The Albatross Of Product Innovation

The Albatross Of Product Innovation Tasadduq Shervani and Philip C, Zerrillo

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roduct innovation is the driving force behind many of today’s most successful companies. These firms have devoted tremendous resources to the new product development process in a dynamic attempt to meet the needs of the marketplace. New products are, in fact, a central element of their competitive strategy. The potential benefits of successful product innovation-prolonged growth, superior returns, strong investor interest, esprit de corps among employees-are undeniable. However, the question arises: Are there conditions under which product innovation can detract from corporate performance? In our opinion, a narrow focus on product innovation can detract from firm performance under two conditions. First, the ability of an organization to profit from new products can be severely hampered if it has neglected other functions and business processes that allow it to extract greater profits from innovative products. Second, these “other” functions and business processes can themselves be arenas for innovation, suggesting that firms should focus on broadbased innovation, or innovation in multiple functions and business processes. The two scenarios described below capture the situations in which product innovation either does not or cannot deliver results for a firm. Scenario 1: “All we need is a new product.” A company has developed a new product that is superior to and differentiated from the competition. Believing they have created a “winner” and that “the job is done,” management awaits the rewards associated with their Herculean product innovation effort. Unfortunately, the firm is unable to capitalize on the new product’s potential. Competitors rapidly develop knock-off products and take away market share, leaving the firm demoralized and shaken. Managers are left wonThe Albatross Of Product Innovation

dering how they are ever going to make meaningful and sustained gains in competitive position. The firm’s business partners are left expressing a similar sentiment, reducing the likelihood of much support for any future new product introductions. A case in point is the experience of Sara Lee Corporation, which introduced the Wonderbra in 1994. This product innovation, a much ballyhooed departure from conventional products available in the lingerie business, was already a huge success in British markets. Not only did Sara Lee have a new product, it also had all the public relations opportunities inherent in introducing a novel new product. The Wonderbra had immediate product and, more important, brand recognition. Competitor VF Corporation did not begin to sell its copycat product until after Sara Lee had already established sales in the U.S. market. However, despite Sara Lee’s early presence in the market, VF attained national distribution of its copycat product five months ahead of Sara Lee. This it did by concentrating on advances in using information technology, streamlining its distribution system, and managing available stocks at the retail level. Although VF did not invent the product and did not enter the market until after Sara Lee had tested the waters, its superior business system allowed it to match the needs of the marketplace better. Relying on new products alone, to the exclusion of investments aimed at strengthening the 57

entire business system can leave a firm vulnerable to competitors. While such firms are investing extensively in new product development, their competitors may be strengthening other functions and business processes, such as marketing systems, information systems, accounting and financial systems, employee compensation and reward systems, and so on. By exploiting their advantages in these “other” functions and business processes, such competitors are often able to thwart the product innovator.

Scenario 2: “Our product is a commodity.” Often, companies look at their products and services and see commodities. Despite a strong desire to develop new products, management perceives that the opportunity for a dramatically superior product is fleeting. So the firm gives up and continues with business as usual, concluding that innovation cannot occur in that industry. As prices fall and margins erode. rnanagement eventually finds that the firm no longer has the resources to sustain product innovation, thus further reinforcing the commodity status of its products. A case in point is the experience of the airline industry. Asking airline executives in the early 1980s about innovation in their industry would have brought many groans but few suggestions. Most managers believed a seat was a seat, and airlines that wished to prosper would have to tend to business better than their competitors to survive. Analysts and managers declared that the competitive battle would be fought on the ability to manage the major elements of airlines’ cost structures-fuel, labor, and capital. To most firms, cost-cutting is a fairly straightforward exercise in which investments and expenditures are trimmed. However, the experience of Southwest Airlines is an exception to this rule. Southwest focused on cutting costs through innovation in human resource development, finance, marketing, and operations. To increase operational efficiency, Southwest standardized the type of plane it flew. This meant that pilots, maintenance personnel, and ground crew required training on only one type of aircraft, thereby cutting staffing and training costs. Ground crews were able to shorten turnaround cycles for aircraft, enabling Southwest to fly its planes about 15 percent more than the industry average. The increased use of aircraft reduced Southwest’s fleet size relative to competitors, thereby lowering its capital requirements. Southwest Airlines has also been a leader in several marketing innovations, such as bypassing travel agents to reduce the cost of ticket handling and being first to market with ticketless travel. And it has made tremendous strides in capitaliz58

ing on good management-labor relations-something quite atypical of the airline industry. In 1994, it reached a pioneering agreement with its pilots’ union: In exchange for 700 stock options per pilot per year over a ten-year period, Southwest pilots agreed to a five-year pay freeze, with only three raises (of 3 percent each) in the following five-year period. The net result of this agreement will be to stabilize Southwest’s labor cost and lower it relative to competitors. With predictably lower costs, Southwest can cut prices, increase market share, and enhance the probability that the stock options held by pilots will eventually be worth more than the potential salary increases they have forgone. In fact, Southwest pilots stand to make approximately half a million dollars each if the value of their stock appreciates at about 20 percent annually-considerably below the historical average. The bottom line is that Southwest Airlines practices broad-based innovation in its development of such novel compensation practices, marketing, finance, and operations. Southwest took an industry with a commodity product and found ways to innovate in other aspects of the business system. Other airlines do not appear to be able to match this competitive advantage. A seat may indeed be a seat, but Southwest realized that the battle will be won by the competitor with the best overull business system. BROAD-BASED

INNOVATION

he two scenarios discussed above generally occur because firms possess a decidT edly narrow concept of innovation. They suffer from what could be termed product paralysis, continually looking to new products as the starting point for innovation. Succinctly stated, companies focused on product innovation experience difficulties both when they Carz develop new products (“An innovative product is all we need”) and when they camot (“Our product is a commodity”). Unfortunately, product innovators are often unable to see beyond mere products. The fallacy of this approach can best be articulated by repeating the advice Compaq CEO Eckhard Pfeiffer gave to the executive team at Microsoft. As recounted by Microsoft Vice President Jeff bikes (Schlender 19951, Pfeiffer told them that if we [Microsoft] are serious about taking on the responsibility of driving the whole computer industry to the next level, [then] a great vision and great products won’t be enough. We have to master all the nuts and bolts of husiness-manufacturing, sales and marketing, and product support operations-

and we must have a business plan that matches the new marketplace. E.M. Rogers (1983) defined the term “innovation” as an idea, practice, or object that is perceived as new. Innovation in business goes much farther than just inventing new products; it can occur in every business process or functional area of a firm. Indeed, consistent and effective innovation requires excellence throughout the entire organization. Firms can innovate by developing new products (product innovation), new manufacturing processes and techniques (manufacturing innovation), new ways to reach customers or new customers to reach (marketing innovation), new approaches to rewarding and empowering employees (human resource innovation), new ways of approaching financing and investment decisions (financial innovation), new methods of acquiring, storing, transforming, and transmitting information (information innovation), new types of organization structures and processes (organizational innovation), and new tools and techniques for measuring and allocating costs (accounting innovation). Companies that restrict their definition of innovation to include only new products are, in effect, limiting their opportunities to achieve a sustainable competitive advantage. l

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firms consciously target or avoid certain competitors based on the weakness or strength of their entire business system. Third, other functions and business processes can themselves be areas in which innovation takes place. The reality of today’s marketplace is that product innovation affords firms less and less insulation from their competitors. It has become clear that the ultimate battle in any industry will be won not at the level of product versus product, but rather at the level of business system versus business system. Some of today’s most successful corporations downplay the importance of product-only innovation, focusing instead on innovating all facets of the business system. Put differently, a focus on broad-based innovation should be seen as a way of enabling a firm to achieve market leadership, not just as a way of introducing and supporting new products. As in the case of Southwest Airlines, recognizing that innovation may not involve new products at all is the first step in developing a truly competitive business system.

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Figure Forms Of Innovation And The Shortcomings They Address

Benefits Of Broad-Based Innovation The benefits of broad-based innovation are threefold. First, new and improved functions and business processes provide firms with a systemwide supporting infrastructure for their product innovation. By developing competitive advantages, or at least parity, across the entire business system, firms are better able to launch and support new products. Developing systemwide competencies allows the product innovator to extract greater revenues and profits from new products. On the other hand, firms that emphasize product innovation and neglect the systems can be victimized by smart competitors who copy their products and then use their superiority in other functions and business processes to gain a competitive advantage. Second, developing a competitive business system often acts as an entry barrier to would-be competitors. A formidable advantage in any aspect of the business system can deter potential competitors just as much as a new product or technological advantage. On the other hand, as displayed in the Figure, pockets of weakness in the business system render a company vulnerable to competitive activity, It is no secret that some The Albatross

Of Product

Innovation

unng process ration structures and

physical/financial resources

human

efficient1

resources

Information Technology

New WdyS information

Accounting

New tools and techniques for assessing/ allocating costs

Unable to decide appropriately on resource commitments

Financial

New ways to approach financing/investment/ dividend decisions

LJnable to maximize shareholder value

to use

Lack of speed, efficiency; lack of information for making decisions

Persistence

Of Product-Only

Innovation

Why do we continue to see so much emphasis on product novelty? At least three factors contribute to the creation of a product-only approach to innovation in many firms: cultural issues, incremental decision making, and erroneous attrikutions. Cultural Issues. Remarkably, the organizational culture of product innovators can often be their undoing in the marketplace. Such companies create incentive structures that favor developing new products to the exclusion of many other areas. A quick survey of such companies would reveal a preponderance of incentives for employees, such as time off, cash bonuses, internal recognition, and promotions for their product discoveries. Meanwhile, purchasing agents, channel managers, information support teams, and human resource coordinators often have limited incentives to go beyond present circumstances. Within these de-emphasized processes and functions, employees often suffer from low self-csteem and diminished morale, which only serves to filrther stifle creative initiatives. Measurement systems within firms can also create a bias in favor of investing in new products. Returns from new products are perceived to be- more immejiate. more directly measurable, more quantifiable, and easier to interpret than are investments in the “support” elements of the business system. For instance, the accounting systems of most firms are set up to detail the costs and revenues of each new product. But it is more difficult to measure the effects of information advances or changes in the organizational structure on ^ revenues and costs. Consequently, firms are reluctant to make investments in these “non-revenue producing” areas. Returns from such investments are often less immediate and harder to justify because potential contributions to the bottom line are much less obvious. In recent years, it has been suggested that firms should focus their finite resources on developing a limited number of core processes or functions and seek to cooperate with partners who may be better suited to provide “other” services. Although we are not suggesting that firms s’lould ignore this advice, we wish to inject the following note of caution. If a firm’s strategy is to focus on developing a core competency in product innovation, it is imperative that the firm concomitantly develop a competency in managing out-

sourcing relationships. Historically, companies that emphasize internal new product research and development often have great difficulty in managing outsourcing relationships. They are seldom able to outsource effectively because their culture emphasizes internal development. This orientation also makes it more difficult to justify investment in areas other than product innovation. Incremental Decision Making. Managers constantly cite a “core competency of product development” as the reason for neglecting efforts in systemwide innovation. But they also fail to invest in supporting infrastructure because of incremental decision processes. They may be aware of their firm’s shortcomings in several functional areas or processes. However, when decisions are made to invest marginal dollars, their natural inclination is to invest in new products.

Investment in product innovation is not only politically palatable within their organization, it is also demanded by outside constituents as a tangible signal of the firm’s desire to be an industry leader. The pressure for immediate results and the tenuous employment picture for many corporate managers has only reinforced their focus on product innovation. New product introductions serve as a material rallying point for mobilizing organizational resources. And when they work they stand as shining examples for management, shareholders, and employees to behold. Erroneous Attributions. Adding further to this problem is the self-inspection process so often encountered at product-oriented firms. In diagnosing a product failure, a common attribution is that the new products are unsuccessful because of some inadequacy in either the R&D process or in the end product. In a knee-jerk reaction, firms reinvest in the new product development process with a vengeance. R&D budgets are often raised while investment in supporting processes and functions is slashed. IJnfortunately, this only serves to exaggerate the deficiencies found in ‘*other” functions and processes of the business system. As they continue to fall behind, such firms ultimately are unable to compete in the marketplace-not because their products are inadequate, but because the rest of their business system does not allow them to interact efficiently with their potential market partners. Consequences

Of Product-Only

Innovation

A failure to dedicate resources to systemwide innovation exacerbates the problems of many product innovators by further isolating them from the marketplace. The firm’s customers can be under competitive pressures of their own, and increasingly want suppliers who are strong across Business

Horizons

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1997

the entire business system, not just those who can make great new products. In other words, threshold levels of competency in every aspect of the business system are needed to conduct business with customers who have developed stateof-the-art business systems of their own. Today, these customers are dictating how business will be transacted; they have limited patience with suppliers whose antiquated processes do not allow for the creation of systemwide efficiencies in the value chain. A rather simple illustration occurred recently when Wal-Mart sent notice to a number of large manufacturers stating it would no longer accept invoices from multiple divisions. Several wonderful product innovators had tremendous difficulty trying to coordinate their supply chains with different product divisions that historically had operated autonomously. Specialized divisions within firms were often unaware of the marketing, ordering, delivery, billing, and collection processes employed by their counterpart divisions. This failure to develop internal information flows is an outgrowth of both a lack of information technology and a failure to modify organizational design. Consequently, this lack of internally coordinated processes adversely affected the bargaining positions of these multi-division firms in their negotiations with Wal-Mart. Just as the lack of systemwide infrastructure isolates businesses from their customers, it also inevitably reduces their new product success rate. The probability of successful innovation is reduced for three reasons. First, the inability to interact with customers across the entire business system reduces the opportunity to develop innovative ideas. Innovations generally emerge from the interactions between buyers with needs and sellers with potential solutions. Second, interaction among exchanging firms leads to a combination of skill sets and allows for the interplay of corporate knowledge structures. This exchange of corporate knowledge may enable the interacting firms to achieve objectives that would not be possible for either firm acting individually. Third, such interplay is generally necessary for successful innovation if for no other reason than it helps to develop a ready market for the eventual innovation. By innovating in concert with the members of the firm’s value chain, the creation of an immediate market is more likely. Innovating in isolation leads to a nail-biting experience for managers as they anxiously wait to see whether their expectations of customer intentions are realizable. By specializing in a limited number of processes and functions and failing to develop a threshold level of competence in others, a company can run the risk of steadily reducing the scope of activities it is capable of performing for The Albatross Of Product Innovation

customers. Over time, companies that interact on only a limited number of the elements of the business system will jeopardize their understanding of customers’ needs and the potential for developing new markets and solutions. By reducing their points of contact with customers, their opportunities for business expansion in the relationship are limited. Furthermore, this detachment can reduce the number of internal advocates within a customer buying center. By distancing their functional contacts, product-focused firms can find their customer relations becoming unstable.

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e have chronicled just a few instances of companies that have become innovative in their “other” business functions and processes. Although these innovations may be short-lived, such advances have rapidly become the standard for survival. Consider the process of software development. In this industry, time-to-market is the paramount concern, given short product life cycles and rapid technological advances. Initially, several firms began to use project teams around the globe as a means of reducing development times. Teams are set up in several separate time zones. At the end of each business day the team forwards work to counterparts located in a distant time zone, thereby reducing the real time development cycle. This initiation of a new organizational design was used to better employ human resources and reduce response time to market demands. Firms that fail to rethink their organizational designs in light of developments such as this are in danger of being left behind. Companies must realize that competition in the twenty-first century will not be product versus product but rather business system versus business system. As such, it is essential for managers to consider all the functions and processes performed by a business as potential opportunities for innovation. The 1990s have brought new challenges for business as globalization has created a new class of competition. Many of these competitors have extensive financing, protected domestic markets, and lower costs of labor and capital. But most important, they have displayed an appetite for growth that belies a willingness to sacrifice current returns in order to dominate markets over time. These competitors are often willing to

modify their business systems in a manner that allows them to thrive in multiple types of markets. They forsake the initial high margins available to product developers, but they are then able to enter markets during the early stages of expansion with minimal risk. A focus on broadbased business system innovation allows firms to create the nimbler organizations that are required in today’s marketplace. 0

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Tasadduq Shervani and Philip C. Zerrillo are assistant professors of marketing at the University of Texas at Austin, They would like to thank Raj Srivastava and Kate Gillespie for their encouragement and comments.