Summary table

Further reading
David Teece’s 1986 article – ‘Profiting from technological innovation’, Research Policy 15(6) 285–305 – remains a seminal
work in this area and he has followed this more recently with an article written with Gary Pisano:
Pisano, G. and Teece, D. (2007). How to capture value from innovation: Shaping intellectual property and industry
architecture. California Management Review, 50(1): 278–96.
Shapiro and Varian provide an excellent exposition of the strategic issues surrounding the establishment of standards and
the routes to success in standards wars in:
Shapiro, C. and Varian, H. (1999). The art of standards wars. California Management Review, 41(2), 8–32.
In an article published in 2008, Teresa Amabile and Mukti Khaire report on a two-day colloquium held at Harvard Business
School with invited leaders from businesses whose success depends on creativity and scholars specializing in the study of
creativity. Their conclusions from this event are written up in the following article:
Amabile, T. and Khaire, M. (2008). Creativity and the role of the leader. Harvard Business Review, October, 101–9.
Self-study questions
1. Trevor Baylis, a British inventor, submitted a patent application in November 1992 for a wind-up radio for use in Africa in areas
where there was no electricity supply and people were too poor to afford batteries. He was excited by the prospects for radio
broadcasts as a means of disseminating health education in areas of Africa devastated by AIDS. After appearances on British and
South African TV, Baylis attracted a number of entrepreneurs and companies interested in manufacturing and marketing his
clockwork radio. However, Baylis was concerned by the fact that his patent provided only limited protection for his invention:
most of the main components – a clockwork generator and transistor radio – were long-established technologies. What advice
would you offer Baylis as to how he could best protect and exploit his invention?
2. There have been several efforts to develop 3D printers suitable for desktop use by individual households. What are the main risks
facing a start-up company intending to develop such a product?
3. From the evidence presented in Table 6.1, what conclusions can you draw regarding the factors that determine whether leaders or
followers win out in the markets for new products?
4. What are the sources of network externalities in the e-book reader market? Will e-book readers become a winner-takes-all market?
Why has Amazon been able to gain a lead over rivals? Can Kobo and Nook fight back? If so, how?
5. ‘Creativity is just connecting things. When you ask creative people how they did something they feel a little guilty because they
didn’t really do it, they just saw something. It seemed obvious to them after a while.’ Steve Jobs.

Discuss the quote and consider its implications for organizations that wish to innovate.

Closing Case
Nespresso
Nespresso is the brand name of a coffee brewing system developed in the late 1970s by Nestlé, the multinational food company founded
and headquartered in Switzerland. Nespresso allows consumers to brew high-quality coffee at the push of a button by placing
hermetically sealed, aluminium covered, coffee capsules into a specially designed machine. While the idea sounds simple, the technology
behind Nespresso is, in fact, complex because it requires air and water to be passed through ground coffee at the right temperature and
pressure. At the time of its development, Nespresso constituted a major departure for Nestlé from its core operations that were based on
the large-scale production and mass marketing of food products. In the late 1970s Nestlé’s presence in the coffee market centred on
instant coffees with products like Nescafé accounting for 80% of its revenue from coffee sales.

Early development
The original technology underpinning Nespresso was developed by the Battelle Institute, an independent research organization based in
Geneva,58 but Nestlé acquired the rights to develop the idea commercially in 1974 and went on to file a large number of patents on the
product.59 Camillo Pagano, who was at that time the senior executive in charge, felt that the product had potential despite the fact that
sales in the coffee market were sluggish. At the time, the gourmet coffee market was beginning to expand and Nestlé saw Nespresso as a
vehicle by which it could expand coffee sales by moving into the restaurant market. Many of Pagano’s colleagues were sceptical about
the innovation, questioning whether Nespresso could be commercialized and expressing concern about the amount of time and effort that
would be taken up in launching such a niche product that had a poor fit with Nestlé’s mainstream operations. Pagano felt that in order to
flourish the Nespresso project needed to be taken outside Nestlé’s day-to-day operations so, in 1984, he established Nespresso as a
separate company (100% owned by Nestlé) which was free to develop its own marketing, operations and personnel policies.
Nespresso developed its system in conjunction with a number of partners: it collaborated with a Swiss company to improve the design of
the machines; it licensed the manufacture of the machines to Turmix, a Swiss domestic appliance manufacturer; it partnered with Sobal, a
distributor, to sell the product to end-users. The Nespresso system was launched in 1986 in Italy, Switzerland and Japan but the product
flopped. By the end of 1987, only half the machines that had been manufactured had been sold and without sales of machines there could
be no sales of the specially designed capsules. It looked very likely that Nestlé headquarters would kill off the project but it was decided
to give it a further chance by bringing in an outsider to see whether a turnaround could be effected. The person selected for this role was
Jean-Paul Gaillard, a former executive with Philip Morris, the tobacco company.60
The turnaround
Rupert Gasser, head of research at Nestlé, described Gaillard as ‘ambitious and strong headed. He wanted to do something
outstanding. [Gaillard] had personality; he was a force. Andimportantly, he did not carry all the trappings of the company
history.’61 Gaillard made a number of changes, the most important of which were:
 Changing the customer focus: Gaillard reasoned that the Nespresso system was more suited to the household than the restaurant
market. Although his intuition was not supported by explicit market research, market trends in the late 1980s pointed in that
direction. Gaillard’s strategy was to target high-income households and, in line with that strategy, he sought to ensure that the
coffee machines were retailed through high-end stores.
 Establishing a direct channel to the end-users through the establishment of Nespresso Clubs: selling Nespresso coffee capsules
through supermarkets did not fit well with the exclusive brand image Gaillard wished to create, and so he had the idea of
establishing the Nespresso Club. When households bought a machine, they automatically became members of the Club that
offered around-the-clock ordering of coffee capsules, prompt delivery of orders and advice on coffee making and machine
maintenance. The Club had the additional advantage of providing the company with up-to-date customer information.
 Positioning the brand at the top end of the market: the company developed partnerships with kitchen appliance makers such as
Alessi, Krups, Magimix and Philips to produce well-designed machines sold through upmarket retail outlets.
By the time Gaillard left Nespresso in 1996, sales had taken off and there were 220 000 club members across Europe.
After Gaillard’s departure, Nespresso continued to grow as it expanded geographically, extending its target market into small
offices and businesses and widening it range of coffee capsules. The range of machines was increased to offer a number of
sophisticated design options and the company opened a number of retail outlets – Nespresso boutiques – that sold coffee-
related paraphernalia as well as the Nespresso system. Augmenting a marketing campaign that relied heavily on social media,
Nespresso launched a long-running and successful television and billboard advertising campaign featuring George Clooney
to further promote the product. By 2014, Nespresso had estimated annual sales of SFr 4 billion (US$4.5 billion), margins on
earnings before interest and tax (most of which came from pods rather than machines) of more than 30% and accounted for
around 8% of Nestlé’s total operating profit.62
More recent challenges
As might be expected, the success of Nespresso paved the way for new competitors to enter the market. Despite having more
than 1700 patents on Nespresso capsules and machinery, more than 20 years had elapsed since the product was first
developed and early patents were beginning to expire. In addition, the product had proved relatively simple for new players
to re-engineer without infringing Nestlé’s patents. Nonetheless, Nestlé had built a strong brand and was the global market
leader (Table 6.4). However, in the US Keurig, part of Keurig Green Mountain, and its K-Cup system dominated the market,
with several other players, including both Starbucks and Walmart entering this market. In 2014, Nespresso launched its
VertuoLine range designed to make the larger coffee servings preferred by Americans.
Table 6.4 Suppliers of single-serve coffee systems.
Parent company Brand Estimated global market share 2014(%)
Nestlé Nespresso
Sara Lee Senseo
Keurig Green Mountain Keurig (K-Cup system)
Kraft Tassimo
The bulk of the profit from single-serve pod coffee makers came from selling capsules rather than the machines themselves
and this opened up a second route for new entrants. A number of companies, including one set up by Nespresso’s former
head, John-Paul Galliard, started selling substitute coffee pods for Nespresso machines. Nestlé robustly defended its
property rights but in a landmark case in 2013 the UK High Court ruled that Dualit, a UK manufacturer of small domestic
appliances, had not infringed Nestlé’s patents by making substitute capsules for its Nespresso regime. Similar rulings
followed in test cases in other European countries with significant repercussions for the viability of Nespresso’s business
model.
Nespresso and other makers of pod coffee machines also found themselves under increasing pressure from environmental
campaigners, who highlighted the fact that capsules were difficult to recycle and added to waste and environmental damage.
Nespresso launched a recycling campaign allowing consumers to return the single-use aluminium containers in special bags
but this did little to dampen criticism.
By 2014, Nespresso was faced with a number of dilemmas with regard to its future direction. Could it sustain rapid growth in
the face of increasing competition? Was it possible for Nespresso to retain and develop its exclusive image or should it move
downmarket to increase its target market? Should Nestle re-integrate Nespresso into its mainstream organization to
stimulate a new wave of innovation?

Case questions
 What insights into the innovation process can be gained from this case?
 The Nespresso innovation took more than 20 years to come to fruition. How would you account for the slow commercialization
of this product?
 Nespresso’s patents have not prevented competitors from offering coffee pods which fit Nespresso machines. How big a problem
is this for Nespresso?
 Do you think that Nespresso has a sustainable competitive advantage? What suggestions would you make to Nespresso’s
management regarding future strategy?

Notes
1 K. Cool, P. Paranika and T. Cool, ‘iPad vs. Kindle: e-Books in the US in 2010’, (INSEAD Case Study, 2011).
2 Ibid.: 2.
3 C. Foresman, ‘Apple way ahead of tablet competitors’, Ars Technica (11th March 2011), http://www.wired.com/2011/03/apple-
tablet-80-share/, accessed 29th September 2014.
4 The Economist, ‘The difference engine: send in the clones’ (11th March
2011), http://www.economist.com/blogs/babbage/2011/03/tablet_computers_0, accessed 29th September 2013.
5 See, for example, G. A. Fowler, ‘Price cuts electrify the e-reader market’, Wall Street Journal (22nd June 2010).
6 Morgan Stanley research.
7 The ‘razor and blades’ strategy refers to a business model that involves selling an item at a low price, sometimes even at a
loss, in order to sell complementary products at a much higher margin. The name refers to the original Gillette company,
which sold razors at cost and made a high margin on selling its razorblades.
8 http://seekingalpha.com/article/2376765-rakutens-rknuf-ceo-hiroshi-mikitani-on-q2-2014-results-earnings-call-transcript, accessed
29th September 2014.
9 See, for example, https://technology.ihs.com/417568/ebook-readers-device-to-go-the-way-of-dinosaurs, accessed 15th April 2014;
and http://247wallst.com/special-report/2013/05/23/ten-brands-that-will-disappear-in-2014/, accessed 15th April 2014.
10 ‘The logic that dares not speak its name,’ The Economist (16th April 1994): 89–91.
11 In the US, the return to R & D spending was estimated at between 3.7 and 5.5%. See M. Warusawitharana, ‘Research and
development, profits and firm value: A structural estimation’, Discussion Paper (Washington, DC: Federal Reserve Board,
September 2008).
12 The Economist, ‘Knowledge monopolies: Patent wars’, (8th April 2000): 95–9.
13 F. T. Rothermael, ‘Incumbent advantage through exploiting complementary assets via interfirm cooperation’, Strategic
Management Journal, 22 (2001): 687–99.
14 R. C. Levin, A. K. Klevorick, R. R. Nelson and S. G. Winter, ‘Appropriating the returns from industrial research and
development’, Brookings Papers on Economic Activity, 3 (1987).
15 ‘Why Google acquired eBook technologies’, http://mashable.com/2011/01/13/why-google-acquired-ebook-technologies/, accessed
29th September 2014.
16 Matt Phillips, ‘Tablet glut won’t matter for ARM Holdings analyst says’, Wall Street Journal (11th March 2011).
17 ‘The semi-conductor industry: Space Invaders’, Economist (7th January 2012).
18 R. Adner, ‘Match your innovation strategy to your innovation ecosystem’, Harvard Business Review (April 2006): 17–37.
19 S. Shulman, The Telephone Gambit (New York: W. W. Norton, 2008).
20 ‘The Human Genome Race’, Scientific American (24th April 2000).
21 C. Markides and P. A. Geroski, Fast Second (San Francisco: Jossey-Bass, 2005).
22 D. Sull, ‘Strategy as active waiting’, Harvard Business Review (September 2005): 120–9.
23 See, for example, C. Beaumont, ‘Apple launches iPad tablet computer’, The Telegraph (27th January 2010).
24 For example, data on penetration rates for electric toothbrushes and CD players were used to forecast the market demand
for HD TVs in the United States. See B. L. Bayus, ‘High-definition television: Assessing demand forecasts for the next
generation consumer durable’, Management Science, 39 (1993): 1319–33.
25 E. Von Hippel, ‘Lead users: A source of novel product concepts’, Management Science, 32 (July 1986): 791–805.
26 In electronic instruments, customers’ ideas initiated most of the successful new products introduced by manufacturers.
See E. Von Hippel, ‘Users as innovators’, Technology Review, 5 (1976): 212–39.
27 A. Friedlander, The Growth of Railroads (Arlington, VA: CNRI, 1995).
28 S. Postrel, ‘Competing networks and proprietary standards: The case of quadraphonic sound’, Journal of Industrial
Economics, 24 (December 1990): 169–86.
29 S. J. Liebowitz and S. E. Margolis, ‘Network externality: An uncommon tragedy’, Journal of Economic Perspectives, 8,
(Spring 1994): 133–50) refer to these user-to-user externalities as ‘direct externalities’.
30 M. Gladwell, The Tipping Point (Boston: Little Brown, 2000).
31 P. David, ‘Clio and the economics of QWERTY’, American Economic Review, 75 (May 1985): 332–7; S. J. Gould, ‘The
panda’s thumb of technology’, Natural History, 96 (1986). For an alternative view see S. J. Leibowitz and S. Margolis, ‘The
fable of the keys’, Journal of Law and Economics, 33 (1990): 1–26.
32 C. Shapiro and H. R. Varian, ‘The art of standards wars’, California Management Review, 41 (Winter 1999): 8–32.
33 R. M. Grant ‘The DVD war of 2006–8: Blu-ray vs. HD-DVD’, Contemporary Strategic Analysis, 7th edn (Chichester: John
Wiley & Sons Ltd, 2009): 692–7.
34 Shapiro and Varian (1999), op. cit.: 15–16.
35 Ibid.: 16–18.
36 C. Nucci, ‘E-book dilemma: Potboiler of the digital age’, TechWeb (5th February 2001).
37 S. Ahn, Firm dynamics and productivity growth: A review of micro evidence from OECD countries, Economics Department
Working Paper 297 (OECD, 2001).
38 J. M. George, ‘Creativity in organisations’, Academy of Management Annals, 1 (2007): 439–77.
39 M. L. Tushman, ‘Managing communication networks in R&D laboratories’, Sloan Management Review (Winter 1979): 37–49.
40 D. Dougherty and C. H. Takacs, ‘Team play: Heedful interrelating as the boundary for innovation’, Long Range Planning, 37
(December 2004): 569–90.
41 S. Thomke, ‘Enlightened experimentation: The new imperative for innovation’, Harvard Business Review (February 2001):
66–75.
42 ‘The printed world’, The Economist (12th February 2011): 75–7.
43 R. Florida and J. Goodnight, ‘Managing for creativity’, Harvard Business Review (July–August 2005).
44 D. Leonard and S. Straus, ‘Putting your company’s whole brain to work’, Harvard Business Review (July–August 1997): 111–
21; D. Leonard and P. Swap, When Sparks Fly: Igniting creativity in groups (Boston: Harvard Business School Press, 1999).
45 ‘How to manage a dream factory’, The Economist (16th January 2003).
46 ‘Lunch with the FT: John Lasseter’, Financial Times (17th January 2009).
47 E. Von Hippel, The Sources of Innovation (New York: Oxford University Press, 1988) provides strong evidence of the
dominant role of users in the innovation process.
48 E. Morrison, ‘Gunfire at sea: A case study of innovation’, in M. Tushman and W. L. Moore (eds), Readings in the
Management of Innovation (Cambridge, MA: Ballinger, 1988): 165–78.
49 K. Clark and T. Fujimoto, Product Development Performance: Strategy, organisation and management in the world car
industry (Boston: Harvard Business School Press, 1991).
50 K. Imai, I. Nonaka and H. Takeuchi, ‘Managing the new product development process: How Japanese companies learn
and unlearn’, in K. Clark, R. Hayes and C. Lorenz (eds), The Uneasy Alliance(Boston: Harvard Business School Press, 1985).
51 D. A. Schön, ‘Champions for radical new inventions’, Harvard Business Review (March–April, 1963): 84.
52 R. Rothwell, C. Freeman, A. Horsley et al., ‘SAPPHO updated – Project SAPPHO Phase II’, Research Policy 3 (1974): 258–
91.
53 G. P. Pisano, Science Business: The Promise, the reality and the future of biotech (Boston: Harvard Business School Press,
2006).
54 A. Arora, A. Fosfur and A. Gambardella, Markets for Technology (Cambridge, MA: MIT Press, 2001); S. Breschi and F.
Malerba, Clusters, Networks and Innovation (Oxford: Oxford University Press, 2005).
55 M. T. Hansen, H. W. Chesborough, N. Nohria and D. N. Sull, ‘Networked Incubators: Hothouse of the new
economy’, Harvard Business Review (September–October, 2000): 74–88.
56 G. Hamel and C. K Prahalad, ‘Nurturing creativity: Putting passions to work’, Shell World (Royal Dutch Shell, 14th
September 2007): 1–12.
57 J. Sculley, Odyssey: Pepsi to Apple: A journey of adventure, ideas and the future (New York: Harper & Row, 1987).
58 J. Miller, Innovation and Renovation: The Nespresso story, Case 543 (Lausanne: IMD, 2003).
59 Nespresso. Wikipedia [online]. Last updated 26th September 2014, http://en.wikipedia/wiki/nespresso, accessed 29th
September 2014.
60 Jean-Paul Gaillard is referred to as Yannick Lang in the IMD case, see P. Silberzahn, ‘Nespresso: Victim of low-end
disruption?’ The Management of Innovation [blog] (13th April 2010),http://philippesilberzahneng.wordpress.com/tag/jean-paul-
gaillard/, accessed 29th September 2014.
61 IMD case study (2003), op. cit.: 6.
62 J. Shotter, ‘Nespresso brews plans to see off rivals’, Financial Times (1st January 2014); L. Ludes ‘Nespresso’s bitter taste of
defeat’, Financial Times (24th April 2013).