The Innovation Lifecycle

Bio-X Title slide

The Innovation Lifecycle

A Disruptive Innovation Thought Exercise

1 2014 John Boddie

Disclaimers

This presentation involves several premises used in the context of

Disruptive Innovation

This deck reflects my own take on Disruptive Innovation

Most of the useful work in Disruptive Innovation is done by Innosight LLC. I

am not a part of Innosight, LLC.

The ideas in this deck center on consumer goods and services and may

not be relevant to commodities et al

The presentation is very general. One can find counterexamples to every

statement made. No investment advice intended except, perhaps, “be

careful and do your homework.”

2 2014 John Boddie

Low End Disruption

A common form of disruptive innovation

Here, a product or service marches upmarket over time by

peeling successive layers of “low value” customers [i.e..

customers that will not pay top dollar for fully featured goods]

away from sector leaders in a given market.

This new product or service offers a differently-featured

substitute with new value proposition that is appealing to these

disaffected customers

3 2014 John Boddie

The concept was developed at Harvard

Business School

Prof. Clayton Christensen developed these theories in the 1990’s

Photo Taken from onpoint.wbur.org

4 2014 John Boddie

Disruptive theory stemmed from a

management question

Prof. Christensen looked at innovative companies with

great technology, capable staff and strong mangers, and

noticed that these companies were losing market share

despite doing everything right.

5 2014 John Boddie

What do we mean by “Doing everything right?”

Identify your

best customers

Improve

operational

efficiency

Develop higher

margin

products

Drop

underperforming

parts of your

portfolio

By taking all of the steps required to become a world class company…

You narrow the range of customers whose needs you can address

…and lose the ability to respond to new market entrants

6 2014 John Boddie

Let’s look at a hypothetical example

7 2014 John Boddie

Suppose that your firm has developed a new

good that serves a new and interesting market

The Butterfly Labs Bitcoin Miner

Runs a decryption algorithm in

order to “mine” bitcoins

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The big break has finally happened and your

product is attracting notice

… You are now one of a few leading players in

the market. You see regular (if small) profits

and sheer survival is less of a struggle.

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… lessons learned during the struggle to

develop a profitable product drive all four of

you to compete over similar features

Hashing speed

Plug and play

High security

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… going forward, you (and your competitors) try

to grow sales volume through similar channels

… these channels give each of you great data on

very similar customers, improving your forecasts

while driving common customer segmentations

11 2014 John Boddie

Obtaining data from similar channels, the

major players in your space begin to cluster

consumers in similar ways

Currency Mining

90%

Secure comm 8%

Gold Farming in MMORPGS

2%

Home Hardware

25%

Cloud Based 12%

Hosted Hardware

34%

USB Stick 9%

Over 1TH 1%

250 to 500 GH 80%

1GH to 250GH 17%

below1GH 2%

You need to grow quickly to carve out lasting

positions in these rich markets

12 2014 John Boddie

Investors love your projection-friendly

market cycle

We have 35% of this market

We expect 20% sector growth this year and we are releasing 3 new products that should capture an additional 10% of the sector…

…so, given our margins, investors

should see 5% to 6% profit growth over the

last quarter

In order to gain more money for expansion,

you grow your investor pool

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Over time, your market saturates and it

becomes more expensive to reach new

customers

14 2014 John Boddie

But you’ve been able to entice your core

customers with improved products, allowing

you to maintain profitability…

Faster

Can be run in parallel

Cloud management software

You remain innovative but you’ve

started to focus on improvements

rather than new product lines

15 2014 John Boddie

Pricing for new features begins to flatten out

quickly while old features are commoditized

At some point a competitor will start invading

your customer base by driving down prices.

2010 2012 2020 2025

250 to 500

GH/Second

Hosting

services

Exclusive

mining

pools

Solve for all 10

established

currencies

Manage

Derivatives Banking services

USD 4,000 USD 1,000 USD 500 USD 200-400

Adapted from http://www.marketingtechblog.com/history-mobile-phone-cost/

250 to 500 TH/

second and low

power

16 2014 John Boddie

Sales peak in accepted consumer segments, making

it even harder to find “new growth” customers

At the same time…

Cryptocurrency mining

service subscriptions

per 1000 people

2014-2023

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

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Despite these challenges, investors expect

consistent quarterly earnings forecasts

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It starts to look tough when things were finally

supposed to become easy

You start to worry

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You start to look for growth within the existing

market rather than outside

I need to take customers

from the competition

I need to lower prices

Lower production costs!

Enter large volume contracts

at better prices with bigger

supply chain partners

Remove low margin products

and standardize components Create internal cost savings

initiatives for production

managers

20 2014 John Boddie

You might improve profitability by reducing

overhead costs

I need to reduce my

overhead costs

Combine jobs and reduce

headcount. Focus on

terminating underperformers

Set higher productivity metrics

for my departments and

pressure managers to succeed

Let’s identify pipeline products that

really help the bottom line and shelve

those that don’t promise good returns

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Sales and distribution may also contribute

I should focus on developing

better deals with my top 5

distribution and sales

partners…..

Who is the best at selling my

high-margin goods?

Who has the best

geographic reach?

Who is offering the

best customer

incentive programs?

Who will help me I reduce

my service costs?

Who offers the best data?

22 2014 John Boddie

Whew! After some struggle, you’re able to confidently

project quarter-to-quarter earnings growth

You are able to meet your targets

You have some great core product variations in your

pipeline… you are innovative

You might be able to do this for years

But there is a small, low end company on the horizon

23 2014 John Boddie

A (Hypothetical) large-scale,

distributed computing approach to

cryptocurrency mining. Uses mobile

phone processors. No separate

hardware component. Users get

fractions of mined currency.

24 2014 John Boddie

At first...

Hey, have

any of you

heard about

bitcrowd?

Nope, too busy

engineering this

new processor

Yeah, but I

wouldn’t take

distributed

computing too

seriously. You can’t

do much with it. I’ll ask our

marketing

partners

Software, not

hardware. Not

my problem.

25 2014 John Boddie

Then...

Hey,

bitcrowd has

over 1 m

users

We don’t know

mobile phones.

You’d need to

give us $$ for a

new team.

We are making a

ton of money from

our new services

software. I can’t

afford to lose focus

Yeah, but that 1m

would never be

our customers

anyway

I’m going all out here.

I’d need a command

from the top to shift

resources

26 2014 John Boddie

Eventually...

We really

need to kill

bitcrowd..

We have specs from

software. We can do the

chips and get them into

production in the next year

Our software team has put

together something similar

called Bitsource. Given

Bitcrowd’s apparent

market we should make a

kajillion dollars.

I will press our

channel partners

to push it once it is

ready to go

We have a mobile

phone partner who

may be willing to install

the chips

27 2014 John Boddie

Finally...

I told our

investors

that we’d win

this. What

happened?

We needed to spend extra time

debugging our next gen platform.

We lowered our projections for the

mobile phone chip volumes

anyway so this was the correct

approach.

The software was good but

marketing couldn’t design

a user friendly interface

that attracted customers

Don’t blame us. It

tested well with our

current customers. Our

channel partners hate

it anyway.

I couldn’t get them to

prioritize production of

the new mobile

phones

28 2014 John Boddie

Enter large volume contracts

at better prices with bigger

supply chain partners


and standardize components

Create internal cost savings


managers

The company sets a new, higher bar for product

margins, making it more difficult to experiment

with products that don’t project great returns

It becomes harder to set up small product test

runs and large scale suppliers may be less able

to help with custom work.

Managers may respond by pressuring staff

members to focus solely on products that

support the current bottom line. There will be

less time for experimentation.

It seems that the drive to grow within a mature

market often comes with a cost

29 2014 John Boddie


headcount. Focus on





Identify pipeline products that

really help the bottom line and

shelve those that don’t promise

good returns

Average workloads rise and employees have

less time to experiment with new ideas.

Employees that do try new things need to create

outsized justifications for side work, setting

impossible benchmarks for side projects.

This favors products with the best, most airtight

market data (i.e., those in existing markets).

Managers inflate returns beyond all reason in

order to preserve projects, raising the risk that

they will be killed prematurely.

Managers will resist any new initiatives that

might risk their KPI’s; understanding that it is

safer to promote similar products using known

suppliers through proven sales and distribution

channels.

30 2014 John Boddie

Who is the best at selling my

high-margin goods?

Who has the best

geographic reach?

Who is offering the

best customer

incentive programs?

Who will help me I reduce

my service costs?

Who offers the best data?

These partners may be far less willing to sell a

mix of goods or experiment with lower-margin

goods

These partners may offer great prices and

incentives but may make aftermarket service

problematic, alienating customers that were best

served by older (essentially de-featured) product

models.

Even if you get the best, most airtight data for

existing products, this data is often only useful

for similar/ next square products. The quality of

the data, however, may increase the perceived

risk of the unknown.

31 2014 John Boddie

To Summarize So Far…

After a period of often desperate competition, a few small

companies will finally figure out how to profitably bring a new

good or service to a new customer base, opening a new market

These few companies will grow rapidly, often pursuing customers

through similar channels. Data from these channels drives

common, highly-trusted, customer segmentations

Companies grow their investor base in order to expand their

reach. Investors love the steady sales growth and the profits

Eventually the market will mature. New growth will slow and

pricing will flatten, leading companies to compete for an

increased share of existing customers

This struggle to preserve profit growth within a mature market will

drive increased focus on efficiency, reducing the flexibility and

responsiveness required for out of category competition

These companies

become more

vulnerable to disruption

32 2014 John Boddie

Companies remain innovative, but much of

this innovation focuses on variations

around a core product line

Time

Total

Sales

Volume

33 2014 John Boddie

Many of the improvements boil down to

better data, better margins, better efficiency

The need for

better market

projections

Favors well

defined markets

And makes it

hard to see

emerging

customer

segments

Competition for

existing

customers

Drives a focus on

value

Forcing

companies to

preserve profits

by reducing

internal costs

Profitability

pressures raise

new product risks

Favoring batter

market projects

and lower costs

Leading

companies to

double down on

existing product

lines

34 2014 John Boddie

This cycle feels inescapable, a bit like the

product lifecycle

Development Growth Maturity Decline

Time

Sales

Volume

Levitt’s Product

Lifecycle

35 2014 John Boddie

It is worth thinking about an innovation

lifecycle that leads a product lifecycle

Development Targeted

Innovation

In-Category

Innovation

Stagnation

Time

Resources

allocated to

innovation

work that can

impact the

trajectory of a

firm

Low

High

36 2014 John Boddie

Companies are often highly innovative when

developing new products for new markets

Development

Time

• Innovation work speeds up after the

company is able to get money

• Actively searching for customers

• Profitability is enough- willing to live with

low margins

• Products are refined continually in order

to find the best possible customer fit

• The company is small so it behaves like

one big team with constant

communication

37 2014 John Boddie

They can do their best work once a direction

is established

Targeted

Innovation

Time

• The company knows it’s customers and

how to reach them

• Innovations are increasingly focused on

performance breakthroughs that make life

easier for these customers

• The company is larger and decisions are

more formalized. This often free

engineers and market testers to do their

best work

38 2014 John Boddie

Eventually the desire for low risk, profitable

goods and services drives a company to

focus on “variations on a theme”

In-Category

Innovation

Time

• Market projections are

overweighted, favoring

existing customer data

• The company is big and

investors expect returns

• It becomes safer to release

differentiated core products

than to investigate

fundamentally new product

lines

• Engineers adopt in-

category tech

breakthroughs quickly

39 2014 John Boddie

Eventually the company focuses on cutting

costs while struggling to respond to new

market pressures

Stagnation

Time

• Sales volumes and profits begin to drop

• Underserved customers and finding substitute

goods that offer a better fit

• Innovation increasingly focuses on cost

reductions

40 2014 John Boddie

Companies can remain profitable even while losing

the ability to drive non-core innovations

Are there any metrics to suggest that a company is

on the far side of the innovation lifecycle?

41 2014 John Boddie

What have we surmised so far?

Common customer

segmentations

This is a bit tricky to quantify. For consumer goods, check to see whether

Amazon et al have distich product categories. For more opaque items,

check industry surveys.

A Mature Market

Again, this requires a bit of judgment. Is the majority of the market held by

a handful of major competitors?, Are each of the competitors making

similar breakthroughs and offering similar new features on their flagship

products? Does pricing seem to flatten out? Is geographic growth

slowing?

A drive toward

efficiency to

preserve profits

Revenue per employee may rise as headcounts are trimmed and

efficiency drives are launched. Similarly, the operating margins should

rise.

Erstwhile happy

investors Stock prices should remain steady or rise.

Price pressure/

Rapid

Commoditization

Internally, companies may try to standardize new product features as

quickly as possible, making the COGS appear to spike with each product

release and then fall. Similarly, Gross Profit margins may spike then fall.

42 2014 John Boddie

A warning and a reminder

This presentation talks about conditions that may leave companies within a sector

open for disruption. This does not mean that these companies will invariably be

disrupted

These are only theories, drawn from common observations about problems that

face companies in mature markets. As we will see on the next pages, associated

key financial measurements are problematic at best.

Every company deals with challenges using its own mix of approaches. In larger

companies, weakness in a product line may be entirely hidden.

Even if metrics are refined and a more exacting approach evolves, guidance will

never reach beyond “it’s time to pay attention to small, emerging companies in a

space.” Anyone who buys or sells stock or options based solely on the listed metrics

is an idiot

43 2014 John Boddie


and standardize components

Create internal cost savings


managers

Operating Margins Rise

Sample Troublesome Data


headcount. Focus on


Revenue per

employee rises




Some potential problems:

1) Data prior to 1995 can be

difficult to obtain.

2) It may be difficult to separate a

natural growth in revenue per

employee (the result of common

technological advances) from

revenue growth driven by cost

cutting measures.

3) Large companies have a

variety of products across several

divisions. Data within a particular

product division is normally

unavailable. It may be hard to

detect changes within a particular

product division at a large

company.

4) Mature markets often undergo

a round of M&A, making it more

difficult to track individual

company performance

44 2014 John Boddie

Example: Mahindra enters the US tractor

market in 1994 and is 4th largest mfr. by 2005

John Deere 6900- 6 cyl, 130 hp, 264 cm wheelbase, 5391 kg, 250 L fuel tank

Mahindra 575- 4 cyl, 45 hp, 194 cm wheelbase, 1876 kg, 35 L fuel tank.

Ford 7810- 6 cyl, 90 hp, 81 L fuel tank

New Holland 9880- 6 cyl, 400 hp

In 1994, Mahindra

launched M&M USA with

a 45HP consumer grade

tractor.

We are interested in the

tractor market between

1990 and 1998 or so,

when companies finally

began responding to

pressure in the consumer

segment.

45 2014 John Boddie

Let’s look at the tractor market in the

US in the 1990s

Was the majority of the market held by a

handful of major competitors in 1990 to

1995?

Were each of the competitors making similar

breakthroughs and approaching similar

customers with similar new features?

Did pricing seem to flatten out?

Was geographic growth slowing?

Highly fragmented (150 companies) but

fewer than 10 owned 80% of the market

Most of the market targeted big farms,

innovations focused on horsepower, cab

comfort, electronics

Old features were quickly commoditized.

Companies seemed to price in similar

horsepower bands

Strong round of M&A in India, China etc.

in the 1990’s, suggesting maturing

overseas markets

46 2014 John Boddie

High

Pow

er Tractor

Segmen

t

Consumer Tractor Segment

Competitors focused on in-category

innovation while losing consumer market

share

HP

Mahindra vs John Deere new product

launches by horsepower 1992-1998

47 2014 John Boddie

In 2004, John Deere overhauled their marketing

department in order to fight for the consumer sector

John Deere’s

marketing

director

identified 3

interesting

problems

They were developing products and then trying to

find consumers

They were basing market research on current

customers rather than potential customers

They were hiring too many people internally, failing

to diversify their talent base

[1] marketingsherpa.com. Jan 19th 2004 How John Deere Increased Mass Consumer Market Share by Revamping its Market Research Tactics

[1]

48 2014 John Boddie

AGCO (purchased Massey Ferguson in 1995),

and John Deere COGS and Gross Profit

Margins* 1992 to 1999

*charts generated by Ycharts, Data unavailable for Harvester, Case,

Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford.

Gross Profit Margins

and COGS were

cyclic, suggesting

price pressure and

commoditization of

new tractor features.

49 2014 John Boddie

AGCO and John Deere Rev/Employee and

Operating Margins 1992 to 1999

Revenue per employee

rises for Deere but

remains flat for ACGO.

Operating margins seem

cyclic, within a rough 7%

variation

50 2014 John Boddie

AGCO and John Deere Stock

prices 1992 to 1999

Investors seem happy with Deere and AGCO until 2H 1998

51 2014 John Boddie

So, was it helpful?

The Good

The Bad

John Deere showed the cyclic COGS and Gross Profit margins that

we’d expect in a mature market where new products are rapidly

commoditized. They also showed rising revenue per employee, which

suggests that operations were being streamlined and becoming more

efficient. Last, investors, as is their wont, seemed to love both Deere

and AGCO until 1998, when they suddenly pulled away.

The case is much less clear with AGCO. COGS seems cyclic but

muted while gross profit margins seem to hover around 20%. Revenue

per employee falls after 1995 while operating margins for both Deere

and AGCO seem to hover between 8% and 15%

Conclusion COGS and Revenue per employee seem to be modestly promising

indicators. Operating margins and gross margins seem to be less useful

52 2014 John Boddie

Example: The mobile phone market looks

mature

There are only a handful of major competitors?

Are each of the competitors making similar

breakthroughs and offering similar new features

on their flagship products?

Does pricing seem to flatten out?

Is geographic growth slowing?

AAPL, SSNLF, Motorola

(Stock info for HTC, LG

unavailable)

4G LTE, better screens, more

memory, faster processors

Old features are quickly

commoditized. Companies

seem to price in similar bands

Penetration is slowing in most

countries though many

consumers are purchasing

better and better phones

53 2014 John Boddie

AAPL, SNSFL, SNE, MSI: COGS and Gross

Profit Margins June 2007 to present

*charts generated by Ycharts, Data unavailable for Harvester, Case,

Moline, Oliver, Allis Chambers. Tractor breakout unavailable for Ford.

Gross Profit Margins

and COGS are cyclic,

suggesting price

pressure and

commoditization of

new mobile phone

features.

54 2014 John Boddie

AAPL, SNSFL, SNE, MSI: Rev/Employee and

Operating Margins June 2007 to Present

Revenue per employee

has risen annually for

Apple and Samsung but

has remained steady for

Sony and Motorola

At the same time,

operating margins have

shown a slight climb for

Apple, Samsung and

Motorola over the last

two years while

remaining steady for

Sony

55 2014 John Boddie

AAPL, SNSFL, SNE, MSI: Stock Price

June 27 to present

Apple and Samsung electronics have both

done very well, while Sony and Motorola

have remained relatively flat

56 2014 John Boddie

So, is this useful

The Good

The Bad

AAPL, MSI and SSNLF data seems to suggest that the phone market

has matured and that new features are being commoditized. All three

have also become slightly more efficient since 2011, suggesting that

they may be losing some flexibility.

Three of the four companies are very large, with multiple product lines.

It is difficult to attribute any change in key data to maturation of the

mobile handset market.

Conclusion

Again, it seems as if companies in mobile handsets are facing

commoditization pressure. It is hard to tell whether they are trying to

support profits by becoming more efficient. They may do this in 2014

given the apparent downside risk of a missed profit forecast.

57 2014 John Boddie

Next steps

More research. Additional key metrics should be tested on markets

where disruptive product trajectories have injured one or more major

players.

Better data. Baseline growth in revenue per employee should be

separated out. It is worth looking at data within a particular division or

product line (if possible).

Test the idea of a bellwether company. It appears that Deere and

Apple may rely enough on their core product categories (tractors and

phones) to act as effective signals that a market is suitably mature and

that company (or divisions) within a market may not be able to address

disruptive entrants.

Move beyond disruption. By characterizing the innovation cycle and

winnowing out the nest associated metrics, it may be possible to give

companies the tools needed to explain forays into new markets and lower-

margin products despite enjoying record profits from established customers.