V83-2009-04

V83 Business Strategies for V83 Business Strategies for Sustainable Innovation

Christian Erik KampmannChristian Erik [email protected]

2009-09-12

A dAgenda

• Does it pay to be first (FMA)?– (Markides and Geroski – and others)

• The systems approach• Systems and FMA – a quantitative

approach pp– (Sterman et al)

• Systems and sustainability efforts – a • Systems and sustainability efforts a qualitative approach – (Marshall and Brown)– (Marshall and Brown)

H d FMA i ?How do FMAs arise?• Create a technological edge over competitors• Create a technological edge over competitors

– But you must maintain proprietary control

• Learning-curve effects• Learning curve effects– If they are appropriable …

• Economies of scale and scopeEconomies of scale and scope– If they are appropriable…

• Control access to scarce resources– You already possess a key resource, or can occupy a

market niche that enables you to perform better than your rivalsthan your rivals

• Leverage customer commitments– Switching costs brand loyalty network externalitiesSwitching costs, brand loyalty, network externalities

3

S f fi t ff tSources of first-mover effects

Sources of FMA’s Sources of FMDs• Technological

leadershipL i

• Free-rider effects• Costly errors

• Learning-curve effects

• Economy of scale

• Resolution of technological or market uncertainty• Economy of scale

and scope• Preemption of scarce

market uncertainty• Shifts in technology

or customer needs• Preemption of scarce assets

• Switching costs or

or customer needs• Incumbent inertia

• Switching costs or buyer choice under uncertainty

M kid d G ki (2004)Markides and Geroski (2004)

• Puzzle: early pioneers have the necessary technology and enter the market earlyand enter the market early– Why do they consistently lose out and surrender the

markets they create to other firms?• Not because they are small or badly managed• Not because they are small or badly managed• Not because their products are inferior

• Why do big, established companies only rarely create di l k t b t till i ?radical new markets – but still win?

– Colonizing / consolidating

• Main point: Firms that are first when the market (and p (not the product) emerges end up with most of the profits

5

Complementary assets p y(Teece 1986)

• Why do innovating firms often fail to profit their innovation?their innovation?

• Profits often accrue to owners of complementary assetscomplementary assets– Service system– Distribution systemy– Customer contact and updating– Market access– Supply chain– ...

Cl if i i tiClassifying innovations…

Effect on supplier competency

Effect on customer

Effect on supplier competency base and complementary assets

customer habits and behavior

Enhances Destroys

MajorMajor

innovationRadical

innovation

MinorIncremental

innovationStrategicinnovationinnovation innovation

Radical vs. strategic ginnovations

Radical Strategic• Television• PC’s

• Internet banking• Low-cost flights

• Cars• Semiconductors

g• Generic drugs• Discount retail • Semiconductors

• Mobile phones• Discount retail

storesO li i it• Online university

Radical innovations on the horizon...

• Smart grids• Alternative-fuel vehicles• Cradle to crade systems• Cradle-to-crade systems• Distributed energy systems• De-materializing of offerings

Characteristics of radical innovations

• Disrupt both customers and producers• Rarely driven by demand or immediate

need• Lack champions (lead customers or

market leaders))• No one knows…

– what customers really wantwhat customers really want– what technology can do– how to produce it best– how to produce it best

Utterback: Technology cyclesUtterback: Technology cyclesand stages of market evolution

Fluid phase

Emergence of

dominant d i

Mature massmarket

design

Utterback (1994) Mastering the Dynamics of Innovation

C ti l tfCompeting platforms

Car platforms and total no. of producers, USA 1876-1942

Wh t i “f t d”?What is a “fast second”?

• A “first mover strategy”: get in there quickly and producing your own product variantsand producing your own product variants

• A traditional “second-mover strategy”: wait for the dominant design to be completely the dominant design to be completely accepted, then compete on costs and low pricesp

• A “fast second strategy”: wait for the dominant design to begin to emerge before moving, but establish base for entering

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“S t ” ?“Systems” … ?

• Systems analysis – (engineering discipline, mostly technical)

• System dynamics – (control theory concepts and simulation,

with emphasis on social science issues)

• Systems thinking – (Peter Senge, Checkland, …, qualitative, ( g , , , q ,

management philosophy)

P bl l i iProblem-solving view

G lGoals

Problem Decision ResultsProblem Decision Results

Current state

15

F db k iFeedback view

F db k iFeedback viewDecisions

Goals

Decisions(continuous process) Side

effectseffects

Current state

Goals ofothers

Actions of others

17

others

D i l it f tDynamic complexity of systems

• Tight coupling (”everything depends on everything else”)y g )

• Feedback (”what goes around comes around”)• Nonlinear (”chaos”)

P h d d (”l k i ”)• Path-dependent (”lock-in”)• Self-organizing (”emergent properties”)• Adaptive (”humans not clocks”)• Adaptive ( humans, not clocks )• Counterintuitive (”cause and effect are distant

in time and space”)• Policy resistant (”seemingly obvious solutions

don’t work or make matters worse”)• Trade-offs (”worse-before-better behavior”)• Trade offs ( worse before better behavior )

18

St t b h i d tStructure, behavior and events

Feedback structureag

e

Patterns of behavior

vera

Le

Events

19

Wh t i ” t t ”?What is ”structure”?

• Stocks and flows – (physical, financial, social, ...)

• Information links– (who knows what when)

• Organization• Organization– (incentives, power, rules, criteria, …)D i i ki b h i• Decision-making behavior– (heuristics, rules, expectations, ...)

20

Th d liThe modeling processCausal

Problem Causal

Behavior over time

diagrams,Stock/flow structure

Problemformulation

Causalhypotheses

Policy levers

P li F l

Policy leversSensitivity

testingScenarios

Under-standing

Policy analyisis

(simulation)

Formalmodel

development

Modeltesting

Computer modelRationality

testing, g(simulation)

21

test g,Hypothesis

testing

Structure as causal diagrams Structure as causal diagrams (feedback loops)

Desiredtemp. Int.

rateLink polarity

Positive/Reinforcing

Looprate

V l+ +Causal

Negative/Balancing

Loop

oop

Interestcredited

Valveposition- +

Causallink

Loop

R (or +)B (or -) Variable

Temperature Account balance

+ +22

Negative or balancingfeedback loop

Positive or reinforcingfeedback loop

F db k l lAttractiveness

of MarketCumulativeProduction

Feedback loop examples

Profits Number ofCompetitors

of Market Production

MarketShare

UnitCostsCompetitors

Price Price

Share Costs

Bank CashReserves

Pressure to CleanUp Environment ese es

PerceivedSolvency of

Bank

NetWithdrawals

CleanupEffort

EnvironmentalQuality

Up o e t

Banky

Identify and label the polarity of the links and loops in the examples shown.23

Four equivalent representationsFour equivalent representationsof stock and flow structure

Hydraulic Metaphor:

Stock and Flow Diagram: StockInflow OutflowSource Sink

Integral Equation:

Source Sink

tSt kdO tflI fltSt kt

Integral Equation: 00

tStockdssOutflowsInflowtStockt

Differential Equation:

tOutflowtInflowdt

tdStock

24

Stock/flow distinctions in Stock/flow distinctions in different disciplines

Field Stocks Flows

Math, physics, engineering

Integrals, state variables, stocks

Derivatives, rates of change, flowsengineering variables, stocks change, flows

Chemistry Reactants and products

Reaction rates

fManufacturing Inventories Throughput

Economics Capital stock, money supply, population

Investment, lending, borrowing, births, pp y p p gdeaths

Accounting Balance sheet items Income statement itemsitems

Biology, physiology

Compartments Diffusion rates, flows

M di i P l I id i f i Medicine, epedimiology

Prevalence, reservoirs

Incidence, infection, morbidity and mortality rates25

Wh t k d fl ?Why stocks and flows?

• Stocks define the state of the t d id th b i f system and provide the basis for

actions• Stocks introduce inertia and

memoryy• Stocks are the source of delays• Stocks decouple rates of flow and • Stocks decouple rates of flow and

create disequilibrium dynamics

26

6

8

issi

ons

ear)

CO24

6

ogen

ic C

O2 E

mi

on m

etric

tons

/ye CO2-emission and

0

2

1950 1975 2000 2025 2050

Ant

hrop

o(B

illio

800

emission and global

750

heric

CO

2 et

ric to

ns) warming

650

700

Atm

osph

(Bill

ion

m

Data

Model

Global temperature rises well after TGHG emissions fall to zero. Simulated emissions fall to zero in 2000 M f t t

6501950 1975 2000 2025 2050

0.8

1.0

ace

mal

y un

d)

Angell Data

2000. Mean surface temperature continues to rise for roughly 20 years.

S Fidd (1997) i t d i St0 2

0.4

0.6

Glo

bal M

ean

Surf

aem

pera

ture

Ano

mC

abo

ve b

ackg

ro

Model

Source: Fiddaman (1997), reprinted in Sterman (2000)

0.0

0.2

1950 1975 2000 2025 2050

G Te (°C

JWW Data

27

Th 1979 il i iThe 1979 oil crisis

28

P li Policy responses

• Odd/even days linked to license plate numbers

• Maximum purchase each time ($ • Maximum purchase each time ($ or gallons)

29

I t t dImports went up, now downSo where did the gas go???

U.S. Crude oil imports (1000 bbl/day)

So where did the gas go???

78 000

78.500

77.000

77.500

78.000

75 500

76.000

76.500

75.000

75.500

1978 1979

30

Source: U.S. DoE

P i iPair up exercise

• What was/were the key cause/causes of the gas shortage?

• Do you think the policies worked?• Do you think the policies worked?• Why/why not?• Alternative policies that might

work better?work better?

31

St t f th blStructure of the problem

Gas in carsGas instationsSupply of gas Filling Consumption

--

Incidence ofshortage

+ -

Perceivedshortage

Desired level ingas tank

Intensity of mediacoverage

32

St t l (2007)Sterman et al (2007)

• Example of quantitative system dynamics study

• Explores the challenges of the “get • Explores the challenges of the get big fast” strategy often dictated by neoclassical perspectives on FMAneoclassical perspectives on FMA

T b i t t iTwo basic strategies

• Aggressive–High market share (80%)g ( )–Price more to capture market

Grab any uncontested market share–Grab any uncontested market share

• Conservative–Equal market share (50%)–Price more to cover costPrice more to cover cost–Cede market share if 50% share

would result in over-capacity in would result in over-capacity in industry

Fi t l t’ b ild d lFirst, let’s build a model…

• Vensim Bass model• Extension

Different speeds of padjustment (WOM effect)

Payoff matrixy(No capacity lags)

Payoff structure independent y pof WOM speed

Aggressive strategy Aggressive strategy dominates (better off doing A no matter what opponent does)

Incentive to defect

No incentive for unilateral cooperation

Dynamics under perfect y pforesight

Aggressive firm has cost advantage….

… and wins out from out from higher sales and margins

P ff t i ( ith l )Payoff matrix (with lags)

Conservative strategy now dominant in Conservative strategy now dominant in fast markets

Incentive to cooperate

Incentive to defect

But also incentive for unilateralcooperation (No Nash Equil.)

Why? Due to capacity dynamics Why? Due to capacity dynamics and errors

Note that aggressive firm still has cost advantage….

… but loses out due to excess capacity buildup

I t t tiInterpretation

• Classical GBF strategy not always the right one even when conditions would appear to one, even when conditions would appear to call for it

• Don’t take neoclassical game theory results for • Don t take neoclassical game theory results for granted

• Can you forecast better? Can you forecast better? – “by the time sufficient observations have developed

for reliable estimation, it is too late to use the ti t f f ti ”estimates for forecasting purposes.”

• Understanding/appreciating dynamics is key

M h ll & B (2003)Marshall & Brown (2003)

• Example of qualitative use of systems thinking

• NTO: Catalog sales of high-end • NTO: Catalog sales of high end outdoors equipment and apparelT i bili ff• Two sustainability efforts–Recycled paper for catalogsy p p g–Sustainability supply strategy

Recycled paper business y p psystemDocumentation

and industry efforts

Overall demand for RC

efforts

Perceived quality of recycled content (RC)

Industry investment in RC

technologyRC to virgin content price

differential

Scope and scale of RC production

Marginal ROIon investment

in RC tech.Individual

Rate of improvement in RC quality

Individual negotiation with paper suppliers

Rate of changed of RC quality

Collection effort effectiveness

Raw material cost

RC raw material supply

Cotton life cycle analysisy y(Sustainability toolkit)

Simplified scoring system forsystem for buyers

Part of compensationcompensation package

Buyer and supplier business y ppsystem v. 1.0

Rate of product meeting design specs incoming

to NTOCustomer demand

Supplier

Product portfolio margin

NTO financial performance

ppsales.

Design time

Buyer compensation

Supplier changes to

prod. designRate of change in prod. design

Supplier investments to meet redesignRate of change

in no of productsSupplier

dependence on NTO

in no. of products ordered

Buyer and supplier business y ppsystem v. 2.0



Supplier



ppsales.

Design time

Buyer compensation

Supplier changes to



in no of products

Buyer willingness to use

sustainability criteria Change in sust.

Supplier dependence

on NTO


gproduct selected

Buyer ability to

Learning time

choose high-margin sust.

products

Buyer and supplier business y ppsystem, leverage actions



Supplier Comp. package



ppsales.

Design time

package

Toolkit

Buyer compensation

Supplier changes to


Scorecard


in no of products

Buyer willingness to use

sustainability criteria Change in sust.

Supplier dependence

on NTO


gproduct selected

Buyer ability to

Learning time

Training choose high-margin sust.

products Toolkit

Cl i th htClosing thoughts

• Greentech is likely to revolutionize i d t i ti it ti f many industries – creating situations of

radical technology change• This brings about situations where

FMA/FMD are highly pertinent• Systems thinking/system dynamics can

be a useful tool for analyzing strategies y g gunder radical change

• And a tool for indentifying leverage And a tool for indentifying leverage points for less radical innovation

N t tiNext time…

Open innovation and platform strategy in the context of sustainability innovationy(with Jens Frøslev Christensen)

Documents

V83-2009-04