Strategic Management 2nd Edition Rothaermel Solutions Manual

Strategic Management 2nd Edition Rothaermel

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CHAPTER 7
BUSINESS STRATEGY: INNOVATION AND ENTREPRENEURSHIP

Overview
CHAPTER OUTLINE
In this chapter, we turn our attention to innovation. We start by defining innovation
and reviewing how it can affect competition. Then, we look at the creation of new
Chapter Case businesses with strategic or social entrepreneurship. We bring in a dynamic
Wikipedia: The Free perspective by discussing how innovation changes over the industry life cycle. We
Encyclopedia discuss a number of significant changes in the business landscape, including the
increasing role of the Internet and other paradigm shifts. We close with a discussion
7.1 Com petition of the practical implications of these ideas for strategists.
Driven by Innovation

7.2 Strategic and Learning Objectives

Social
Entrepreneurship LO 7-1 Outline the four-step innovation process from idea to imitation.

7.3 Innovation and LO 7-2 Apply strategic management concepts to entrepreneurship and innovation.
the Industry Life
Cycle LO 7-3 Describe the competitive implications of different stages in the industry life
cycle.
7.4 Types of LO 7-4 Derive strategic implications of the crossing- the-chasm framework.
Innovation
LO 7-5 Categorize different types of innovations in the markets-and-technology
7.5 Im plications for framework.
the Strategist
LO 7-6 Explain the long-tail concept and derive its strategic implications.
Strategy Term Project
LO 7-7 Compare and contrast closed and open innovation.
my STRATEGY

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CHAPTER CASE Consider This Discussion Questions

This brief case is designed
to bring out the speed and
impact that innovation can
have on an industry. Even
one with nearly 200 years
of success behind it can be
brought down in far less
than a decade.
In the “Consider This”
section at the end of the
chapter, we consider the
business model for
Wikipedia.
Most students used Encarta or something like it during their earlier years in
school. Of course, they are all using Wikipedia now (though they don’t always
admit this to their instructors!). Even so, we find most have never given much
thought to how Wikipedia stays in business. Instead of funding the business
with banner ads or membership fees, the founders set it up to operate largely
with volunteers and cash donations as a not-for-profit structure (go to
http://en.wikipedia.org/wiki/Main_Page and click on “donate to Wikipedia” to
learn more about this aspect of the firm).
If students have not seen the Encyclopedia Britannica, ask if their parents or
grandparents have a set of World Book Encyclopedia books, which had a large
market share in the U.S. for many decades.
The other point we like to make with this case is the “disappearance” of over
$1 billion in value. The case notes that in 1991 the encyclopedia market was
$1.2 billion annually. By 2009, when Microsoft shut down Encarta, there was
virtually no revenue left for firms creating an encyclopedia. But did the value
really disappear? NO… We argue that the value is now spread across wide
swaths of humanity that are now able to access a breadth and depth of
knowledge never before possible. And in nearly 300 languages, the reach of
Wikipedia is phenomenal. So what used to be $1.2 billion in sales revenue for a
handful of firms is now spread to billions of people in “consumer surplus” (to
use the term from Chapter 5). This same “social good” argument can be made
for many of the digital shifts now underway in newspapers, music, and books.

How can Wikipedia maintain and grow its ability to harness the crowdsourcing of its “Wikipedians” to
maintain high-quality (and quickly updated) content? AACSB 2013 Standard 9 Making sound decisions and
exercising good judgment under uncertainty

Attracting and retaining Wikipedians is vital to the future success of Wikipedia. Recent surveys illustrate a potential
challenge—only 15 percent of women contribute to Wikipedia, and the average age of contributors is the mid-20s. To
grow, Wikipedia should undertake a variety of strategies, all of which solicit help from the underrepresented.
Wikipedia should partner with translation companies in order to increase the content of underrepresented languages.
Wikipedia could also partner with computer training companies to educate women and digital immigrants on the
proper method to update Wikipedia. Lastly, Wikipedia could partner with colleges and universities to improve content.
For example, professors could create projects that require students to update content where they are subject matter
experts. These are just three ways for Wikipedia to improve and grow content. Students will undoubtedly have many
more suggestions.

As Wikipedia keeps growing, do you think it can continue to rely ex clusively on donations (in time and
money)? Why or why not? What other “business models” could be considered? Would any of those “violate
the spirit of Wikipedia”? Why or why not? AACSB 2013 Standard 9 Social responsibility, including sustainability,
and ethical behavior and approaches to management

One could imagine Wikipedia being acquired and becoming supported by ad dollars. The problem that might occur as
the result of such a shift is that the content may become biased to please advertisers or to entice people to pages
supported by advertisers. Even if no impropriety occurred, a perception of bias toward advertisers may develop.
Another way to generate revenue would be to develop a cadre of paid content providers whose work would be
available exclusively to a set of users that paid subscription fees of some type. Either of these methods would change
the spirit of what the original founder intended Wikipedia to become.

What, if anything, should Wikipedia do to ensure that its articles indeed present a “neutral point
of view”? Shouldn’t the crowdsourcing approach ensure an objectivity? Does a “neutral point of view” matter
to Wikipedia’s sustainability? Why or why not?

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Crowdsourcing does not ensure objectivity, it only ensures that the range of viewpoints of the people who make up that
particular “crowd” are represented. Students are likely to have different opinions as to how important objectivity is to the
usefulness and success of Wikipedia. Wikipedia has already seen a gradual shift toward less bias. One might argue that an
imbalance in perspective will inspire a new group of Wikipedians who feel that their views have not been adequately
represented in the past.

How has the “long tail” affected Wikipedia?

The “long tail” has had a significant effect on Wikipedia. Wikipedia provides a forum for subject matter experts (who
previously might have been unheard) to provide specific and accurate content, efficiently and cheaply.

Discussion Topics
What type of innovations should Wikipedia use to gain or sustain a competitive advantage? Students should be able to
come up with a variety of suggestions. Wikipedia has become an established incumbent in the digital encyclopedia
industry. The company should emphasize incremental innovation to help defend its strategic position and market power.
Incremental innovations will extend the time for Wikipedia’s success; meanwhile, radical innovations will threaten the
company’s dominant position.

While it is easy to recognize that today’s undergraduates may not even be able to visualize the “ancient” process of
conducting research for term papers using encyclopedias, card catalogues, and print journals in the stacks, many of these
Millennials may not even have much experience with Encarta. To give them an appreciation of industry evolution, you may
want to send them to the university library with an assignment to research a topic using encyclopedias and journals not
available for online search (at my university this would include full text of recent Harvard Business Review articles). The
topic of the research does not need to be consistent (it could be directed toward a paper they need to write in a different
class, or it could be directed toward the firm the student is using for the Strategy Term Project in this textbook. What is
important for this discussion is the process. This research could then form the basis for a discussion about industry
evolution and types of innovation. You could complement this discussion with a humorous video on what the process of
renting videos used to be like. The ensuing discussion may touch upon how the physical space limitations in the
encyclopedias and the stacks restricted access to “long tail” information or limitations on access to information for people
who were not physically near a library (or a well-stocked library). What does this tell you about the impact of the new
technology on emerging economies or even rural areas in developed nations? The students may also note that research the
old way was more time consuming.

7.1 COMPETITION DRIVEN BY INNOVATION [LO 7-1]

Examples
There are many examples of creative destruction that you might offer to supplement those in the text. One that will resonate
with students is the way that phones have killed the market for point-and-shoot cameras. (See “Smart phones expose
camera maker to trouble,” The Wall Street Journal, 8/13/13.) Others to consider: video streaming and kiosks have
displaced video rental stores, e-books and e-mags are replacing paper books and magazines, tablets are replacing PCs, and
K-cup-style machines are replacing standard coffee pots. Biologics are displacing chemical drugs in that established
pharmaceutical companies, like Merck and Pfizer, brought major new drugs to market in the past, using a chemical-based
drug discovery and development paradigm. These same companies are struggling to maintain their dominance as relative
newcomers like Amgen and Genentech are leveraging advances in genomics, genetic engineering, and biotechnology to
produce drugs that are better targeted to treat diseases and that eventually can be designed for individual patients.

Another example is the digital marketing revolution in the way firms communicate with customers. In “The Coming Era of
‘On-demand’ Marketing” (McKinsey Quarterly, April 2013) the firm forecasts that consumers will begin to expect to
interact at any time, for their interaction to be customized to be relevant to them, for the interactions to be simple, and for
the interactions to create value for them in new ways. Traditional marketing communications like newspaper ads cannot

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meet these requirements. For example, ask students how they expect their bank to interact with them and contrast it with
the fact that their grandparents probably visit their bank in person and might expect a free toaster for opening a checking
account.

The life experience of the Gen-Y population reflects the accelerated pace of technology diffusion shown in Exhibit 7.1.
New technologies are a natural part of their lives. The Gen-Y cohort came of age during the boom of the Internet; its
members are accustomed to constant connectivity and to rapid technological change. By the time they graduate from
college, the average Gen-Y student has spent over 10,000 hours playing video games and over 20,000 hours watching TV.
The Gen-Y cohort is sometimes called digital natives—people who grew up with the Internet and other advanced
technologies and who need no help to adapt to new technologies. Those who did not grow up with the Internet and other
advanced technologies, and so have taken longer to adapt to them, are called digital immigrants.

The discussion of the innovation process shown in Exhibit 7.2 is worth spending a few moments on in class. Many students
will come into the classroom confused over the difference between inventions and innovations. It is important to set the
framework here at the start of the chapter for a better understanding of the concepts to follow.

Being the first to bring a new technology to market has benefits, but also risks. Often the first mover falls by the wayside
and cedes the dominant share to a second mover that brings unique competencies or more resources to the market.
Samsung and others have launched first-generation smartwatch products, but do they have the competencies needed to
deter imitation and keep the lead? Will this market have network effects? Sony launched the first e-reader, but market
dominance went to Amazon’s Kindle, based on Amazon’s business model that took advantage of its competitive advantage
in content.

To further capitalize on a firm’s first-mover advantage, a company could form exclusive partnerships with suppliers of
hardware and content providers (Apple’s iPhone, see Strategy Highlight 7.1). This leads to network effects and increased
demand for the product. Furthermore, a firm should investigate developing robust distribution channels and continuing
R&D investment to fuel future incremental innovations.

As an example of network effects, in the early days of the Internet, for instance, only a small network of scientists had
access to e-mail. Today, e-mail is a ubiquitous communications tool with more than a billion users, and is now much more
valuable to users. Another example of network effect: If all of your friends interact socially exclusively on Facebook, what
challenges does Google face in getting you to spend time on Google+?

Discussion Topics
Apple disrupted the phone market with the first iPhone and created the tablet market with the first iPad. Why do they still
hold a commanding share of the tablet market, while Android makers lead in cell phones? Students will have a variety of
ideas on this topic, but the goal will be to get them to build from the theoretical drivers of first-mover advantage listed in
the text, rather than intuitive ideas as consumers. Apple launched the tablet with great content; they designed the iPad and
negotiated supply contracts that gave them a cost-leadership position for that level of features and priced the product
aggressively. AACSB 2013 Standard 9 Analytical thinking (able to analyze and frame problems)

Exercise
Have students investigate a new technology on the market and use it as a basis for building or assessing critical reasoning
skills. One example you might use is Samsung’s new smart watch. (See “For smart watch, Samsung’s timing counts,” The
Wall Street Journal, 9/3/13.) For this exercise, ask students to make a list of the advantages of being a first mover from the
text. For each of the first-mover advantages: Is it relevant to this product? If so, write a one-sentence logical argument for
why the first mover will gain this benefit and a one-sentence description of a piece of evidence supporting that argument
that he/she found in his research.

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7.2 STRATEGIC AND SOCIAL ENTREPRENEURSHIP [LO 7-2]

Examples
Beyond starting and running new businesses, entrepreneurs are change agents who transform innovation into reality.
Apple Inc. is known as one of the world’s most innovative companies, and its co-founder Steve Jobs was credited with
Apple’s most important breakthrough innovations. Steve Jobs also founded Pixar, one of the most successful film studios
of all time. Leveraging 3D computer animation, Pixar has created blockbuster hits such as Toy Story 1, 2, and 3, A Bug’s
Life, Monsters Inc., Finding Nemo, and The Incredibles, among others. Steve Jobs was clearly an entrepreneur
extraordinaire, and has effected continuous innovation in his quest to create value through new products or services.
For an expanded discussion beyond what is in the textbook see this interview with Sara Blakely of Spanx from The Wall
Street Journal, 10/11/13.

The textbook describes a few serial entrepreneurs, but the flip side of that is that as firms mature they often need different
skill sets in their CEO than the entrepreneurial expertise of the founder. A good example of this is Twitter. As they
approach their public offering, none of the four founders are leading the firm. According to “Success after Founders’
Exit” (The Wall Street Journal, 10/3/13) fewer than half of the firms that go public still have a founder as CEO.

Exercise
To illustrate how difficult it is for firms to be innovative in their thinking when they have a great deal of experience in an
area, I bring 7 items to class and arrange them in order on a table. The only requirement for these items is that they be
varied (banana, shoe, pencil, book, coffee cup, chair, etc.). Then I tell students that they are being asked to develop a new
name for each of these items and write it on a piece of paper. I hold up each item in order, and then add an 8th item—a
verb—by jumping or skipping. I give them only about 2 seconds between showing each item, then I go through them a
second time. At the end, I ask them to score themselves, giving themselves zero points if their new name is the same as
the old name in a different language than English, 1 point if the name is a noun in the same family (for example, apple for
banana), 2 points if the name is a noun in an unrelated family (for example, chair for banana), 3 points if the new name is
not the same part of speech (happy for banana), and 4 points if the new name is not an existing word. Then, I ask students
to raise their hands if they scored more than 10, 20, or 30. (I have only had one student over the years who got all fours—
a manager for the Girl Scouts.) I use this exercise to initiate a discussion of how challenging innovation is because
organizations often limit it with risk aversion, incentives for incremental innovation, discouragement of experimentation,
and a focus on short-term profit. However, an equally big challenge for firms is that even when they do not limit
employees’ innovation, the employees limit themselves by imagining non-existent constraints and being unable to break
free from their own mental models. As an option for extending the exercise, you can follow this discussion with a second
phase in which you ask students to form small teams and assume that they are the managers of an R&D team. What
processes, culture, or incentives might they use to facilitate higher levels of creativity in their team? This humorous video
would be a good jumping off point for such a discussion. It describes the boss who excelled at killing good ideas. AACSB
2013 Standard 9 Thinking creatively

For an exercise in critical reasoning skills, ask the students to watch an episode of Shark Tank, and then choose one of
the following assignments to prepare for class discussion:
M For one of the startups that received funding, what traits of that business made it attractive to the investor? Why?
M For one of the startups that received funding, what traits or experiences of the entrepreneur made the business
attractive to the investor? Why?
M For one of the businesses, what resources or capabilities were they looking for in the sharks, in addition to money?
Why?
M For one of the businesses that did not receive funding, what was the fatal flaw that discouraged investors? Why?
M Look at the ABC website to learn something about one of the sharks. What experience does he/she have as an
entrepreneur?

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7.3 INNOVATION AND THE INDUSTRY LIFE CYCLE

[LO 7-3 and 7-4]

Examples
Discussion of Exhibit 7.4 can be enhanced with this video, “Google’s Android Seizes Smart Phone Market” (The Wall
Street Journal, 8/12/13), which describes the growth of Android in the emerging markets.

One point we like to make when discussing the declining stage of the industry life cycle is that there is still an opportunity
for businesses in this phase. Indeed the “harvest” strategic option can prove to be very profitable for firms. It is a close
parallel to a “cash cow” from the Boston Consulting Group (BCG) portfolio matrix (discussed in Chapter 8 of the text).

To expand on the Google Glass example in the text, mention that GM and BMW are developing smart windshields for cars
that can display location based information, as well as social media updates. (See “A computer for your Car’s Windshield,”
The Wall Street Journal, 12/4/12.)

“Crossing the Chasm in Consumer Markets: A Visual Example by Geoffrey Moore” is an engaging video to illustrate the
concept of the industry life cycle and crossing the chasm.
Standards are extremely important because they represent a common set of engineering features and design choices.
Standards reduce industry uncertainty and confusion and ensure product quality, performance, and safety. As standards
become dominant, the competitive nature of an industry intensifies. Firms begin to reap economies of scale and learning,
prices begin to fall, and distribution channels are expanded. As shown in Exhibit 7.6, the basis of competition transitions
more toward process innovation (lean manufacturing, Six Sigma, and others) instead of product innovation.

Though the emergence of a dominant design fosters the development of complementary assets, firms sometimes choose not
to support certain new standards or applications. As an example, the QWERTY keyboard, named for the sequence of the
first six letters on the upper-left row, was introduced in the 1870s as a way to slow typists in order to avoid jamming the
type bars in mechanical typewriters. While generally considered an inefficient arrangement of the most frequently used
letters, the QWERTY keyboard remains the standard today, but not for lack of alternatives. In the 1930s, August Dvorak
designed and patented an alternative keyboard (DSK) intended to speed up typing by locating the most frequently used
letters in the center row. But given the sunk cost people had invested in learning the QWERTY keyboard, the DSK did not
catch on. Today, however, every personal computer comes with an optional DSK setting that requires only a minor
software modification. Even though most people have never heard about it, the DSK has a passionate core of devotees.
They were quite surprised to learn that when smartphones with virtual keyboards, like the iPhone and the BlackBerry
Storm, and the media tablet iPad, were introduced, they came only with the traditional QWERTY keyboard layout. A
software developer created an iPhone app to allow users to add the Dvorak layout. But since it is not an “approved Apple
App,” users must hack into their systems to install the unofficial program. (Caution: Such “jail breaking” voids the
iPhone’s warranty.) This example shows how hard it can be to overthrow entrenched standards, even when they are inferior
and the cost of alternative options is quite low.

Social network sites have followed a pattern similar to that illustrated in Exhibit 7.8. Friendster was unable to cross the
chasm. MySpace was successful with the early majority, but only Facebook went on to succeed with the late majority and
laggards.

Exercise
Ask student teams to draw a projected industry life cycle for self-driving cars. When they have had a few minutes to
discuss this, guide a group discussion on what uncertainties auto makers are experiencing in this area. This discussion
should lead to an identification of PESTEL factors, such as technology developments, societal attitudes, legal barriers, and
consumer behaviors that are highly uncertain. How might the firms reduce their risk? Students may suggest alliances or
staged investments. (See “Auto makers accelerate efforts to develop self-driving cars,” The Wall Street Journal, 9/10/13.)
AACSB 2013 Standard 9 Making sound decisions and exercising good judgment under uncertainty

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Strategy Highlight 7.1
“Apple Leverages Network
Effects to Propel Growth”
Most students will immediately recognize that they do indeed often value
the apps more than the actual phone features (or would if they actually had
a smartphone). Yet so often they have not thought through the implications
of this. Link back to Porter’s five forces and recall the idea of switching
costs. The access to unique apps not only can drive consumer value and
therefore volumes, but it also increases the “stickiness” of customers. If a
customer is comfortable with the Apple app store products and the
interface with iTunes to purchase and organize their apps, they are far less
likely to explore Android (from Google) or Windows 8 (from Microsoft)
even if these latter firms introduce a really attractive hardware/software
phone package or features.

End of Chapter Discussion Question 1

Select an industry and consider how the industry life cycle has affected business strategy for the firms in that
industry over time. Detail your answer based on each stage: introduction, growth, shakeout, maturity, and
decline.

Refer the students to the comprehensive overview of industry life cycles in Exhibit 7.9. The industry life cycle
significantly affects a firm’s business strategy. Strategies for each phase are discussed below:

Introduction – In this phase, a firm’s objective is to achieve market acceptance and seed future growth. Firms typically
invest heavily in R&D and some in marketing, emphasizing unique product features and performance (differentiation).
Network effects are leveraged to propel a firm to the next stage.

Growth – In this phase, a firm’s objective is to stake out a strong strategic position. This is done through a shift toward
manufacturing and marketing capabilities, with an R&D emphasis on process innovation instead of product innovation.
Some firms continue to follow a differentiation strategy, but others determine that a cost-leadership strategy is imperative.

Maturity – Growth primarily comes from the late majority and the firm’s focus should be on maintaining a strong strategic
position. Improved manufacturing and process engineering capabilities drive down the costs, which leads to intense price
competitions. Typically, either a cost-leadership or integration strategy is employed by a firm.

Decline – As the size of the market contracts, firms consider four options in this stage: exit, harvest, maintain, or
consolidate. Firms can claim market share through a cost-leadership, a differentiation, or an integration strategy.

Discussion Topics
If you want to launch a discussion of competency development plans and core rigidity over an industry life cycle, this
humorous video might be a good opener (stop it before the commercial at the end). It shows people on an escalator that has
stopped working. Their core rigidity prevents them from realizing that they can just walk up and off the escalator, so they
behave as if they were stuck. You can use this to talk about how a firm’s mental models and strengths can limit them when
markets change rapidly.

Update the information on alternatively fueled vehicle technology in Mini-Case 12 with this video “Will BMW i3 Herald
New Dawn for Electric Cars?” The Wall Street Journal 7/29/13. It discusses the problems that electric cars have had in
moving beyond the early-adopter market. It gives you the opportunity to open a discussion on what technology
improvements must be made before electric cars can cross the chasm. AACSB 2013 Standard 9 Analytical thinking (able
to analyze and frame problems)

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End of Chapter Ethical/Social Issues 1

You are a co-founder of a startup firm making electronic sensors. After a year of sales, your business is not
growing rapidly, but you have some steady customers keeping the business afloat. A major supplier has informed
you it can no longer supply your firm because it is moving to serve large customers only, and your volume does
not qualify. Though you have no current orders to support an increased commitment to this supplier, you do
have a new version of your sensor coming out that you hope will increase the purchase volume by over 75 percent
and qualify you for continued supply. This supplier is important to your plans. What do you do? AACSB 2013
Standard 9 Ethical understanding and reasoning (able to identify ethical issues and address the issues in a socially
responsible manner)

This can be a common issue for a startup firm, and students will have a variety of opinions on what the firm should do. The
co-founder could consider a cost-benefit analysis when evaluating this problem. If the firm can identify another supplier(s)
who will produce the sensors and mitigate the risk of losing the current supplier, then this should be considered an option.
Likewise, the co-founder could elect to continue with the current supplier, but just increase the purchase volume to account
for the anticipated sales. In this instance, the startup can be confident that the sensor quality is maintained. Additionally,
he/she could negotiate a new sensor price, with the current supplier assuming economies of scale will be achieved during
production. Would the startup go ahead and purchase the increased quantity even if their sales don’t justify it, thus creating
an inventory problem? Students will come up with other factors to consider, with the general theme that this is not an easy
decision to make.

7.4 TYPES OF INNOVATION

Classification [LO 7-5]

Examples
Process innovation:

The tendency is to focus on “cool” product innovations that occur in the introductory stages of an industry. However,
it’s actually the process innovations that build a sustainable competitive advantage in many cases. Groupon had a neat
product idea for daily local coupons e-mailed out to people who provided their accounts. But if Groupon is to build
lasting success, it will have to rework their processes, such as gaining new and repeat businesses to run coupons on
their platform, to make them more competitive with many firms now offering similar services.  

Accepting bank deposits made via a smartphone photo.  
Radical innovation (Ex hibit 7.10):

iPad  

iPhone  

Coffee in K-cups  

Space Shuttle  

Bluetooth connection  

Incremental innovation (Ex hibit 7.10):

The many flavors of Oreos  

Diet Decaf Cherry Coke  

Tide with bleach, fabric softener, improved stain removing power, etc.  

New sizes of Samsung Galaxy products  

“Spinner” suitcases  

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Architectural innovation (Ex hibit 7.10):

We find many students are not familiar with the older “furniture-sized” photocopy machines that were heavily
centralized in large offices and required nearly constant maintenance to keep running. This same shift in copiers can
also be seen with computer printers as well.  

The global positioning system (GPS) technology and satellite infrastructure was originally developed for military
applications. After several years in operation there, the government opened up the satellite feeds for commercial uses.
Today, running on those existing technologies, we have a variety of new and inexpensive consumer products
incorporating GPS technology.  

Tide in single-use pods.  
Disruptive innovation (Ex hibit 7.11):
M VoIP (Skype is one example) is challenging the traditional landline technology.
M Propeller airplanes to supersonic jets
M Branch-based brick-and-motor banking to online banking (and the same for stock brokerage)
M Large (tube-based) computer and TV screens to high-definition flat-panel displays
M Data storage products advanced from the floppy disk to the hard disk to the CD, then to the ZIP drive, and now to flash
drives. Each new memory device invaded the market from the bottom up and performance improved over time.
M The vinyl record player to the cassette tape to the CD, and then to digital MP3 players like the iPod
M The emergence of electric arc furnaces, for example, was a disruptive innovation that allowed so-called mini-mills like
Nucor and Chaparral to produce steel in small batches and at lower cost compared with fully integrated steel mills such
as U.S. Steel or Bethlehem Steel. Initially, though, the quality of steel produced by mini-mills was poor and could
compete only in the lowest tier of the market: steel used to reinforce construction concrete (rebar steel). Once the mini-
mills entered segment 1 of the steel market, the integrated mills could no longer be cost-competitive given their high
fixed cost; the incumbents happily ceded segment 1 of the market to the new entrants because it was a low-margin
business to begin with. However, invading segment 1 of a market creates a beachhead for a new technology, which the
new entrant uses to gain more market expertise, build economies of scale, lower costs, and further improve quality.
M Currently, in the car industry, different technologies are being put forth as potential alternatives to gasoline, including
electric, hybrid (a cross between gasoline and electric), hydrogen, biofuels, solar, steam, and even exotic alternatives
like algae. In this case, we have a swarm of disruptive technologies developing. One technology may eventually
emerge as the new paradigm, or different technologies may dominate in different regions (hydrogen fuel cells in
Germany and battery hybrids in the U.S., for example), but during the discontinuity, the winner is far from clear (see
MiniCase 12).

Exercise or Assessment
Provide students with a list of innovations and ask them to identify the type of innovation for each. One option is to connect
this exercise to the discussions from Chapter 6 by using Proctor & Gamble’s most recent innovations. If you use this
option, remind students to click on both the brand innovations tab and the business/commercial innovations tab.

End of Chapter Discussion Question 2

Describe a firm you think has been highly innovative. Which of the four types of innovation—radical,
incremental, disruptive, or architectural—did it use? Did the firm use different types over time?

When describing the chosen firm, the key principle is that the student understands the differences between the four types of
innovation. A sample company is Samsung, which has been innovative in the TV industry and has utilized several of these
innovation types. Each year, Samsung makes incremental innovation improvements to its LED TV line: improved contrast
ratios, more HDMI inputs, thinner screens, and so on. Samsung also created two new technologies in this market: a
bendable OLED screen and the 3D TV. Both of these are classified as disruptive innovations. This is just one example as
the number of innovative firms is limitless.

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A two-minute video produced by GE shows the Vscan handheld device in use.

Strategy Highlight We have found students relate best to seeing it used rather than viewing just a
7.2 “GE’s New photo of it.
Innovation Mantra:
Disrupt Yourself” End of Chapter Ethical/Social Issues 2
Given the global To what ex tent is GE ethically responsible for how—and why—the Vscan
is used? Consider ways that GE might become involved in communities in
demographic shifts, India to show the company’s concern for the underlying problems by
health care will be of improving conditions for women. What other ways might GE influence the
increasing concern in way that its equipment is used? AACSB 2013 Standard 9 Ethical
coming years. This understanding and reasoning (able to identify ethical issues and address the issues
in a socially responsible manner)
brief strategy highlight
may be useful in Abortion and gender-selection are very challenging topics to manage in a large
helping students group setting. Keeping the focus on ethical theories and more general assessments
consider how to of corporate responsibility for product use may help. Utilitarian ethical theories
would argue that the Vscan product provides the “greatest good for the greatest
provide better health
number,” Thus, GE’s decision to market this product would be viewed as ethical.
care less expensively Justice theories might argue that if some people are harmed (unborn women or men
in the decades to twenty years from now unable to find spouses), then marketing this product may be
come, but it raises a unethical, particularly if those negative effects are not evenly distributed in society.
Since GE does not control either the hospitals or the physicians, they have very
number of ethical
little opportunity to influence the way that the equipment is used. The students are
issues in strategy likely to have varying perceptions of the value of philanthropic endeavors aimed at
formulation. benefiting living women as compensation for the wrongs done to unborn women.

Students raised in countries with high levels of poverty exacerbated by high

population growth rates may have different perspectives on this problem than those
raised in developed nations where food is plentiful and health care is accessible.

Exercise
The new Vscan is self-disrupting in that it may cannibalize sales of other
ultrasound equipment and thus cause job losses in other parts of GE that make
sophisticated, large ultrasound machines. As a manager, how would you present
this issue to employees in a positive manner?

Students will highlight a variety of talking points during this exercise. Three
example points are the following: Some jobs apportioned to high-end imaging
systems can be rolled over to the Vscan division to support continued growth or to
generate new ventures in the GE Healthcare practice. The Vscan will provide
better health care at an affordable cost to the underprivileged. The Vscan will
generate significantly high revenues and profits for GE Healthcare (Vscan cost is
approximately 5 percent of the high-end ultrasound machines, but the customer
base is more than 20 times larger than the current base for the high-end
machines). This may provide other new opportunities for the GE team to move
into different growing businesses.

GE Healthcare managers can explain that a revolution in the ultrasound industry is

inevitable. By reverse-innovating, GE is identifying the future of the industry
while maintaining its competitive advantage. If GE Healthcare had become
complacent, then another company could have invented the Vscan. Given this,
many more jobs would have been in jeopardy at GE Healthcare. By innovating in-
house, employees who worked previously on the high-end ultrasound machine
can be redistributed to the Vscan division. This, combined with voluntary
separation incentive payments, will minimize the number of involuntary layoffs.

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Discussion Topic
Assume you work for a small firm that developed a better and faster operating system for netbooks than Microsoft
Windows. Why does Microsoft dominate the operating system market? What strategy might your firm use to
unseat Windows in this market?

Microsoft dominates the industry for PC operating system (OS) software with a 90 percent market share. How can this be?
Microsoft’s strategy shaped the industry structure in its favor. Its installed base of Windows operating systems on existing
computers and its long-term relationships with original equipment manufacturers (OEMs) like Dell and Lenovo create
tremendous entry barriers for newcomers. The buyer power of OEMs in turn is low, given the fact that the successful
combination of Microsoft’s Windows and Intel’s processors has produced the Wintel standard in the PC industry. Perhaps
most important, consumer switching costs are high. Once users have learned a specific software application program such
as MS Word, they are much less likely to use a product from a different vendor. Supplier power is also low, because
writing computer code has become a commodity. The threat of comparable substitutes that deliver similar or higher
performance benefits, including compatibility among different software programs, is low. Finally, Intel’s semiconductor
chips are the perfect complement to Microsoft’s operating system. Every time Microsoft releases a new operating system,
demand for Intel’s latest processor goes up, because new operating systems require more computing power. Due to the
complementary nature of their products, Microsoft’s and Intel’s alternating advances have created a virtuous cycle. The
competitive forces of the PC operating system software industry and Microsoft’s positioning in the industry combine to
make the PC-OS software industry very attractive for Microsoft. Yet, the Wintel standard is not the only competition to
consider. Linux provides a free, open-source alternative. Red Hat, a software company, has created an $800 million
business by distributing and servicing customized Linux versions for many major corporations. In addition, cloud
computing—the move to distributed computing over the Internet—is also gaining momentum. All these forces threaten the
dominance of the Wintel standard in certain segments of the industry and thus undermine the value of Microsoft’s
dominance in the PC-OS software industry.

Students may come up with a variety of strategies to unseat Windows; however, this new operating system is a disruptive
technology and should be introduced through a bottom-up approach. For example, the small firm might introduce the
operating system as a low-cost solution (possibly even free) in order to penetrate the low-end segment. As the small firm
gains market share, it can then begin to acquire more market expertise and further improve quality. For instance, the small
firm can utilize network effects (partner with software developers to create exclusive content for the new OS) in order to
cross into the additional market segments. As this is done, the incumbent technology—Microsoft Windows—will begin to
experience enhanced industry competition. Why are standards important in many industries? As standards get adapted and
become dominant, how does this process influence the competitive nature of the industry?

7.4 TYPES OF INNOVATION

The Internet as Disruptive Force: The Long Tail [LO 7-6]

Examples
McKinsey Quarterly has published a video interview with inventor, futurist, and author Ray Kurzweil, which is embedded
at the bottom. The video is in four sections, but if you choose to play all of them, it runs 13 minutes. Mr. Kurzweil proposes
that the growth of technologies is transforming industries and creating challenges for society.

Chris Anderson, author and editor of Wired explains the “long tail” theory (illustrated in Exhibit 7.12) with examples from
the music and film industries in a 9-minute video.

End of Chapter Small-Group Exercise 1

What are the key issues you must grapple with to improve the position of Warner Music Group? Students will have
a variety of answers to this question. It is difficult to prevent the piracy of music, especially in this digital age. Thus, WMG
should determine a strategy which capitalizes upon this growing digital trend. WMG can partner (or buy out) with several
netlabels and online music stores (iTunes) to claim some of the lost revenue from piracy. Additionally, to further improve
their position, WMG should look to draft deals with artists that give the Label additional control and potential for revenue
from tours, merchandising, and endorsements.

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In what phase of the life cycle is the record-label industry? The record-label industry is in the decline stage. The
increase in file sharing and drop in music sales have required record labels to reconsider their strategies.

How does this life-cycle phase affect the types of innovation that should be considered to help WMG be
successful? The decline stage of the life cycle suggests four strategic options: exit, harvest, maintain, or consolidate. None
of these strategies recommend a firm should invest heavily in future innovation. However, to extend the long tail the
record-label industry could identify a disruptive innovation which will aid in the collection of revenue from legitimate and
illegitimate music sales.

7.4 TYPES OF INNOVATION

Open Innovation [LO 7-7]

Discussion Topics
Microsoft’s innovation processes are very different from those of Google or Apple. Incremental innovations predominate at
Microsoft (see “Next CEO’s biggest job: Fixing Microsoft’s culture,” The Wall Street Journal, 8/25/13). How might the
new CEO of Microsoft use open innovation processes to engage users in the innovation of new and existing products?
What other ideas might work? One example is the CEO of the Extended Stay America hotel chain, who gives out “Get Out
of Jail Free” cards to his employees to use when they take a risk on behalf of the company (see “Memo to staff: Take more
risks,” The Wall Street Journal, 3/20/13). AACSB 2013 Standard 9 Leading in organizational situations

Discuss how Exhibit 7.13 works in the context of P&G’s Open Innovation model using ChapterCase 6. If you used the
exercise in the earlier “Types of Innovation: Classification” section on Procter and Gamble, ask students to compare the
innovations developed in the Connect + Develop open innovation process with those developed in the closed system. I
thought that the Tide Dry Cleaners and laundry detergent pods developed through Connect + Develop were some of P&G’s
more radical innovations among the list shown in late 2013.

7.5 IMPLICATIONS FOR THE STRATEGIST

Discussion Topics
The video game industry offers the opportunity for a discussion of the practical implications of several of the concepts in
this chapter. Freemium business model games have been a disruptive force that is rapidly depleting the market for game
consoles. The long tail facilitated by Internet distribution has facilitated this decline. One destructive wave was driven by
social games that reached customers through Facebook, such as Zynga. Recently, those games have been negatively
impacted by games originally designed for mobile device use and distributed through Apple and Google app stores. It is
also a market in which Asian and Western markets have required different criteria for success. It is also an industry in
which strategic entrepreneurs have risen to success almost overnight. Students will be very familiar with this industry, and
the pace of evolution has been so rapid that they can probably recall several generations of disruptive innovation. Consider
the case of Supercell (see “Zero to $3 billion in 3 years,” The Wall Street Journal, 10/16/13) as a basis for identifying the
opportunity that the app stores offer to enable firms to rise from nothing to multibillion dollar valuations. The contrast with
Zynga provides an example of the low durability of competitive advantage in industries that are so easy to enter.
Microsoft’s and Sony’s recent moves to build alliances with freemium business model games illustrates one method that
firms in the disrupted industry can use to survive and learn from the disruption (see “A truce in the video game war,” The
Wall Street Journal, 10/15/13).

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STRATEGY TERM Term Project Module 7

PROJECT Where is your firm’s industry on the life cycle as shown in Ex hibit 7.4?
What are the strategic implications?

The firm’s industry has already been well documented, especially in module 3.
This question can be largely answered by using previous research and careful
study of the relevant sections of this chapter.

What is the firm’s innovation strategy? Does it rely on incremental or

radical innovations? Disruptive or architectural? What are the competitive
implications of the firm’s innovation strategies?

This may be an opportunity for the student to apply the productivity frontier
model from Chapter 6. Ask them to consider how close the firm has been to the
frontier over the past few years. What product or process innovations have
enabled them to achieve that performance?

Are intellectual property rights important for your firm? Can you find
what strategies the firm is implementing to protect its proprietary position?
Identify a recent innovation by your firm. What is your firm’s strategy to
cross the chasm(s) to achieve mass market adoption of their innovation?

Intellectual property and other ways of protecting your firm’s current position can
be helpful in staving off hyper-competition and disruptive forces if the value your
firm produces for its customers is not superseded by some new innovation.

What attributes describe the current major customer segment for your firm?
Are these changing? If so, is your firm prepared to meet these new customer
demands?

The point of reviewing customer segments here is to think through what a

“bottom up” disruption in the industry might look like. This can be an area where
students demonstrate some creativity. Ask them to reflect on how other industries
may influence theirs or discuss events that are happening in other industries that
could spur changes in theirs with some creative business models. What will be the
role for custom-designed clothes or cars, for example, that are realistically
becoming available in areas where mass production has been the standard for
decades. Students should also be considering how the firm is monitoring and
developing absorptive capacity in emerging technologies.

How does your firm organize for innovation? Does it use a closed or an
open innovation approach? Is its current approach working out well, or
does it need changing? If yes, how?

Encourage the students to go beyond the issue of open vs. closed innovation.
What can they learn about the firm’s new product pipeline. For a U.S. firm,
innovation performance can be roughly measured with a count of new patents
over recent years. Has the innovation productivity been rising or falling? How has
the firm performed on this measure vs. rivals? Does the firm have a practice, like
Google or 3M, of allowing employees some free time to work on projects of their
choice?

Where does the firm do its research? In a separate lab made to develop a separate
creative culture, or is it integrated with manufacturing and engineering? A lab
located in a knowledge cluster or near headquarters? At several locations around
the globe (close to customers), or only in the company headquarters?

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m y STRATEGY Do You Want to Be an Entrepreneur?

Why do you think recessions are a good time to start a business? Wouldn’t
that seem counterintuitive?
How to position yourself
for career advantage The text covers some of these areas, but availability of great human capital is high
when jobs are scarce. Also, with recent low interest rates, investors may be more
willing to accept the risks of investing in startups since other avenues are
producing very small returns.

Thinking about today’s business climate, would you say that now is a good
time to start a business? Why or why not?

Interest rates, real estate leases, and an abundance of qualified applicants for many
jobs are all favorable factors. Reduced bank lending for small businesses is a
negative.

If you were to start a business, what type of business would you want to
start, and why? What idea or invention would you be commercializing?

Students will have a variety of answers. Encourage them to think through this one
and only consider starting a business if they are really passionate about it.

Does it matter where (in terms of geography) you start your business? Why
or why not?

A location near key suppliers or customers needs to be considered. Also, varying

regulator environments can play a role in some locations being better than others
in some industries.

Ex plain how you would apply the strategic management framework to

enhance your startup’s chances to gain and sustain a competitive
advantage. AACSB 2013 Standard 9 Reflective thinking (able to understand
oneself in the context of society)

Students will have a variety of answers. Ask them to consider the role of
innovation, the industry life cycle, and whether the industry is hyper-competitive
in order to frame an answer to this question.

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