V83 Business Strategies for Sustainable Innovation Christian Erik Kampmann cek.ino@cbs.dk 2009-09-12
A Agenda d • Does it pay to be first (FMA)? – (Markides and Geroski – and others)
• The systems approach • Systems and FMA – a quantitative approach pp – (Sterman et al)
• Systems and sustainability efforts – a qualitative approach – (Marshall and Brown)
H How d do FMAs FMA arise? i ? • Create a technological edge over competitors – But you must maintain proprietary control
• Learning Learning-curve curve effects – If they are appropriable …
• Economies of scale and scope – If they are appropriable…
• Control access to scarce resources – You already possess a key resource, or can occupy a market niche that enables you to perform better than your rivals
• Leverage customer commitments – Switching costs, costs brand loyalty loyalty, network externalities 3
S Sources off first-mover fi t effects ff t Sources of FMA’s
Sources of FMDs
• Technological leadership • Learning-curve L i effects • Economy of scale and scope • Preemption of scarce assets • Switching costs or buyer choice under uncertainty
• Free-rider effects • Costly errors • Resolution of technological or market uncertainty • Shifts in technology or customer needs • Incumbent inertia
M kid and Markides d Geroski G ki (2004) • Puzzle: early pioneers have the necessary technology and enter the market early – Why do they consistently lose out and surrender the markets they create to other firms? • Not because they are small or badly managed • Not because their products are inferior
• Why do big, established companies only rarely create radical di l new markets k t – but b t still till win? i ? – Colonizing / consolidating
• Main p point: Firms that are first when the market ((and not the product) emerges end up with most of the profits
5
Complementary p y assets (Teece 1986) • Why do innovating firms often fail to profit their innovation? • Profits often accrue to owners of complementary assets – – – – – –
Service system Distribution system y Customer contact and updating Market access Supply chain ...
Cl Classifying if i iinnovations‌ ti
Effect on customer habits and behavior
Effect on supplier competency base and complementary assets Enhances
Destroys
Major
Major innovation
Radical innovation
Minor
Incremental innovation
Strategic innovation
Radical vs. strategic g innovations Radical • Television • PC’s • Cars • Semiconductors • Mobile phones
Strategic • Internet banking g • Low-cost flights • Generic drugs • Discount retail stores • Online O li university i it
Radical innovations on the horizon... • Smart grids • Alternative-fuel vehicles • Cradle-to-crade Cradle to crade systems • Distributed energy systems • De-materializing of offerings
Characteristics of radical innovations • Disrupt both customers and producers • Rarely driven by demand or immediate need • Lack champions (lead customers or market leaders)) • No one knows… – what customers really want – what technology can do – how to produce it best
Utterback: Technology cycles and stages of market evolution
Fluid phase
Emergence of dominant d i design
Mature mass market
Utterback (1994) Mastering the Dynamics of Innovation
C Competing ti platforms l tf
Car platforms and total no. of producers, USA 1876-1942
Wh t is What i a “fast “f t second”? d”? • A “first mover strategy”: get in there quickly and producing your own product variants • A traditional “second-mover strategy”: wait for the dominant design to be completely accepted, then compete on costs and low p prices • A “fast second strategy”: wait for the dominant design to begin to emerge before moving, but establish base for entering
13
“S t “Systems” ”…? • Systems analysis – (engineering discipline, mostly technical)
• System dynamics – (control theory concepts and simulation, with emphasis on social science issues)
• Systems thinking – (Peter ( Senge, g , Checkland,, …,, qualitative, q , management philosophy)
P bl Problem-solving l i view i
G l Goals
Problem
Current state
15
Decision
Results
F db k view Feedback i
F db k view Feedback i Goals
Decisions (continuous process)
Current state
Goals of others Actions of others 17
Side effects
D Dynamic i complexity l it off systems t • Tight coupling (”everything depends on everything y g else”)) • Feedback (”what goes around comes around”) • Nonlinear (”chaos”) • Path-dependent P h d d (”l k i ”) (”lock-in”) • Self-organizing (”emergent properties”) • Adaptive ((”humans humans, not clocks clocks”)) • Counterintuitive (”cause and effect are distant in time and space”) • Policy resistant (”seemingly obvious solutions don’t work or make matters worse”) • Trade Trade-offs offs ((”worse-before-better worse before better behavior behavior”)) 18
St Structure, t b h i and behavior d events t
Levera age
Feedback structure
Patterns of behavior
Events 19
Wh t is What i ””structure”? t t ”? • Stocks and flows – (physical, financial, social, ...)
• Information links – (who knows what when)
• Organization – (incentives, power, rules, criteria, …)
• Decision-making D i i ki b h i behavior – (heuristics, rules, expectations, ...) 20
Th modeling The d li process Behavior over time
Problem formulation Policy levers Sensitivity testing Scenarios
21
Causal hypotheses
Causal diagrams, Stock/flow structure
Understanding
Formall F model development
Policy P li analyisis (simulation)
Rationality testing, test g, Hypothesis testing
Model testing g (simulation)
Computer model
Structure as causal diagrams (feedback loops) Desired temp. Negative/ Balancing Loop
+ -
Causal link
B (or -) Temperature
22
Int. rate
Link polarity
Valve V l position
Negative or balancing feedback loop
Positive/ Reinforcing Loop oop
Variable
+ +
Interest credited
R (or +) Account balance
+
+ Positive or reinforcing feedback loop
F db k loop Feedback l examples l Attractiveness of Market
Cumulative Production
Number of Competitors
Profits
Market Share
Price
Price
Pressure to Clean Up Environment o e t Environmental Quality y
Unit Costs
Cleanup Effort
Bank Cash ese es Reserves Net Withdrawals
Perceived Solvency of Bank
Identify and label the polarity of the links and loops in the examples shown. 23
Four equivalent representations of stock and flow structure
Hydraulic Metaphor:
Stock
Stock and Flow Diagram: Source
Integral Equation:
Differential Equation: 24
Inflow
Outflow
Sink
St k t IInflow Stock fl s Outflow O tfl s ds d Stock St k t 0 t
t0
dStock t Inflowt Outflowt dt
Stock/flow distinctions in different disciplines
25
Field
Stocks
Flows
Math, physics, engineering
Integrals, state variables, stocks
Derivatives, rates of change, flows
Chemistry
Reactants and products
Reaction rates
Manufacturing f
Inventories
Throughput
Economics
Capital stock, money supply, pp y population p p
Investment, lending, borrowing, g births, deaths
Accounting
Balance sheet items
Income statement items
Biology, physiology
Compartments
Diffusion rates, flows
Medicine, M di i epedimiology
Prevalence, P l reservoirs
IIncidence, id iinfection, f i morbidity and mortality rates
Wh stocks Why t k and d flows? fl ? • Stocks define the state of the system t and d provide id the th basis b i for f actions • Stocks introduce inertia and y memory • Stocks are the source of delays • Stocks decouple rates of flow and create disequilibrium dynamics 26
Anthropo ogenic CO 2 Emiissions (Billio on metric tons/ye ear)
8
6
4
2
Atmosph heric CO 2 (Billion metric tons)
0 1950 800
2000
2025
2050
1975
2000
2025
2050
750
700 Data
650 1950 1.0 Global Mean Surfa G ace Te emperature Anom maly (째C C above background)
1975
Model
Angell Data
0.8 0.6 Model 0.4
0.0 1950
Global temperature rises well after TGHG emissions fall to zero. Simulated emissions fall to zero in 2000 M 2000. Mean surface f ttemperature t continues to rise for roughly 20 years. Source: Fiddaman S Fidd (1997), (1997) reprinted i t d iin St Sterman (2000)
02 0.2 JWW Data
27
CO2CO2 emission and global warming
1975
2000
2025
2050
Th 1979 oil The il crisis i i
28
P li responses Policy • Odd/even days linked to license plate numbers • Maximum purchase each time ($ or gallons)
29
I Imports t wentt up, now down d So where did the gas go???
U.S. Crude oil imports (1000 bbl/day) 78.500 78 000 78.000 77.500 77.000 76.500 76.000 75 500 75.500 75.000
1978
Source: U.S. DoE 30
1979
P i up exercise Pair i • What was/were the key cause/causes of the gas shortage? • Do you think the policies worked? • Why/why not? • Alternative policies that might work better?
31
St Structure t off the th problem bl -
Supply of gas
Gas in stations
Incidence of shortage
Perceived shortage Intensity of media coverage
32
Gas in cars Consumption
Filling
-
+
Desired level in gas tank
St Sterman ett all (2007) • Example of quantitative system dynamics study • Explores the challenges of the “get get big fast” strategy often dictated by neoclassical perspectives on FMA
T Two b basic i strategies t t i • Aggressive – High g market share ((80%)) – Price more to capture market – Grab any uncontested market share
• Conservative – Equal market share (50%) – Price more to cover cost – Cede market share if 50% share would result in over-capacity in industry
Fi t let’s First, l t’ build b ild a model… d l • Vensim Bass model • Extension
Different speeds p of adjustment (WOM effect)
Payoff y matrix (No capacity lags)
Payoff y structure independent p of WOM speed Aggressive strategy dominates (better off doing A no matter what opponent does)
Incentive to defect
No incentive for unilateral cooperation
Dynamics y under perfect p foresight
Aggressive firm has cost advantage‌.
‌ and wins out from higher sales and margins
P Payoff ff matrix t i (with ( ith lags) l )
Conservative strategy now dominant in fast markets
Incentive to cooperate
Incentive to defect
But also incentive for unilateral cooperation (No Nash Equil.)
Why? Due to capacity dynamics and errors
Note that aggressive firm still has cost advantage‌.
‌ but loses out due to excess capacity buildup
I t Interpretation t ti • Classical GBF strategy not always the right one even when conditions would appear to one, call for it • Don Don’tt take neoclassical game theory results for granted • Can you forecast better? – “by the time sufficient observations have developed for reliable estimation, it is too late to use the estimates ti t ffor forecasting f ti purposes.””
• Understanding/appreciating dynamics is key
M Marshall h ll & Brown B (2003) • Example of qualitative use of systems thinking • NTO: Catalog sales of high high-end end outdoors equipment and apparel • Two T sustainability i bili efforts ff – Recycled y paper p p for catalogs g – Sustainability supply strategy
Recycled y paper p p business system Documentation and industry efforts
RC to virgin content price differential
Individual negotiation with paper suppliers
Overall demand for RC
Industry investment in RC technology
Perceived quality of recycled content (RC)
Marginal ROI on investment in RC tech.
Scope and scale of RC production Rate of improvement in RC quality
Collection effort effectiveness
Raw material cost RC raw material supply
Rate of changed of RC quality
Cotton life cycle y analysis y (Sustainability toolkit)
Simplified scoring system for buyers
Part of compensation package
Buyer y and supplier pp business system v. 1.0 Rate of product meeting design specs incoming to NTO
Customer demand
NTO financial performance
Supplier pp sales.
Product portfolio margin Buyer compensation
Design time
Supplier changes to prod. design
Rate of change in prod. design
Rate of change in no. no of products ordered
Supplier investments to meet redesign Supplier dependence on NTO
Buyer y and supplier pp business system v. 2.0 Rate of product meeting design specs incoming to NTO
Customer demand
NTO financial performance
Product portfolio margin Buyer compensation
Buyer willingness to use sustainability criteria Learning time
Supplier pp sales.
Change g in sust. product selected
Buyer ability to choose highmargin sust. products
Design time
Supplier changes to prod. design
Rate of change in prod. design
Rate of change in no. no of products ordered
Supplier investments to meet redesign Supplier dependence on NTO
Buyer y and supplier pp business system, leverage actions Rate of product meeting design specs incoming to NTO
Customer demand
Comp. package NTO financial performance
Scorecard Buyer willingness to use sustainability criteria Learning time
Training
Toolkit
Product portfolio margin Buyer compensation
Change g in sust. product selected
Buyer ability to choose highmargin sust. products
Toolkit
Supplier pp sales.
Design time
Supplier changes to prod. design
Rate of change in prod. design
Rate of change in no. no of products ordered
Supplier investments to meet redesign Supplier dependence on NTO
Cl i Closing th thoughts ht • Greentech is likely to revolutionize many industries i d t i – creating ti situations it ti off radical technology change • This brings about situations where FMA/FMD are highly pertinent • Systems thinking/system dynamics can be a useful tool for analyzing y g strategies g under radical change • And a tool for indentifying leverage points for less radical innovation
N t ti Next time‌ Open innovation and platform strategy in the context of y innovation sustainability (with Jens Frøslev Christensen)