From creating to conquering markets: How mature firms innovate

Costas Markides and Paul Geroski

LondonBusinessSchool

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London NW1 4SA

England

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Abstract

Successful innovation is essentially a coupling process that requires the linking of two distinct activities: the discovery of a new idea (and its initial testing in the market) with the transformation of the idea from a small niche to a mass market. Even though we all recognize that commercial success requires both of these activities to take place, many people equate innovation with discovery only. As a result, most academic research and advice aims to make firms better at discovery while precious little advice exists on how firms can scale up markets. This is unfortunate because scaling up a market is not only as creative and innovative as creating the market in the first place, but it’s also more rewarding financially. In this paper, we show first how companies can scale up a market and then argue that big, established firms have exactly the skills necessary for scaling up markets. This suggests to us that instead of spending our time telling established companies how to become better at discovering new markets—an area where they have few skills and are at a disadvantage to start up firms—we should be advising them how to innovate by scaling up niche markets into mass markets

From creating to conquering markets: How mature firms innovate

Consider the following cases:

  • the market for online services was created by CompuServe in 1979 with the provision of its first online service, the CompuServe information service. Over time, CompuServe used its pioneering efforts in videotex technology to enable users to not only access information but also perform banking and shopping transactions from their homes. Additional services such as e-mail, electronic bulletin boards and forums were added throughout the 1980s and new competitors (such as AOL and Prodigy) entered the new market. By 1990, the market for online services had about one million subscribers and CompuServe was its clear leader. Then, the market simply “exploded”: while it took more than ten years for the market to grow to one million subscribers, it took only another seven for the market to increase ten times, to more than 10 million subscribers by the start of 1998. By then, AOL had emerged as the clear leader, having acquired CompuServe’s subscriber base and content operations in February 1998.
  • The market for personal digital assistants (PDAs) was created by Apple when it announced its plans to introduce the Apple Newton in May 1992 (and eventually introduced it in August 1993). The Newton was using handwriting-recognition software developed by Apple and was small enough to fit in one’s hand. John Sculley (Apple’s CEO) called it “nothing less than a revolution” and predicted that it will launch “the mother of all markets,” with PDAs constituting a trillion dollar market. A few months later, Palm released the Palm Zoomer. Both products fared poorly in the market but this did not stop competitors (such as HP, Psion, Casio and Microsoft) from rushing into the new market. In April 1995, Palm (then a division of US Robotics) introduced the Pilot organizer, which not only utilized the Graffiti interface software but was also the first organizer to be connected to the PC (something which allowed the synchronization of information between the two machines). The market for PDAs took off—from a few hundred thousand units sold in 1995 to millions of units in two years. In the year 2000 alone, more than 6.5 million PDAs were sold and Palm emerged as the undisputed leader with 70% market share.

Both examples highlight a simple point—something that the famous economist Joseph Schumpeter pointed out one hundred years ago: successful innovation is essentially a coupling process that requires the linking of two distinct activities: the discovery of a new idea and its initial testing in the market that, if successful, creates a new market niche—what Apple and CompuServe did in their respective markets; and the transformation of the idea from a little niche into a mass market—what Palm and AOL did.

Both activities are, obviously, important and necessary for successful innovation but as the examples above show, there is no need for the same firm to do both—Apple and CompuServe came up with the ideas but Palm and AOL created the mass markets. In fact, as we will show later, it is often the case that the firm that comes up with a new idea—the pioneer—is rarely the one that creates a mass market out of that idea.

Everybody derides Xerox for coming up with zillion of new products and technologies at its PARC research center and then failing to bring them to market. The truth of the matter is that this happens more often that we think!

Unfortunately, even though we all recognize that commercial success will follow only when both of these activities take place, few people seem to consider the second activity as innovation. While everybody knows and celebrates what inventors and pioneers do, few people seem to appreciate that scaling-up a market is equally (if not more) innovative.

For example, who do you regard as more “innovative” in the personal computer industry: Apple or IBM? Most people who think that innovation is all about introducing new and exciting products will immediately consider this a no-brainer—Apple is the “innovator”. But which of these firms do you think is responsible for the major growth and development of the PC market that occurred in the early 1980’s? Are you confident that the business as it is today would have come about quite as quickly and quite as effectively if IBM had decided to focus its business on mainframes? Wasn’t the IBM PC an innovation of substance, even if it contained nothing particularly new or breathtaking from a technology point of view?

We all aspire to become a modern-day Christopher Columbus—the pioneer, the inventor, the company that discovers the industries of the future—forgetting that this is only half of the story. A natural by-product of this bias is that most of the advice that academics and consultants give to companies to make them more “innovative” is primarily advice on how companies can become better at “creation”—discovering something new, testing it in the market and, if successful, creating a new market niche. There is precious little advice on how companies could become better at “scaling up.”

For example, Gary Hamel (1996, 1999 and 2000) has proposed ideas such as making the strategy process democratic and bringing Silicon Valley inside the organization as ingredients to strategic innovation. Similarly, Markides (1997, 1998) has argued that corporations could learn from the success of the capitalist system by importing into their organizations those features of capitalism (such as decentralized allocation of resources, multiple sources of financing and constant experimentation) that promote innovation. And Christensen et al (2002) as well as Burgelman & Sayles (1986) have advocated the creation of separate units or divisions within an established organization where new disruptive growth businesses could be nurtured. These are all excellent ideas—but none of them is helpful in making a company better at the “scaling-up” half of innovation.

We have recently researched a number of industries to understand how new markets get created and how they evolve.[1] Based on this research, we’d like to argue that not only is scaling up a new market as innovative an activity as discovering the new market in the first place, but also—and perhaps more importantly—scaling up is far more financially rewarding than pioneering: what we saw again and again in the industries we studied was that the companies that created new markets were not the ones that ended up dominating those markets. To the contrary, most (if not all) of the pioneers in a new market disappeared without a trace. The companies that ended up dominating a new market were not those that created the market, nor were they the ones that rushed to enter it first. Rather, it was the companies that entered the new markets at the right time and scaled them up[2]. Henry Ford did not discover the car nor did he create the initial niche in which it was sold. Yet, his genius in creating a new way of making cars acted as a catalyst in scaling up the car business into a mass market after1909 and earned Mr. Ford a fortune.

If scaling up is so important, how can a company do it?

How to scale up niche markets

To appreciate how a firm can innovate by scaling up a niche market, we need to understand what happens from the moment a new market gets created until it is ready for scaling up.

Consider, for example, the car industry. Most of us date the beginning of the car industry with the arrival of the Model T (1908). But the Model T was not Henry Ford’s first car nor was the Ford Motor Company his first car company. Furthermore, Ford was neither the first nor the only producer of cars in the US at the turn of the century. Though it is difficult to pinpoint the exact birthday of the car industry, the fact is that there existed an enormous number of carmakers operating in the USA before the Model T was introduced in 1908.

Indeed, more than one thousand firms populated the industry at one time or another. 14 firms entered into the fledgling US market between 1885 and 1898; 19 entered in 1899, 37 in 1900, 27 in 1901 and then an average of about 48 new firms entered per year from 1902 until 1910. Thereafter, the surge subsided: from 1911 until 1921, an average of 11 new automobile producers stated up per year but that seems to have been it—very few firms entered the industry after the early 1920s.

Even more remarkable than the population of car producers operating in the early years of the car business is the enormous variety in cars that they produced. In those early days, one could purchase cars powered by petrol, electricity, steam; cars with three and four wheels and cars with open or closed bodies that came in a bewildering variety of different designs. Cars differed in their suspension, transmission and brake systems and in a wide variety of extra or optional features. Not only were there a large variety of different types of cars on the market, but also, most of the features that marked out the basis of this variety changed rapidly over time. For example, underneath the hood, a continuous stream of innovations led to the development of the four-cylinder engine by 1902, fuel-injection systems by 1910, electric starters by 1912, the V-8 engine by 1914, synchro-mesh transmission in 1929 and so on. In fact, the industry witnessed a wave of innovation between 1899-1905 that it never again experienced (although the periods 1912-15 and 1922-25 also saw noticeable waves of innovation). Furthermore, these innovations were introduced by a wide range of firms (the dominance of the innovation process by the big Three occurred later on), and their use diffused rapidly throughout the industry.

These features of the early evolution of the car industry are by no means unique to that industry. The market for tires followed much the same pattern as automobiles. From 1906 to 1911, an average of 15 entrants entered this industry per year, a figure that doubled (on a per annum basis) between 1911-1922. Entry peaked at a staggering 115 new firms formed in the year 1922 alone, a year which saw the population of tire producers reach 274. Much the same kind of structural dynamics occurred in the television industry. Thirty firms were producing TV sets in 1947, forty more entered the following year and another 71 entered between 1949 and 1953.

What happens to all these pioneers? Most of them die, never to be heard of again. For example, from a peak of about 275 car manufacturers in 1907, a mere 7 were left by the late 1950s. From a peak of 274 tire manufacturers in 1922, about 50 survived till the 1930s and only 23 were alive in 1970. And from a peak of 89 TV manufacturers operating in 1951, numbers sagged to less than 40 before the end of the 1950s. Color television production and the arrival of the Japanese producers in the 1960s completed the rout, leaving only a small handful of US-owned producers at the end of the 1980s, and none after 1995.

Why such high death rates? That’s because at some stage in the evolution of early markets a “dominant design” emerges. As a result, those pioneering firms that happened to bet on this winning design survive; all others die.

The dominant design is a basic template or “core good” which defines what the product is. It is a consensus good that commands the support of a wide range of early consumers (even if it is not their first preference); it is a product standard that sends signals to suppliers upstream, retailers downstream and producers of complementary goods everywhere. Effectively, the winning design wins because it is cheaper, widely available and, therefore, an easy choice for consumers confronted by excessive variety.

The problem for most pioneers who rushed into the market is that the arrival of the dominant design signals their death. All those firms that rushed in, trying their luck with all kinds of possible product designs, eventually exit the market when their designs lose out to the dominant design.

Who, then, ends up dominating the mass market that grows as soon as the dominant design emerges? Simple. Those companies that were “lucky” enough to either possess the dominant design at the time of its establishment or jumped into the market right when the dominant design was to emerge. But jumping in at the right time is not enough to conquer the market! Not only do the eventual winners time their entry into the market to perfection but they also undertake a series of actions that grows the market from a niche into a mass market. Typically that means making heavy investments in exploiting scale economies, traveling down learning curves, developing strong brands and controlling the channels of distribution to the mass market.

Specifically, we have identified the following strategies that “latecomers” use to scale up niche markets:

(a)Emphasize different product attributes

The early pioneers that rush to colonize a new market do so by emphasizing the performance attributes of the product. Most of the time, this happens simply because the entrepreneurs who created the company are engineers. It is their technical and engineering skills that allowed them to translate a certain technology into a product, and it is the functionality of this product that attracts the early consumers.

You see this happening in industry after industry. Thus, Xerox sold its copiers by emphasizing their functionality and speed at which they make copies; Ampex sold its VCRs on the quality of their recording; Leica sold its cameras on the quality of its lenses which guaranteed quality pictures; Cuisinart sold its food processors by focusing on its engineering skills which translated into high-quality food processors; and Apple sold its handheld computer on its breakthrough software-recognition software.

This emphasis on the technical aspects and functionality of the product early on in the evolution of a new market is understandable. To begin with, the product comes into being to satisfy a customer need. Unless it has the necessary technical features to meet this need, it will not succeed. Second, the entrepreneurs who created the product are engineers—they are the ones who understand the technology and toil for years to translate it into a workable product that can satisfy an unmet customer need. Their natural inclination is to emphasize the things they know and the things they believe make their product better than other products. Finally, at the start of any new market, the performance of early products is still below what the customers expect or want. This means that a competitor that invests in improving the performance of its product to bring its level closer to what the customers want, will benefit from such investment. This implies that competition in the early stages of the market is based on product features and performance—early pioneers compete against each other by adding functionality to their products.

The efforts of these early pioneers create the early market niche. Unfortunately for them, two things follow which set the stage for their downfall. First, as a result of their investments in improving the performance of the product, most products actually improve to performance levels that are either good enough, or even surpass customer needs. At that stage, any additional investments to improve the performance of the product further are not really necessary. But the early pioneers cannot help it! Their engineering cultures go to work and sure enough, more and more money goes into R&D to improve the product further and add to its functionality. All this happens even though they know full well that the customers do not need nor will they ever use the added functionality. Over-engineering of the product is linked to the second change taking place: the extra investments and incremental additions to the product’s performance do not come free. The rising costs lead to rising prices. The high price, in turn, limits the attraction of the product to a small segment made up of technology enthusiasts and early adopters.