The Innovation Lifecycle
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The Innovation Lifecycle



Disruptive innovation suggests that successful companies engage in practices that reduce their ability to respond to disruptive market entrants. This presentation looks at the process in detail. Along ...

Disruptive innovation suggests that successful companies engage in practices that reduce their ability to respond to disruptive market entrants. This presentation looks at the process in detail. Along the way it suggests an "innovation lifecycle" similar to a product lifecycle and asks whether we can find key financial metrics that suggests a company is losing its responsiveness. The results are inconclusive.



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    The Innovation Lifecycle The Innovation Lifecycle Presentation Transcript

    • Bio-X Title slide The Innovation Lifecycle A Disruptive Innovation Thought Exercise
    • Disclaimers This presentation involves several premises used in the context of Disruptive Innovation This deck reflects my own take on Disruptive Innovation Most of the useful work in Disruptive Innovation is done by Innosight LLC. I am not a part of Innosight, LLC. The ideas in this deck center on consumer goods and services and may not be relevant to commodities et al The presentation is very general. One can find counterexamples to every statement made. No investment advice intended except, perhaps, “be careful and do your homework.” 2014 John Boddie 1
    • Low End Disruption A common form of disruptive innovation Here, a product or service marches upmarket over time by peeling successive layers of “low value” customers [i.e.. customers that will not pay top dollar for fully featured goods] away from sector leaders in a given market. This new product or service offers a differently-featured substitute with new value proposition that is appealing to these disaffected customers 2014 John Boddie 2
    • The concept was developed at Harvard Business School Photo Taken from Prof. Clayton Christensen developed these theories in the 1990’s 2014 John Boddie 3
    • Disruptive theory stemmed from a management question Prof. Christensen looked at innovative companies with great technology, capable staff and strong mangers, and noticed that these companies were losing market share despite doing everything right. 2014 John Boddie 4
    • What do we mean by “Doing everything right?” By taking all of the steps required to become a world class company… Identify your best customers Improve operational efficiency Develop higher margin products Drop underperforming parts of your portfolio You narrow the range of customers whose needs you can address …and lose the ability to respond to new market entrants 2014 John Boddie 5
    • Let’s look at a hypothetical example 2014 John Boddie 6
    • Suppose that your firm has developed a new good that serves a new and interesting market The Butterfly Labs Bitcoin Miner Runs a decryption algorithm in order to “mine” bitcoins 2014 John Boddie 7
    • The big break has finally happened and your product is attracting notice … You are now one of a few leading players in the market. You see regular (if small) profits and sheer survival is less of a struggle. 2014 John Boddie 8
    • … lessons learned during the struggle to develop a profitable product drive all four of you to compete over similar features Hashing speed Plug and play High security 2014 John Boddie 9
    • … going forward, you (and your competitors) try to grow sales volume through similar channels … these channels give each of you great data on very similar customers, improving your forecasts while driving common customer segmentations 2014 John Boddie 10
    • Obtaining data from similar channels, the major players in your space begin to cluster consumers in similar ways Secure comm 8% Gold Farming in MMORPGS 2% 1GH to 250GH 17% below1GH 2% Over 1TH 1% USB Stick 9% Home Hardware 25% Currency Mining 90% Hosted Hardware 34% Cloud Based 12% 250 to 500 GH 80% You need to grow quickly to carve out lasting positions in these rich markets 2014 John Boddie 11
    • In order to gain more money for expansion, you grow your investor pool We have 35% of this market We expect 20% sector growth this year and we are releasing 3 new products that should capture an additional 10% of the sector… …so, given our margins, investors should see 5% to 6% profit growth over the last quarter Investors love your projection-friendly market cycle 2014 John Boddie 12
    • Over time, your market saturates and it becomes more expensive to reach new customers 2014 John Boddie 13
    • But you’ve been able to entice your core customers with improved products, allowing you to maintain profitability… Faster Can be run in parallel Cloud management software You remain innovative but you’ve started to focus on improvements rather than new product lines 2014 John Boddie 14
    • At some point a competitor will start invading your customer base by driving down prices. Pricing for new features begins to flatten out quickly while old features are commoditized 250 to 500 GH/Second 2010 USD 4,000 Hosting services Exclusive mining pools 250 to 500 TH/ second and low power 2012 USD 1,000 Solve for all 10 established currencies Manage Derivatives Banking services 2020 USD 500 2025 USD 200-400 Adapted from 2014 John Boddie 15
    • At the same time… Sales peak in accepted consumer segments, making it even harder to find “new growth” customers Cryptocurrency mining service subscriptions per 1000 people 2014-2023 2014 2015 2014 John Boddie 2016 2017 2018 2019 2020 2021 2022 2023 16
    • Despite these challenges, investors expect consistent quarterly earnings forecasts 2014 John Boddie 17
    • It starts to look tough when things were finally supposed to become easy You start to worry 2014 John Boddie 18
    • You start to look for growth within the existing market rather than outside I need to lower prices I need to take customers from the competition Lower production costs! Remove low margin products and standardize components Create internal cost savings initiatives for production managers Enter large volume contracts at better prices with bigger supply chain partners 2014 John Boddie 19
    • You might improve profitability by reducing overhead costs Combine jobs and reduce headcount. Focus on terminating underperformers I need to reduce my overhead costs Let’s identify pipeline products that really help the bottom line and shelve those that don’t promise good returns Set higher productivity metrics for my departments and pressure managers to succeed 2014 John Boddie 20
    • Sales and distribution may also contribute Who is the best at selling my high-margin goods? I should focus on developing better deals with my top 5 distribution and sales partners….. Who has the best geographic reach? Who is offering the best customer incentive programs? Who will help me I reduce my service costs? Who offers the best data? 2014 John Boddie 21
    • Whew! After some struggle, you’re able to confidently project quarter-to-quarter earnings growth You are able to meet your targets You have some great core product variations in your pipeline… you are innovative You might be able to do this for years But there is a small, low end company on the horizon 2014 John Boddie 22
    • A (Hypothetical) large-scale, distributed computing approach to cryptocurrency mining. Uses mobile phone processors. No separate hardware component. Users get fractions of mined currency. 2014 John Boddie 23
    • At first... Nope, too busy engineering this new processor Hey, have any of you heard about bitcrowd? I’ll ask our marketing partners Yeah, but I wouldn’t take distributed computing too seriously. You can’t do much with it. Software, not hardware. Not my problem. 2014 John Boddie 24
    • Then... Hey, bitcrowd has over 1 m users We don’t know mobile phones. You’d need to give us $$ for a new team. We are making a ton of money from our new services software. I can’t afford to lose focus Yeah, but that 1m would never be our customers anyway I’m going all out here. I’d need a command from the top to shift resources 2014 John Boddie 25
    • Eventually... We really need to kill bitcrowd.. We have specs from software. We can do the chips and get them into production in the next year Our software team has put together something similar called Bitsource. Given Bitcrowd’s apparent market we should make a kajillion dollars. I will press our channel partners to push it once it is ready to go We have a mobile phone partner who may be willing to install the chips 2014 John Boddie 26
    • We needed to spend extra time debugging our next gen platform. We lowered our projections for the mobile phone chip volumes anyway so this was the correct approach. Finally... The software was good but marketing couldn’t design a user friendly interface that attracted customers I told our investors that we’d win this. What happened? Don’t blame us. It tested well with our current customers. Our channel partners hate it anyway. I couldn’t get them to prioritize production of the new mobile phones 2014 John Boddie 27
    • It seems that the drive to grow within a mature market often comes with a cost Remove low margin products and standardize components The company sets a new, higher bar for product margins, making it more difficult to experiment with products that don’t project great returns Enter large volume contracts at better prices with bigger supply chain partners It becomes harder to set up small product test runs and large scale suppliers may be less able to help with custom work. Create internal cost savings initiatives for production managers 2014 John Boddie Managers may respond by pressuring staff members to focus solely on products that support the current bottom line. There will be less time for experimentation. 28
    • Combine jobs and reduce headcount. Focus on terminating underperformers Identify pipeline products that really help the bottom line and shelve those that don’t promise good returns Set higher productivity metrics for my departments and pressure managers to succeed 2014 John Boddie Average workloads rise and employees have less time to experiment with new ideas. Employees that do try new things need to create outsized justifications for side work, setting impossible benchmarks for side projects. This favors products with the best, most airtight market data (i.e., those in existing markets). Managers inflate returns beyond all reason in order to preserve projects, raising the risk that they will be killed prematurely. Managers will resist any new initiatives that might risk their KPI’s; understanding that it is safer to promote similar products using known suppliers through proven sales and distribution channels. 29
    • Who is the best at selling my high-margin goods? These partners may be far less willing to sell a mix of goods or experiment with lower-margin goods Who has the best geographic reach? Who will help me I reduce my service costs? These partners may offer great prices and incentives but may make aftermarket service problematic, alienating customers that were best served by older (essentially de-featured) product models. Who is offering the best customer incentive programs? Who offers the best data? 2014 John Boddie Even if you get the best, most airtight data for existing products, this data is often only useful for similar/ next square products. The quality of the data, however, may increase the perceived risk of the unknown. 30
    • To Summarize So Far… After a period of often desperate competition, a few small companies will finally figure out how to profitably bring a new good or service to a new customer base, opening a new market These few companies will grow rapidly, often pursuing customers through similar channels. Data from these channels drives common, highly-trusted, customer segmentations Companies grow their investor base in order to expand their reach. Investors love the steady sales growth and the profits Eventually the market will mature. New growth will slow and pricing will flatten, leading companies to compete for an increased share of existing customers This struggle to preserve profit growth within a mature market will drive increased focus on efficiency, reducing the flexibility and responsiveness required for out of category competition 2014 John Boddie These companies become more vulnerable to disruption 31
    • Companies remain innovative, but much of this innovation focuses on variations around a core product line Total Sales Volume Time 2014 John Boddie 32
    • Many of the improvements boil down to better data, better margins, better efficiency The need for better market projections Profitability pressures raise new product risks Favors well defined markets Drives a focus on value Favoring batter market projects and lower costs And makes it hard to see emerging customer segments 2014 John Boddie Competition for existing customers Forcing companies to preserve profits by reducing internal costs Leading companies to double down on existing product lines 33
    • This cycle feels inescapable, a bit like the product lifecycle Sales Volume Development Growth Maturity Decline Levitt’s Product Lifecycle Time 2014 John Boddie 34
    • It is worth thinking about an innovation lifecycle that leads a product lifecycle High Resources allocated to innovation work that can impact the trajectory of a firm Development Targeted Innovation In-Category Innovation Stagnation Low Time 2014 John Boddie 35
    • Companies are often highly innovative when developing new products for new markets Development • Innovation work speeds up after the company is able to get money • Actively searching for customers • Profitability is enough- willing to live with low margins • Products are refined continually in order to find the best possible customer fit • The company is small so it behaves like one big team with constant communication Time 2014 John Boddie 36
    • They can do their best work once a direction is established Targeted Innovation • The company knows it’s customers and how to reach them • Innovations are increasingly focused on performance breakthroughs that make life easier for these customers • The company is larger and decisions are more formalized. This often free engineers and market testers to do their best work Time 2014 John Boddie 37
    • Eventually the desire for low risk, profitable goods and services drives a company to focus on “variations on a theme” In-Category Innovation • Market projections are overweighted, favoring existing customer data • The company is big and investors expect returns • It becomes safer to release differentiated core products than to investigate fundamentally new product lines • Engineers adopt incategory tech breakthroughs quickly Time 2014 John Boddie 38
    • Eventually the company focuses on cutting costs while struggling to respond to new market pressures • Sales volumes and profits begin to drop • Underserved customers and finding substitute goods that offer a better fit • Innovation increasingly focuses on cost reductions Stagnation Time 2014 John Boddie 39
    • Companies can remain profitable even while losing the ability to drive non-core innovations Are there any metrics to suggest that a company is on the far side of the innovation lifecycle? 2014 John Boddie 40
    • What have we surmised so far? Common customer segmentations This is a bit tricky to quantify. For consumer goods, check to see whether Amazon et al have distich product categories. For more opaque items, check industry surveys. A Mature Market Again, this requires a bit of judgment. Is the majority of the market held by a handful of major competitors?, Are each of the competitors making similar breakthroughs and offering similar new features on their flagship products? Does pricing seem to flatten out? Is geographic growth slowing? Price pressure/ Rapid Commoditization Internally, companies may try to standardize new product features as quickly as possible, making the COGS appear to spike with each product release and then fall. Similarly, Gross Profit margins may spike then fall. A drive toward efficiency to preserve profits Revenue per employee may rise as headcounts are trimmed and efficiency drives are launched. Similarly, the operating margins should rise. Erstwhile happy investors Stock prices should remain steady or rise. 2014 John Boddie 41
    • A warning and a reminder This presentation talks about conditions that may leave companies within a sector open for disruption. This does not mean that these companies will invariably be disrupted These are only theories, drawn from common observations about problems that face companies in mature markets. As we will see on the next pages, associated key financial measurements are problematic at best. Every company deals with challenges using its own mix of approaches. In larger companies, weakness in a product line may be entirely hidden. Even if metrics are refined and a more exacting approach evolves, guidance will never reach beyond “it’s time to pay attention to small, emerging companies in a space.” Anyone who buys or sells stock or options based solely on the listed metrics is an idiot 2014 John Boddie 42
    • Sample Troublesome Data Some potential problems: 1) Data prior to 1995 can be difficult to obtain. Remove low margin products and standardize components Operating Margins Rise Create internal cost savings initiatives for production managers Set higher productivity metrics for my departments and pressure managers to succeed Combine jobs and reduce headcount. Focus on terminating underperformers 2014 John Boddie Revenue per employee rises 2) It may be difficult to separate a natural growth in revenue per employee (the result of common technological advances) from revenue growth driven by cost cutting measures. 3) Large companies have a variety of products across several divisions. Data within a particular product division is normally unavailable. It may be hard to detect changes within a particular product division at a large company. 4) Mature markets often undergo a round of M&A, making it more difficult to track individual company performance 43
    • Example: Mahindra enters the US tractor market in 1994 and is 4th largest mfr. by 2005 Ford 7810- 6 cyl, 90 hp, 81 L fuel tank John Deere 6900- 6 cyl, 130 hp, 264 cm wheelbase, 5391 kg, 250 L fuel tank New Holland 9880- 6 cyl, 400 hp In 1994, Mahindra launched M&M USA with a 45HP consumer grade tractor. We are interested in the tractor market between 1990 and 1998 or so, when companies finally began responding to pressure in the consumer segment. Mahindra 575- 4 cyl, 45 hp, 194 cm wheelbase, 1876 kg, 35 L fuel tank. 2014 John Boddie 44
    • Let’s look at the tractor market in the US in the 1990s Was the majority of the market held by a handful of major competitors in 1990 to 1995? Were each of the competitors making similar breakthroughs and approaching similar customers with similar new features? Did pricing seem to flatten out? Was geographic growth slowing? 2014 John Boddie Highly fragmented (150 companies) but fewer than 10 owned 80% of the market Most of the market targeted big farms, innovations focused on horsepower, cab comfort, electronics Old features were quickly commoditized. Companies seemed to price in similar horsepower bands Strong round of M&A in India, China etc. in the 1990’s, suggesting maturing overseas markets 45
    • Competitors focused on in-category innovation while losing consumer market share Mahindra vs John Deere new product launches by horsepower 1992-1998 HP High Power Tractor Segment Consumer Tractor Segment 2014 John Boddie 46
    • In 2004, John Deere overhauled their marketing department in order to fight for the consumer sector [1] They were developing products and then trying to find consumers John Deere’s marketing director identified 3 interesting problems They were basing market research on current customers rather than potential customers They were hiring too many people internally, failing to diversify their talent base [1] Jan 19th 2004 How John Deere Increased Mass Consumer Market Share by Revamping its Market Research Tactics 2014 John Boddie 47
    • AGCO (purchased Massey Ferguson in 1995), and John Deere COGS and Gross Profit Margins* 1992 to 1999 Gross Profit Margins and COGS were cyclic, suggesting price pressure and commoditization of new tractor features. *charts generated by Ycharts, Data unavailable for Harvester, Case, Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford. 2014 John Boddie 48
    • AGCO and John Deere Rev/Employee and Operating Margins 1992 to 1999 Revenue per employee rises for Deere but remains flat for ACGO. Operating margins seem cyclic, within a rough 7% variation 2014 John Boddie 49
    • AGCO and John Deere Stock prices 1992 to 1999 Investors seem happy with Deere and AGCO until 2H 1998 2014 John Boddie 50
    • So, was it helpful? The Good John Deere showed the cyclic COGS and Gross Profit margins that we’d expect in a mature market where new products are rapidly commoditized. They also showed rising revenue per employee, which suggests that operations were being streamlined and becoming more efficient. Last, investors, as is their wont, seemed to love both Deere and AGCO until 1998, when they suddenly pulled away. The Bad The case is much less clear with AGCO. COGS seems cyclic but muted while gross profit margins seem to hover around 20%. Revenue per employee falls after 1995 while operating margins for both Deere and AGCO seem to hover between 8% and 15% Conclusion COGS and Revenue per employee seem to be modestly promising indicators. Operating margins and gross margins seem to be less useful 2014 John Boddie 51
    • Example: The mobile phone market looks mature There are only a handful of major competitors? AAPL, SSNLF, Motorola (Stock info for HTC, LG unavailable) Are each of the competitors making similar breakthroughs and offering similar new features on their flagship products? 4G LTE, better screens, more memory, faster processors Does pricing seem to flatten out? Old features are quickly commoditized. Companies seem to price in similar bands Is geographic growth slowing? Penetration is slowing in most countries though many consumers are purchasing better and better phones 2014 John Boddie 52
    • AAPL, SNSFL, SNE, MSI: COGS and Gross Profit Margins June 2007 to present Gross Profit Margins and COGS are cyclic, suggesting price pressure and commoditization of new mobile phone features. *charts generated by Ycharts, Data unavailable for Harvester, Case, Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford. 2014 John Boddie 53
    • AAPL, SNSFL, SNE, MSI: Rev/Employee and Operating Margins June 2007 to Present Revenue per employee has risen annually for Apple and Samsung but has remained steady for Sony and Motorola At the same time, operating margins have shown a slight climb for Apple, Samsung and Motorola over the last two years while remaining steady for Sony 2014 John Boddie 54
    • AAPL, SNSFL, SNE, MSI: Stock Price June 27 to present Apple and Samsung electronics have both done very well, while Sony and Motorola have remained relatively flat 2014 John Boddie 55
    • So, is this useful The Good AAPL, MSI and SSNLF data seems to suggest that the phone market has matured and that new features are being commoditized. All three have also become slightly more efficient since 2011, suggesting that they may be losing some flexibility. The Bad Three of the four companies are very large, with multiple product lines. It is difficult to attribute any change in key data to maturation of the mobile handset market. Conclusion Again, it seems as if companies in mobile handsets are facing commoditization pressure. It is hard to tell whether they are trying to support profits by becoming more efficient. They may do this in 2014 given the apparent downside risk of a missed profit forecast. 2014 John Boddie 56
    • Next steps More research. Additional key metrics should be tested on markets where disruptive product trajectories have injured one or more major players. Better data. Baseline growth in revenue per employee should be separated out. It is worth looking at data within a particular division or product line (if possible). Test the idea of a bellwether company. It appears that Deere and Apple may rely enough on their core product categories (tractors and phones) to act as effective signals that a market is suitably mature and that company (or divisions) within a market may not be able to address disruptive entrants. Move beyond disruption. By characterizing the innovation cycle and winnowing out the nest associated metrics, it may be possible to give companies the tools needed to explain forays into new markets and lowermargin products despite enjoying record profits from established customers. 2014 John Boddie 57