It is almost impossible to avoid the messages about the importance of innovation that dominate business magazines, web sites, and conferences. At a most recent Annual Meeting of the Institute for the Study of Business Markets, innovation joined “Big Data” and channel disruption as the three themes cited by CEOs, CMOs, and academic experts as most critical to the future success of business-to-business manufacturing firms. That emphasis is nothing new. Peter Drucker said “Innovation is the specific instrument of entrepreneurship, the act that endows resources with a new capacity to create wealth.” Michael Porter similarly observed that “Innovation is the central issue in economic prosperity.” And Steve Jobs believed that “Innovation distinguishes between a leader and a follower.”
I agree with the emphasis on innovation as central to the future growth and profitability of our companies. There are far too many success stories rooted in innovation to credibly argue otherwise, and, unfortunately, far too many stories of firms that deteriorated from great to second rate by failing to keep pace with innovative competitors. But, at the same time, I believe our firms far too often have tunnel vision with respect to the ways in which they think about innovation.
An example supports that conclusion. Over a breakfast meeting recently with a number of business executives, I asked for their favorite example of an innovation success story, one drawn either from their own experience or from other firms with which they were familiar. Each individual easily offered an example, and in every case, described a situation in which success was achieved by raising the bar – identifying a way to enhance products with new features, improved performance, superior design, or along some other dimension. A few involved success stories familiar to many of us, but most reflected something that was known mostly by participants in the industry in question.
There was no question that all of these examples were in fact innovation success stories, ones that any firm would have been proud to claim. In fact, innovations that “raise the bar” are those that we most frequently celebrate, those that we invest scarce technical resources and R&D dollars to achieve.
And should there be any question, there are good reasons for investing in raising the bar. A number of years ago, I worked with a client to estimate the relative shares of the “Good”, “Better”, and “Best” segments of their market. With some modest rounding, we found that the split was about 40%, 30%, and 30%. While acknowledging that all generalizations are false, that rule of thumb has been remarkable in terms of being a good approximation in other markets that I’ve studied since then. The finding is also good news in terms of “raise the bar” innovations – 60% of customers are looking for, and willing to pay for, products that go beyond the bare bones “Good” offering. And it is in fact the firms that raise the bar most successfully that are likely to win the customers in the “Best” segment, the customers most likely to pay a price premium for those features and attributes that distinguish each generation of “Best”. Those firms that can raise the bar should raise the bar. They are likely to be rewarded for doing so.
But raising the bar is not the only option for innovation strategies. There are two very different innovation strategies that should be considered, ones that have the potential for creating value that can be captured. And, like raising the bar, they are demanding in terms of creativity and out-of-the-box thinking. In my experience, western firms are far less likely to assign resources to innovations that fall into these two categories, preferring to focus their attention on opportunities to raise the bar.
My perspective on the first of these opportunities for innovation was recently motivated by the work I have done along with my colleague David Hartman on the changing competitive environment. In a series of articles, we have argued that the future competitive landscape will be changed in fundamental ways by firms from emerging markets like China that have learned how to produce “almost-as-good products at a great price point”. What these firms have done is dramatically expand their markets, reaching the large middle markets of countries like China and India with innovative products that retained the key features of the high-end “Best” offerings from the west, at a price point affordable to the much larger middle market segments of their home countries. These firms have found innovative ways to preserve the key product features critical to customer acceptance while at the same time identifying economies that allow them to reach a much lower price point. Often their innovations involve strategies to remove costly features that are not critical to the customers in their targeted markets. In other instances, their innovations involve creative approaches to manufacturing, sourcing, service, and other elements of their cost base.
For those that aren’t yet studying the success stories of emerging market firms like Huawei, Mindray, Sany, Haier, and others that have innovated through this “expand the market” strategy, I point to the much more familiar success story of Henry Ford, another creative executive that figured out the “almost-as-good product at a great price point” formula. In his autobiography, Ford wrote: “I will build a car for the great multitude. It will be large enough for the family, but small enough for the individual to run and care for. It will be constructed of the best materials, by the best men to be hired, after the simplest designs that modern engineering can devise. But it will be so low in price that no man making a good salary will be unable to own one.” His vision required many innovative concepts, not the least of which was the assembly line, but it not only created value for his company, but in fact a whole industry, by expanding the market.
This approach to innovation is particularly important today. Many of the same firms that tout innovation as key to their future cite the middle markets of emerging countries as their growth markets of the future. Success in those segments will only come from the firms that figure out the strategy of creating “almost-as-good products at a great price point”. Without attention and focus on innovations that “expand the market”, it is a good bet that it will be firms from countries like China that are the eventual winners in those huge markets of the future. Today, firms from those countries are probably as far ahead along this dimension of innovation as western firms are in terms of innovations that raise the bar. Unless success can be achieved in the increasingly squeezed “Best” segments, investments that can yield success stories in the “Better” and “Good” market segments must be part of the innovation portfolio of western manufacturing companies.
Almost every business firm with which I work puts considerable importance on strategies that enable them to reach new markets. And, as mentioned above, today, the broad middle markets of the emerging economies are high on the list of targets that have scale and growth potential. But it is rare that I hear innovation linked to the discussion of strategies through which these markets can be reached. And in fact too often I hear executives sadly dismiss the potential of serving these markets, making statements like “at the price points that exist in that market, we could never hope to make any money”. Innovation is potentially the answer to that problem. Finding creative ways to take costs out while retaining the critical features of products is a possibility, one that can yield major dividends in terms of growth in new markets.
There is a third innovation strategy that can yield dividends in some markets. Many manufacturers sell through complex customer chains. Ingredient and component suppliers sell to OEMs and other manufacturers that incorporate their ingredients and components into their own products, eventually reaching end customers. Other manufacturers sell to distributors who sell to contractors, installers, and VARs who themselves serve end customers. In many of these situations, the end customers involved are price buyers, giving considerable weight to price in their purchase decisions. The suppliers in such situations frequently report an inability to gain traction from traditional “raise the bar” innovations, as the intermediaries between them and the end customer are unwilling to agree to improvements that carry with them a higher price tag. In numerous instances, I have heard the frustration of suppliers involved in such markets, as their innovations are met with a cold shoulder by their direct customer.
What has been far more successful in many of these situations have been innovations that “change the game”, that create value by creative approaches to profitably transform the economic and business relationship between the supplier and their direct customer. The opportunity to “change the game” in this way builds upon the fact that there are significant adjacency costs associated with most products that are sold through the types of complex customer chains described above. Some of those adjacency costs involve the manufacturing process, others are more subtle like those associated with warranty costs. But adjacency costs are always there, and are frequently much larger than the product costs per se. I have seen many instances in which the adjacency costs linked to a product are an order of magnitude larger than the product cost itself.
Working recently with a manufacturing firm that supplied an important component to its business customers, we went through a systematic process to identify and quantify these adjacency costs. A few of their strategic accounts provided on-site access to allow the teams working on this initiative to identify all of the cost elements that were linked to the use of this firm’s component. The results were shocking to all involved, as it turned out that the “value pool” that emerged from this work was many multiples of the cost of the component itself. As one executive noted, “we’ve not created the opportunity for value creation and capture that goes dramatically beyond the price of our product”.
It is such value pools that create the opportunity for innovations that “change the game”, ones that take costs out of the system through creative approaches to product design, through changes in the roles and the boundaries between suppliers and customers, and through other strategies that enable value creation and capture. Such innovations respect the reality of the price pressures of end customers, and enable margin improvements centered in the business processes within and between the manufacturing partners at earlier stages of the customer chain. In interviews with OEMs and other manufacturers, many of the success stories that they tell about their favorite suppliers involve innovations that “change the game”. In some markets, those are in fact about the only opportunities for innovation that are available to suppliers.
There is no question that innovation will create the foundation for future success stories for many manufacturing firms. The focus on innovation correctly belongs high on the agenda. But innovative thinking about innovation is the first step in the process. The three flavors of innovation described here – ones that can raise the bar, ones that can expand the market, and ones that change the game by tapping into available value pools – all have the potential to be the foundations of those future success stories. Thinking through your firm’s opportunities within each of these categories, in the context of the markets targeted, the customers along the customer chain, and the competitors against whom you must win can allow the creation of an innovation portfolio that draws appropriately on all three possibilities and allocates resources to those opportunities most likely to yield future success.