by Constantinos C. Markides and Paul A. Geroski, Jossey-Bass, 2004.
Pioneering companies who have created markets through radical innovation are almost never the companies that scale these markets up into mass markets and conquer them. The competencies, culture, structure and processes required for creating a radically new market not only differ from those needed to grow and consolidate the market but also conflict with one another. Firms that are good at creation ("colonising" the market) are unlikely to be good at scaling up ("consolidating" the market). Rather than attempting to become colonists, big, established firms should focus on what they have the competencies for – consolidating new markets. They should follow a "fast-second" strategy, i.e. wait until the "dominant design" is about to emerge and then move in to help create it.
(Reviewed by Kevin Barham in December 2005)
(These book reviews aim to represent some of the key aspects of what the author has written. They do not necessarily represent the views of the reviewer or of Ashridge. Equally the author of the book reviewed must not be held responsible for any misperceptions of the reviewer.)
This book challenges the conventional wisdom that every firm's competitive advantage depends on building breakthrough, innovative capability. Its message is that conquering new markets is not about creating them, but about clever timing and a smart strategy for scaling up.
We are often told that first movers have the edge. But Constantinos Markides and Paul Geroski show that the pioneering firms who create markets through radical innovation are almost never the companies that scale these markets up and conquer them. Markides is a professor of strategic management at London Business school, and Geroski, a former economics professor at LBS, is chairman of the UK Competition Commission. They believe that the skills, mindsets and attitudes required for creating a radically new market not only differ from those needed to grow and consolidate the market but also conflict with one another. Firms that are good at creation are unlikely to be good at scaling up. Most established companies would do better if they follow the "fast-second strategy". The companies that conquer radically new markets do so by "racing to be second".
If you thought it was Amazon.com that brought us online bookselling you would be wrong, say the authors. The idea for online bookselling came from Charles Stack, an Ohio-based bookseller in 1991. Amazon didn't enter the market until 1995. Likewise, it was not Charles Schwab who invented online brokerage services. It was Netvestor who launched the first Internet stock trading service in 1995. Schwab did not launch its Web trading service until 1996.
These are examples of the author's central argument: that the individuals or companies who create radically new markets are not necessarily the ones that scale them up into big mass markets. There are plenty of other examples: Ford did not invent the car, Procter & Gamble did not create the market for disposable diapers and General Electric did not create the CAT scanner market – although it was these firms that exploited these markets. When it comes to radically new markets, the pioneers almost always lose out to the latecomers.
Radical innovations are the ones that give rise to "new-to-the-world" markets. They are radical if they meet two conditions:
Most big companies cannot create radical new markets; nor should they want to. Creating radically new markets is not where the real money is. Real value comes from consolidating newly created markets, not discovering them. Nor do you have to be the discoverer of a new market to be able to consolidate it.
Colonisation and consolidation are essentially different activities undertaken by different firms. First, the innovation process that creates radically new markets cannot be easily replicated inside the modern large corporation. Radical innovations that give rise to entirely new markets are rarely driven by demand or customer needs. Rather, they are pushed onto the market by scientists working on independent projects. They are developed in a haphazard way without a clear customer need driving them, often through the efforts of a large number of scientists working on seemingly unrelated projects who sometimes devise the technology for their own uses. They go through a long gestation period when nothing seems to happen but then suddenly explode onto the market. This is not a process that can be replicated inside big firms' R&D facilities.
Secondly, big companies do not have the skills or mindsets for radically new markets because the skills and mindsets they possess – and which they need for competing in their mature businesses - conflict with those they would need for creation.
Successful innovation is a coupling process that links two distinct activities:
The skills, mindsets and competencies needed for discovery and colonisation are not only different from those needed for consolidation and commercialisation, they also conflict with them. Firms that are good at invention are unlikely to be good at commercialisation and vice versa. Firms need to focus on what they do best.
Radical innovations that create new-to-the-world markets have a disruptive effect on both consumers and producers. They create radically new markets, demand new customer behaviours, and present major challenges to existing competitors. As a result, these kinds of innovations are rarely driven by demand or immediate customer needs. Instead, they result from a supply-push process that originates from those responsible for developing the new technologies. The new-to-the-world products that emerge out of these technologies are generally not well adapted to users' needs. This creates many opportunities for entrepreneurs to offer different adaptations or applications of the new technology to the market.
Such innovations typically lack champions either in the form of lead customers or of existing market leaders. They are developed in a haphazard way without a clear customer need driving them. They go through a long gestation period when nothing seems to happen when they suddenly explode onto the market. This is not a process that can be imported or replicated in the R&D facilities of a single firm.
Since the ultimate consumers of the new products or services that embody a new radical technology typically have very little knowledge of what the products have to offer them, the race to bring the results of the new technology to market is wide open. No one knows exactly what the new technologies can do or how to produce the results of the innovation economically. This results in a massive wave of entrepreneurs entering the market with many different product variants.
Supply-push innovations emerge in a confused and disorganised fashion. As the product does not meet an immediate well-articulated need, it will be a long time before consumers adopt it and take-up rates will be slow. Also, since it is impossible to be sure exactly what the right design of a new product should be, the market can be expected to fill up with a wide range of product variants introduced by entrepreneurs guessing about consumer wants. And since consumer preferences evolve with experience, there will be as much post-innovation product development as before its introduction. Plenty of opportunities will therefore exist for a second mover to come in and win a place in the market.
Supply-push innovations create niches. To grow and develop, a niche needs to attract a wide range of users. For this to happen, the new product must appear relatively-risk-free for potential consumers, prices must fall, and someone must provide the wide range of complementary goods that users need. The new product must become established in consumers' minds through a process of "legitimation".
Most innovations that have the potential to become radical never reach that potential and remain as niches in other markets or simply fail. A few of those niches, however, suddenly begin to grow rapidly and ultimately form a mass market of their own, displacing the previously well-established markets they grew out of.
Even when it is clear that demand for a new innovation exists and that it will be the basis of a large and profitable market, it may still be unclear how best to design and manufacture it. Learning by doing is the way forward – innovators must try out their idea and see if it flies. Newly created markets will therefore be invaded by a tidal wave of new entrants and product variety will surge to amazingly high levels. Entrants seem to be involved in a desperate race to get ahead. The Internet bubble is a recent example.
Most markets cannot sustain the huge number of firms that enter early or the wide range of product variants. As a result, there is often a shakeout, both among different product variants and the firms that supply them. A "dominant design" emerges in the market signalling the beginning of growth in the industry. The dominant design is a well-defined product, a product standard that comes to define and shape the market. It creates the ground on which the market subsequently evolves. The Model T Ford and Microsoft Windows are classic examples here.
The dominant design is an example of "network effects" – situations where everyone benefits if they make the same choice – possibly because the consumer base becomes large enough to stimulate the production of complementary goods or it stimulates producers to take advantage of economies of scale or learning curves.
In the short run, the emergence of a dominant design lays the groundwork for the rapid expansion of the market, bringing a number of different types of consumers who together make up the mass market. In the longer run, the dominant design shapes the nature of the competition that shapes its future evolution.
The emergence of a dominant design helps producers of complementary goods design products that "fit". And because a dominant design is basically a standard, it is possible to take advantage of economies of scale in production and to travel down learning curves. It opens up the possibility of massive cost savings in production which in turn means that prices are likely to fall.
The dominant design triggers a severe consolidation in the market as the firms who bet on the winning design survive and the others die. The consolidators who win are rarely the first into the new market. The things that consolidators do – standardising the product, cutting prices, scaling up production, etc – are the things that create real first-mover advantages. Consolidators are the real first movers – they are the first to the market that counts, i.e. the mass market.
A dominant design emerges through a bandwagon process:
Firms that come up with the winning design are well placed to take control of the market. They can, for example, travel down learning curves rapidly and exploit economies of scale that open up large cost advantages over late-entering rivals. A dominant design will therefore trigger a major consolidation wave. Only so many firms can operate in a market when economies of scale are large. Against a first mover who is able to establish proprietary control over its design or seize control of key inputs, few rivals will survive. The result is that the structure of the market will be a small number of large firms competing among themselves and against a larger number of small players operating in new market niches.
The emergence of a dominant design makes it easier and more attractive for new consumers to enter the market. It is the event that transforms the niche market into a large mass market.
The skills, mindsets and structures needed for discovery and colonisation are fundamentally different from those needed for consolidation and commercialisation. Not only are the skills different, they conflict with each other. Firms that are good at colonisation are unlikely to be good at consolidation. Big, established firms have the skills and mindsets to be good consolidators but are unlikely to be good at creating new markets.
Colonisers. New markets are turbulent and fluid so effective colonisers need the ability to compete in unstructured and ever-changing environments. They are enthusiasts who are willing to bet on speculative projects that go beyond the frontier of current knowledge. They need to have skills rooted in a deep knowledge of the basic science and technology and to be flexible and adaptable to respond to new developments. They do not need marketing skills as they often only need to attract the attention of a few lead users. They do not need sophisticated production skills or large, complex systems. They do require a culture that promotes experimentation and risk-taking. This needs a loose and decentralised structure with limited hierarchy, flexible planning systems, incentives that reward new ideas and do not punish failure, and small entrepreneurial task-oriented teams that can experiment without worrying about efficiencies or profits.
Consolidators. To transform niches into mass markets, consolidators need to make serious investments in production and to be able to identify and reach many potential consumers. They need an organisation that can serve a large and rapidly growing market. They are typically slow movers (and ought to be, say the authors). It requires a disciplined organisation with a clear market vision and a single-minded commitment. They should be structured so that the diverse functional skills needed to consolidate a market are effectively integrated. They also need to be able to carry a substantial amount of financial risk.
The most serious conflict that arises between the two sets is cultural. Colonisers focus on technology and producing "the best". Consolidators focus on costs – they aim to produce a product that is good enough performance-wise but cheap enough to attract the masses. Colonisers are motivated by autonomy and freedom. Consolidators are more interested in making money; they are organisation people, happy to work in big organisations.
The structures required are different too. Colonists require a flat organisation without hierarchical controls, processes for generating new ideas, flexible planning processes, loose financial controls, and task-oriented project teams. They need managers who act as sponsors and coaches rather than operators. Consolidators require a more bureaucratic organisation with clear hierarchy and transparent division of labour, efficient systems and operating controls that keep a tight lid on costs. Colonisers are experimenters; consolidators are integrators with very different attitudes to risk.
Conflicts may also arise because managers whose incentives are tied to existing markets may see new radical markets as threats and be unwilling to promote their growth or support colleagues trying to do so. Even if they want to do something about new markets, they may find it hard to justify investment in what are seen as risky, low-margin ventures that are marginal to the mainstream business.
A firm that attempts to adopt both sets of skills and mindsets risks compromising both and getting caught in the middle. (3M and its success in both discovering and commercialising the Post-it note is seen as a rare exception to the rule.)
Setting up a separate organisational entity for colonisation is one solution (and was the strategy IBM used for developing the personal computer) but has its own problems and risks. One of the biggest costs of keeping the two organisations separate is inability to exploit synergies. And, given the failure rate of many early pioneers, why should a big firm be a pioneer that will later lose out to a consolidator as the market evolves?
Another (largely ignored) option is to outsource colonisation. Instead of spending valuable resources on growing radical new businesses inside the company, it should create and sustain a network of entrepreneurial "feeder" firms. It could then build a new mass market on the most promising platform provided by the feeder firms. This would allow the firm to cover more market niches, allow the feeders to compete with each other, and be easier to manage as it avoids the problem of managing two conflicting businesses simultaneously.
What the established firm ought to focus on therefore is not creating new` markets but taking the markets that start-up firms have created and scaling them up into mass markets.
The authors propose the following strategies for scaling up a niche market:
The skills for all this reside in the big, established corporation. Again, the message is that, rather than attempting to become colonists, they should focus on what they have the competencies for – taking markets out of the hands of the pioneers and scaling them up into mass markets.
The firms that capture the market are those that time their entry into the market just when the dominant design is about to emerge. A fast-second strategy (what the authors call "racing to be second") involves waiting for the dominant design to begin to emerge and then moving in to help create it.
The choice between being a coloniser or a consolidator is really a choice between being a first mover or a fast second mover. A first-mover strategy involves getting in there quickly and producing your own product variants. A fast-second strategy involves waiting for the dominant design to begin to emerge before moving. A traditional second-mover strategy would involve waiting for the dominant design to be completely established and accepted in the market, and then producing a me-too product under that standard, competing on costs and low prices.
First movers are rarely able to capture significant first-mover advantages in radically new markets. The market has to be large and relatively settled for first-mover advantages to exist and very young radical markets are neither of these. Second movers who wait until a dominant design emerges to enter the market have to face formidable and entrenched competitors. To succeed, they must either compete on price or find ways to break the rules of the game.
Fast-second movers do not wait until the dominant design emerges. They time their entry to coincide with the emergence of the dominant design and they actively influence which design will emerge as the winner. By moving at the right time and by helping develop the mass market, these firms create true first-mover advantages. Examples of the fast-second strategy include GE in CT scanners, JVC in video recorders, Canon in cameras, Black & Decker in food processors, P&G in diapers, Sharp in fax machines, and Texas Instruments in pocket calculators.
Guessing when the market is ready for a dominant design is not easy but the authors suggest some pointers: a slowing in the rate of innovation; a growing sense of legitimacy as the majority of consumers accept that the product is useful to them; and the appearance of complementary goods producers.
Dominant designs do not just emerge. They are imposed on markets by would-be champions who achieve a wide consensus among consumers by offering low prices based on economies of scale. They create a bandwagon by getting early consumers to recruit further consumers by word-of-mouth. They make the product easily available to consumers by getting the product into retail outlets that consumers trust. They reduce competition from other designs and create a sense that a choice has already been made by forming alliances with competitor firms who are happy to ensure their place in the market by producing variants of the dominant design.
The firm whose product forms the basis of the dominant design often develops substantial and enduring first-mover advantages. On the demand side, it may create barriers to entry by locking in consumers through high switching costs (e.g. by facilitating the provision of complementary goods that complement its product but not those of rivals). On the supply side, it may be able to buy or gain control of key assets such as intellectual property rights or key inputs such as natural resources or specialised workers). It can also get ahead in moving down the learning curve or building facilities for economies of scale.
Once the market is scaled up and starts to fragment into distinct customer segments, the winning firm must decide what strategic position to claim as its own in the market and which it should leave to competitors. It cannot serve everybody in that market. Developing a well-differentiated strategy requires difficult choices about target customers, the products or services to offer to them, and how to do this in an efficient way. Without clear and explicit choices on these three dimensions, chaos will result.
Competition after the emergence of the dominant design comes to focus more and more on price. The sources of competitive advantage therefore lie increasingly with lowering costs. The shift to price competition leads to major structural changes and consolidation in the market, leaving sales in the hands of the top three or four producers.
This triggers a shift away from product innovation toward process innovation. Anything that reduces costs appreciably is likely to improve a firm's competitive position. Process innovation is harder to spot than product innovation so the market will appear technologically stagnant and consumers will regard it as a commodity. This will increase the incentives that producers have to lower costs, driving them further down the path of process innovation at a time when they should perhaps be investing in new product designs.
As the market matures further, strategic innovation becomes a major source of competitive advantage. This involves the discovery of a new business model or unexploited position in the industry. Established companies, however, find this difficult. New business models emphasise different product or service attributes from the traditional business models of established competitors. These will likely appeal to a different customer base and may require a different culture, structure and internal processes which may be incompatible with the existing ones. A company that tries to compete in both positions may degrade the value of its existing activities. This is why once-formidable companies find themselves humbled by relatively unknown competitors.
The better that established companies become at playing their chosen game, the harder they find it to conceive of a different one. They must develop a mindset which says strategies are not cast in concrete. A firm needs to remain flexible and ready to readjust its strategy if the feedback from the market indicates this is necessary. It must continuously question the way it operates in its current position.
The arrival of a dominant design triggers another major change: vertical disintegration of production. In the early days of a new market, production runs are small, production methods are craft-based and the early entrants not only assemble the product but have to make many of the inputs themselves. Production therefore tends to high levels of vertical integration. In-house production has a large opportunity cost, however. An independent operator specialising in the production of an input may be able to produce it faster or at a much lower cost. The difference between what an in-house supplier and what an independent can offer is likely to widen as the market grows. The increasing size of the market may support an increasingly fine division of labour and the market may separate into different components or modules.
The resulting efficiency is usually accompanied by a reduction in the flexibility of established competitors. As a market builds up around a finer and finer division of labour in producing the core product, the ability of existing suppliers and producers to come up with a new dominant design weakens. The result is that the market can get locked into the existing dominant design. Existing market leaders tend to develop mindsets, processes, and ways of competing appropriate to that market and find it difficult to change radically.
Lock-in occurs when firms invest in specific (but difficult to change) assets so as to out-compete their rivals, or when they become afraid to disturb their customers. Such firms become rigid in their operations, focus on current operations and neglect future developments – especially when these threaten the current profits of the firm. The more profitable the existing activities, the harder it is to walk away from them. Whatever its causes, lock-in makes incumbent firms very vulnerable to challenges by outsiders.
It is futile for large, established companies to aspire to create radically new markets. The authors say you only have to look at how the radically new markets of the 20th century were created to predict how those of the 21st century will come about. Big companies cannot create radically new markets, nor should they want to. They should leave the task of creation to the "market" – the vast number of small start-up firms around the world that have the right skills and attitudes to succeed at creation. Big firms should concentrate on what they are good at – consolidating young markets into mass markets. They could do this by creating a network of feeder firms as described above.
The authors propose that the modern corporation should subcontract the creation of radical new products to the market and start-up firms should subcontract the consolidation of these products to big, established firms. The model for this, the authors suggest, already exists in creative industries such cinema, theatre and publishing which live and die on their ability to bring creative new products to the market continuously. There is a clear separation in such industries between those that create the product and those that promote, distribute and sell it. [The authors might have done more to examine the ramifications of this model. Another example to study might be recent co-operation in the pharmaceutical industry such as that between ImClone and Bristol-Myers Squibb.]
The authors also explore how a firm can compete with dual strategies. An established firm that has successfully moved into and scaled up to a radically new market is operating in two kinds of markets: its old, mature market and the new market it has just colonised. The key success factors and the required competencies in the two markets are different. How can a firm manage two conflicting games?
Such a situation might create two possible problems. First, the established organisation may be too old and efficiency-driven to accommodate a youthful, entrepreneurial venture in its existing infrastructure. Second, the new market may be growing at the expense of the existing business or may require the firm to engage in activities that conflict with those of the established mature business. As a result, managers of the established business might have incentives to constrain or even kill the new business. Conventional wisdom is that the new business should be separated from the existing business but this means that the organisation may in certain situations fail to exploit synergies between them.
The authors propose a solution which expands the number of options. The key factors are how serious the conflicts between the two businesses are and how strategically similar the new business is to the existing business (i.e. whether there are important synergies to be exploited). Four strategies are possible:
As the latter four strategies indicate, the choice between being a colonising pioneer and a market conquering consolidator is perhaps not as stark as the authors initially suggest. It might have been useful if they had delved more deeply into how and why 3M, the exception to the rule (as they see it), was able to avoid getting "caught in the middle". Nevertheless, their hypothesis is certainly provocative and is backed by plenty of examples and case studies. The authors acknowledge that their advice may not sit well with "established orthodoxies" about pioneering, creating new markets and the role of R&D in the modern corporation. Their book will have served its purpose, they say, if it challenges the reader to at least question (if not change) some of these orthodoxies.