisms 197

Wholly Proprietary Systems versus Wholly Open Systems 198

Advantages of Protection 200 Advantages of Diffusion 201

Summary of Chapter 204 Discussion Questions 205 Suggested Further Reading 205 Endnotes 206

PART THREE IMPLEMENTING TECHNOLOGICAL INNOVATION STRATEGY 209

Chapter 10 Organizing for Innovation 211 Organizing for Innovation at Google 211 Overview 213 Size and Structural Dimensions of the Firm 214

Size: Is Bigger Better? 214 Structural Dimensions of the Firm 216

Centralization 216 Formalization and Standardization 217 Mechanistic versus Organic Structures 218 Size versus Structure 218

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The Ambidextrous Organization: The Best of Both Worlds? 220

Modularity and “Loosely Coupled” Organizations 222

Modular Products 222 Loosely Coupled Organizational Structures 223

Managing Innovation Across Borders 226 Summary of Chapter 229 Discussion Questions 230 Suggested Further Reading 230 Endnotes 231

Chapter 11 Managing the New Product Development Process 235 Skullcandy: Developing Extreme Headphones 235 The Idea 235 Building an Action Sports Brand 236 Developing the Ultimate DJ Headphone 236 Overview 240 Objectives of the New Product Development Process 241

Maximizing Fit with Customer Requirements 241 Minimizing Development Cycle Time 242 Controlling Development Costs 242

Sequential Versus Partly Parallel Development Processes 243 Project Champions 245

Risks of Championing 245 Involving Customers and Suppliers in the Development Process 247

Involving Customers 247 Involving Suppliers 248 Crowdsourcing 248

Tools for Improving the New Product Development Process 249

Stage-Gate Processes 250 Quality Function Deployment (QFD)—The House of Quality 252 Design for Manufacturing 254 Failure Modes and Effects Analysis 255

Computer-Aided Design Computer- Aided Engineering/Computer-Aided Manufacturing 256

Tools for Measuring New Product Development Performance 257

New Product Development Process Metrics 259 Overall Innovation Performance 259

Summary of Chapter 259 Discussion Questions 260 Suggested Further Reading 260 Endnotes 261

Chapter 12 Managing New Product Development Teams 265 Innovation Teams at the Walt Disney Company 265 The Making of an Animated Film 265 Workspace and Collocation 266 Team Communication 266 Creating a Creative Culture 266 Overview 267 Constructing New Product Development Teams 267

Team Size 268 Team Composition 268

The Structure of New Product Development Teams 271

Functional Teams 271 Lightweight Teams 272 Heavyweight Teams 272 Autonomous Teams 272

The Management of New Product Development Teams 274

Team Leadership 274 Team Administration 274 Managing Virtual Teams 275

Summary of Chapter 278 Discussion Questions 278 Suggested Further Reading 279 Endnotes 279

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Chapter 13 Crafting a Deployment Strategy 283 Deployment Tactics in the Global Video Game Industry 283 Pong: The Beginning of an Era 283 The Emergence of 8-Bit Systems 284 The 16-Bit Video Game Systems 284 32/64-Bit Systems 285 128-Bit Systems 286 The Seventh Generation: A Second Round of Competition in 128-bit Systems 288 The Eighth Generation: Increasing Competition from Mobile Devices 289 Overview 291 Launch Timing 292

Strategic Launch Timing 292 Optimizing Cash Flow versus Embracing Cannibalization 293

Licensing and Compatibility 294 Pricing 295 Distribution 297

Selling Direct versus Using Intermediaries 297 Strategies for Accelerating Distribution 299

Marketing 301 Major Marketing Methods 301 Tailoring the Marketing Plan to Intended Adopters 303 Using Marketing to Shape Perceptions and Expectations 305

Summary of Chapter 308 Discussion Questions 309 Suggested Further Reading 309 Endnotes 310

Index 311

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1

Chapter One

Introduction

THE IMPORTANCE OF TECHNOLOGICAL INNOVATION

In many industries technological innovation is now the most important driver of competitive success. Firms in a wide range of industries rely on products developed within the past five years for almost one-third (or more) of their sales and profits. For example, at Johnson & Johnson, products developed within the last five years account for over 30 percent of sales, and sales from products developed within the past five years at 3M have hit as high as 45 percent in recent years.

The increasing importance of innovation is due in part to the globalization of mar- kets. Foreign competition has put pressure on firms to continuously innovate in order to produce differentiated products and services. Introducing new products helps firms protect their margins, while investing in process innovation helps firms lower their costs. Advances in information technology also have played a role in speeding the pace of innovation. Computer-aided design and computer-aided manufacturing have made it easier and faster for firms to design and produce new products, while flex- ible manufacturing technologies have made shorter production runs economical and have reduced the importance of production economies of scale.1 These technologies help firms develop and produce more product variants that closely meet the needs of narrowly defined customer groups, thus achieving differentiation from competi- tors. For example, in 2015, Toyota offered 21 different passenger vehicle lines under the Toyota brand (e.g., Camry, Prius, Highlander, and Tundra). Within each of the vehicle lines, Toyota also offered several different models (e.g., Camry L, Camry LE, and Camry SE) with different features and at different price points. In total, Toyota offered 167 car models ranging in price from $14,845 (for the Yaris three-door lift- back) to $80,115 (for the Land Cruiser), and seating anywhere from three passengers (e.g., Tacoma Regular Cab truck) to eight passengers (Sienna Minivan). On top of this, Toyota also produced a range of luxury vehicles under its Lexus brand. Similarly, Samsung introduced 52 unique smartphones in 2014 alone. Companies can use broad portfolios of product models to help ensure they can penetrate almost every conceiv- able market niche. While producing multiple product variations used to be expensive

technological innovation The act of introducing a new device, method, or material for application to commercial or practical objectives.

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2 Chapter 1 Introduction

and time-consuming, flexible manufacturing technologies now enable firms to seam- lessly transition from producing one product model to the next, adjusting production schedules with real-time information on demand. Firms further reduce production costs by using common components in many of the models.

As firms such as Toyota, Samsung, and others adopt these new technologies and increase their pace of innovation, they raise the bar for competitors, triggering an industrywide shift to shortened development cycles and more rapid new product introductions. The net results are greater market segmentation and rapid product obso- lescence.2 Product life cycles (the time between a product’s introduction and its with- drawal from the market or replacement by a next-generation product) have become as short as 4 to 12 months for software, 12 to 24 months for computer hardware and consumer electronics, and 18 to 36 months for large home appliances.3 This spurs firms to focus increasingly on innovation as a strategic imperative—a firm that does not innovate quickly finds its margins diminishing as its products become obsolete.

THE IMPACT OF TECHNOLOGICAL INNOVATION ON SOCIETY

If the push for innovation has raised the competitive bar for industries, arguably mak- ing success just that much more complicated for organizations, its net effect on society is more clearly positive. Innovation enables a wider range of goods and services to be delivered to people worldwide. It has made the production of food and other neces- sities more efficient, yielded medical treatments that improve health conditions, and enabled people to travel to and communicate with almost every part of the world. To get a real sense of the magnitude of the effect of technological innovation on society, look at Figure 1.1, which shows a timeline of some of the most important technologi- cal innovations developed over the last 200 years. Imagine how different life would be without these innovations!

The aggregate impact of technological innovation can be observed by looking at gross domestic product (GDP). The gross domestic product of an economy is its total annual output, measured by final purchase price. Figure 1.2 shows the average GDP per capita (that is, GDP divided by the population) for the world, developed countries, and developing countries from 1969 to 2014. The figures have been con- verted into U.S. dollars and adjusted for inflation. As shown in the figure, the average world GDP per capita has risen steadily since 1969. In a series of studies of economic growth conducted at the National Bureau of Economic Research, economists showed that the historic rate of economic growth in GDP could not be accounted for entirely by growth in labor and capital inputs. Economist Robert Merton Solow argued that this unaccounted-for residual growth represented technological change: Technologi- cal innovation increased the amount of output achievable from a given quantity of labor and capital. This explanation was not immediately accepted; many researchers attempted to explain the residual away in terms of measurement error, inaccurate price deflation, or labor improvement. But in each case the additional variables were unable to eliminate this residual growth component. A consensus gradually emerged that the

gross domestic product (GDP) The total annual output of an economy as measured by its final purchase price.

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Chapter 1 Introduction 3

FIGURE 1.1 Timeline of Some of The Most Important Technological Innovations In The Last 200 Years

1800 - 1800—Electric battery - 1804—Steam locomotive - 1807—Internal combustion engine - 1809—Telegraph - 1817—Bicycle 1820 - 1821—Dynamo - 1824—Braille writing system - 1828—Hot blast furnace - 1831—Electric generator - 1836—Five-shot revolver 1840 - 1841—Bunsen battery (voltaic cell) - 1842—Sulfuric ether-based anesthesia - 1846—Hydraulic crane - 1850—Petroleum refining - 1856—Aniline dyes 1860 - 1862—Gatling gun - 1867—Typewriter - 1876—Telephone - 1877—Phonograph - 1878—Incandescent lightbulb 1880 - 1885—Light steel skyscrapers - 1886—Internal combustion automobile - 1887—Pneumatic tire - 1892—Electric stove - 1895—X-ray machine 1900 - 1902—Air conditioner (electric) - 1903—Wright biplane - 1906—Electric vacuum cleaner - 1910—Electric washing machine - 1914—Rocket 1920 - 1921—Insulin (extracted) - 1927—Television - 1928—Penicillin - 1936—First programmable computer - 1939—Atom fission 1940 - 1942—Aqua lung - 1943—Nuclear reactor - 1947—Transistor - 1957—Satellite - 1958—Integrated circuit 1960 - 1967—Portable handheld calculator - 1969—ARPANET (precursor to Internet) - 1971—Microprocessor - 1973—Mobile (portable cellular) phone - 1976—Supercomputer 1980 - 1981—Space shuttle (reusable) - 1987—Disposable contact lenses - 1989—High-definition television - 1990—World Wide Web protocol - 1996—Wireless Internet 2000 - 2003—Map of human genome

residual did in fact capture techno- logical change. Solow received a Nobel Prize for his work in 1981, and the residual became known as the Solow Residual.4 While GDP has its shortcomings as a measure of standard of living, it does relate very directly to the amount of goods consumers can purchase. Thus, to the extent that goods improve quality of life, we can ascribe some beneficial impact of technological innovation.

Sometimes technological inno- vation results in negative extern- alities. Production technologies may create pollution that is harmful to the surrounding communities; agri- cultural and fishing technologies can result in erosion, elimination of natural habitats, and depletion of ocean stocks; medical technolo- gies can result in unanticipated consequences such as antibiotic- resistant strains of bacteria or moral dilemmas regarding the use of genetic modification. However, technology is, in its purest essence, knowledge—knowledge to solve our problems and pursue our goals.5 Technological innovation is thus the creation of new knowledge that is applied to practical prob- lems. Sometimes this knowledge is applied to problems hastily, without full consideration of the consequences and alternatives, but overall it will probably serve us better to have more knowledge than less.

externalities Costs (or benefits) that are borne (or reaped) by individuals other than those responsible for creating them. Thus, if a business emits pollutants in a community, it imposes a nega- tive externality on the community members; if a business builds a park in a commu- nity, it creates a positive external- ity for community members.

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4 Chapter 1 Introduction

INNOVATION BY INDUSTRY: THE IMPORTANCE OF STRATEGY

As will be shown in Chapter Two, the majority of effort and money invested in tech- nological innovation comes from industrial firms. However, in the frenetic race to innovate, many firms charge headlong into new product development without clear strategies or well-developed processes for choosing and managing projects. Such firms often initiate more projects than they can effectively support, choose projects that are a poor fit with the firm’s resources and objectives, and suffer long development cycles and high project failure rates as a consequence (see the accompanying Research Brief for a recent study of the length of new product development cycles). While innova- tion is popularly depicted as a freewheeling process that is unconstrained by rules and plans, study after study has revealed that successful innovators have clearly defined innovation strategies and management processes.6

The Innovation Funnel Most innovative ideas do not become successful new products. Many studies suggest that only one out of several thousand ideas results in a successful new product: Many projects do not result in technically feasible products and, of those that do, many fail to earn a commercial return. According a 2012 study by the Product Development and Management Association, only about one in nine projects that are initiated are success- ful, and of those that make it to the point of being launched to the market, only about half earn a profit.7 Furthermore, many ideas are sifted through and abandoned before

FIGURE 1.2 Gross Domestic Product per Capita, 1969– 2014 (in Real 2010 $US Billions)

Source: USDA Economic Research Service, International Macroeconomic Dataset (http://www. ers.usda.gov, accessed August 17, 2015)

19 69

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Chapter 1 Introduction 5

Research Brief How Long Does New Product Development Take?a

In a large-scale survey administered by the Prod- uct Development and Management Association (PDMA), researchers examined the length of time it took firms to develop a new product from initial concept to market introduction. The study divided new product development projects into catego- ries representing their degree of innovativeness: “radical” projects, “more innovative” projects, and “incremental” projects. On average, incremental projects took only 33 weeks from concept to mar- ket introduction. More innovative projects took

significantly longer, clocking in at 57 weeks. The development of radical products or technologies took the longest, averaging 82 weeks. The study also found that on average, for more innovative and radical projects, firms reported significantly shorter cycle times than those reported in the pre- vious PDMA surveys conducted in 1995 and 2004. a Adapted from Markham, SK, and Lee, H. “ Product Development and Management Association’s 2012 comparative performance assessment study,” Journal of Product Innovation Management 30 (2013), issue 3: 408–429.

a project is even formally initiated. According to one study that combined data from prior studies of innovation success rates with data on patents, venture capital fund- ing, and surveys, it takes about 3,000 raw ideas to produce one significantly new and successful commercial product.8 The pharmaceutical industry demonstrates this well—only one out of every 5,000 compounds makes it to the pharmacist’s shelf, and only one-third of those will be successful enough to recoup their R&D costs.9 Further- more, most studies indicate that it costs at least $1.5 billion and a decade of research to bring a new Food and Drug Administration (FDA)-approved pharmaceutical product to market! 10 The innovation process is thus often conceived of as a funnel, with many potential new product ideas going in the wide end, but very few making it through the development process (see Figure 1.3).

FIGURE 1.3 The New Prod- uct Develop- ment Funnel in Pharmaceuticals

125 Leads 2-3 drugs tested 1 drug Rx

5,000 Compounds

Discovery & Preclinical 3–6 years

Clinical Trials 6–7 years

Approval ½–2 years

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6 Chapter 1 Introduction

The Strategic Management of Technological Innovation Improving a firm’s innovation success rate requires a well-crafted strategy. A firm’s innovation projects should align with its resources and objectives, leveraging its core competencies and helping it achieve its strategic intent. A firm’s organizational struc- ture and control systems should encourage the generation of innovative ideas while also ensuring efficient implementation. A firm’s new product development process should maximize the likelihood of projects being both technically and commercially successful. To achieve these things, a firm needs (a) an in-depth understanding of the dynamics of innovation, (b) a well-crafted innovation strategy, and (c) well-designed processes for implementing the innovation strategy. We will cover each of these in turn (see Figure 1.4).

In Part One, we will cover the foundations of technological innovation, gaining an in-depth understanding of how and why innovation occurs in an industry, and why some innovations rise to dominate others. First, we will look at the sources of innova- tion in Chapter Two. We will address questions such as: Where do great ideas come from? How can firms harness the power of individual creativity? What role do cus- tomers, government organizations, universities, and alliance networks play in creating innovation? In this chapter we will first explore the role of creativity in the generation of novel and useful ideas. We then look at various sources of innovation, including the role of individual inventors, firms, publicly sponsored research, and collaborative networks.

In Chapter Three, we will review models of types of innovation (such as radical ver- sus incremental and architectural versus modular) and patterns of innovation (including s-curves of technology performance and diffusion, and technology cycles). We will address questions such as: Why are some innovations much harder to create and imple- ment than others? Why do innovations often diffuse slowly even when they appear to offer a great advantage? What factors influence the rate at which a technology tends to improve over time? Familiarity with these types and patterns of innovation will help us distinguish how one project is different from another and the underlying factors that shape the project’s likelihood of technical or commercial success.