Not all resources develop in a positive direction. Equipment and other fixed assets deteriorate, often through recognizable stages. Management of physical assets is a neglected issue in strategy, even in operations management.

Yet for many companies the value involved is considerable — a typical utility company, could have tangible assets worth more than five times the company’s annual turnover. For such organizations, the renewal and maintenance of physical assets is a dominant component of its business strategy. This is not simply due to the sheer scale of financial value and expenditure involved; the consequences of success or failure on the issue reaches out into the market, through the impact on customers’ experience and hence on the company’s reputation.

Briefing 28 discussed how physical assets deteriorate, often by becoming increasingly unreliable. It treated any particular type of asset as a single population, and averaged out its reliability across all units. We also pointed out that the distribution of asset quality has important implications for asset management strategy, whether quality is rather uniform across all units, or heavily skewed by a few particularly poor units.

Strategic management of an asset base includes a number of policy options— how often to do routine maintenance, when to replace a unit completely, and when to refurbish a unit. Refurbishment involves taking the unit out of service, replacing worn-out parts and effectively restoring it to an as-new state. Depending on the asset involved, this may be possible only with units that are not too seriously dilapidated, and may only restore the unit to a partial state of as-new health. Similar stages can be seen with buildings and assets in other industries, such as refrigeration equipment in data centers, vehicles in logistics firms, food preparation equipment in catering and the quality of fittings in restaurants, hotels and leisure outlets. To use the framework in other cases, you need only define the appropriate life stages, identify how many units reside in each stage, and why and how fast they move between them.

The figure below shows a population of units in a regulated power-supply firm, distributed amongst four states, and the corresponding failure rate. The company receives a fee for each unit of power it supplies to customers in its region, but a penalty charge is deducted from this fee for any failures in its system that inconvenience its customers. (This reflects a particular regulatory regime, which may differ in other countries.)

The business starts with a poor asset base that continues to deteriorate for the first five years:

• maintenance on reliable assets is not sufficient to keep this number at its initial level.
• maintenance and refurbishment of degenerating units are not enough to prevent a rapid flow of units into the unreliable state.
• spend on new equipment is insufficient to prevent the number of unreliable units growing quickly.
• the total rate of failures is growing, driven especially by the rising number of unreliable units, and price penalties are reducing the company’s revenue.
• falling revenue and rising operating costs are causing a rapid decline in the company’s net cash flow.

The strategic question here is where to intervene with changed spending rates, and how those spending rates should change as time passes, so as to both reestablish and sustain an acceptably low failure rate whilst at the same time producing acceptable and sustainable cash flow. The strategy depicted is as follows: From years 5 – 10, the company undertakes a major investment program to replace many of its unreliable units.

• Over the same period, most of the degenerating units are refurbished. This not only reduces their contribution to the overall failure rate, but also cuts drastically the pool of degenerating units that subsequently become unreliable. The number of unreliable units therefore continues to decline even after the replacement program is cut back from year 10.
• To prevent the number of degenerating units rising too quickly once again, maintenance of reliable units is progressively increased—a switch of spending away from the declining number of degenerating units. The rate of reliable units starting to degenerate does rise, simply because of the greater number of reliable units in existence, but not sufficiently to allow much increase in the population of degenerating units.
• Over the later years, the continuing fall in unreliable units allows a slight reduction in overall failure rates, though this is partly countered by a small increase in degenerating units.

Until next time…

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It’s not just equipment that degrades

Certain intangible “assets” also degrade over time. Information technology systems (as distinct from the hardware on which they run) effectively become less useful, even though the code of which they consist remains the same or even improves, because the business needs that the systems serve are moving forward. Similar decline applies to business processes and technologies.

Content’ in many media sectors also degrades – we see feature films released first in cinemas, before moving to rental channels and cable or satellite TV, before reaching broadcast channels and eventually the bottom of the pile – off-peak multiple repeats.

This briefing summarises material from chapter 6 of Strategic Management Dynamics, pages 336-340.

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One particular issue it brings up is the tension between what works for customer-facing issues vs. what works back in operations. Here, consumers want a single relationship, whether they rent physical DVDs or stream video-movies, but the business operations to provide those two services are fundamentally different.

Briefing 36 introduced the idea that resources develop through stages. Product development is one such process that has long been well understood.
What are the typical stages?

Typical stages may include:

• idea generation, making use of diverse sources including basic R&D, competitors’ products, customer focus groups or direct requests, employee suggestions, and so on
  initial screening, where the basic technological feasibility and market potential are assessed.
• technical development, which includes the product’s initial specification and testing.
• commercial evaluation, including market research, assessment of likely sales volumes, prices and revenues, and detailed estimation of production costs and capital investment.
• final development, when the product itself takes the form that customers will actually see, and the details of the production process are specified.
• product launch, when marketing and sales activity start, sales are generated and product is shipped.

The exact stages involved and the activities that occur in each vary considerably from industry to industry. It is also common for companies to run stages in parallel in order to collapse the time between initial idea and product launch — for example, production engineering running in parallel with final product design and market testing.

Figure 1 illustrates a staged resource structure for such a product development process. New ideas enter the process at the bottom left, and progress up the chain. At each stage, a product may fail and fall out towards the bottom right. There is a fractional probability of each product making it from one stage to the next, and each development stage requires some time to work on a product idea. The total time for a product to pass through development is 14 quarters or 3½ years, provided that the rate of new ideas and products passing between stages is within the limits that staff in each stage can handle.

Figure 1: Dynamics of a product development process with increase in initial ideas.

After quarter four, management take steps to increase the rate of new product ideas entering the process from 150 to 200 per quarter. Although the technical development staff are able to cope with the faster arrival of new ideas, products reach the later stages faster than those teams can handle, and the total process lengthens by 1.5 quarters. More new products are launched, but slightly later than before.

After quarter eight, a further initiative raises the rate of new ideas to 300 per quarter. Management recognizes that this could throw much more work into technical development than the group can handle (dashed lines), a problem that would also feed through to later stages. Consequently, a tighter screening process is introduced at the same time. This cuts sharply the number of ideas that would otherwise flow into technical development. It would be expected also to cut the flow of work into later stages, but the tighter screening increases the quality of new product ideas, so more make it through at each stage. As a result, the increase in new product launch rate (5.0 per quarter versus 2.2 originally) is proportionately greater than the increase in the rate of new ideas. However, this comes with a penalty of longer development times overall (20 quarters versus 14) due to the higher workload—a problem that could be tackled by increasing staffing selectively on the stages where work pressure becomes most severe.

Until next time…

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Pipelines must contain the samestuff

The resources flowing up the chain in Figure 1 are all “products.” This is the general principle that resource development pipelines must contain the same kind of resource in every stock and in every flow between those stocks. We do not have, for example, “research staff” in the first stage of Figure1 and “product” in the second stage.

Note too that some of the stages listed above in the description of typical product development steps actually describe the transitions from stage to stage (i.e. the flow rates) rather than the stocks themselves. ‘Idea generation’, for example, is a flow of new ideas into a stock that has not yet been screened, and screening results inflows that push each idea either into technical development or else out of the system as a reject. ‘Technical development’, on the other hand, is a state in which a product resides for some time, as is commercial evaluation and final development. If the progress of product development is to be quantified, then, it is important to describe each state and each flow rate accurately. So, when using resource development chains, be sure to define precisely each state in which the resource can be [that is, the stocks] and the flow rates between each state.

This briefing summarises material from chapter 6 of Strategic Management Dynamics, pages 328-336.

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So far, we have simply assumed that resources can be switched on and off, but in many cases, resources may develop through a series of states. Sometimes this happens entirely within an organization, such as products being moved through stages in the R&D process. For some items, though, development may extend outside the organization, such as the growing awareness and interest of potential customers, and the continued influence of former customers.
How does this influence strategic thinking?
Staff development

The promotion of staff from junior to senior positions provides a clear example of a resource (people) moving from state to state (junior to senior) in many organizations. In figure 1, lawyers are hired and promoted to partner along a simple two-stage chain. (There may of course be more than two levels of staff in an organization or department.) This figure shows both an issue of concern — the rising lawyer attrition at the bottom of the diagram — and the reduced rate of promoting lawyers to partner that has been one cause of the problem.

Figure 1: Two-level staff chain in a law firm.

Previous briefings explained how the math in stock-and-flow relationships is vital to the quest for a rigorous causal explanation of performance, and emphasized in particular the mathematical identity between the quantity of a resource at any point in time and the cumulative history of all resource gains minus all resource losses. The same principle applies equally to each state in a developing resource chain. Here, the number of 180 lawyers below the partner level is entirely explained by the firm’s history of all lawyers who were ever hired, promoted and lost. Similarly, the number of 28 partners at quarter 12 is precisely explained by the sum of all lawyers ever promoted to partnership minus all partners who ever left. There could in practice be a third flow affecting partner numbers — experienced people who are hired directly into the partner grade, rather than being promoted up through the firm — but that has not been happening in this particular firm.

This stage-by-stage development of staff and other resources has important implications for strategy, since it extends the timescale over which cause and effect are separated. In this case, for example, no more than 4% of lawyers have ever been promoted in any quarter (in quarter three, when four were promoted out of a population of 107). This means that a newly hired lawyer cannot expect to be promoted to partner in less than 25 quarters, or about six years. More recently, the expected delay between being hired and promoted has extended still further – one of the major reasons lawyers are leaving. An important consequence of this delay is that promotion rates in any year are in part dependent on the number of lawyers hired many years previously — if the firm hired no new lawyers six years ago, then there will be no lawyers today with six years’ experience. If this resulted in a shortage of partners today, and if this shortage were to cut the firm’s ability to win work from clients, the resulting performance reduction would have been caused by the firm’s hiring failure six years previously.

Until next time…

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When staff develop too quickly

Many senior executives express concern at the difficulty of finding enough of the people they need and the challenging war for talent into which they are drawn. Yet it is easy to overlook the converse problem, namely that staff hierarchies are in effect powerful “breeding machines” for management.

Consider a company starting and developing different retail businesses over about 10 years. Groups of stores in each chain are controlled by area managers, who report to a few regional vice-presidents, who report in turn to a head of operations. Whilst each business is growing, there is a continuing need for more area managers, and thus a good prospect of promotion for store managers. There is also a continuing need for regional VPs, and thus opportunities for area managers to be promoted. As growth opportunities slow down, there is no need for more area managers and regional VPs, so promotion rates fall sharply.

The problem is reduced if the organization invents new retail store formats and starts to grow more new businesses. A manager in a mature business can then be offered an equivalent position or a more senior post in one of the new businesses. Some professional firms solve the problem a different way – with an ‘up or out’ policy, in which staff must seek promotion after a certain number of years in their current grade. If they succeed in winning promotion, all well and good. If they fail, they are asked to leave.

This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 203-308.

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Appraising competitors often involves assessing their strengths and weaknesses in some way, comparable to parts of the SWOT approach that management might use to assess their own business. But such approaches are qualitative and high-level, and quite inadequate for designing and implementing specific competitive campaigns. So a more rigorous approach is needed.
A more rigorous approach builds on two principles:

1. A competitor operating in our own industry will likely have both a similar set of resources and a similar architecture for organizing them to ourselves. Competitors may differ in exactly which segments they serve, what products and services they offer, and so on, but the elements will be largely the same. Even where they differ (e.g. outsourcing certain activities that we do ourselves) many of the remaining parts of their resource system will be similar to our own.
2. Like us, a competitor will have a range of “quality” for each of its resources—larger and smaller customers, products that perform well and not so well, stronger and weaker sales people, and so on.

If we can understand how our own business performs, we should be able to evaluate the performance of any competitor — and therein lies the opportunity to damage that performance at little risk to ourselves.

To illustrate how this can be done, consider the real case of a mid-scale, mid-market restaurant chain, developing fast in a promising market, but number two to a long-established market leader. Although operating only 120 restaurants compared with the leader’s 300+, it was generating nearly as much profit, due to a recent history of finding great locations and developing better products than the leader. With a good understanding of the profit profile of its own restaurants, it was able to estimate the equivalent profile for the competitor (see figure 1).

Making this estimation of the competitor’s performance was especially easy in this case — without resorting to illegal espionage! The profit of a restaurant is simply given by the revenue that comes from customer numbers and prices, minus its costs, which are dominated by numbers of staff and the ownership cost of the real estate. Prices are on the menu, customers can be counted, and their typical meal purchases can be observed. Staff numbers can be counted, and the costs of real estate are in the public domain. The resulting estimation was not exact, but close enough to know roughly how much profit was coming from each of the competitor’s units.

Figure 1: Comparable profit curves for two mid-market restaurant chains.

Armed with this information, selecting the point of attack was simple. Trying to damage their most profitable units would be hard – they were popular with their local consumers, were well run, and received plenty of attention from headquarters’ management. Any attack on these would certainly have been noticed, and vigorously defended.

Attacking unprofitable units was pointless, as the competitor would not be concerned or damaged by their loss. The appropriate targets were the restaurants contributing profits in the mid-range. These moderately profitable units were geographically dispersed and supervised by different regional managers. Consequently, attacks on a random selection of this list were not noticed, provided that the tactics were subtle. So what should those tactics be, bearing in mind that they are local; that is, conducted by specific units in our business against neighboring units of the competitor?

• The tactics were not led by price cuts. Reductions significant enough for customers to notice would have hit profit margins hard.
• Promotions offering extra value for customers were less costly, and more difficult to retaliate against. Those promotions were selectively targeted at specific neighborhoods from which the competing restaurant drew its customers.
• The next principle is to address every item on consumers’ value curve – service quality, the environment and product quality. Local tactics therefore included ensuring that restaurants were oversupplied with staff and fitted out to give the best possible customer experience.
• Finally, the units leading the attack were allocated the best unit managers – those most skilled at motivating staff, at ensuring high quality of product and service, and at befriending customers.

Taken together, these tactics took hit badly the revenue from the competitor’s units that were targeted, at which point their own policies started to act against them. With lower revenue, management tried to sustain profits by cutting costs, especially staffing, which then damaged consumers’ experience. With the targeted restaurants becoming rather quiet, they became increasingly unappealing and lost still more consumers. Eventually, the targeted units became so unprofitable that they were neglected by management until they were closed.

Repeating these tactics across a selection of mid-profit outlets inflicted disproportionate damage to the competitor’s overall profits. In Figure 2, eliminating the profits of just 11 units hits the competitor’s profits by 12%, a process that could be accomplished in as little as six months. Repeating this principle over two to three years, dealing in all with 70–80 of the competitor’s units did such damage that they started to experience further problems.

Figure 2: Targeting selected units does disproportionate damage to a restaurant competitor’s profits.

• The pressure to sustain profits drove them into system-wide policies that did further damage, such as price discounting and cuts in staffing, marketing, product development and maintenance, all of which undermined critical resources in their strategic architecture.
• The competitor’s central management started to lose motivation and commitment, and many left for better opportunities—often with the attacker!
• The confidence of investors was damaged—in this particular case, the business was one of several similar operations operated by the competitor’s corporate owners—so requests for capital were turned down, making it impossible for the rival to match the high quality new units that were being added to the aggressor’s business.

In this case, the competitor left the industry after just a few years of the competitive strategy being implemented, selling most of its remaining viable restaurants to the one-time number two, who was left with a dominant position.

Not all situations make it so simple for management to develop focused competitive tactics. More commonly, it is necessary to learn about the competitor’s source of profitability from customers, rather than from distribution outlets as in the restaurant case.

The business banking division of a major bank did not know which competitors were making how much profit from which customers. However, the bank knew from its own experience the likely value of the banking services for any customer of any size in any sector. It could then make a reasonable estimate of the profit a competitor might be receiving from a similar customer of a similar size in the same sector. From this initial estimate, management could make adjustments if they had reason to believe for example that the competitor made better margins or had some cost disadvantage. The bank’s customer – relationship managers were also able, over a period, to approach customers with whom they did not deal and find out which bank provided its services.

Until next time…

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Issues to consider

Briefing 34 already discussed the need to pick a specific competitor to target, rather than spread competitive efforts widely, and how to make that choice. Two other key questions arise:

Whether to be open or covert about the attack.
In the restaurant case, secrecy was important because, had the competitor been aware of the plan, it could have looked out for those units that were under attack and responded. In both these cases, the strength of the competitor made it important to be covert. In other cases, it can be appropriate to be open about the attack if it helps the competitor decide early on to admit defeat and withdraw.

Choosing which resources to use as the basis for a competitive attack.
The quality curve can sometimes be constructed, for example, for the profit a competitor makes from individual items in its product range. The attack can then focus on products that are weak, even though they contribute significantly to the competitor’s performance – perhaps a product that is becoming obsolete or is poorly supported. US car makers, for example have repeatedly been picked off by European and Japanese rivals offering superior models in product segments seen as secondary, such as compact cars, performance saloons and hybrid vehicles. The result was, as pundit Tom Peters remarked, that the US auto industry was not defeated by overwhelming force, but was instead “nibbled to death,” piece by piece, over four decades.

This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 203-308.

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Some such statement comes up on just about every strategy discussion group I follow, but it’s a false dichotomy, and untrue in any case. The ‘Picasso’ analogy is a nonsense – not only is every work by true artists highly creative, but every brush-stroke is too.

Creativity is a minuscule element strategy – spotting some business idea that no-one else has done – but 99% of it is serious, logical thinking and working-out. Even issues where creativity might be helpful are much more often tackled, successfully, by reasoning than by creative genius – you can think your way to spotting new market opportunity, and work out analytically how to tackle a competitor.

There are armies of strategy professionals out there (even if not named as such) doing rigorous investigation, analysis, and decision-making, and helping their organisations do well as a result. Even where a genius insight happens, it will then be built on by hundreds of times more effort in its implementation than the split-second Eureka moment.

Can we please stop devaluing the vast amounts of hugely important, professional work that strategy professionals do?

Strategy very often includes a need to beat competitors as well as running our own business well, and we have long understood how competitive forces affect industry profitability. Those forces include not just existing direct competitors, but customers’ buying power, suppliers’ control of key inputs, and pressure from substitute products and new competitors. Firms can and do try to manipulate those forces to support stronger profits, for example by getting their customers locked-in to buying from them in some way.

But you can go further!
You can work to actually alter those competitive conditions. Two particular objectives can be helpful:

• encouraging current competitors to leave the industry
• deterring possible new entrants from starting up in the industry.

Certain forms of anti-competitive behavior are illegal in many countries, such as artificially restricting customers’ freedom of choice, or cutting prices below cost to drive rivals out of business and deter new entrants. Nevertheless, it is quite possible to influence competitors in ways that are entirely legal. To see why this is important, think about how competitive conditions change over time.

In the figure below, the left-hand column in each case shows a fragmented industry whose total revenue is made up of the revenue of each firm in the market. The industry’s growth and hoped-for profitability is attracting new competitors. In the scenario on the left, our own business grows little, both because those new entrants absorb the industry’s growth and because we are not so successful at capturing some of that growth. These changes make it harder to sustain profits and second, and mean that efficiency improvements are competed away by lower prices.

Average profitability is therefore reduced, and we suffer more from this process than others who develop more successfully. It is entirely possible that both new entrants and the original competitors make little or no profit. Indeed, the situation shown on the left could well result in many firms, or even the industry as a whole, being unprofitable for many years. We would likely do better if we could both persuade existing competitors to leave the industry, and deter new firms from entering.

Two scenarios for changing competitive concentration in a growing industry

The scenario on the right depicts the same overall industry growth, but this time with fewer new entrants, and the exit of some of the original competitors. As a result, there is more space for us and the remaining firms to grow. The smaller number of rivals both reduces the tendency to compete away prices and margins in a desperate attempt to capture sales, and also enables remaining firms to extract efficiency savings more quickly. These mechanisms allow us and our remaining rivals to be more profitable. In this scenario, we have also been more successful in developing our own business and overtaken the previous number two competitor.

Not only is it helpful to deter new competitors, then, but it can also be valuable to help existing rivals leave the market. But how to do it? Trying simply to be better than everyone across the whole market has several disadvantages.

• Taking on everyone at once can be very costly. Any effort that is spread across the entire market has to be of a commensurate scale, so trying to under-price, out-market, outsell and out-service all competitors will inevitably be very costly.
• Efforts dissipated across the whole industry will likely have less impact than efforts focused on specific parts of the market or against particular competitors.
• Such industry-wide competitive efforts will attract retaliation from many competitors, risking great damage to our own business.
• Our efforts will be very visible, exacerbating the very competitive conditions that make it difficult to sustain profitability, for example by triggering price wars, escalating advertizing commitments or starting a war for talent.

Taken together, these considerations mean that indiscriminate competitive efforts simply don’t work, or else take so long and at such great cost that the business pursuing them suffers along with all the others. That is why selecting specific competitors to attack is more advisable than indiscriminate efforts. In many cases it even makes sense, and is possible, to eliminate them entirely from the market. We will look at a powerful way to do that in the next briefing.

Choosing which competitor offers the best target needs to be done with care. Small rivals are not necessarily easy to take on, and eliminating them may in any case bring little benefit. On the other hand, bigger stronger competitors can have powerful resources with which to defend or retaliate. Often it can be best to choose a mid-ranking rival, but the key criteria should be (1) that their defeat offers a significant improvement to overall competitive conditions and (2) that a tactical campaign can be devised that is feasible and minimizes the risk of retaliation. Getting it wrong can be costly – in one case, a new competitor tried taking on McDonalds in an important country market, and were destroyed in just 18 months.

Selecting who to attack and working out how to do it requires a deep understanding of individual rivals. In their efforts to contain costs, many companies lack the resources to build-up even the most basic competitor intelligence. Given the value at stake from even modest progress against rivals, this is a false economy.

Until next time…

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Keeping the Vandals out of Rome!

You also need to think about what it might be worth to deter new entrants. In one restaurant market, some twenty would-be competitors had announced development plans that in total would have tripled the number of restaurants in the market over a five year period. These plans were encouraged by the market’s growth, and by the winning company’s own very public success. Had that number of units actually been opened, virtually all of those competitors would have lost money and failed, but inflicted considerable damage to the eventual victor in the meantime. Too many firms thought that running restaurant chains was easy, not understanding the complexity of product development, staff training, operating procedures, sourcing and logistics, and real-estate development. The strategically wise competitor used open communications, such as industry magazines and conferences, to clarify the difficulty of building a successful business and demonstrate just how powerful was its system of resources. The implicit message was “Sure, we are successful, but do not for a minute imagine you can match us — and be sure that we will destroy you if you try!” On reflection, many of the would-be entrants decided that the challenge looked just too difficult, and abandoned their plans. Less than half of the announced new units were ever opened.

This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 233-303.

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The Strategic Planning Society got a meeting together yesterday at Said Business School to see if there is some way to make the practice of strategy more professional, but the FT already decided this is a bad idea, citing examples of top execs appointed because of their experience alone. This hardly accounts for the endless procession of CEOs, appointed for exactly that experience, who end up getting fired for messing up the strategy of their companies. And these are just the tip of a huge iceberg of lesser failures that are never reported.

We also know from endless studies that most senior executives have little confidence in their own strategy, many cannot articulate what it is, and most of those below them share their scepticism. Any effort to inject some basic skills into corporate management would seem to be welcome – and we might just end up with fewer Goodwins leading corporations to disaster.

This cannot be an adequate definition of strategy. First, the answer today is no different than it would have been 30 years ago when S-W started – so what has S-W “strategic management” been doing over all that time? Secondly, 60-odd airlines have tried that strategy in Europe, over 40 have failed, and only a handful are successful, so these choices cannot possibly explain what constitutes a successful strategy. The same is true of just about every other well-known success-story- a one-time clever choice, never significantly changed, copied by many, but most failing.

The discipline is called “strategic management”, so surely any answer must encompass what management does on a continuing basis – not just one-off choices. So Strategy (whether successful or not) is something like “The stream of quantitative decisions made across all functions of the organisation, continually over time, against changing external conditions, that causes performance to change over time“. Whether the strategy is successful for business cases shows up (as Booz explain) in creation of business value, as given by the net present value of free cash flows. The alternative basic definition, though, has the merit of being equally applicable to non-commercial cases (and many business cases too), where performance aims are not primarily financial.

Another context where the quality-curve concept can be valuable is…

The development of product features: When introducing new products and services, firms race to provide sufficient functionality to make them useful enough for customers to buy. As usage rises, suppliers compete by “improving” their products — adding to the sheer number of features included (figure 1). In effect, functionality for such products and services lies behind the user benefits captured by the value curve of reasons why customers choose the product and stick with it rather than switching to rival products.

Figure 1: Increasing functionality by adding features.

In many cases, this feature-war results in products that have many, many more features than most customers will ever use or even understand, such as the ‘outlining’ tool or macros in word-processing software or 3-way calling in cell phones. But if a supplier stops participating in this improvement race, their once exemplary product becomes merely average, and then obsolete. They are left behind, not because their offering has actually become worse, but because customers’ expectations have risen. This happens because users become accustomed to what is currently offered, and because suppliers try constantly to rise above their rivals by offering more. The cell phone industry has been a powerful illustration of how this race can develop into desperation as firms explore every possible avenue for providing more reasons for customers to take their products and services.

Figure 2 illustrates how this might play out over time. Market research for a consumer electronic product indicates that without a minimum of four specific features no one will find the product useful. Product development efforts make progress in raising the product’s features, resulting in a useable product after one year. During year two, added features make the product more appealing so the product’s sales rate escalates. By year four, the product has been made about as useful as can be to likely customers, and uptake slows down.

Figure 2: The dynamics of product adoption as features are added.

Several further factors may be involved:

• The price must be sufficiently attractive, awareness must be built with marketing, and the product must be available for customers to find.
• There will likely be a diffusion effect, with uptake being accelerated by word of mouth from existing customers, and increasingly limited by the declining pool of potential customers who do not yet own the product (see the Bass diffusion framework in briefing 20).
• In the case of consumable products sales clearly continue after all potential customers have been captured, but durables too may to continue to sell as users replace or upgrade products.

Until next time…

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Disruptive technologies and the innovator’s dilemma

It is tempting for companies with a successful stream of products to continue pursuing the process described above time after time, with each new release of a product raising functionality so as to appeal to more and more customers and fulfill more and more of their needs. However, this can leave them vulnerable to innovations that may at first seem to be no threat, but which emerge to overtake the established product type so comprehensively as to make them obsolete. Well-known historical examples are numerous: gas lighting for homes and streets became obsolete as electric lighting developed, propeller engines for aircraft reached a limit that jet engines could surpass, and some readers may remember the Sony Walkman—a small portable tape-cassette player that allowed users to listen to 100 hours of music whilst on the move, provided they could carry 100 tape cassettes!

The dilemma for established product providers is whether and when to switch to the disruptive technology themselves—if they can. A company that has built massive scale and driven down cost in the old technology will have grown sales and strong cash flows from that product. Why would they deliberately accelerate the replacement of those sales and cash flows by introducing a product that will cannibalize them? The answer is often that if they don’t do it themselves, others will do it to them. Difficulties arise when the threatening technology is one in which the incumbent firms have no significant capability.

For more on this topic, see Christensen, C.M. (1995) Disruptive technologies: Catching the wave. Harvard Business Review, 75(1), (January–February), 43–53. Two books expand on these ideas: Christensen, C.M. (1997) The Innovator’s Dilemma, Harvard Business School Press Boston, MA, and Christensen, C.M. and Raynor, M.E (2003) The Innovator’s Solution, Harvard Business School Press, Boston, MA.

This briefing summarises material from chapter 5 of Strategic Management Dynamics, pages 294-297.

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