A new innovation strategy for the 21th century : lessons from startup methodology to stimulate an entrepreneurial based innovation economy.

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A new innovation strategy for the 21th century:

lessons from startup methodology to stimulate an

entrepreneurial based innovation economy

Executing search and discovery

A Philips case study

‘’There is nothing quite so useless, as doing with great efficiency, something that should not be done at all’’

(Peter F. Drucker)

Amsterdam Business School Master Thesis Innovation & Entrepreneurship

Author: H.B. ter Brugge First Supervisor: Drs. A.C.C. Gruijters Second supervisor: Dr. W. van der Aa Date of submission: 25-02-2014

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H.B. ter Brugge Master Business Studies 3

Abstract

This research presents lessons from startup methodology for Philips and other large organizations. It will give insight on both an operational and a strategic level. A comparison is drawn between lean startup principles and characteristics found within Philips’ Accelerate! program. The main focus will be on the threat of disruptive innovation for incumbents, and the opportunity in the identification of the unmet need within the established value network of a firm. Large organizations are adapting their strategies to become more entrepreneurial and innovative. These organizations can take lessons from startup methodology, to be able to better deal with the challenges of the 21th century fast paced business environment. While startup lessons can have a major impact on the innovation efforts of a large organization they need to make sure the corporate culture is ready to adopt these lessons.

Key words: Lean startup method, disruptive innovation, customer centricity, corporate culture change, innovation economy, Philips Accelerate!

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Author’s acknowledgement

I would like to take this opportunity to thank a few people that supported me during the course of this research. First of all my supervisor Drs. A.C.C. Gruijters for the numerous meetings in which he helped me transform my enthusiastic ‘big’ ideas into something I could work with. His feedback and guidance have been absolutely necessary in the completion of this thesis. I would also like to thank my partner for her patience and motivational words on those days when slow progress in the research was taking its toll on the mood of the author. Also special thanks go out to my good friend who has been writing his master thesis, often literally, alongside with me. Spending hours talking and discussing, drinking a lot of coffee and having a good laugh in between the work. Also the help of my family and other friends has been much appreciated.

I would like to thank the people at Philips, who invested their time and effort, and without whom this thesis would not have been finished. A special thanks goes out to Rukshana for providing the first contacts.

To the reader, thank you for your interest and enjoy the words to come. I hope it will make you think, even long after you put this paper away.

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Definitions

Innovation: The overall process whereby an invention is transformed into a commercial product that can be sold profitably (Crawford & Di Benedetto, 2006, as cited in Yang & Tao, 2012)

Disruptive innovation: A process by which a product or service takes root initially in simple applications at the bottom of a market and then relentlessly moves up market, eventually displacing established competitors’’ (Christensen, 2013).

Startup: A human institution designed to create new products and services under conditions of extreme uncertainty (Eric Ries, 2011)

Accelerate!: Philips companywide transformation program with the goal to become a faster, more agile, entrepreneurial innovator (Philips, 2012)

Lean startup: A method to build continuous feedback loops with the customer during the product development process (Mueller & Thöring, 2012)

Leading corporation: The leaders in the industry, companies that many managers have admired and tried to emulate, the companies known for their abilities to innovate and execute (Christensen, 1997).

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1. Introduction

- ’’Big companies are not the same as startups, and never will be. But that doesn’t mean that

they can’t be as innovative and fast moving as startups’’-

(Ashkenas, 2011)

The 21st century business environment is all about speed, uncertainty and customer centricity. Innovation has become a strategic on-going process that embraces all resources available to the enterprise (Engel, 2011). Due to fast improvements in information technology (IT), costs are driven down along with prices. This deems the original price-performance trade off irrelevant (Peterson & Bray, 2013). Companies are increasingly faced with the need to innovate fast, and customers are only willing to pay a premium when the product or service is something they really want. Incumbents are still pursuing short-term advantages by means of slightly better price or performance, or by continuously innovating. Instead, especially startups, are creating innovations in a flash which are brought to the world at tremendous speed thanks to the always-on 21st century IT. Thereby entire markets are created and destroyed almost overnight (Peterson & Bray, 2013), making this an eminent threat to incumbents.

In 1997, Clayton Christensen wrote a book titled ‘’The innovators dilemma: When New Technologies Cause Great Firms to Fail’’. It demonstrates how successful and outstanding corporations1 can do everything right and still lose their market leadership- or even fail- as new, unexpected competitors rise and take over the market (Christensen, 1997). The answer would lay in identifying, and focussing on, disruptive innovations. According to Christensen, at the time of writing, markets for disruptive technologies were not only unknown, but also unknowable.

Recent methodologies, which found its origin in the fast paced world of startups, indicate there is an answer to the identification of the unmet or unknown need. Large organizations should take lessons from these disrupters, to avoid being overthrown by surprise. There is a trend within large

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H.B. ter Brugge Master Business Studies 9 organizations to change their business models to become more entrepreneurial and agile, which seems necessary to remain their dominance or even their very existence. Product lifetime cycles are becoming shorter and large companies need to innovate at greater speed and focus more on the needs in the market.

Recent authors agree that disruptive innovations from startups are capable of changing long life business models and are a growing concern for large organizations (Blank, 2013). To ensure their survival and growth, corporations need to keep inventing new business models driven by entrepreneurial thought (Blank, 2013).

While dominant and experienced leading corporations and startups can be seen as each other’s antipode and generally lessons are to be learnt from the experienced, this study seeks to answer how Philips and other large organizations can learn from the startup methodology and help them be able to better deal with the competitive and unpredictable 21st century business environment. It also explores the importance of a changed corporate culture. It will provide an insight into Philips’ 7 year change program Accelerate! 2, which is designed to make ‘’ Philips a more customer focused, agile, entrepreneurial innovator’’ (Frans van Houten, CEO Philips, 2013). While the broad aspects of Accelerate are mentioned, the main focus will be on the comparison between the lean startup and the Accelerate program and the lessons for Philips and other companies. The results of this research will be presented to Frans van Houten (CEO Philips), which underpins the corporate interest in the topic. A more detailed description of problem definition and the purpose of this research will be discussed in the next paragraph.

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1.1 Problem definition and research goal

- ‘’If you think you are too small to make a difference, try sleeping with a mosquito’’-

This study will give an insight in the lessons for Philips and other companies by comparing the Accelerate program and the lean startup method. It will provide a useful insight for Philips, and also other organizations, to help them deal with the pressure of rapid change and the need for more relevant innovation at a greater pace. It will highlight the growing importance of customer centricity and local adaptation in the innovation models of large organizations and its importance to stay competitive or even to remain in existence. Large companies are adapting their strategies to a more entrepreneurial driven and innovation based economy. The main research question is:

Can leading corporations take lessons from startup methodology in their

innovation process?

The research will provide a case study around Philips and the Accelerate transformation program, which started in 2010 under the supervision of Chief Executive Officer (CEO) Frans van Houten. Following Andersen & Tushman (1990), the 21th century organizations have to cope with an increasing amount of competition in today’s highly versatile environment. ‘’While technological breakthroughs may be unpredictable events, firms must develop the capacity either to initiate these discontinuities or respond rapidly’’ (Cohen and Levinthal, 1990, as cited in Andersen & Tushman, 1990).

Most innovation research has been on large companies, which have generally been seen as the ones to take the lessons from. Unfortunately for these corporate giants an increasing amount of game changing innovation is brought to the world and its more than 7 billion potential customers, by startups (CIA Factbook estimate 2012). It is especially startups that are able to break down corporate giants by surprise by means of introduction of disruptive (technological) innovations. In current literature the definitions of these innovations provide answers for dealing with disruptive innovation

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H.B. ter Brugge Master Business Studies 11 in existing value networks. Sandström (2010) empirically proved that ‘’disruptive technologies may be in demand from mainstream customers at an early point, despite their traditional performance’’. (Sandstorm, 2010, p.56). Managerial challenges and solutions have possibly been overlooked in their dealing with disruptive innovation and the possible identification in the established value network, by focussing on the customer.

Since the company under study is a technical product company the literature will be focussing on technological product innovation. The topic under study is cross disciplinary and therefore choices had to be made regarding the topics. The main choice was based on a first series of interviews with a corporate strategist at Philips to give direction to this thesis and its knowledge product. Based on this set of interviews three main topics where derived. These topics are disruptive innovation, customer centricity, and startup methodology (the lean startup method) as can be found in the literature analysis in chapter 2. The literature analysis will provide the reader with an understanding of the current innovation challenges and opportunities in large organizations, while secondly it will define a successful startup methodology and its relevance for leading organizations to better cope with the 21st century environment. A link between both is proposed. This leads to new questions, which can be researched empirically, and in turn form the basis for the remainder of this research.

This thesis examines lessons from startup methodology, which could enable large organizations to identify the unknown or unmet customer need within their existing value network. The structure of this research can be found in the next paragraph.

1.2 Structure of research

The qualitative research method is chosen to get a deep understanding of the topic of interest. While the research topic is primarily focussed on the above, its qualitative character allowed a second topic to emerge from the interviews. A core strength of qualitative research is that it allows the design, the research question and the goal to evolve during the research, which in turn allows that the complex phenomenon can be studied and understood in depth (Maxwell, 2005). The

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H.B. ter Brugge Master Business Studies 12 literature analysis is the main driver behind the remainder of the research, and while this research started inductively, it gradually evolved to be both inductive and deductive. The interviews allow to come up with a conclusion, which is plausible and reliable in its context.

This research is structured in the following way. First the literature analysis provides a link between the theory of disruptive innovation by Christensen (1997) with the lean startup method (Ries, 2011). The three main topics in chapter 2 are: disruptive innovation, customers’ unmet need and startup methodology. It will start by providing the distinction between radical and disruptive innovation, where after disruptive innovation and the theory of disruptive innovation are explained. This is followed by providing the need for disruptive innovation and the identification of the unmet need within the existing value network of an organization. The customer development process is explained and the link is made to the lean startup method, also providing an explanation of the principles of this method. A conclusion is given. Chapter 3 states the type of knowledge product that this research aims to deliver. Chapter 4 explains the research methodology used in this thesis. Chapter 5 gives the case description, explaining Philips and the Accelerate program briefly, for which Appendix C provides a deeper background. Also a document analysis is part of this background. Chapter 6 will present the results as have been found from the conducted interviews within Philips. Chapter 7 provides a discussion based on the results, and in line with the research topic. It will make a distinction between startup lessons for Philips on both an operational and a strategic level. This is followed by lessons for other companies and a paragraph containing propositions, implications for theory development, future research and reflection on the research method. Finally, chapter 8 presents the conclusions of this research.

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2. Literature analysis

- ‘’Perhaps the greatest challenge business leaders face today is how to stay competitive

amid constant turbulence and disruption’’- (kotter, 2012)

This literature analysis links the topics disruptive innovation, customer centricity, and lean startup methodology. It will explain the opportunities and challenges of disruptive innovation for leading corporations and the lessons from startup methodologies. The innovation process in a corporate setting will be described and the needs and challenges for disruptive innovation highlighted. This is followed by mentioning the importance for the 21th century large organization, in the identification of the unmet need in their existing value network. An answer can be found in the popular lean startup method. The early identification of the unmet need can increase the amount of meaningful innovations in a corporate setting.

2.1 Disruptive innovation

This section defines disruptive innovations, which are able to overthrow incumbents by surprise. It is described by Christensen (1997) as an important threat, for these organizations that are dominant in an industry and appear to have all the right processes in place to sustain their position. The need for more attention to disruptive innovation in the 21st century organization is explained, and it is concluded that disruptive innovation is highly dimensional and characterized by a high degree of uncertainty and risk.

2.1.1 Innovation spectrum

Innovation in an organisational setting is ‘’the overall process whereby an invention is transformed into a commercial product that can be sold profitably’’ (Crawford & Di Benedetto, 2006, as cited in Yang & Tao, 2012). Innovation should not be confused with invention, although the two can be so closely linked that it’s impossible to make a clear distinction (Fagerberg, 2006). Invention means doing something in a new way; innovation requires that the invention creates economic value

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H.B. ter Brugge Master Business Studies 14 (Liedtka & Ogilvie, 2012). It is innovation, not invention, which produces revenue growth or profit growth. According to Norman & Verganti (2012) there are a lot of different kinds of innovation and classification of the innovation is dependent on the A) Object of innovation: for example innovation in business models, products, services, processes, organizations, etc., B) Drivers of innovation: for example innovation in technologies, markets, design , users etc. and the C) Intensity of innovation. Johnson (2001) writes about various forms of innovation: R&D product development, new usage of established product or service, changes in market exploitation, operational and logistical innovation, and business model innovation.

Innovation is ‘’complex, uncertain, somewhat disorderly, and subject to changes of many sorts’’ (Kline & Rosenberg, 1986). It is becoming increasingly important, next to growth, as a means of survival in the face of ‘’ intensifying competition and environmental uncertainty’’ (Gronhaug & Kaufmann, 1988). The emphasize of innovation studies is related to technological innovations (Van der Aa & Elfring, 2002) (Norman & Verganti, 2012) and change of meaning (Norman & Verganti, 2012). The sources of innovation (or opportunities) where first proposed by Drucker in 1986: unexpected, incongruities, process needs, industry and market

structure, demographics, changes in perception, and new knowledge. In his influential book the main lesson is that there is no such thing as an eureka moment. Innovation is an iterative process, and a process of hard work. ‘’The ultimate goal is to create major new revenue streams and sources of corporate wealth’’ (Kaplan, 1999). Schumpeter, who is best known for his theory of creative destruction, stated five types of innovation, which are (a) new products, (b) new methods of

Exhibit I

Innovation according to Fagerberg

’Innovation is not a new phenomenon. Arguably, it is as old as mankind itself. There seems to be something inherently

‘’human’’ about the tendency to think about new and better ways of doing things and to try them out in practice. Without it, the world in which we live would look very, very different. Try for a

moment to think of a world without airplanes, automobiles,

telecommunications, and refrigerators, just to mention a few of the more important innovations from the

not-too-distant past. Or- from an even longer perspective- where would we be without

such fundamental innovations as agriculture, the wheel, the alphabet, or

printing?’’

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H.B. ter Brugge Master Business Studies 15 production, (c) new sources of supply, (d) exploitation of new markets, and (e) new ways to organize business (Schumpeter, 1934 & 2008, as cited in Croitoru, 2012).

Mainstream literature mentions two categories of innovation: Incremental- and radical innovation. While the former is a critical driver for growing market share and protecting revenues, the latter drives substantial growth over the long horizon (Kaplan, 1999). According to Norman & Verganti (2012) the difference between both lies in the process and outcome of the innovation efforts. Incremental innovations are those innovations that ‘’do better what they already do’’. These are innovations within a given frame or solution. The radical innovations let companies come up with products or services that ‘’do what could not be done before’’. It deals with a change of frame instead of only an improvement (Norman & Verganti, 2012). Gibraith (1995) came up with a helpful overview of the different innovations, as presented in figure 2.1.1.1. Although helpful, it appears his model is not completely correct. He wrongly states disruptive new technologies are necessarily on the radical side of innovation. This highlights the confusion that exists regarding the meaning of disruptive innovation. The next chapter will elaborate on disruptive innovation and the fact that they can be just as likely incremental innovations.

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2.1.2 Difference between disruptive innovation and radical innovation

In articles, reports, books and blogs the term disruptive innovation is often mistakenly used interchangeable with radical innovation or even destructive innovation, and incremental innovation with sustaining innovation. It is important to note that this paper takes the perspective from the disruptive- versus sustainable innovation point, instead of the more widely used radical- versus incremental innovation. Both the word radical and disruptive make people infer that a major technological upset happened because of a major change3. It is falsely generalised that disruptive innovation is the same as technical radical innovation, as indicated in the example of figure 2.1.1.1. Rao (2007): ‘’Major breakthroughs may or may not be disruptive, while minor, or incremental innovations can be massively disruptive. The opposite of disruptive is sustaining ‘’. Intel already termed disruptive innovation as the ‘Christensen’s effect’4, to avoid the possibility of their managers to use it interchangeably with radical innovation (yu &Hang 2010). It is also mentioned that new product development professionals would be ‘’well served to adopt the definitions of sustaining and disruptive innovations and to avoid the mistake of calling all radical innovations disruptive’’ (Smith, 2005, as cited in Yu & Hang, 2010).

First literature on disruptive innovation can be dated back to Schumpeters 1942 mentioning of creative destruction, which describes the replacement of incumbents by new entrants and the temporary monopoly profits that can be attained by these entrepreneurial firms. This has been used again by Foster & Kaplan (2001) as seen in a figure 2.1.2.1, outlining the evolution of disruptive innovation theory.

3

The same can be said for incremental and sustaining, which is often wrongly referenced with only slow and small instead of major and fast

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H.B. ter Brugge Master Business Studies 17 Figure 2.1.2.1: Evolution of disruptive innovation theory (Yu & Hang, 2010)

2.1.3 The need for disruptive innovation in the 21st century

The need for innovation to achieve competitive advantage requires no explanation in the 21st century volatile marketplace. However, also the need for disruptive innovation in corporate setting is increasingly indicated for a firm’s survival. Tushman et al. (1997, as cited in Karlson & Nordström, 2012) mention that managing only continuous innovation appears to be insufficient for building competitive advantage. Tidd et al. (1997) indicate that there is a relationship between market performance and new products. With product lifecycles getting shorter, innovations need to accelerate as organizations are starting to feel the pain of their often inefficient R&D apparatus, too much focussed on sustaining innovations. Too often organizations keep improving their current products, in order to attain an ever higher demanding customer base to sell their product with increasingly higher profits. According to Engel (2011) the real danger of this inefficiency, could be felt already half a century ago, in a new business innovation model which is characterised by the convergence of entrepreneurs, rapid technological change and venture capital as the main drivers

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H.B. ter Brugge Master Business Studies 18 for disruptive innovation. This could ‘leave incumbents organizations shattered in their wake’ (Engel, 2011).

Corporations are expected to be profitable and show growth to keep shareholders sentiment positive. Unfortunately this becomes increasingly difficult when companies become larger and more successful as can be read in Exhibit II.

Laurie et al. 2006 agree that sooner or later large corporations reach a point where the ability to generate growth, falls short of the expectations of investors and CEO. They become victims of their own success. Still possibilities for growth arise when forces of change create possibilities for satisfying unmet or latent customer needs (Laurie et al. 2006). Comparable with the human pursuit of being healthy, corporate growth is both a disciplined and everlasting exercise. Incremental innovations are necessary and likely to reinforce the dominance of leading firms in the industry, but when compared with entrants they show to be conservative and not effective in the exploitation of ground breaking innovation. The gap for organizational growth is big and increasingly getting larger and this cannot be solved by means of periodic innovation initiatives (Laurie et al. 2006). There appears to be a need to stimulate disruptive innovation in corporate setting.

Unfortunately, the problem for all big companies confronting disruptive innovation is that these innovations expedite the emergence of new markets. Unfortunately there are no immediate hundred million dollars emerging markets and it is precisely when emerging markets are small when they are the least attractive to large companies (Christensen, 1997, Page 108), while entering them at that time can be seen as critical in their search of large amounts of new revenue.

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H.B. ter Brugge Master Business Studies 19 Management teams worldwide are beginning to realize that the incremental changes of the past are not able to deliver the uplift necessary to deal with the challenges of today’s disruptive global business environment (Peterson & Bray, 2013).

Companies face dual organizational objectives, which according to O’Reilly & Tushman (2011) can be managed ambidextrous by means of exploitation and exploration. This entails, for senior managers, to both sense changes in the competitive environment and at the same time seize them. Companies need to explore new technologies and markets to capture existing and new opportunities, which is ‘’fundamental for the long term survival of an organization’’ (O’Reilly & Tushman, 2011). In order to keep growing, companies need to promote disruptive innovations. The following paragraph will explain the theory of disruptive innovation.

2.1.4 Christensen’s theory of disruptive innovation

One of the most influential scholars in the field of disruptive innovation has been Clayton Christensen, starting with his theory of disruptive innovation. In order to fully understand the meaning of disruptive innovation this paragraph will explain his work in detail. As mentioned before, there is a lot of confusion on the term disruptive innovation; therefore this paragraph will provide the reader with a deep insight in the topic.

Christensen (1997), in his book titled The Innovators Dilemma: When new technologies Cause Great Firms to Fail, makes the first informative distinction between disruptive and sustaining innovation. He creates the link to radical and incremental innovation and allows to understand innovation on a different level than merely the radical and incremental extremes. An example proposed by Christensen (1997) is that not all of the sustaining technologies need to be incremental in character; they are just as likely to have a radical nature. Sustaining innovations are the mantra of the business world since they result in better products which can be sold for higher profits to most demanding customers and generally find a better fit in the short term result, value creation mindset, of keeping the shareholders satisfied. Disruptive innovations are those that create new markets and in the end,

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H.B. ter Brugge Master Business Studies 20 mostly unexpected by the incumbents, overtake the existing market. Examples for a better understanding can be found in exhibit III

.

Sustaining innovations do not affect the existing markets whereas disruptive innovations do. An important finding of Christensen (1997) adds the fact that rarely even the most radically difficult sustaining technologies have caused the failure of leading firms. It has almost always been disruptive technologies that triggered the failure of leading firms. The difference between both is graphically explained in figure 2.1.4.1 on the next page.

Exhibit III: Sustaining & disruptive innovation and examples

Sustaining

An innovation that does not affect existing

markets

A: Evolutionary

-> From carburetors to electronic fuel

injection)

B: Radical (discontinuous, revolutionary)

-> From horse cart to automobile

Disruptive

An innovation which creates a new

market or (unexpectedly) overthrows an

existing one

(Christensen, 1997)

-> For example the lower priced model

Ford T

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H.B. ter Brugge Master Business Studies 21 Figure 2.1.4.1 the theory of disruptive innovation (Christensen, 1997)

It depicts the customers demanded performance over time. The upper solid line indicates the sustaining innovation, or the continual improvement of a product or service introduced by companies over time (Hwang & Christensen, 2008). The performance improvement is sustained over time. Innovations can be sold to an ever more demanding customer, resulting in a higher profit than before the innovation. When products move upmarket and more functionality is added than the market demands, sustaining innovation can make way for disruptive innovations. The disruptive innovation’s performance is less than the market demands and therefore, at first, doesn’t appeal to a lot of customers. Because the new product is generally more easy to use, less expensive, and simpler, it gradually starts to attract a new set of customers. The least demanding customers are starting to consume the new innovation, whereas the successful incumbent firms still try to service the upper market with the most demanding (and highest paying) customers (Hwang & Christensen, 2008).

The above is described as the theory of disruptive innovation in Clayton Christensen’s book ‘The Innovators Dilemma’ (1997). It is a high impact study because of his findings to explain the pattern of entrants in an industry or market, overthrowing leading incumbents and the inconsistency of his theory with findings from earlier scholars like Tushman & Anderson (1986) and Henderson & Clark (1990). The focus is primarily on the organizational culture and the ability of the organization to innovate. Over time the idea is expanded in various newer articles written by Christensen (for

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H.B. ter Brugge Master Business Studies 22 example Christensen, 1993; Christensen and Bower, 1996; Christensen and Rosenbloom, 1995; Christensen, 1996; Christensen et al, 1998 (as cited in Sandström, 2010)) but the idea behind it remains the same.

Christensen’s studies focus on innovation in commercial organizations and can be seen as an answer to the, at that time, dominant focus of researchers on technical innovation in incremental steps and the accompanied focus of investors or shareholders on short term return on investment (ROI). An influential article by Christensen, Kaufman, & Shih (2008) mentions three innovation killers in a large company: (A) the use of discounted cash flow and net present value, (B) the emphasis on earnings per share, and (C) treatment of sunk costs to evaluate investment opportunities.

The Innovators Dilemma describes the failure of companies who are trying to stay atop in the industries they operate in, when facing certain types of markets and technological change (Christensen, 1997). According to Christensen (1997) companies struggle for many reasons ‘’among them bureaucracy, arrogance, tired executive blood, poor planning, short term investment horizons, inadequate skills and resources, and just plain bad luck’’.

Exhibit IV: Failure of a leading corporation

Consider this assessment of Digital Equipment Company, made in 1986: “Taking on Digital Equipment Corp. these days is like standing in front of a

moving train. The $7.6 billion computer maker has been gathering speed while most rivals are stalled in a

slump in the computer industry.” The author proceeded to warn IBM to watch out, because it was standing on

the tracks.

Indeed, Digital was one of the most prominently featured companies in the McKinsey study that led to the book In

Search of Excellence. Yet a few years later, writers characterized DEC quite differently: ‘’Digital Equipment Corporation is a company in need of triage. Sales are drying up in its key minicomputer line.

A two-year-old restructuring plan has failed miserably. Forecasting and production planning systems have failed miserably. Cost-cutting hasn’t come close to restoring profitability. . .

But the real misfortune may be DEC’s lost opportunities. It has squandered two years trying halfway measures to respond to the low-margin personal computers and workstations that have

transformed the computer industry. Christensen, 1997 (p8)

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H.B. ter Brugge Master Business Studies 23 The book of Christensen is not about these types of failures. It is about the well managed companies who still lose their market dominance although having their competitive antennae up, investing heavily in new technologies, and while listening astutely to their customers. These are the leaders in the industry, the companies that ‘’many managers have admired and tried to emulate, the companies known for their abilities to innovate and execute’’ (Christensen, 1997). These are the companies that are termed leading corporations.

Christensen develops the theory of disruptive innovation to describe how large corporations can fail although they do everything right. The reason for their failure is that their successes and capabilities become obstacles in the face of changing markets and technologies (Christensen, 1997). Digital Equipment Company (DEC) is an example of overshooting the needs of the market as can be seen in exhibit IV on the previous page.

A more current example can be illustrated with the case of the PC and the emergence of smartphones and tablets. It typifies where the theory of Christensen is all about. It aims to describe how often technologically complicated and expensive products, are converted into simpler and more affordable ones (Hwang & Christensen, 2008). The disruptive innovation creates conflict in the established network and therefore incumbent firms struggle, at first, to introduce them (Sandström, 2010).

There are two necessary conditions for disruptive innovation to be present. The first is (A) technological enablers, the second (B) the existence of a disruptive business model (Christensen, 1997). The technological enablers are these technologies that provide a repetitive solution to situations that first where typified by trial and experimentation. The disruptive business model allows to deliver these routines or repetitive solutions to the customers in a convenient and affordable way. Christensen (1997) and other scholars don’t seem to agree on the definition of disruptive innovation. According to Christensen disruptive innovation is ‘’a process by which a product or service takes root initially in simple applications at the bottom of a market and then

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H.B. ter Brugge Master Business Studies 24 relentlessly moves up market, eventually displacing established competitors’’ (Christensen, 2013). The author of this paper choose to also mention the following definition for it is easier to understand what disruptive innovation, in essence, is: ‘’disruptive innovation is a technology or a business model that brings a more affordable service or product to the market, which is much easier in its use. More consumers in this particular market are able to afford, and have the skill, to make use of this product or service. The innovation causes a change that is so big that it will ultimately replace or disrupt the current way the product or service is provided’’ (Source unknown). Disruptive innovations tend to create their own new market (Sandberg, 2002). The following figure indicates the impact of sustaining and disruptive technological change. It also highlights the new emerging segment or new market that can be created by disruptive innovation. While the theory can look easy to understand, the practice is extremely difficult and problematic (Christensen, 2013).

Figure 2.1.4.2. Christensen, 1997 (page XVI): The impact of sustaining and disruptive technological change

To conclude, the disruptive innovation theory of Christensen makes clear that it is often entrants that by means of disruptive innovation take the incumbent by surprises. In the 21st century it is often startups, and examples are numerous.

2.1.5 Misunderstandings in disruptive innovation

Having discussed the context and impact of disruptive innovation, a recent article by Yu & Hang (2010) elaborates on the meaning of disruptive innovation. Apart from the misconception of

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H.B. ter Brugge Master Business Studies 25 managers and scholars confusing the terms radical and disruptive innovation, there are three other misunderstandings which need to be mentioned to fully understand the term disruptive innovation.

1: The term disruption is a relative phenomenon

While Dell computers initiative to go from selling computers over the telephone to selling them online was a sustaining innovation in light of their business model, it disrupted the industry.

2: Disruptive innovation does not always imply that entrants or emerging business will replace the incumbents business; it does not imply that disrupters are necessarily startups.

While nowadays it is most often startups that introduce the disruptive innovation, it can also be another incumbent that came up with the disruptive technology. Also the introduction of a disruptive innovation in an existing market doesn’t necessarily mean it always replaces the market. Examples are the introduction of digital cameras, replacing the analog camera. Although the general public embraced the digital version, there is still a big market for analog camera’s selling to for example professionals or enthusiasts.

3: Disruptive innovation is not equal to destructive innovation

While a disruptive innovation by definition is a technological innovation with lower cost and initial lower performance causing a major change in the incumbents market, it doesn’t mean it has to be more destructive than other innovations. An example is the SiGe-chip introduced by IBM. It has lower cost but higher performance than the current industries standard. Also existing factories can be used to produce them. Therefore it is not disruptive in nature, but able to heavily destruct the market leaving other incumbents no choice than to adopt the new standard (Yu & Hang, 2010).

It can be concluded that disruptive innovation theory is highly dimensional and characterized by its high degree of uncertainty. Disruptive innovation generally creates new markets or shakes up (or worse) existing ones. A new way of stimulating and assessing these innovations on its market value

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H.B. ter Brugge Master Business Studies 26 is necessary. Since most disruptive innovations come from either new (i.e. entrepreneurs/ startups) or small companies, large organizations need to take lessons from them to deal with the uncertainty and risk associated with disruptive innovation.

2.2 Customers unmet need

This section explains the possible sources of identifying opportunities for disruptive innovations within the established value network of a firm. Customers are seen as the key in the identification and the customer development process is explained to provide a link with startup methodology.

2.2.1 Disruptive innovation in established value networks

Having understood the meaning of, need for, misconceptions and difficulties of disruptive innovations in a corporate setting, this analysis will now work to an area where possibly could be solutions for leading companies dealing with the competitive environment of the 21st century by means of identifying disruptive innovation. To recapitulate, Christensen proposes two types of disruptive innovation: Low end disruption and new market disruption. For disruptive innovation to be present there need to be technological enablers and the existence of a disruptive business model (Christensen, 1997). It became clear that the problem of disruptive innovation for corporations resides in technologies introduced by entrants, because these technologies appear to not be initially demanded by the firms established customer base. It is even stated that markets for disruptive technologies are not only unknown, but also unknowable.

Recently, scholars start to write about whether and how disruptive innovation can prosper inside an incumbents firm established market segment. This is especially interesting for leading corporations because of their enormous expertise and ability of fast adoption to act upon opportunities inside their market. Sandström (2010) mentions that in the theory of Christensen (1997), and in numerous definitions of disruptive technologies, is enclosed that ‘’the properties of disruptive innovations are to make them grow only in new value networks, which makes it problematic for incumbent firms to handle.’’. It makes it also hard to identify, since the market is unknown. However, new empirical

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H.B. ter Brugge Master Business Studies 27 research indicates that the disruptive technologies can emerge by an evolution in established value networks. This means that disruptive innovations comes to existence in a less binary way than researched before, and can be in demand from the mainstream customers at an early point, despite the lower performance at the beginning (Sandström, 2012, P56). The theory of disruptive innovation has overlooked other environmental elements and the interconnectedness that characterizes the relations of the focal firm with its surrounding network (Sandström, 2012, P55). Rao (2007) takes this a step further by mentioning that disruption has even little to do with technology per se and therefore does not have to represent a technological breakthrough. Instead it can be a market/business phenomenon. Christensen & Bower’s (1996) research supports this indicating the scope for strategic change of a firm is strongly restricted by the interests of external entities, which in their study are the customers: ‘’they provide the resources the firm needs to survive’’. By focussing on the customers, corporations could be able to identify and act upon opportunities for disruptive innovation within their current industry and market. This would allow organizations to become more efficient in their disruptive innovation efforts and better in dealing with the current forces of continuous disruption (Blank, 2013). Under the pressure of increased cost cutting, disruptive products are created by companies, which are simultaneously better and less expensive than existing products. Nunes and Downes (2013), two Accenture consultants, describe this paradigm with a quote in their article named ‘Big Bang Disruption: The Innovators Disaster’: ‘’the upshot? Success for those who play by the new rules of strategy and competition- and disaster for incumbents who can’t adapt fast enough.’’ According to them the disruptive products5 enter a market in only two stages, instead of the five proposed in the well-known model of Geoffrey Moore, as can be seen in figure 2.2.1.1.

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H.B. ter Brugge Master Business Studies 28 Figure 2.2.1.1: Traditional adoption versus big-bang disrupters. Nunes & Downes (2013)

The first are the trial users, who are a lot of times the de facto co-creators or co-funders, the second stage being everyone else, even in every market segment. The disruptive innovation should be found at, or with the customer.

While relevant for every organization, either corporations, governments, startups or small businesses, it will prove its essence for leading corporations struggling with the threat of disruptive innovation and help them initiate this change instead of being overthrown unexpectedly. The next paragraph will indicate the current shift of corporations to focus more on the customer in their innovation efforts, thereby becoming more entrepreneurial and innovative.

2.2.2 Disruptive innovation processes focussing on customers

Customers are defined as all external actors for who or which the disruption potentially could provide a solution. It includes individuals, as also companies, governments etc. The following example gives insight in a case where a large organization is successfully able to stimulate disruptive innovations.

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H.B. ter Brugge Master Business Studies 29 Proctor and Gamble case example

An example of a company who ‘tripled its innovation success rate’ by focussing on the costumer in their innovation efforts is Proctor & Gamble (P&G) as described in a Harvard Business Review article by Brown & Anthony (2011). The article highlights the fact that shrinking product cycles and increasing global competition made it necessary for P&G to strategically change their innovation efforts. More breakthrough innovations where necessary, even ones that could create completely new markets.

Their approach worked. P&G went from 15 % of innovation efforts meeting profit and revenue targets in 2000, to 50 % as of today (2011). They found a way to combine the creativity of Edison with the speed and reliability of Ford’s factory to design a new growth factory ‘’whose intellectual underpinnings would derive from Christensen’s disruptive innovation theory’’ (Brown & Anthony, 2011). This has been done by means of the so-called New Growth Factory. Exhibit V provides some background information.

The New Growth Factory was specifically designed to manage high uncertainty, one of the big challenges of disruptive innovation. This was done by making use of new growth teams which are small and nimble and therefore better able to focus on most promising product ideas at greater speed. While collective creativity can be managed, individual creativity can be impulsive and unpredictable. Team members need to be fully dedicated

Exhibit V: Henry Ford and Thomas Edison

‘’To understand P&G’s strategy, we need to go back more than a century to the sources of its inspiration – Thomas Edison and Henry Ford. In

the 1870’s Edison created the world’s first industrial research lab, Menlo Park, which gave

rise to the technologies behind the modern electric-power and motion-picture industries. Under his inspired direction, the lab churned out

ideas. Edison himself ultimately held more than 1,000 patents. Edison of course understood the importance of mass production, but it was his friend Henry Ford who, decades later, perfected it. In 1910 the Ford Motor Company shifted the

production of its famous Model T from the Piquette Avenue Plant, in Detroit, to its new Highland Park complex nearby. Although the assembly line wasn’t a novel concept, Highland

Park showed what it was capable of: In four years Ford slashed the time required to build a

car from more than 12 hours to just 93 minutes’’

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H.B. ter Brugge Master Business Studies 30 and have an undivided attention to the disruptive and transformational-sustaining efforts, easily to understand by the saying that ‘’Nine women can’t make a baby in 1 month’’ (Brown & Anthony, 2011). Team members need to be experienced in innovation, allowing them to make judgements when available data is uncertain or even lacking.

Senior management and project team members received training in topics focused on customer centricity, like assessing the demand for an early-stage idea, as also encouraging entrepreneurship. Teams where kept small until key commercial questions were answered, like knowing if customers would use the product habitually. Teams take products to market at speed and conduct Transaction Learning Experiments (TLE), which basically means putting small amounts of products in the market and letting customers vote with their wallets, a startup venture capital approach for testing the market for alignment.

This factory style approach is able to create sustainable sources of revenue growth, indifferent of the size a company becomes. Disruptive innovation suddenly doesn’t seem to be so unexpected anymore. It appears that it can be managed by looking at the customer and working in small, dedicated teams within a large organization. In the P&G case example, possible disruptive innovations or breakthrough products are brought in the market following the principles of failing fast, thereby learning continuously.

It is comparable to the way startups innovate. This is acknowledged by Christensen & Raynor (2003) and a link can be made by looking at the customers’ unmet need as a source of identifying possible disruptive innovation: ‘’When we [someone] start a new business … it should be disruptive relative to competitors so that they are motivated to flee rather than fight. The business should start with a set of customers who have been noncustomers so that they are pleased with modest products. Businesses must target jobs that customers are trying to get done […] and move to where the money will be, not to where it was. Initially, [new] businesses must be flexible to respond as a viable strategy emerges’’. The customer development model by Blank (2006) moves the learning from

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H.B. ter Brugge Master Business Studies 31 customers and their problems into the earliest development process as possible. The model is additionally built around the notion that there is a set of definable milestones ‘’that no amount of funding can accelerate’’ (Blank, 2006). This is the topic of the next section.

2.2.3 Customer development process

Customer development is essentially a process which is able to quickly search for a profitable business model in the external environment (‘outside the building’) when customer needs are unknown (Blank, 2010). As can be seen in figure 2.2.3.1, it consists of 4 stages.

Figure 2.2.3.1 Customer development (Blank, 2010)

The pivot is important since these are ‘’ the core of the iterative nature of both customer and agile development’’ (Blank, 2010). A pivot is a large course correction in the current business model hopefully leading to capitalizing on another market opportunity (Cummings, 2011). Pivoting should not be confused with iteration, which is a small course correction in the current business model to capitalize on narrowly related market opportunity (Cummings, 2011).

Paragraph 2.2 mentions examples and gives an overview of current literature focusing on the identification of the unmet need, which could be the answer in the identification of disruptive innovation within large organizations. The process is comparable with the way startups work with their customers. The TLE approach and the ability to learn from mistakes successfully helped P&G to bring products to the market at speed. Paragraph 2.3 will elaborate on a popular startup method proposed by Eric Ries, who has linked customer development with the agile development model. This model is targeted at building a product in the case of unknown initial feature sets. Together

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H.B. ter Brugge Master Business Studies 32 they form the basis for the Lean Startup method (Ries, 2011) which makes entrepreneurs able to deal with both a customer unknown need (high uncertainty) and a product unknown feature set. This methodology addressing both the unknown need and the fact that startups can become new entrants, allows to infer that the lean startup could be a way in identifying disruptive innovation. Blank believes companies need to get their ‘hands dirty’ and stop chasing the romance – the way they think things are, and start pursuing the realities- the way things really are (Lesonsky, 2013). Misfortune happens to those companies that fail to understand the customer need. We will now take a look in the startup methodology focused on speed and customer unmet needs.

2.3 Startup methodology

This part will provide a definition of a startup, which takes it outside its notion of the general public perception of startups. It will explain the Lean startup method as proposed by Eric Ries. It is proposed that the lean startup method could be the answer to the identification of the unmet (or unknowable) customer need.

2.3.1 Startup

Every large company in the world was once a startup. There was an idea which was transformed into a core business which expanded over time. They grew big, and according to Khosla (2011) this is where the problems of innovation start: ‘’it is safe to say that the moment a company starts to talk about innovation in a structured way (innovation conferences, innovation forums etc.), it has stopped really innovating’’. Two lessons from the work of Christensen, as mentioned in the previous paragraphs, seem to support this statement. He proposes that large organizations need a culture in which failure is acceptable (or even supported) and that innovations should be also targeted on the search for new markets instead of focusing too much on sustainable innovations to serve the needs of existing customers.

The given example of P&G earlier in this literature analysis indicates this as possible and profitable within a large organization. Mostly, large organizations are still able to grow effectively outside their

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H.B. ter Brugge Master Business Studies 33 ‘core’ business by acquisition of smaller, more innovative companies (Khosla, 2011). Even when an innovation originates in a large company, it are often small companies or startups who have the first success commercialization, as can be read in Exhibit VI on the next page. Also a current example of Facebook acquiring Whatsapp for 19 billion dollar highlights the difficulty incumbents have with commercializing new innovations (Constine, 2014).

According to Hogan (2005), there is a higher probability for small companies to commercialize disruptive innovations, than for large companies. Reasons are related to the key factors that large organizations differ from small companies. Small companies can be seen as light versions of large companies. Although different, both can be the source of a startup. According to Eric Ries (2011), startups are ‘‘a human institution designed to create new products and services under conditions of extreme uncertainty.’’ He extents this definition by stating that a startup is a ‘’temporary organization used to search a scalable business model’’. This implies startups are not merely the preconceived idea of the entrepreneur working on a good idea in his dorm room. Entrepreneurs, in a corporate setting generally referred to as intrapreneurs, are everywhere (Ries, 2011). An idea acknowledged by Mueller & Thöring (2012) who mention the existence of startups within departments of large organizations. Interesting is that according to this definition, startups can also exist within teams or departments in established companies. This is an

Exhibit VI: Commercialization of new innovations

‘’One other interesting phenomenon is even when the innovation originates in a big company,

the first successful commercialization is done by a startup. For instance, while it could be argued that IBM invented virtualization on commodity

hardware, but it was VMWare that made it matter. Solar cells weren’t invented by First Solar or Sunpower, but they made them mainstream despite the larger and more expensive efforts of oil companies like BP and Shell – LEDs weren’t invented by Cree, but Cree

made them relevant despite all the claims of lighting innovation by GE and Philips. Jeff Bezos

at Amazon didn’t invent online sales, but made them relevant (and invented the one-click purchase) with Walmart as a follower. Similarly,

biotechnology was commercialized by a little startup called Genentech rather than the large

pharmaceutical companies with their massive R&D budgets. A common statement is that not

all areas are subject to innovation. I do think they are, though the difficulty of innovation depends upon time, technical change, rate of market change, rate of experimentation and ease

of (barriers to) experimentation.’’

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H.B. ter Brugge Master Business Studies 34 interesting point which highlights that large organizations can be just as likely to come up with disruptive innovations as small companies. Startup literature indicates a startup becomes a mature company when product/market fit is achieved, which basically means having a product that satisfies the market when being present in this market.

Steve Blank (2013) indicates there is one key difference between a startup and an existing company. Startups search for a scalable business model, while existing companies execute against it. This key distinction lies at the heart of the lean startup method proposed by Eric Ries. The Lean startup approach can be relevant for a company of any size, including very large enterprises, indifferent of the type of industry or sector they operate in (Ries, 2011, P8).

2.3.2 The lean startup

A method to address the high failure rate of startups 6 is proposed by Eric Ries in his book titled ’The Lean Startup’. It is a method written around the philosophy of ‘’improving the success rate of new innovative products worldwide’’ (Ries, 2011). The method revolves around 5 principles.

1. Entrepreneurs are everywhere 2. Entrepreneurship is management 3. Validated Learning

4. Build-Measure-Learn 5. Innovation accounting

According to Ries (2011), most of the startup failures can be avoided by shifting the attention of the entrepreneur more to customer feedback, for which a deep knowledge of the customer and their behaviour is necessary. This can be achieved by ‘getting out of the building’ (Ries, 2011), or interact with the customers as early as possible. Customer centricity is key. This allows to not only produce a product that the customer really wants, but also make sure you have an established customer base when the product is finished and launched.

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H.B. ter Brugge Master Business Studies 35 Mueller & Thöring (2012) define the lean startup as a

method to ‘’build continuous feedback loops with the customer during the product development process’’. Ries’ mentioning of lean should be interpreted in the context of the definition of lean manufacturing, which has its roots in the Toyota Production Systems, and is about the reduction of ‘waste’. In the Lean Startup, it means trying to minimize the use of resources for everything that doesn’t contribute to the creation of value for the customer. The lean startup originated around the Silicon Valley US west coast startup world, and the primary ideas are derived around web based startups who are dealing with a high degree of uncertainty.

Interestingly, only a few years after its publication in 2011, there are already some large corporations like General Electric (GE), Qualcomm, and Intuit, who are openly starting to implement lean startup techniques to improve their innovation process (Blank, S. 2013). Exhibit VI gives more information about how it helped for example GE Energy Storage division. The example of GE indicates its potential worth and its applicability for large organizations.

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H.B. ter Brugge Master Business Studies 36 The essentials of the lean startup evolved from agile development7, lean product development8, design thinking9 and the discussed customer development process. Key words when talking about the Lean startup method are customer centricity, minimum viable product (MVP) and small iterations or larger pivots. What is different about the lean startup method in contrast to a traditional product development method, which is typified by stages occurring in a linear way and possibly lasting up to months, is the way it is producing MVP’s (Blank, 2013). A core component of the lean startup is the build-measure-learn feedback loop, which enables learning. This learned is called Validated Learning (VL), which assumes startups have to learn from their mistakes, thereby learning how to build a sustainable business. The learning is validated because of the repeated experiments to test each element of the vision of the entrepreneur (Ries, 2011, Page 9).

Figure 2.3.2.1. Lean development cycle (Ries, 2013)

By making use of the lean startup method, uncertainty can be reduced or even eliminated, by using its tools to continuously test the idea in the market (Ries, 2011). It doesn’t only make sure you ‘fail fast, fail cheap’ but makes sure the product development process is fast and iterative. The entrepreneurship principle of the lean startup is focused on managing this extreme uncertainty,

7

Agile development is originally a set of software development methods. The methods are based on iterative and incremental development.

8_{Lean manufacturing is a term derived from the Toyota Production Systems (TPS). It is an approach}

targeted at creating a maximum amount of value for the customer while using the minimum amount of resources.

9_{Design thinking is a method to solve complex problems and generate innovative solutions, based}

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H.B. ter Brugge Master Business Studies 37 which allows for a new kind of management. An important aspect of the lean startup method is that individual or departmental efficiency is not the most important, the goal is cross functional teams who achieve validated learning by means of actionable metrics. These are metrics that indicate a clear cause and effect when testing an assumption.

The first step in the build-measure-learn loop is figuring out what the problem is and building a MVP to begin learning. It starts with an idea, an assumption, or hypothesis, which is built into a MVP. This MVP is put in the hands of the customer as fast as possible. Feedback is collected and used to validate or reject assumptions. Speed is key in the measure-learn feedback loop. The build-measure-learn cycle can also be called a lean learning cycle (Mueller & Thöring, 2012) and can be applied to both the micro- and the meta level of a process.

The MVP only contains the critical features and is based on an initial idea. In short cycles customer feedback is gathered, followed by a revised MVP. Speed is of essence in the 21st century marketplace as stressed by Gothleff (2011) ‘’as organizations struggle to stay nimble in the face of an ever-changing marketplace that is disrupted constantly by incumbents as well as startups, getting to market fast becomes top priority.’’ By the time a large organization has figured out internally how a product should be further developed and designed, the customer can already be provided with alternative in the market, or even worse, complete customer needs could have changed which would make the product outdated or even obsolete.

The lean startup process can make sure a product is built which the market demands, how the market demands it and when the market demands it. The lean startup will not guarantee success, but can be a very helpful tool of testing hypothesis and make better decisions accordingly.

Lean startup strategies are not just for startups anymore (Nobel, 2013). Intuit co-founder Scott Cook stated during a Harvard Business School seminar that ‘’success is a powerful thing, it tends to make

A new innovation strategy for the 21th century : lessons from startup methodology to stimulate an entrepreneurial based innovation economy.