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Method of Strategic Control
7th Session in MT5016
Biz Models for Hi-Tech Products
A/Prof Jeffrey Funk
Division of Engineering and Technology Management
National University of Singapore
Sources: (Teece, 1986; Trajtenberg, 1990; Pisano and Teece, 2007; Zuckerman, 2008)
Business Model
 Value proposition: what to offer and how to
differentiate
 Customer selection: whom to serve and not serve
 Scope of activities: what activities to carry out and
what relationships to have
 Value capture: dominant sources of revenue
 Strategic control: how to sustain profitability (e.g.,
how to control architecture and standards)
Strategic Control
 Methods to ensure profitability for a product/business
 Some use the term “competitive advantage” (e.g.,
strategy class)
 Both deal with factors that enable firms to survive
and achieve above average profitability
 Survival is one outcome of good strategic control
 Ability to be profitable over long period of time (one
measure is market capitalization) is stronger outcome
 Some firms have higher profitability than others
 Some industries have higher profitability than others
Shakeouts Often Occur in an Industry
 Defining an industry is problematic
◦ Industry is defined by specific technology
◦ And a specific vertically disintegrated layer in the industry
 But for a specific layer, number of suppliers often
rises initially, but then falls
◦ Initially it is new entrants copying previous entrants
◦ But then falls through exits, mergers, and acquisitions as
economies of scale in operations and R&D increase
 How can your firm survive?
◦ This requires good method of strategic control
Source: Klepper and Simons, Industry Shakeouts and Technological Change
Change is More Rapid in Some Industries
 Some industries experience more rapid change than
others
◦ Not just economies of scale drive shakeouts
◦ Also changes in technology
 For example, Internet experienced very rapid changes
◦ Fiber optic cable
◦ Servers and routers
◦ Access devices: desk-top, laptop, and tablet computers; and
smart phones
◦ Software and content for these devices
 Has caused large changes in leading firms
Rank Company Market
Capitalization
Type of Business
1 Apple $742 Billion Hardware
3 Google $375 Billion Search
4 Microsoft $360 Billion Software
21 Facebook $211 Billion Content
26 Oracle $192 Billion Software
30 Amazon $177 Billion Online Sales
37 Intel $171 Billion Integrated Circuits
39 Samsung $162 Billion Electronics
40 IBM $158 Billion Hardware
41 Tencent $156 Billion Internet content
43 Comcast $153 Billion Cable TV, content
51 Cisco $150 Billion Hardware
53 TMSC $122 Billion Integrated Circuits
57 Qualcomm $117 Billion Integrated Circuits
98 SAP $92 Billion Software
Top IT Firms Among Top 100 - Market Capitalization (17 Feb 2015)
http://www.corpo
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100.aspx?topcase
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%2f%2fwww.lib.
uwo.ca%2fnews
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2011%2f04%2f0
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Success of Billion Dollar Startups in Internet Also
Reflects Degree of Technology Change and Lack of
Strategic Control
Software (33)
e-commerce (25)
Consumer internet (22)
Financial services (11)
Hardware: phones,
wearable computing (10)
Healthcare (5)
Energy (3)
Entertainment and Games (2)
Aerospace and defense (1)
Real Estate (1)
Education (1)
Mostly Internet
related firms
with a few
exceptions
Lots of change is also evident
when we look at most popular
web sites
 http://www.washingtonpost.com/news/the-
intersect/wp/2014/12/15/from-lycos-to-ask-
jeeves-to-facebook-tracking-the-20-most-
popular-web-sites-every-year-since-1996/
 Only 6 of the most popular web sites in 2000
were still in top 20 in 2013
◦ And they aren’t very profitable, at least from
Internet activities
Changes in Leading Internet Firms
 Initially first stop services for users were
popular
◦ Search, Portal
◦ Service provider
 Specialty sites have become most visited
sites
◦ Facebook, eBay, Apple, Amazon, Wikimedia,
Ask, Weather Co, Walmart, Answers, Linkedin,
Glam Media
 Only a few first stop services remain of
which one is very profitable
◦ Google
◦ Yahoo, Microsoft, AOL
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
assets/functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Insufficient Methods of Strategic
Control
 Being a first entrant
◦ Many first entrants fail
 Having a better product/service
◦ A better product can be copied
 Having a better product development
process might be sufficient
◦ Japanese firms used their short product
development times (and superior manufacturing
systems) to create competitive advantage for
many years.
◦ But then competition changed…..
Being First Entrant is not Sufficient
 EMI lost to GE, Siemens, and Philips in CAT
scanners
 Bowmar lost to many in electronics calculators
 Altair, IMS Associates, South West Technical,
Apple, Radio Shack, and Commodore lost to IBM
(now Lenovo), Dell, and HP in PCs
 Xerox (PARC) and Apple invented graphical user
interface, but Microsoft Windows dominates
market (until recently)
 Apple introduced first PDA (Newton) but Palm
became dominant player (at least until
emergence of “smart phones”)
Being First Entrant is not
Sufficient (2)
 Netscape invented browser, but Microsoft
dominates it
 Early MP3 suppliers lost to Apple’s iPod
 Merck was pioneer in cholesterol lowering
drugs (Zocor)
◦ but Pfizer, a late entrant, secured a superior
market position with Lipitor
 Excite and Lycos were first real search
engines, but they lost to Yahoo—
◦ and Yahoo lost to Google
Why is being first entrant insufficient?
 They had reasonably good business models along
some elements
◦ Value proposition: what to offer and how to differentiate
◦ Customer selection: whom to serve and not serve
◦ Scope of activities: what activities and relationships to
have, i.e., level of vertical integration
◦ Value capture: how to make money
 But changes occurred in these areas that prevent
them from succeeding (discussed in previous weeks)
 In this session, we pull some of these ideas together
under the term method of strategic control
Why is being first entrant insufficient? (2)
 Other firms may enter the market unless first
mover
◦ has strong natural protection against imitation and/or
strong intellectual property protection
◦ controls complementary assets or standards
◦ has advantages in scale or network effects
 These new entrants may succeed
◦ for many reasons discussed in previous weeks
◦ in this session, we discuss other reasons under concept
of strategic control
 Some new entrants provide same types of
products while other provide complementary
products (or have complementary assets)
Why is being first entrant insufficient? (3)
 Few innovations provide value by themselves
 every innovation requires complementary “assets”
- service, manufacturing, product development,
and distribution
 many innovations require complementary
technologies such as components, equipment,
materials, etc.
 network-based innovations, discussed in Week 6
(last week), require standards and complementary
products and services (hardware, software,
content, apps)
 firms must think of entire value chain when
innovating
Insufficient Methods of Strategic
Control
 Being a first entrant
◦ Many first entrants fail
 Having a better product/service
◦ A better product can be copied
 Having a better product development
process might be sufficient
◦ Japanese firms used their short product
development times (and superior manufacturing
systems) to create competitive advantage for
many years.
◦ But then competition changed…..
Better Product Development was
Insufficient for Japanese Firms
 Other firms copied Japan’s product
development process (and manufacturing
methods)
 Low-cost and efficient manufacturing
became available in China
◦ reducing Japan’s manufacturing advantages
Better Product Development was
Insufficient for Japanese Firms (2)
 Entrepreneurial startups focused on
lucrative niches as vertical disintegration
emerged
◦ Placing vertically integrated Japanese firms at
a disadvantage
 Japan only has advantages in some hi-
tech industries now
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Appropriability
 Dictionary’s definition of appropriate
◦ 1) suitable
◦ 2) to take or obtain possession (today’s focus)
 Appropriability regime – a regime in which a firm is
able to capture profits from an innovation
◦ Nature of technology: economies of scale, network effects,
tacit vs. explicit knowledge, complexity
◦ Legal mechanisms of protection: patent (17 years in U.S.),
copyright, trademark, trade secret
◦ Control of industry architecture or complementary assets
 Protecting vs. appropriating benefits
◦ You can protect your technology without appropriating the
benefits from it
Nature of Technology:
Economies of Scale
 Some technologies benefit from
economies of scale more than do other
technologies
 Manufacturing: chemicals benefit more
than does discrete-parts assembly
 Software and other digital products: very
large economies of scale and thus winner
take all
◦ Products with small market shares have trouble
surviving
Nature of Technology:
Economies of Scale (2)
 Economies of scale across different
markets: how many different markets can
your digital product be sold?
 JK Rowling’s Harry Potter is sold in
◦ Books, Movies
◦ games across the world
 Marvel Comics created more than 100
characters
◦ They profit from every movie made with these
characters
◦ Capitan America, Thor, Ant Man
Nature of Technology:
Economies of Scale (3)
 While the Long Tail enables more niche
products, the Internet has enabled
creation of superstars and super products
◦ Top 10% of one publisher’s books generate
64% of costs but 126% of profits
◦ 102 of the 8 million digital musical tracks
generated almost 1/6 of the sales
Source: Blockbusters: Hit-making, Risk-taking, and the Big Business of Entertainment)
Economies of Scale in R&D
(From Week 2)
 R&D is a fixed cost in many industries
◦ Firms must spend a certain amount on R&D just to participate
in industry
 Largest firms can spend more on R&D and thus
introduce more products and obtain higher shares
◦ Positive feedback between R&D, new products, and share
◦ Initially successful firms can spend more on R&D, which lead
to better products, higher profits, more money for R&D
 Economies of scale in R&D causes a “shakeout” in the
industry: smaller firms are acquired or exit the industry
Economies of Scale in R&D (2)
 Depends on the trajectory that the industry takes
 Firms that follow the same trajectory as the industry
will benefit
◦ Same technologies, dominant design, standards or
architecture
◦ Firms that don’t, perhaps because the industry went in a
different direction than they did, will not benefit from the
economies of scale in R&D
◦ For example, what will be the trajectory for wearable
computing, what types of designs, what architecture?
Appropriability
 Dictionary’s definition of appropriate
◦ 1) suitable
◦ 2) to take or obtain possession (today’s focus)
 Appropriability regime – a regime in which a firm is
able to capture profits from an innovation
◦ Nature of technology: economies of scale, network effects,
tacit vs. explicit knowledge, complexity
◦ Legal mechanisms of protection: patent (17 years in U.S.),
copyright, trademark, trade secret
◦ Control of industry architecture or complementary assets
 Protecting vs. appropriating benefits
◦ You can protect your technology without appropriating the
benefits from it
Legal Mechanims: (Relatively)
Strong/Tight Appropriability (1)
 Software
◦ specific lines of codes and concepts can be
protected by both patents and copyrights in the
U.S. and Europe
◦ producers can also shield the source code from
competitors and users
◦ Exceptions: inexpensive copies are available for
many popular software programs (plus music,
video games, and movies) outside rich countries
 Books
◦ Steven King and J.K. Rowling do not need to own
a printing press, publication house, or book
distributor to make money, but copies are made
Examples of (Relatively)
Strong/Tight Appropriability (2)
 Chemicals, drugs, and materials
◦ Strong patent protection
◦ Difficult to re-engineer many of these products (e.g.,
Synthetic dyes, cellophane, photographic film)
 For example Pfizer
◦ employs 330 attorneys for intellectual property protection
◦ won judgment of $56 million in 1983 involving doxycycline,
an orally administered antibiotic
◦ won $53 million in 1989 involving blood oxygenators
◦ won recent dismissal of patent infringement lawsuit
regarding COX-2 inhibitors and lawsuit alleging possible
suicidal effects of antidepressant Zoloft®.
Examples of (Relatively)
Strong/Tight Appropriability (3)
 Mobile phone services in Singapore
 Cable television in Singapore
 Internet services in Singapore
 Why do they have strong
appropriability?
 How does this affect their behavior?
 What might cause changes to this
strong appropriability?
Possible Changes to Monopolies
 Young people don’t pay for mobile
phone services
◦ Instead they use free Wi-Fi
 Young people don’t pay for cable TV
◦ Instead they watch free content on Internet
◦ Example are FB and YouTube, which profit
from advertising
 Will young people pay for Internet as
free Wi-Fi increaes
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
First , What do Economists Think?
First , What do Economists Think?
 What economists think. Protection of IP
should balance:
◦ Benefits from spread of information
◦ Enable firms to recoup investments in R&D
 Of course, firms are concerned about their
own profits and thus this determines
whether they want to strengthen or weaken
patent laws
Firms can try to strengthen
patent laws, other forms of IP
 European and US firms strengthened IP
protection in late 1980s to compete better
against Japanese firms
 E.g., European mobile phone firms did so
in GSM
 U.S. and European firms are always
trying to do this with respect to China and
India
Firms may also try to Weaken
Appropriability Regimes (1)
 Genes
◦ Possibility that firms might take
ownership of specific genes caused
concern in governments, drug companies,
and other organizations
◦ Why?
Firms may also try to Weaken
Appropriability Regimes (2)
 Open Source
◦ make source code for computer programs
available to everyone so that other
developers can build upon on the code base
◦ reduces the profits for providers of basic
software such as operating systems
 IBM supports Linux in order to weaken
Microsoft
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Standards and Appropriability
 Control of standards enable firms to make
above average profits
 So competition between firms to make
your technology the standard
 Due to big impact of standards on
competition, Most standard-setting bodies,
i.e., committees, insist that technology
providers be willing to
◦ license relevant IP before the standard-setting
body will adopt a standard that requires the
practice of technology
◦ license to all interested parties on reasonable
and non-discriminatory terms
Standards and Appropriability
 But what
◦ should the royalty rates be?
◦ is reasonable and non-discriminatory?
 Closed-door debates (and coalitions) in
standard setting committees often revolve
around these issues
 For example,
◦ IEEE recently placed less emphasis on
Qualcomm’s technology until royalty rates are
reduced below 5% of phone price
◦ Stock price fell
http://www.wsj.com/articles/qualcomms-main-profit-driver-is-under-pressure-1428967051
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Complementary Assets
 What are complementary assets?
◦ any capabilities or assets needed to commercialize an innovation
 manufacturing, marketing, sales, service, brand name, distribution
 complementary products, any new technological capabilities that are needed
to commercialize the innovation
◦ accurate description of value chain/network can help us
understand these assets
 In 1980s and 1990s focus (e.g., 1986 paper by David
Teece) was on these kinds of complementary assets:
◦ manufacturing
◦ marketing, sales
◦ service, maintenance
◦ development
Complementary Assets (2)
 Japanese firms were the leaders in manufacturing and
David Teece argued that Japanese firms would thus
dominate all hi-tech industries
 It didn’t happen………for a variety of reasons
 As discussed in previous slides
◦ Emergence of vertical disintegration has enabled separation
between design, manufacturing and other functions, which
enables firms to outsource manufacturing and other functions
◦ Focus of strategic control has changed to interface standards
and industry architecture for many industries
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Industry Architecture
 Industry architectures characterize nature
and degree of specialization of firms and
the interfaces between their products
 In addition to levels of vertical
(dis)integration, industry architecture also
◦ specifies interfaces
◦ who controls them
 For a specific industry (for a final
product), we can very roughly distinguish
between
◦ modular industry architectures
◦ integral industry architectures
Industry Architecture, Modular Design,
and Profits to Component Suppliers (1)
 Modular design often causes most profitable
firms to be suppliers of key components. For
example, in personal computers
◦ Microsoft and Intel are most profitable firms
◦ Much lower profits in disk drives, memory, displays
 Why?
◦ Microsoft and to lesser extent Intel control interfaces
between operating systems, microprocessors, etc.
◦ Other suppliers of components do not control these
interfaces and thus there is excessive competition
and low profits
Rank Company Market Capitalization Type of Business
1 Apple $742 Billion Hardware
3 Google $375 Billion Search
4 Microsoft $360 Billion Software
21 Facebook $211 Billion Content
26 Oracle $192 Billion Software
30 Amazon $177 Billion Online Sales
37 Intel $171 Billion Integrated Circuits
39 Samsung $162 Billion Electronics
40 IBM $158 Billion Hardware
41 Tencent $156 Billion Internet content
43 Comcast $153 Billion Cable TV, content
51 Cisco $150 Billion Hardware
53 TMSC $122 Billion Integrated Circuits
57 Qualcomm $117 Billion Integrated Circuits
98 SAP $92 Billion Software
http://www.corpo
rateinformation.c
om/Top-
100.aspx?topcase
=b%3b+http%3a
%2f%2fwww.lib.
uwo.ca%2fnews
%2fbusiness%2f
2011%2f04%2f0
8%2ftopglobal10
0companiesbyma
rketcapitalization.
html
Industry Architecture, Modular Design,
and Profits to Component Suppliers (2)
As noted last, week most of the profits are flowing to
modular components: exceptions are Apple, IBM, Samsung
Industry Architecture, Modular Design,
and Profits to Component Suppliers (3)
 Apple is a big exception
◦ It uses proprietary OS, microprocessor design,
and app and user interface
 Google offers “components” in the form
of Android OS and mobile ads
 Will Android (or something else) grow
stronger and thus weaken Apple
 Or will Apple grow stronger by
dominating other markets
Industry Architecture, Modular Design,
and Profits to Component Suppliers (4)
 Who will dominate new markets such as
◦ Smart watches, other forms of wearable
computing
◦ Online TV
◦ Automated Vehicles
◦ Internet of Things
◦ Home Automation
◦ Smart televisions
Industry Architecture, Modular Design,
and Profits to Component Suppliers (4)
 Other component suppliers also have big
profits
◦ Many materials such as chemicals, plastics, and
elastomers do not involve interface standards.
Similar story with drugs
◦ If the materials have a big impact on a system’s
performance or stand-alone benefits (e.g.,
drugs), profits flow to suppliers with best
materials or ones with lowest cost
 Scale is a major issue
◦ Production cost is function of scale
◦ Output from R&D also depends on scale of R&D
 Patent protection can raise profits
Industry Architecture, Modular Design,
and Profits to Component Suppliers (5)
 Movies
◦ Motion picture studios are assemblers of various
resources required to produce a movie
 actors and actresses
 director and other specialists
 finance, technology,
◦ Movies make money, but movie studios often do
not. Why?
 rents flow to the bottleneck “modules,” or
“complementary assets” that are in short supply such as
star performers
 How about Professors?
 Let’s talk about integral design
Industry Architecture, Integral
Design, and Profits to System
Suppliers (1)
 Integral architectures shift the locus of
innovation and rent appropriation up to
system level
◦ “owner” of architecture has power to set
interface protocols and to decide which
innovations are adopted and which ones are not
innovators
◦ This bargaining power creates a source of
above average profits for the system owner and
below average profits for the component
supplier
Consider the Automobile
Industry
 Cars are highly integral systems
 E.g., BMW 325ix sedan consists of
interdependent sub-systems
◦ chassis, body panels
◦ suspension system, power train
◦ interior, dashboard
◦ that are not “plug compatible” with those of for
example, a Toyota Camry
Consider the Automobile
Industry (2)
 Car companies tightly coordinate integration
across development of these systems
◦ It is a major driver of high-quality development
performance
◦ Tight integration limits opportunities for independent
innovation to occur
 Japanese firms are leaders in automobiles
partly because of need for integral design
 Japanese firms used to be leaders in other
products when the products required integral
design…..but as modular design emerged,
their advantages disappeared……..
http://www2.deloitte.com/content/dam/Deloitte/de/Documents/manufacturing/MFG-Delivering-Exceptional-Shareholder-Value.pdf
Suppliers
$320 Billion
for 214
suppliers
Dec 2013
Market Cap
Auto suppliers
$800 Billion
August 2013
http://www.bloomberg.com/bw/
articles/2013-08-27/tesla-is-now-
worth-20-billion
Consider the Automobile
Industry (3)
 BMW, Daimler, and Audii Purchase Nokia’s
Maps Business
 Why? Because they think
◦ integral design is essential
◦ Nokia’s map business should not be acquired
by Google, Uber, or Apple
 Could automobiles become a modular
business in which Google, Uber, or Apple
are dominant suppliers of driverless
vehicles?
◦ Uber just opened a research group in SG
http://www.wsj.com/articles/bmw-daimler-audi-agree-to-buy-nokias-here-maps-business-1438580698
Systems Integration
 Complex and high-value products involve
system integration
◦ Boeing and Airbus in aircraft
◦ Alstom in trains and signaling systems
◦ Thales in flight simulators
◦ Ericsson in mobile communication systems
◦ Atkins in baggage handling systems
 Although lots of vertical disintegration, the
interdependencies between sub-systems
require integral design and this enables
systems integrators to be very profitable
Source: Charting a Path Toward Integrated Solutions, Andrew Davies, Tim Brady
and Michael Hobday, Sloan Management Review, Spring 2006
Integral vs. Modular Design
 When is integral design required and thus
profits will flow to system
suppliers/designers?
 When does modular design work and thus
profits will flow to component
suppliers/designers?
 This is one reason why these issues and
vertical (dis)integration were covered in
previous sessions
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Context (1)
 First commercially viable CAT (computer-
aided tomography) scanner invented by Sir
Godfrey Hounsfield in Hayes, United Kingdom
at EMI Central Research Laboratories
 Hounsfield conceived his idea in 1967, and it
was publicly announced in 1972. Allan
McLeod Cormack of Tufts University in
Massachusetts independently invented a
similar process
 Both Hounsfield and Cormack shared the
1979 Nobel Prize in Medicine
 EMI was a fairly large “conglomerate” in the
1970s that did defense, health care, music
Source: Capturing Value Through Technology Strategy, Presentation by Ezra Zuckerman, 2008
Context (2): Key Complementary
Assets
 Success in medical equipment requires
specialized sales, manufacturing, and
maintenance departments
 EMI (record and defense company) did not
have these capabilities while Siemens,
Phillips, and GE did
 None of these assets were externally
available in 1970s and service and sales
are still not available
 Why still not available?
Implications for EMI
 Should EMI commercialize alone or work with
leaders?
 If the CT cannot be imitated or replicated, EMI
could do either. If it works with leaders, it would
have a lot of leverage
◦ Could threaten to go to Siemens (and vice versa)
◦ If also large market potential known in advance, GE
and Siemens would have to pay a great deal for
license
 But if it can be imitated or replicated,
◦ it will be very hard for EMI to go it alone
◦ And less negotiating leverage with GE and Siemens
 Let’s focus on negotiation with GE or Siemens
Capturing Value from
Negotiation: Challenges for EMI
 Can they convince GE or Siemens that
they have rights to technology?
 Can they write an effective license
without giving away the innovation?
 Can they convince GE or Siemens that
the market will be big?
 What percentage of profits should EMI
give to GE or Siemens in the license?
◦ Give too much, no profits
◦ Give too little, and GE has no incentive to
manufacture and sell product
Negotiation scenario
GE: Oh, you have a great innovation, huh?
Let’s see it.
EMI: Here it is.
GE: Oh, one of those 3-D X-Ray thingies!
We’ve been working on that for years! And we
expect to have one out within 12 months. Nice
try, record-company guys! But you should
leave medical equipment to the big boys
The Upshot
 EMI had a great innovation, with temporary
uniqueness, and no real ability to capture
value through license
 But they didn’t succeed in negotiations
 Just went alone. But to capture value by
themselves, would need to:
1. Defend uniqueness as much as possible
2. Build (differentiated) complementary assets to
compete once uniqueness disappears.
 But they didn’t do either:
◦ Slow to respond to patent infringement
◦ Rather than building complementary assets, they
just sold what they could
Too Much Value-Creation… ?
 Ironic: EMI’s strategy made sense if
market turned out to be small
 But massive demand increased likelihood
of entry and increased the importance of
complementary assets.
◦ Often hard to capture a bigger slice of big pies!
 Should have switched to licensing once it
became a big market, and once they saw
so much entry.
◦ Big mistake was thinking they could go alone
◦ Could have built up business to a point where
they had a viable product, and then sold it to
GE
Demand Grew Quickly
 Cumulative orders (hospitals with 100+
beds):
◦ 1974: 35
◦ 1975: 122
◦ 1976: 450
◦ 1977: 738
◦ 1978: 953
◦ 1979: 1113
◦ 1980: 1183
Diffusion of CT Scanners by Hospital Size(Source: Trajtenberg, 1990)
.. And then too little?
 EMI was especially ill-prepared for shakeout.
 Demand decelerates (4% growth from 376 ordered in
U.S. in 1976 to 389 in 1977; and then plummets (-35%
decline from to 251 in 1978).
– Note: By 1977, half of all U.S. 100+ bed hospitals had
already ordered a scanner.
 Against large capacity, leads to intense price wars,
product and service competition; $99,000 scanners in
the market.
 Shakeout: 12 companies drop out between 1976 and
1980, including Searle and Pfizer, and Technicare sells
to Johnson & Johnson (good example of economies of
scale in manufacturing, service, sales, and R&D)
Outline
 Insufficient methods of strategic control
 Intellectual Property and Appropriability
◦ Strong and Weak Appropriability
◦ Efforts to change appropriability
◦ Standards and appropriability
 Complementary assets
◦ old emphasis: different functions
◦ new emphasis: industry architecture [includes level of vertical
(dis)integration]
 Example of innovations in which complementary
functions played critical role: EMI and the CAT
Scanner
 IBM in PCs and Services
Why did IBM have less success than
expected in PCs? (1)
 A previous session (two weeks ago) focused on
◦ Network effects
◦ Open vs. closed strategy
◦ Compatibility vs. Performance
 Degree of openness was critical
◦ IBM should have pursued more closed policy
◦ Apple should have pursued more open policy
 This session (strategic control) tells a broader story
◦ IBM thought it controlled the:
 critical complementary assets in functions (sales force, R&D)
 IP/architecture (BIOS software and chip)
Personal Computers
 Initial competition
◦ First PC released in 1975
◦ Apple, Commodore, Tandy released PCs in 1977
◦ Apple and CP/M compatible (OS) machines were leaders by
1978
◦ Apples machine used proprietary technology such as OS
 IBM PC
◦ IBM introduced open-modular product in 1981 that used
external technology (e.g., Microsoft and Intel) that is
summarized on the next slide
Personal Computer: IBM’s PC
 Operating System from Microsoft
 Hybrid 8- and 16-bit microprocessor from Intel
◦ 8-bit capability provided compatibility with software written
for CP/M OS
◦ 16-bit capability enabled software superior to that used in
Apple computer: Word Perfect replaced Word Star in word
processing software, Lotus 1-2-3 replaced VisiCalc in
spreadsheets
 But other manufacturers introduced clones
 Microsoft (and Intel) became big winners through
control of key interfaces. Subsequently, they have
introduced products that are backward compatible
Personal Computers - Interpretation
 Network Effects
◦ Increased in importance following release of IBM PC
 Openness versus control
◦ Openness of IBM machine contributed to its success
◦ But openness enabled Microsoft, Intel to become big winners
◦ Lessons:
 IBM should have pursued more closed policy
 Apple should have pursued more open policy
 Compatibility and performance
◦ IBM PC was not compatible with previous generations of
computers (but compatible with some previous PCs)
◦ But for many users IBM PC was superior in terms of
performance-price ratio to mainframe and mini-computers
This Session Gives us Another
Interpretation
 Focusing on complementary assets and IP
 IBM thought it controlled the:
◦ critical complementary assets in functions (sales
force, R&D)
◦ IP/architecture (BIOS software and chip)
Why did IBM have less success than
expected in PCs? (2)
 But
◦ emergence of computer retail outlets for consumers
eliminated IBM’s advantages with sales force
◦ imitation of BIOS chip through reverse engineering
eliminated IBM’s advantage in software, enabled firms to
copy IBM, and led to emergence of IBM compatible clones
◦ Other open interfaces, i.e., modular design, enabled other
firms to use same external modules and caused R&D to
move from computer to components (microprocessor, hard
disk drive, operating systems, and application software)
Why was Lou Gerstner able to Make
IBM a Leader Again in the Late 1990s
 IBM focused on a market segment in which integral
design was needed (in corporate information systems)
and IBM had strong complementary assets
◦ Computer and information services
 Complementary assets
◦ Large installed base of hardware and software
◦ Large computer services business
◦ Better understanding of customer needs than any other firm
 Lou Gerstner focused IBM on helping users integrate
and upgrade systems
 IBM is one of the few computer incumbents to succeed
in the Internet
Conclusions (1)
 Innovators, i.e., first entrants, often fail
 Examples of reasons. They
◦ don’t have sufficient protection of IP
◦ can’t build up sufficient scale in R&D, manufacturing, etc.
◦ don’t have as much access to the relevant complementary
assets as do the incumbents/imitators
◦ Someone else controls the industry architecture
 Firms must think of strategic control from the
beginning
◦ they can’t wait until after they have introduced their product
◦ and must keep thinking of strategic control
Conclusions (2)
 Industry architectures are becoming more complex due
to increasing complexity of systems and vertical
disintegration
◦ This increases the opportunities to control an interface
 Complementary assets are
◦ Becoming more available through vertical disintegration,
which increases the opportunities for outsourcing
◦ But also increases the complexity of the choices
 What are the important complementary assets?
 Which ones are tightly or freely available?
 This is one reason why I want you to identify all the
collaborators and customers in the “value chain”
For Your Presentations
 In addition to other aspects of Biz Model, tell me about
“Strategic control: how to sustain profitability”
◦ IP that is relevant to a specific innovation/technology
◦ complementary assets that are relevant to the specific
innovation/technology
◦ Control of industry architecture and who this favors

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Biz model 7 method of strategic control

  • 1. Method of Strategic Control 7th Session in MT5016 Biz Models for Hi-Tech Products A/Prof Jeffrey Funk Division of Engineering and Technology Management National University of Singapore Sources: (Teece, 1986; Trajtenberg, 1990; Pisano and Teece, 2007; Zuckerman, 2008)
  • 2. Business Model  Value proposition: what to offer and how to differentiate  Customer selection: whom to serve and not serve  Scope of activities: what activities to carry out and what relationships to have  Value capture: dominant sources of revenue  Strategic control: how to sustain profitability (e.g., how to control architecture and standards)
  • 3. Strategic Control  Methods to ensure profitability for a product/business  Some use the term “competitive advantage” (e.g., strategy class)  Both deal with factors that enable firms to survive and achieve above average profitability  Survival is one outcome of good strategic control  Ability to be profitable over long period of time (one measure is market capitalization) is stronger outcome  Some firms have higher profitability than others  Some industries have higher profitability than others
  • 4. Shakeouts Often Occur in an Industry  Defining an industry is problematic ◦ Industry is defined by specific technology ◦ And a specific vertically disintegrated layer in the industry  But for a specific layer, number of suppliers often rises initially, but then falls ◦ Initially it is new entrants copying previous entrants ◦ But then falls through exits, mergers, and acquisitions as economies of scale in operations and R&D increase  How can your firm survive? ◦ This requires good method of strategic control
  • 5. Source: Klepper and Simons, Industry Shakeouts and Technological Change
  • 6. Change is More Rapid in Some Industries  Some industries experience more rapid change than others ◦ Not just economies of scale drive shakeouts ◦ Also changes in technology  For example, Internet experienced very rapid changes ◦ Fiber optic cable ◦ Servers and routers ◦ Access devices: desk-top, laptop, and tablet computers; and smart phones ◦ Software and content for these devices  Has caused large changes in leading firms
  • 7. Rank Company Market Capitalization Type of Business 1 Apple $742 Billion Hardware 3 Google $375 Billion Search 4 Microsoft $360 Billion Software 21 Facebook $211 Billion Content 26 Oracle $192 Billion Software 30 Amazon $177 Billion Online Sales 37 Intel $171 Billion Integrated Circuits 39 Samsung $162 Billion Electronics 40 IBM $158 Billion Hardware 41 Tencent $156 Billion Internet content 43 Comcast $153 Billion Cable TV, content 51 Cisco $150 Billion Hardware 53 TMSC $122 Billion Integrated Circuits 57 Qualcomm $117 Billion Integrated Circuits 98 SAP $92 Billion Software Top IT Firms Among Top 100 - Market Capitalization (17 Feb 2015) http://www.corpo rateinformation.c om/Top- 100.aspx?topcase =b%3b+http%3a %2f%2fwww.lib. uwo.ca%2fnews %2fbusiness%2f 2011%2f04%2f0 8%2ftopglobal10 0companiesbyma rketcapitalization. html
  • 8. Success of Billion Dollar Startups in Internet Also Reflects Degree of Technology Change and Lack of Strategic Control Software (33) e-commerce (25) Consumer internet (22) Financial services (11) Hardware: phones, wearable computing (10) Healthcare (5) Energy (3) Entertainment and Games (2) Aerospace and defense (1) Real Estate (1) Education (1) Mostly Internet related firms with a few exceptions
  • 9. Lots of change is also evident when we look at most popular web sites  http://www.washingtonpost.com/news/the- intersect/wp/2014/12/15/from-lycos-to-ask- jeeves-to-facebook-tracking-the-20-most- popular-web-sites-every-year-since-1996/  Only 6 of the most popular web sites in 2000 were still in top 20 in 2013 ◦ And they aren’t very profitable, at least from Internet activities
  • 10.
  • 11.
  • 12. Changes in Leading Internet Firms  Initially first stop services for users were popular ◦ Search, Portal ◦ Service provider  Specialty sites have become most visited sites ◦ Facebook, eBay, Apple, Amazon, Wikimedia, Ask, Weather Co, Walmart, Answers, Linkedin, Glam Media  Only a few first stop services remain of which one is very profitable ◦ Google ◦ Yahoo, Microsoft, AOL
  • 13. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary assets/functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 14. Insufficient Methods of Strategic Control  Being a first entrant ◦ Many first entrants fail  Having a better product/service ◦ A better product can be copied  Having a better product development process might be sufficient ◦ Japanese firms used their short product development times (and superior manufacturing systems) to create competitive advantage for many years. ◦ But then competition changed…..
  • 15. Being First Entrant is not Sufficient  EMI lost to GE, Siemens, and Philips in CAT scanners  Bowmar lost to many in electronics calculators  Altair, IMS Associates, South West Technical, Apple, Radio Shack, and Commodore lost to IBM (now Lenovo), Dell, and HP in PCs  Xerox (PARC) and Apple invented graphical user interface, but Microsoft Windows dominates market (until recently)  Apple introduced first PDA (Newton) but Palm became dominant player (at least until emergence of “smart phones”)
  • 16. Being First Entrant is not Sufficient (2)  Netscape invented browser, but Microsoft dominates it  Early MP3 suppliers lost to Apple’s iPod  Merck was pioneer in cholesterol lowering drugs (Zocor) ◦ but Pfizer, a late entrant, secured a superior market position with Lipitor  Excite and Lycos were first real search engines, but they lost to Yahoo— ◦ and Yahoo lost to Google
  • 17. Why is being first entrant insufficient?  They had reasonably good business models along some elements ◦ Value proposition: what to offer and how to differentiate ◦ Customer selection: whom to serve and not serve ◦ Scope of activities: what activities and relationships to have, i.e., level of vertical integration ◦ Value capture: how to make money  But changes occurred in these areas that prevent them from succeeding (discussed in previous weeks)  In this session, we pull some of these ideas together under the term method of strategic control
  • 18. Why is being first entrant insufficient? (2)  Other firms may enter the market unless first mover ◦ has strong natural protection against imitation and/or strong intellectual property protection ◦ controls complementary assets or standards ◦ has advantages in scale or network effects  These new entrants may succeed ◦ for many reasons discussed in previous weeks ◦ in this session, we discuss other reasons under concept of strategic control  Some new entrants provide same types of products while other provide complementary products (or have complementary assets)
  • 19. Why is being first entrant insufficient? (3)  Few innovations provide value by themselves  every innovation requires complementary “assets” - service, manufacturing, product development, and distribution  many innovations require complementary technologies such as components, equipment, materials, etc.  network-based innovations, discussed in Week 6 (last week), require standards and complementary products and services (hardware, software, content, apps)  firms must think of entire value chain when innovating
  • 20. Insufficient Methods of Strategic Control  Being a first entrant ◦ Many first entrants fail  Having a better product/service ◦ A better product can be copied  Having a better product development process might be sufficient ◦ Japanese firms used their short product development times (and superior manufacturing systems) to create competitive advantage for many years. ◦ But then competition changed…..
  • 21. Better Product Development was Insufficient for Japanese Firms  Other firms copied Japan’s product development process (and manufacturing methods)  Low-cost and efficient manufacturing became available in China ◦ reducing Japan’s manufacturing advantages
  • 22. Better Product Development was Insufficient for Japanese Firms (2)  Entrepreneurial startups focused on lucrative niches as vertical disintegration emerged ◦ Placing vertically integrated Japanese firms at a disadvantage  Japan only has advantages in some hi- tech industries now
  • 23. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 24. Appropriability  Dictionary’s definition of appropriate ◦ 1) suitable ◦ 2) to take or obtain possession (today’s focus)  Appropriability regime – a regime in which a firm is able to capture profits from an innovation ◦ Nature of technology: economies of scale, network effects, tacit vs. explicit knowledge, complexity ◦ Legal mechanisms of protection: patent (17 years in U.S.), copyright, trademark, trade secret ◦ Control of industry architecture or complementary assets  Protecting vs. appropriating benefits ◦ You can protect your technology without appropriating the benefits from it
  • 25. Nature of Technology: Economies of Scale  Some technologies benefit from economies of scale more than do other technologies  Manufacturing: chemicals benefit more than does discrete-parts assembly  Software and other digital products: very large economies of scale and thus winner take all ◦ Products with small market shares have trouble surviving
  • 26. Nature of Technology: Economies of Scale (2)  Economies of scale across different markets: how many different markets can your digital product be sold?  JK Rowling’s Harry Potter is sold in ◦ Books, Movies ◦ games across the world  Marvel Comics created more than 100 characters ◦ They profit from every movie made with these characters ◦ Capitan America, Thor, Ant Man
  • 27. Nature of Technology: Economies of Scale (3)  While the Long Tail enables more niche products, the Internet has enabled creation of superstars and super products ◦ Top 10% of one publisher’s books generate 64% of costs but 126% of profits ◦ 102 of the 8 million digital musical tracks generated almost 1/6 of the sales Source: Blockbusters: Hit-making, Risk-taking, and the Big Business of Entertainment)
  • 28. Economies of Scale in R&D (From Week 2)  R&D is a fixed cost in many industries ◦ Firms must spend a certain amount on R&D just to participate in industry  Largest firms can spend more on R&D and thus introduce more products and obtain higher shares ◦ Positive feedback between R&D, new products, and share ◦ Initially successful firms can spend more on R&D, which lead to better products, higher profits, more money for R&D  Economies of scale in R&D causes a “shakeout” in the industry: smaller firms are acquired or exit the industry
  • 29. Economies of Scale in R&D (2)  Depends on the trajectory that the industry takes  Firms that follow the same trajectory as the industry will benefit ◦ Same technologies, dominant design, standards or architecture ◦ Firms that don’t, perhaps because the industry went in a different direction than they did, will not benefit from the economies of scale in R&D ◦ For example, what will be the trajectory for wearable computing, what types of designs, what architecture?
  • 30. Appropriability  Dictionary’s definition of appropriate ◦ 1) suitable ◦ 2) to take or obtain possession (today’s focus)  Appropriability regime – a regime in which a firm is able to capture profits from an innovation ◦ Nature of technology: economies of scale, network effects, tacit vs. explicit knowledge, complexity ◦ Legal mechanisms of protection: patent (17 years in U.S.), copyright, trademark, trade secret ◦ Control of industry architecture or complementary assets  Protecting vs. appropriating benefits ◦ You can protect your technology without appropriating the benefits from it
  • 31. Legal Mechanims: (Relatively) Strong/Tight Appropriability (1)  Software ◦ specific lines of codes and concepts can be protected by both patents and copyrights in the U.S. and Europe ◦ producers can also shield the source code from competitors and users ◦ Exceptions: inexpensive copies are available for many popular software programs (plus music, video games, and movies) outside rich countries  Books ◦ Steven King and J.K. Rowling do not need to own a printing press, publication house, or book distributor to make money, but copies are made
  • 32. Examples of (Relatively) Strong/Tight Appropriability (2)  Chemicals, drugs, and materials ◦ Strong patent protection ◦ Difficult to re-engineer many of these products (e.g., Synthetic dyes, cellophane, photographic film)  For example Pfizer ◦ employs 330 attorneys for intellectual property protection ◦ won judgment of $56 million in 1983 involving doxycycline, an orally administered antibiotic ◦ won $53 million in 1989 involving blood oxygenators ◦ won recent dismissal of patent infringement lawsuit regarding COX-2 inhibitors and lawsuit alleging possible suicidal effects of antidepressant Zoloft®.
  • 33. Examples of (Relatively) Strong/Tight Appropriability (3)  Mobile phone services in Singapore  Cable television in Singapore  Internet services in Singapore  Why do they have strong appropriability?  How does this affect their behavior?  What might cause changes to this strong appropriability?
  • 34. Possible Changes to Monopolies  Young people don’t pay for mobile phone services ◦ Instead they use free Wi-Fi  Young people don’t pay for cable TV ◦ Instead they watch free content on Internet ◦ Example are FB and YouTube, which profit from advertising  Will young people pay for Internet as free Wi-Fi increaes
  • 35. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 36. First , What do Economists Think?
  • 37. First , What do Economists Think?  What economists think. Protection of IP should balance: ◦ Benefits from spread of information ◦ Enable firms to recoup investments in R&D  Of course, firms are concerned about their own profits and thus this determines whether they want to strengthen or weaken patent laws
  • 38. Firms can try to strengthen patent laws, other forms of IP  European and US firms strengthened IP protection in late 1980s to compete better against Japanese firms  E.g., European mobile phone firms did so in GSM  U.S. and European firms are always trying to do this with respect to China and India
  • 39. Firms may also try to Weaken Appropriability Regimes (1)  Genes ◦ Possibility that firms might take ownership of specific genes caused concern in governments, drug companies, and other organizations ◦ Why?
  • 40. Firms may also try to Weaken Appropriability Regimes (2)  Open Source ◦ make source code for computer programs available to everyone so that other developers can build upon on the code base ◦ reduces the profits for providers of basic software such as operating systems  IBM supports Linux in order to weaken Microsoft
  • 41. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 42. Standards and Appropriability  Control of standards enable firms to make above average profits  So competition between firms to make your technology the standard  Due to big impact of standards on competition, Most standard-setting bodies, i.e., committees, insist that technology providers be willing to ◦ license relevant IP before the standard-setting body will adopt a standard that requires the practice of technology ◦ license to all interested parties on reasonable and non-discriminatory terms
  • 43. Standards and Appropriability  But what ◦ should the royalty rates be? ◦ is reasonable and non-discriminatory?  Closed-door debates (and coalitions) in standard setting committees often revolve around these issues  For example, ◦ IEEE recently placed less emphasis on Qualcomm’s technology until royalty rates are reduced below 5% of phone price ◦ Stock price fell http://www.wsj.com/articles/qualcomms-main-profit-driver-is-under-pressure-1428967051
  • 44. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 45. Complementary Assets  What are complementary assets? ◦ any capabilities or assets needed to commercialize an innovation  manufacturing, marketing, sales, service, brand name, distribution  complementary products, any new technological capabilities that are needed to commercialize the innovation ◦ accurate description of value chain/network can help us understand these assets  In 1980s and 1990s focus (e.g., 1986 paper by David Teece) was on these kinds of complementary assets: ◦ manufacturing ◦ marketing, sales ◦ service, maintenance ◦ development
  • 46. Complementary Assets (2)  Japanese firms were the leaders in manufacturing and David Teece argued that Japanese firms would thus dominate all hi-tech industries  It didn’t happen………for a variety of reasons  As discussed in previous slides ◦ Emergence of vertical disintegration has enabled separation between design, manufacturing and other functions, which enables firms to outsource manufacturing and other functions ◦ Focus of strategic control has changed to interface standards and industry architecture for many industries
  • 47. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 48. Industry Architecture  Industry architectures characterize nature and degree of specialization of firms and the interfaces between their products  In addition to levels of vertical (dis)integration, industry architecture also ◦ specifies interfaces ◦ who controls them  For a specific industry (for a final product), we can very roughly distinguish between ◦ modular industry architectures ◦ integral industry architectures
  • 49. Industry Architecture, Modular Design, and Profits to Component Suppliers (1)  Modular design often causes most profitable firms to be suppliers of key components. For example, in personal computers ◦ Microsoft and Intel are most profitable firms ◦ Much lower profits in disk drives, memory, displays  Why? ◦ Microsoft and to lesser extent Intel control interfaces between operating systems, microprocessors, etc. ◦ Other suppliers of components do not control these interfaces and thus there is excessive competition and low profits
  • 50. Rank Company Market Capitalization Type of Business 1 Apple $742 Billion Hardware 3 Google $375 Billion Search 4 Microsoft $360 Billion Software 21 Facebook $211 Billion Content 26 Oracle $192 Billion Software 30 Amazon $177 Billion Online Sales 37 Intel $171 Billion Integrated Circuits 39 Samsung $162 Billion Electronics 40 IBM $158 Billion Hardware 41 Tencent $156 Billion Internet content 43 Comcast $153 Billion Cable TV, content 51 Cisco $150 Billion Hardware 53 TMSC $122 Billion Integrated Circuits 57 Qualcomm $117 Billion Integrated Circuits 98 SAP $92 Billion Software http://www.corpo rateinformation.c om/Top- 100.aspx?topcase =b%3b+http%3a %2f%2fwww.lib. uwo.ca%2fnews %2fbusiness%2f 2011%2f04%2f0 8%2ftopglobal10 0companiesbyma rketcapitalization. html Industry Architecture, Modular Design, and Profits to Component Suppliers (2) As noted last, week most of the profits are flowing to modular components: exceptions are Apple, IBM, Samsung
  • 51. Industry Architecture, Modular Design, and Profits to Component Suppliers (3)  Apple is a big exception ◦ It uses proprietary OS, microprocessor design, and app and user interface  Google offers “components” in the form of Android OS and mobile ads  Will Android (or something else) grow stronger and thus weaken Apple  Or will Apple grow stronger by dominating other markets
  • 52. Industry Architecture, Modular Design, and Profits to Component Suppliers (4)  Who will dominate new markets such as ◦ Smart watches, other forms of wearable computing ◦ Online TV ◦ Automated Vehicles ◦ Internet of Things ◦ Home Automation ◦ Smart televisions
  • 53. Industry Architecture, Modular Design, and Profits to Component Suppliers (4)  Other component suppliers also have big profits ◦ Many materials such as chemicals, plastics, and elastomers do not involve interface standards. Similar story with drugs ◦ If the materials have a big impact on a system’s performance or stand-alone benefits (e.g., drugs), profits flow to suppliers with best materials or ones with lowest cost  Scale is a major issue ◦ Production cost is function of scale ◦ Output from R&D also depends on scale of R&D  Patent protection can raise profits
  • 54. Industry Architecture, Modular Design, and Profits to Component Suppliers (5)  Movies ◦ Motion picture studios are assemblers of various resources required to produce a movie  actors and actresses  director and other specialists  finance, technology, ◦ Movies make money, but movie studios often do not. Why?  rents flow to the bottleneck “modules,” or “complementary assets” that are in short supply such as star performers  How about Professors?
  • 55.  Let’s talk about integral design
  • 56. Industry Architecture, Integral Design, and Profits to System Suppliers (1)  Integral architectures shift the locus of innovation and rent appropriation up to system level ◦ “owner” of architecture has power to set interface protocols and to decide which innovations are adopted and which ones are not innovators ◦ This bargaining power creates a source of above average profits for the system owner and below average profits for the component supplier
  • 57. Consider the Automobile Industry  Cars are highly integral systems  E.g., BMW 325ix sedan consists of interdependent sub-systems ◦ chassis, body panels ◦ suspension system, power train ◦ interior, dashboard ◦ that are not “plug compatible” with those of for example, a Toyota Camry
  • 58. Consider the Automobile Industry (2)  Car companies tightly coordinate integration across development of these systems ◦ It is a major driver of high-quality development performance ◦ Tight integration limits opportunities for independent innovation to occur  Japanese firms are leaders in automobiles partly because of need for integral design  Japanese firms used to be leaders in other products when the products required integral design…..but as modular design emerged, their advantages disappeared……..
  • 59. http://www2.deloitte.com/content/dam/Deloitte/de/Documents/manufacturing/MFG-Delivering-Exceptional-Shareholder-Value.pdf Suppliers $320 Billion for 214 suppliers Dec 2013 Market Cap Auto suppliers $800 Billion August 2013 http://www.bloomberg.com/bw/ articles/2013-08-27/tesla-is-now- worth-20-billion
  • 60. Consider the Automobile Industry (3)  BMW, Daimler, and Audii Purchase Nokia’s Maps Business  Why? Because they think ◦ integral design is essential ◦ Nokia’s map business should not be acquired by Google, Uber, or Apple  Could automobiles become a modular business in which Google, Uber, or Apple are dominant suppliers of driverless vehicles? ◦ Uber just opened a research group in SG http://www.wsj.com/articles/bmw-daimler-audi-agree-to-buy-nokias-here-maps-business-1438580698
  • 61. Systems Integration  Complex and high-value products involve system integration ◦ Boeing and Airbus in aircraft ◦ Alstom in trains and signaling systems ◦ Thales in flight simulators ◦ Ericsson in mobile communication systems ◦ Atkins in baggage handling systems  Although lots of vertical disintegration, the interdependencies between sub-systems require integral design and this enables systems integrators to be very profitable Source: Charting a Path Toward Integrated Solutions, Andrew Davies, Tim Brady and Michael Hobday, Sloan Management Review, Spring 2006
  • 62. Integral vs. Modular Design  When is integral design required and thus profits will flow to system suppliers/designers?  When does modular design work and thus profits will flow to component suppliers/designers?  This is one reason why these issues and vertical (dis)integration were covered in previous sessions
  • 63. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 64. Context (1)  First commercially viable CAT (computer- aided tomography) scanner invented by Sir Godfrey Hounsfield in Hayes, United Kingdom at EMI Central Research Laboratories  Hounsfield conceived his idea in 1967, and it was publicly announced in 1972. Allan McLeod Cormack of Tufts University in Massachusetts independently invented a similar process  Both Hounsfield and Cormack shared the 1979 Nobel Prize in Medicine  EMI was a fairly large “conglomerate” in the 1970s that did defense, health care, music Source: Capturing Value Through Technology Strategy, Presentation by Ezra Zuckerman, 2008
  • 65. Context (2): Key Complementary Assets  Success in medical equipment requires specialized sales, manufacturing, and maintenance departments  EMI (record and defense company) did not have these capabilities while Siemens, Phillips, and GE did  None of these assets were externally available in 1970s and service and sales are still not available  Why still not available?
  • 66. Implications for EMI  Should EMI commercialize alone or work with leaders?  If the CT cannot be imitated or replicated, EMI could do either. If it works with leaders, it would have a lot of leverage ◦ Could threaten to go to Siemens (and vice versa) ◦ If also large market potential known in advance, GE and Siemens would have to pay a great deal for license  But if it can be imitated or replicated, ◦ it will be very hard for EMI to go it alone ◦ And less negotiating leverage with GE and Siemens  Let’s focus on negotiation with GE or Siemens
  • 67. Capturing Value from Negotiation: Challenges for EMI  Can they convince GE or Siemens that they have rights to technology?  Can they write an effective license without giving away the innovation?  Can they convince GE or Siemens that the market will be big?  What percentage of profits should EMI give to GE or Siemens in the license? ◦ Give too much, no profits ◦ Give too little, and GE has no incentive to manufacture and sell product
  • 68. Negotiation scenario GE: Oh, you have a great innovation, huh? Let’s see it. EMI: Here it is. GE: Oh, one of those 3-D X-Ray thingies! We’ve been working on that for years! And we expect to have one out within 12 months. Nice try, record-company guys! But you should leave medical equipment to the big boys
  • 69. The Upshot  EMI had a great innovation, with temporary uniqueness, and no real ability to capture value through license  But they didn’t succeed in negotiations  Just went alone. But to capture value by themselves, would need to: 1. Defend uniqueness as much as possible 2. Build (differentiated) complementary assets to compete once uniqueness disappears.  But they didn’t do either: ◦ Slow to respond to patent infringement ◦ Rather than building complementary assets, they just sold what they could
  • 70. Too Much Value-Creation… ?  Ironic: EMI’s strategy made sense if market turned out to be small  But massive demand increased likelihood of entry and increased the importance of complementary assets. ◦ Often hard to capture a bigger slice of big pies!  Should have switched to licensing once it became a big market, and once they saw so much entry. ◦ Big mistake was thinking they could go alone ◦ Could have built up business to a point where they had a viable product, and then sold it to GE
  • 71. Demand Grew Quickly  Cumulative orders (hospitals with 100+ beds): ◦ 1974: 35 ◦ 1975: 122 ◦ 1976: 450 ◦ 1977: 738 ◦ 1978: 953 ◦ 1979: 1113 ◦ 1980: 1183 Diffusion of CT Scanners by Hospital Size(Source: Trajtenberg, 1990)
  • 72. .. And then too little?  EMI was especially ill-prepared for shakeout.  Demand decelerates (4% growth from 376 ordered in U.S. in 1976 to 389 in 1977; and then plummets (-35% decline from to 251 in 1978). – Note: By 1977, half of all U.S. 100+ bed hospitals had already ordered a scanner.  Against large capacity, leads to intense price wars, product and service competition; $99,000 scanners in the market.  Shakeout: 12 companies drop out between 1976 and 1980, including Searle and Pfizer, and Technicare sells to Johnson & Johnson (good example of economies of scale in manufacturing, service, sales, and R&D)
  • 73. Outline  Insufficient methods of strategic control  Intellectual Property and Appropriability ◦ Strong and Weak Appropriability ◦ Efforts to change appropriability ◦ Standards and appropriability  Complementary assets ◦ old emphasis: different functions ◦ new emphasis: industry architecture [includes level of vertical (dis)integration]  Example of innovations in which complementary functions played critical role: EMI and the CAT Scanner  IBM in PCs and Services
  • 74. Why did IBM have less success than expected in PCs? (1)  A previous session (two weeks ago) focused on ◦ Network effects ◦ Open vs. closed strategy ◦ Compatibility vs. Performance  Degree of openness was critical ◦ IBM should have pursued more closed policy ◦ Apple should have pursued more open policy  This session (strategic control) tells a broader story ◦ IBM thought it controlled the:  critical complementary assets in functions (sales force, R&D)  IP/architecture (BIOS software and chip)
  • 75. Personal Computers  Initial competition ◦ First PC released in 1975 ◦ Apple, Commodore, Tandy released PCs in 1977 ◦ Apple and CP/M compatible (OS) machines were leaders by 1978 ◦ Apples machine used proprietary technology such as OS  IBM PC ◦ IBM introduced open-modular product in 1981 that used external technology (e.g., Microsoft and Intel) that is summarized on the next slide
  • 76. Personal Computer: IBM’s PC  Operating System from Microsoft  Hybrid 8- and 16-bit microprocessor from Intel ◦ 8-bit capability provided compatibility with software written for CP/M OS ◦ 16-bit capability enabled software superior to that used in Apple computer: Word Perfect replaced Word Star in word processing software, Lotus 1-2-3 replaced VisiCalc in spreadsheets  But other manufacturers introduced clones  Microsoft (and Intel) became big winners through control of key interfaces. Subsequently, they have introduced products that are backward compatible
  • 77. Personal Computers - Interpretation  Network Effects ◦ Increased in importance following release of IBM PC  Openness versus control ◦ Openness of IBM machine contributed to its success ◦ But openness enabled Microsoft, Intel to become big winners ◦ Lessons:  IBM should have pursued more closed policy  Apple should have pursued more open policy  Compatibility and performance ◦ IBM PC was not compatible with previous generations of computers (but compatible with some previous PCs) ◦ But for many users IBM PC was superior in terms of performance-price ratio to mainframe and mini-computers
  • 78. This Session Gives us Another Interpretation  Focusing on complementary assets and IP  IBM thought it controlled the: ◦ critical complementary assets in functions (sales force, R&D) ◦ IP/architecture (BIOS software and chip)
  • 79. Why did IBM have less success than expected in PCs? (2)  But ◦ emergence of computer retail outlets for consumers eliminated IBM’s advantages with sales force ◦ imitation of BIOS chip through reverse engineering eliminated IBM’s advantage in software, enabled firms to copy IBM, and led to emergence of IBM compatible clones ◦ Other open interfaces, i.e., modular design, enabled other firms to use same external modules and caused R&D to move from computer to components (microprocessor, hard disk drive, operating systems, and application software)
  • 80. Why was Lou Gerstner able to Make IBM a Leader Again in the Late 1990s  IBM focused on a market segment in which integral design was needed (in corporate information systems) and IBM had strong complementary assets ◦ Computer and information services  Complementary assets ◦ Large installed base of hardware and software ◦ Large computer services business ◦ Better understanding of customer needs than any other firm  Lou Gerstner focused IBM on helping users integrate and upgrade systems  IBM is one of the few computer incumbents to succeed in the Internet
  • 81. Conclusions (1)  Innovators, i.e., first entrants, often fail  Examples of reasons. They ◦ don’t have sufficient protection of IP ◦ can’t build up sufficient scale in R&D, manufacturing, etc. ◦ don’t have as much access to the relevant complementary assets as do the incumbents/imitators ◦ Someone else controls the industry architecture  Firms must think of strategic control from the beginning ◦ they can’t wait until after they have introduced their product ◦ and must keep thinking of strategic control
  • 82. Conclusions (2)  Industry architectures are becoming more complex due to increasing complexity of systems and vertical disintegration ◦ This increases the opportunities to control an interface  Complementary assets are ◦ Becoming more available through vertical disintegration, which increases the opportunities for outsourcing ◦ But also increases the complexity of the choices  What are the important complementary assets?  Which ones are tightly or freely available?  This is one reason why I want you to identify all the collaborators and customers in the “value chain”
  • 83. For Your Presentations  In addition to other aspects of Biz Model, tell me about “Strategic control: how to sustain profitability” ◦ IP that is relevant to a specific innovation/technology ◦ complementary assets that are relevant to the specific innovation/technology ◦ Control of industry architecture and who this favors

Editor's Notes

  1. Drug companies published results in order to prevent a change in appropriability regime from development and commercialization to gene patenting
  2. How do they do these things?