Rationalist Strategy

“Rationalist” strategy has been heavily influenced by military experience, where strategy (in principle) consists of the following steps: (i) describe, understand, and analyze the environment; (ii) determine a course of action in the light of the analysis; and (iii) carry out the decided course of action. This is a “linear model” of rational action: appraise, determine, and act. The corporate equivalent is SWOT: the analysis of corporate strengths and weaknesses in the light of external opportunities and threats. This approach is intended to help the firm to:

• Be conscious of trends in the competitive environment.
• Prepare for a changing future.
• Ensure that sufficient attention is focused on the longer term, given the pressures to concentrate on the day to day.
• Ensure coherence in objectives and actions in large, functionally specialized and geographically dispersed organizations.

However, as John Kay has pointed out, the military metaphor can be misleading [4]. Corporate objectives are different from military ones: namely, to establish a distinctive competence enabling them to satisfy customers better than the competition – and not to mobilize sufficient resources to destroy the enemy (with perhaps the exception of some Internet companies). Excessive concentration on the “enemy” (i.e., corporate competitors) can result in strategies emphasizing large commitments of resources for the establishment of monopoly power, at the expense of profitable niche markets and of a commitment to satisfying customer needs. Research Note 4.2 discusses the relationships between R&D spending and innovation performance.

More important, professional experts, including managers, have difficulties in appraising accurately their real situation, essentially for two reasons. First, their external environment is both complex, involving competitors, customers, regulators, and so on; and fast-changing, including technical, economic, social and political change. It is therefore difficult enough to understand the essential features of the present, let alone to predict the future. Case Study 4.1 provides examples of the failings of forecasting. Second, managers in large firms disagree on their firms” strengths and weaknesses in part because their knowledge of what goes on inside the firm is imperfect.

4.2 Innovation “Leadership” versus “Followership”

According to conventional strategic management prescriptions, firms must also decide between two market strategies [17]:

1. Innovation “leadership” – where firms aim at being first to market, based on technological leadership. This requires a strong corporate commitment to creativity and risk-taking, with close linkages both to major sources of relevant new knowledge, and to the needs and responses of customers.
2. Innovation “followership” – where firms aim at being late to market, based on imitating (learning) from the experience of technological leaders. This requires a strong commitment to competitor analysis and intelligence, to reverse engineering (i.e., testing, evaluating, and taking to pieces competitors’ products, in order to understand how they work, how they are made, and why they appeal to customers), and to cost cutting and learning in manufacturing.

However, in practice, the distinction between “innovator” and “follower” is much less clear. For example, a study of the product strategies of 2273 firms found that market pioneers continue to have high expenditures on R&D, but that this subsequent R&D is most likely to be aimed at minor, incremental innovations. A pattern emerges where pioneer firms do not maintain their historical strategy of innovation leadership, but instead focus on leveraging their competencies in minor incremental innovations. Conversely, late entrant firms appear to pursue one of two very different strategies. The first is based on competencies other than R&D and new product development – for example, superior distribution or greater promotion or support. The second, more interesting strategy is to focus on major new product development projects in an effort to compete with the pioneer firm [18]. Research Note 4.4 discusses the influence of different innovation strategies on firm performance.

However, this example also reveals the essential weaknesses of Porter’s framework for analysis and action. As Martin Fransman has pointed out, technical personnel in firms like IBM in the 1970s were well aware of trends in semiconductor technology, and their possible effects on the competitive position of mainframe producers [19]. IBM in fact made at least one major contribution to developments in the revolutionary new technology: RISC microprocessors. Yet, in spite of this knowledge, none of the established firms proved capable over the next 20 years of achieving the primary objective of strategy, as defined by Porter: “… to find a position … where a company can best defend itself against these competitive forces or can influence them in its favour.”

Like many mainstream industrial economics, Porter’s framework underestimates the power of technological change to transform industrial structures, and overestimates the power of managers to decide and implement innovation strategies. Or, to put it another way, it underestimates the importance of technological trajectories, and of the firm-specific technological and organizational competencies to exploit them. Large firms in mainframe computers could not control the semiconductor trajectory. Although they had the necessary technological competencies, their organizational competencies were geared to selling expensive products in a focused market, rather than a proliferating range of cheap products in an increasing range of (as yet) unfocused markets.

These shortcomings of Porter’s framework in its treatment of corporate technology and organization led it to underestimate the constraints on individual firms in choosing their innovation strategies. In particular, a firm’s established product base and related technological competencies will influence the range of technological fields and industrial sectors in which it can hope to compete in future. Chemical-based firms do not diversify into making electronic products, and vice versa. It is very difficult (but not impossible) for a firm manufacturing traditional textiles to have an innovation strategy to develop and make computers [20].

In addition, opportunities are always emerging from advances in knowledge, so that:

• Firms and technologies do not fit tidily into preordained and static industrial structures. In particular, firms in the chemical, electrical, and electronic industries are typically active in a number of product markets and also create new ones like personal computers. Really new innovations (as distinct from radical or incremental), which involve some discontinuity in the technological or marketing base of a firm, are actually very common [21].
• Technological advances can increase opportunities for profitable innovation in so-called mature sectors. See, for example, the opportunities generated over the past 15 years by applications of IT in marketing, distribution, and coordination in such firms as Benetton [22]. See also the increasing opportunities for technology-based innovation in traditional service activities like banking, following massive investments in IT equipment and related software competencies [23].
• Firms do not become stuck in the middle as Porter predicted. John Kay has shown that firms with medium costs and medium quality compared to the competition achieve higher returns on investment than those with either low–low or high–high strategies [24]. Furthermore, some firms achieve a combination of high quality and low cost compared to competitors and this reaps high financial returns. These and related issues of product strategy will be discussed in Chapter 10. Research Note 4.5 contrasts the success of first mover and follower strategies.

There is also little place in Porter’s framework for the problems of implementing a strategy:

• Organizations that are large and specialized must be capable of learning and changing in response to new and often unforeseen opportunities and threats. This does not happen automatically, but must be consciously managed. In particular, the continuous transfer of knowledge and information across functional and divisional boundaries is essential for successful innovation. Studies confirm that the explicit management of competencies across different business divisions can help to create radical innovations, but that such interactions demand attention to leadership roles, team composition, and informal networks [25].
• Elements of Porter’s framework have been contradicted as a result of organizational and related technological changes. The benefits of nonadversarial relations with both suppliers and customers have become apparent. Instead of bargaining in what appears to be a zero-sum game, cooperative links with customers and suppliers can increase competitiveness, by improving both the value of innovations to customers and the efficiency with which they are supplied [26].

According to a survey of innovation strategies in Europe’s largest firms, just over 35% replied that the technical knowledge they obtain from their suppliers and customers is very important for their own innovative activities [27].

Christensen and Raynor provide a recent and balanced summary of the relative merits of the rational versus incremental approaches to strategy:

… core competence, as used by many mangers, is a dangerously inward-looking notion. Competitiveness is far more about doing what customers value, than doing what you think you’re good at … the problem with the core competence/not your core competence categorization is that what might seem to be a noncore activity today might become an absolutely critical competence to have mastered in a proprietary way in the future, and vice versa … emergent processes should dominate in circumstances in which the future is hard to read and it is not clear what the right strategy should be … the deliberate strategy process should dominate once a winning strategy has become clear, because in those circumstances effective execution often spells the difference between success and failure [28].

4.3 The Dynamic Capabilities of Firms

Teece and Pisano [29] integrate the various dimensions of innovation strategy identified above into what they call the “dynamic capabilities” approach to corporate strategy, which underlines the importance of dynamic change and corporate learning:

This source of competitive advantage, dynamic capabilities, emphasizes two aspects. First, it refers to the shifting character of the environment; second, it emphasizes the key role of strategic management in appropriately adapting, integrating, and reconfiguring internal and external organizational skills, resources, and functional competencies toward a changing environment (p. 537).

To be strategic, a capability must be honed to a user need (so that there are customers), unique (so that the products/services can be priced without too much regard for the competition), and difficult to replicate (so that profits will not be competed away) (p. 539).

We advance the argument that the strategic dimensions of the firm are its managerial and organizational processes, its present position, and the paths available to it. By managerial processes, we refer to the way things are done in the firm, or what might be referred to as its “routines,” or patterns of current practice and learning. By position, we refer to its current endowment of technology and intellectual property, as well as its customer base and upstream relations with suppliers. By paths, we refer to the strategic alternatives available to the firm and the attractiveness of the opportunities which lie ahead (pp. 537–41, our italics).

Institutions: Finance, Management, and Corporate Governance

Firms’ innovative behaviors are strongly influenced by the competencies of their managers and the ways in which their performance is judged and rewarded (and punished). Methods of judgement and reward vary considerably among countries, according to their national systems of corporate governance: in other words, the systems for exercising and changing corporate ownership and control. In broad terms, we can distinguish two systems: one that is practiced in the United States and the United Kingdom and the other in Japan, Germany, and its neighbors, such as Sweden and Switzerland. In his book, Capitalism against Capitalism, Michel Albert calls the first the “Anglo-Saxon” and the second the “Nippon–Rhineland” variety [30]. A lively debate continues about the essential characteristics and performance of the two systems, in terms of innovation and other performance variables. Table 4.1 is based on a variety of sources and tries to identify the main differences that affect innovative performance.

Characteristics	Anglo-Saxon	Nippon–Rhineland
Ownership	Individuals, pension funds, insurers	Companies, individuals, banks
Control management	Dispersed, arm’s length Business schools (USA), accountants (UK)	Concentrated, close and direct Engineers with business training
Evaluation of R&D investments	Published information	Insider knowledge
Strengths	Responsive to radically new technological opportunities Efficient use of capital	Higher priority to R&D than to dividends for shareholders Remedial investment in failing firms
Weakness	Short-termism Inability to evaluate firm-specific intangible assets	Slow to deal with poor investment choices Slow to exploit radically new technologies

In the United Kingdom and the United States, corporate ownership (shareholders) is separated from corporate control (managers), and the two are mediated through an active stock market. Investors can be persuaded to hold shares only if there is an expectation of increasing profits and share values. They can shift their investments relatively easily. On the other hand, in countries with governance structures like those of Germany or Japan, banks, suppliers, and customers are more heavily locked into the firms in which they invest.

These differences contribute to different patterns of investment and innovation. For example, the US system has since been more effective in generating resources to exploit radically new opportunities in IT and biotechnology, whereas countries strongly influenced by German and Japanese traditions persisted in investing heavily in R&D in established industries and technologies, such as capital equipment and automotive. Japanese firms have proved unable to repeat in telecommunications, software, microprocessors, and computing their technological and competitive successes in consumer electronics [31]. German firms have been slow to exploit radically new possibilities in IT and biotechnology [32], and there have been criticisms of expensive and unrewarding choices in corporate strategy, like the entry of Daimler-Benz into aerospace [33].

National systems of innovation clearly influence the rate and direction of innovation of domestic firms, and vice versa, but larger firms also learn and exploit innovation from other countries, as shown in Table 4.2. Firms have at least three reasons for monitoring and learning from the development of technological, production, and organizational competencies of national systems of innovation, and especially from those that are growing and strong:

1. They will be the sources of firms with a strong capacity to compete through innovation. For example, beyond Japan, other East Asian countries are developing strong innovation systems, in particular, business firms in South Korea and Taiwan. Following the collapse of the Russian Empire, we have also seen the reemergence of strong systems of innovation in the Czech Republic and Hungary.
2. They are also potential sources of improvement in the corporate management of innovation and in national systems of innovation. However, as we shall see below, understanding, interpreting, and learning general lessons from foreign systems of innovation are a difficult task. Effectiveness in innovation has become bound up with wider national and ideological interests, which makes it more difficult to separate fact from belief. Both the business press and business education are dominated by the English language and Anglo-Saxon examples.
3. Finally, firms can benefit more specifically from the technology generated in foreign systems of innovation. A high proportion of large European firms attach great importance to foreign sources of technical knowledge, whether obtained through affiliated firms (i.e., direct foreign investment) and joint ventures, links with suppliers and customers, or reverse engineering. In general, they find it is more difficult to learn from Japan than from North America and elsewhere in Europe, probably because of greater distances – physical, linguistic, and cultural. Conversely, East Asian firms have been very effective over the past 25 years in making these channels an essential feature of their rapid technological learning. Case Study 4.4 provides examples of how firms from latecomer nations come to dominate emerging sectors.

	Home Country	Other Europe	North America	Japan
Affiliated firms	48.9	42.9	48.2	33.6
Joint ventures	36.6	35.0	39.7	29.4
Independent suppliers	45.7	40.3	30.8	24.1
Independent customers	51.2	42.2	34.8	27.5
Public research	51.1	26.3	28.3	12.9
Reverse engineering	45.3	45.9	40.0	40.0

The slow but significant internationalization of R&D is also a means by which firms can learn from foreign systems of innovation. There are many reasons why multinational companies choose to locate R&D outside their home country, including regulatory regime and incentives, lower cost or more specialist human resources, proximity to lead suppliers or customers, but in many cases a significant motive is to gain access to national or regional innovation networks. Overall, the proportion of R&D expenditure made outside the home nation has grown from less than 15% in 1995 to more than 25% by 2009. However, some countries are more advanced in internationalizing their R&D than others, as shown in Figure 4.1. In this respect, European firms are the most internationalized and the Japanese the least.

Learning and Imitating

While information on competitors’ innovations is relatively cheap and easy to obtain, corporate experience shows that knowledge of how to replicate competitors’ product and process innovations is much more costly and time-consuming to acquire. Such imitation typically costs between 60% and 70% of the original, and typically takes three years to achieve [34].

These conclusions are illustrated by the examples of Japanese and Korean firms, where very effective imitation has been sustained by heavy and firm-specific investments in education, training, and R&D [35]. As Table 4.3 shows, R&D managers’ report that the most important methods of learning about competitors’ innovations were independent R&D, reverse engineering, and licensing, all of which are expensive compared to reading publications and the patent literature. Useful and usable knowledge does not come cheap. A similar and more recent survey of innovation strategy in more than 500 large European firms also found that nearly half reported the great importance of the technical knowledge they accumulated through the reverse engineering of competitors’ products [36].

Method of Learning	Overall Sample Means*
	Processes	Products
Independent R&D	4.76	5.00
Reverse engineering	4.07	4.83
Licensing	4.58	4.62
Hiring employees from innovating firm	4.02	4.08
Publications or open technical meetings	4.07	4.07
Patent disclosures	3.88	4.01
Consultations with employees of the innovating firm	3.64	3.64

^*Range: 1 = not at all effective; 7 = very effective.

More formal approaches to technology intelligence gathering are less widespread, and the use of different approaches varies by company and sector, as shown in Figure 4.2. For example, in the pharmaceutical sector, where much of the knowledge is highly codified in publications and patents, these sources of information are scanned routinely, and the proximity to the science base is reflected in the widespread use of expert panels. In electronics, product technology roadmaps are commonly used along with the lead users. Surprisingly (according to this study of 26 large firms), long-established and proven methods such as Delphi studies, S-curve analysis, and patent citations are not in widespread use.

4.4 Appropriating the Benefits from Innovation

Technological leadership in firms does not necessarily translate itself into economic benefits [37]. Teece argues that the capacity of the firm to appropriate the benefits of its investment in technology depends on two factors: (i) the firm’s capacity to translate its technological advantage into commercially viable products or processes and (ii) the firm’s capacity to defend its advantage against imitators. Thus, effective patent protection enabled Pilkington to defend its technological breakthrough in glass making and stopped Kodak imitating Polaroid’s instant photography. Lack of commitment of complementary assets in production and marketing resulted in the failure of EMI and Xerox to reap commercial benefits from their breakthroughs in medical scanning and personal computing technologies. In video recorders, Matsushita succeeded against the more innovative Sony in imposing its standard, in part because of a more liberal licensing policy toward competitors.

Some of the factors that enable a firm to benefit commercially from its own technological lead can be strongly shaped by its management: for example, the provision of complementary assets to exploit the lead. Other factors can be influenced only slightly by the firm’s management and depend much more on the general nature of the technology, the product market, and the regime of intellectual property rights: for example, the strength of patent protection. We identify nine factors that influence the firm’s capacity to benefit commercially from its technology:

1. Secrecy
2. Accumulated tacit knowledge
3. Lead times and after-sales service
4. The learning curve
5. Complementary assets
6. Product complexity
7. Standards
8. Pioneering radical new products
9. Strength of patent protection

We begin with those over which management has some degree of discretion for action and move on to those where its range of choices is more limited.

1. Secrecy is considered an effective form of protection by industrial managers, especially for process innovations. However, it is unlikely to provide absolute protection, because some process characteristics can be identified from an analysis of the final product, and because process engineers are a professional community, who talk to each other and move from one firm to another, so that the information and knowledge inevitably leak out [38]. Moreover, there is evidence that, in some sectors, firms that share their knowledge with their national system of innovation outperform those that do not, and that those that interact most with global innovation systems have the highest innovative performance [39]. Specifically, firms that regularly have their research (publications and patents) cited by foreign competitors are rated more innovative than others, after controlling for the level of R&D. In some cases, this is because sharing knowledge with the global system of innovation may influence standards and dominant designs (see later) and can help attract and maintain research staff, alliance partners, and other critical resources.
2. Accumulated tacit knowledge can be long and difficult to imitate, especially when it is closely integrated in specific firms and regions. Examples include product design skills, ranging from those of Benetton and similar Italian firms in clothing design to those of Rolls-Royce in aircraft engines.
3. Lead times and after-sales service are considered by practitioners as major sources of protection against imitation, especially for product innovations. Taken together with a strong commitment to product development, they can establish brand loyalty and credibility, accelerate the feedback from customer use to product improvement, generate learning-curve cost advantages, and therefore increase the costs of entry for imitators. Based on the survey of large European firms, Table 4.4 shows that there are considerable differences among sectors in product development lead times, reflecting differences both in the strength of patent protection and in product complexity.
4. The learning curve in production generates both lower costs and a particular and powerful form of accumulated and largely tacit knowledge that is well recognized by practitioners. In certain industries and technologies (e.g., semiconductors, continuous processes), the first-comer advantages are potentially large, given the major possibilities for reducing unit costs with increasing cumulative production. However, such “experience curves” are not automatic and require continuous investment in training and learning.
5. Complementary assets. The effective commercialization of an innovation very often depends on assets (or competencies) in production, marketing, and after-sales to complement those in technology. For example, EMI did not invest in them to exploit its advances in electronic scanning. On the other hand, Teece argues that strong complementary assets enabled IBM to catch up in the personal computer market [40].
6. Product complexity. However, Teece was writing in the mid-1980s, and IBM’s performance in personal computers has been less than impressive since then. Previously, IBM could rely on the size and complexity of its mainframe computers as an effective barrier against imitation, given the long lead times required to design and build copy products. With the advent of the microprocessor and standard software, these technological barriers to imitation disappeared and IBM was faced in the late 1980s with strong competition from IBM “clones,” made in the United States and in East Asia. Boeing and Airbus have faced no such threat to their positions in large civilian aircraft, since the costs and lead times for imitation remain very high. Product complexity is recognized by managers as an effective barrier to imitation.
7. Standards. The widespread acceptance of a company’s product standard widens its own market and raises barriers against competitors. Carl Shapiro and Hal Varian have written the standard (so far) text on the competitive dynamics of the Internet economy [41], where standards compatibility is an essential feature of market growth, and “standards wars” an essential feature of the competitive process. The market leader normally has the advantage in a standards war, but this can be overturned through radical technological change, or a superior response to customers’ needs [42]. Competing firms can adopt either “evolutionary” strategies minimizing switching costs for customers (e.g., backward compatibility with earlier generations of the product) or “revolutionary” strategies based on greatly superior performance–price characteristics, such that customers are willing to accept higher switching costs [43]. Standards wars are made less bitter and dramatic when the costs to the losers of adapting to the winning standard are relatively small. This is discussed in Research Note 4.6.

   Industry	% of Firms Noting >5 years for Development and Marketing of Alternative to a Significant Product Innovation
   All	11.0
   Pharmaceuticals	57.5
   Aerospace	26.3
   Chemicals	17.2
   Petroleum products	13.6
   Instruments	10.0
   Automobiles	7.3
   Machinery	5.7
   Electrical equipment	5.3
   Basic metals	4.2
   Utilities	3.7
   Glass, cement, and ceramics	0
   Plastics and rubber	0
   Food	0
   Telecommunication equipments	0
   Computers	0
   Fabricated metals	0

   Different factors will have an influence at different phases of the standards process. In the early phases, aimed at demonstrating technical feasibility, factors such as the technological superiority, complementary assets, and credibility of the firm are most important, combined with the number and nature of other firms and appropriability regime. In the next phase, creating a market, strategic maneuvering, and regulation are most important. In the decisive phase, the most significant factors are the installed base, complementary assets, credibility and influence of switching costs, and network effects. However, in practice, it is not always easy to trace such ex-ante factors to ex-post success in successfully establishing a standard (see Table 4.5). This is one reason why increasing collaboration is occurring earlier in the standards process, rather than the more historical “winner takes all” standards battles in the later stages [48]. Research in the telecommunications and other complex technological environments, where system-wide compatibility is necessary, confirms that early advocates of standards via alliances are more likely to create standards and achieve dominant positions in the industry network (see also Case Study 4.5 on Ericsson and the GSM standard) [49]. In contrast, the failure of Philips and Sony to establish their respective analog video standards, and subsequent recordable digital media standards, compared to the success of VHS, CD, and DVD standards, which were the result of early alliances. Where strong appropriability regimes exist, compatibility standards may be less important than customer interface standards, which help to “lock-in” customers [50]. Apple’s graphic user interface is a good example of this trade-off.

8. Pioneering radical new products. It is not necessarily a great advantage to be a technological leader in the early stages of the development of radically new products, when the product performance characteristics, and features valued by users, are not always clear, either to the producers or to the users themselves. Especially for consumer products, valued features emerge only gradually through a process of dynamic competition, which involves a considerable amount of trial, error, and learning by both producers and users. New features valued by the users in one product can easily be recognized by competitors and incorporated in subsequent products. That is why market leadership in the early stages of the development of personal computers was so volatile, and why pioneers are often displaced by new entrants [51]. In such circumstances, product development must be closely coupled with the ability to monitor competitors’ products and to learn from customers. According to research by Tellis and Golder, pioneers in radical consumer innovations rarely succeed in establishing long-term market positions. Success goes to so-called “early entrants” with the vision, patience, and flexibility to establish a mass consumer market [52]. As a result, studies suggest that the success of product pioneers ranges between 25% (for consumer products) and 53% (for high-technology products), depending on the technological and market conditions. For example, studies of the PIMS (Profit Impact of Market Strategy) database indicate that (surviving) product pioneers tend to have higher quality and a broader product line than followers, whereas followers tend to compete on price, despite having a cost disadvantage. A pioneer strategy appears more successful in markets where the purchasing frequency is high, or distribution important (e.g., fast-moving consumer goods), but confers no advantage where there are frequent product changes or high advertising expenditure (e.g., consumer durables) [53].
9. Strength of patent protection can, as we have already seen in the earlier described examples, be a strong determinant of the relative commercial benefits to innovators and imitators. Table 4.6 summarizes the results of the surveys of the judgements of managers in large European and US firms about the strength of patent protection. The firms’ sectors are ordered according to the first column of figures, showing the strength of patent protection for product innovations for European firms. Patents are judged to be more effective in protecting product innovations than process innovations in all sectors except petroleum refining, probably reflecting the importance of improvements in chemical catalysts for increasing process efficiency. It also shows that patent protection is rated more highly in chemical-related sectors (especially drugs) than in other sectors. This is because it is more difficult in general to “invent round” a clearly specified chemical formula than round other forms of invention. Case Study 4.5 discusses the relative competitive advantages of standards, patents, and first-mover strategies.

Radically, new technologies are now posing new problems for the protection of intellectual property, including the patenting system. The number of patents granted to protect software technology is growing in the United States and so are the number of financial institutions getting involved in patenting for the first time [54]. Debate and controversy surround important issues, such as the possible effects of digital technology on copyright protection [55], the validity of patents to protect living organisms, and the appropriate breadth of patent protection in biotechnology [56].

Finally, we should note that firms can use more than one of the earlier mentioned nine factors to defend their innovative lead. For example, in the pharmaceutical industry, secrecy is paramount during the early phases of research; however, in the later stages of research, patents become critical. Complementary assets such as global sales and distribution become more important at the later stages. Despite all the merger and acquisitions in this sector, these factors, combined with the need for a significant critical mass of R&D, have resulted in relatively stable international positions of countries in pharmaceutical innovation over a period of some 70 years. Firms typically deploy all the useful means available to them to defend their innovations against imitation [57].

4.5 Exploiting Technological Trajectories

In this section, we focus on firms and broad technological trajectories [58]. This is because firms and industrial sectors differ greatly in their underlying technologies. For example, designing and making an automobile is not the same as designing and making a therapeutic drug, or a personal computer. We are dealing not with one technology, but with several technologies, each with its historical pattern of development, skill requirements, and strategic implications. Therefore, it is a major challenge to develop a framework, for integrating changing technology into strategic analysis, that deals effectively with corporate and sectoral diversity. Later, we describe the framework that one of us has developed over the past 10 or more years to encompass diversity [59]. It has been strongly influenced by the analyses of the emergence of the major new technologies over the past 150 years by Chris Freeman and his colleagues [60] and by David Mowery and Nathan Rosenberg [61].

A number of studies have shown marked, similar, and persistent differences among industrial sectors in the sources and directions of technological change. They can be summarized as follows:

• Size of innovating firms: typically big in chemicals, road vehicles, materials processing, aircraft, and electronic products and small in machinery, instruments, and software.
• Type of product made: typically price sensitive in bulk materials and consumer products and performance sensitive in ethical drugs and machinery.
• Objectives of innovation: typically product innovation in ethical drugs and machinery, process innovation in steel, and both in automobiles.
• Sources of innovation: suppliers of equipment and other production inputs in agriculture and traditional manufacture (such as textiles); customers in instrument, machinery, and software; in-house technological activities in chemicals, electronics, transport, machinery, instruments, and software; and basic research in ethical drugs.
• Locus of own innovation: R&D laboratories in chemicals and electronics, production engineering departments in automobiles and bulk materials, design offices in machine building, and systems departments in service industries (e.g., banks and supermarket chains).

In the face of such diversity, there are two opposite dangers. One is to generalize about the nature, source, directions, and strategic implications of innovation on the basis of experience in one firm or in one sector. In this case, there is a strong probability that many of the conclusions will be misleading or plain wrong. The other danger is to say that all firms and sectors are different and that no generalizations can be made. In this case, there can be no cumulative development of useful knowledge. In order to avoid these twin dangers, one of us distinguished five major technological trajectories, each with its distinctive nature and sources of innovation, and with its distinctive implications for technology strategy and innovation management. This was done on the basis of systematic information on more than 2000 significant innovations in the United Kingdom and of a reading of historical and case material. In Table 4.7, we identify for each trajectory its typical core sectors, its major sources of technological accumulation, and its main strategic management tasks.

Knowledge of these major technological trajectories can improve the analysis of particular companies’ technological strategies, by helping answer the following questions:

• Where do the company’s technologies come from?
• How do they contribute to competitive advantage?
• What are the major tasks of innovation strategy?
• Where are the likely opportunities and threats, and how can they be dealt with?

Although the above taxonomy has held up reasonably well to subsequent empirical tests, it inevitably simplifies [62]. For example, we can find “supplier-dominated” firms in electronics and chemicals, but they are unlikely to be technological pacesetters. In addition, firms can belong in more than one trajectory. In particular, large firms in all sectors have capacities in scale-intensive (mainly mechanical and instrumentation) technologies, in order to ensure efficient production. Software technology is beginning to play a similarly pervasive role across all sectors. We have recently extended this taxonomy based on survey and interview data on the innovative activities of almost 1000 firms, as shown in Table 4.8. Research Note 4.7 identifies different combinations of technology and market strategies.

4.6 Developing Firm-specific Competencies

The ability of firms to track and exploit the technological trajectories described earlier depends on their specific technological and organizational competencies and on the difficulties that competitors have in imitating them. The notion of firm-specific competencies has become increasingly influential among economists, trying to explain why firms are different, and how they change over time, and also among business practitioners and consultants, trying to identify the causes of competitive success [63].

4.7 Globalization of Innovation

Many analysts and practitioners have argued that, following the “globalization” of product markets, financial transactions, and direct investment, large firms’ R&D activities should also be globalized – not only in their traditional role of supporting local production but also in order to create interfaces with specialized skills and innovative opportunities at a world level [84]. This is consistent with more recent notions of “open innovation,” rather than “closed innovation” which relies on internal development. However, although striking examples of the internationalization of R&D can be found (e.g., the large Dutch firms, particularly Philips [85]), more comprehensive evidence casts doubt on the strength of such a trend (Table 4.12). This evidence is based on the countries of origin of the inventors cited on the front page of patents granted in the United States, to nearly 359 of the world’s largest, technologically active firms (and which account for about half of all patenting in the United States). This information turns out to be an accurate guide to the international spread of large firms’ R&D activities.

Taken together, the evidence shows that [86]:

• Twenty years ago, the world’s large firms performed about 12% of their innovative activities outside their home country. The equivalent share of production is now about 25%.
• The most important factor explaining each firm’s share of foreign innovative activities is its share of foreign production. In general, firms from smaller countries have higher shares of foreign innovative activities. On average, the foreign production is less innovation intensive than the home production.
• Most of the foreign innovative activities are performed in the United States and Europe (in fact, Germany). They are not “globalized.”
• Since the late 1980s, European firms – and especially those from France, Germany, and Switzerland – have been performing an increasing share of their innovative activities in the United States, in large part in order to tap into local skills and knowledge in such fields as biotechnology and IT.

Controversy remains both in the interpretation of this general picture and in the identification of implications for the future. The development of major innovations remains complex, costly, and depends crucially on the integration of tacit knowledge. This remains difficult to achieve across national boundaries, so firms therefore still tend to concentrate major product or process developments in one country. They will sometimes choose a foreign country only when it offers identifiable advantages in the skills and resources required for such developments, and/or access to a lead market [87].

Advances in IT have enabled spectacular increases in the international flow of codified knowledge in the form of operating instructions, manuals, and software. They are also having some positive impact on international exchanges of tacit knowledge through teleconferencing, but not anywhere near to the same extent. The main impact will therefore be at the second stage of the “product cycle [88],” when product design has stabilized, and production methods are standardized and documented, thereby facilitating the internationalization of production. Product development and the first stage of the product cycle will still require frequent and intense personal exchanges, and be facilitated by physical proximity. Advances in IT are therefore more likely to favor the internationalization of production than that of the process of innovation.

The two polar extremes of organizing innovation globally are the specialization-based and integration-based, or network structure [89]. In the specialization-based structure the firm develops global centers of excellence in different fields, which are responsible globally for the development of a specific technology or product or process capability. The advantage of such global specialization is that it helps to achieve a critical mass of resources and makes coordination easier. As one R&D director notes:

“… the centre of excellence structure is the most preferable. Competencies related to a certain field are concentrated, coordination is easier, and economies of scale can be achieved. Any R&D director has the dream to structure R&D in such a way. However, the appropriate conditions seldom occur [90].”

Research Note 4.11 contrasts two conflicting strategies for the globalization of innovation.

In practice, hybrids of these two extreme structures are common, often as a result of practical compromises and trade-offs necessary to accommodate history, acquisitions, and politics. For example, specialization by center of excellence may include contributions from other units, and integrated structures may include the contribution of specialized units. The main factors influencing the decision where to locate R&D globally are in the order of importance [90]:

1. The availability of critical competencies for the project.
2. The international credibility (within the organization) of the R&D manager responsible for the project.
3. The importance of external sources of technical and market knowledge, for example, sources of technology, suppliers and customers.
4. The importance and costs of internal transactions, for example, between engineering and production.
5. Cost and disruption of relocating key personnel to the chosen site.

Case Study 4.12 charts the development innovation strategies and capabilities in China.

View 4.1 discusses the various motivations for locating global innovation activities.

4.8 Enabling Strategy Making

Scanning and searching the environment identifies a wide range of potential targets for innovation and effectively answers the question, “What could we do?” But even the best-resourced organization will need to balance this with some difficult choices about which options it will explore – and which it will leave aside. This process should not simply be about responding to what competitors do or what customers ask for in the marketplace. Nor should it simply be a case of following the latest technological fashion. Successful innovation strategy requires understanding the key parameters of the competitive game (markets, competitors, external forces, etc.) and also the role which technological knowledge can play as a resource in this game. How can it be accumulated and shared, how can it be deployed in new products/services and processes, how can complementary knowledge be acquired or brought to bear, and so on? Such questions are as much about the management of the learning process within the firm as about investments or acquisitions – and building effective routines for supporting this process is critical to success.

Although developing such a framework is complex, we can identify a number of key routines that organizations use to create and deploy such frameworks. These help provide answers to the following three key questions:

• Strategic analysis – what, realistically, could we do?
• Strategic choice – what are we going to do (and in choosing to commit our resources to that, what will we leave out)?
• Strategic monitoring – overtime reviewing to check is this still what we want to do?

Chapter 4: Concept Check Questions

Further Reading

Our companion text Strategic Innovation Management (Wiley, 2014) covers all these topics in greater depth. There are a number of texts that describe and compare different systems of national innovation policy, including National Innovation Systems (Oxford University Press, 1993), edited by Richard Nelson; National Systems of Innovation (Pinter, 1992), edited by B.-A. Lundvall; and Systems of Innovation: Technologies, Institutions and Organisations (Pinter, 1997), edited by Charles Edquist. The former is stronger on US policy, the other two on European, but all have an emphasis on public policy rather than corporate strategy. Michael Porter’s The Competitive Advantage of Nations (Macmillan, 1990) provides a useful framework in which to examine the direct impact on corporate behavior of innovation systems. At the other extreme, David Landes’ Wealth and Poverty of Nations (Little Brown, 1998) takes a broad (and stimulating) historical and cultural perspective. The best overview is provided by the anthology of Chris Freeman’s work in Systems of Innovation (Edward Elgar, 2008). More recent reviews of emerging economy systems include Mastering Innovation in China: Insights from History on China’s Journey towards Innovation, by Joachim Jan Thraen (Springer, 2016), China’s Next Strategic Advantage: From Imitation to Innovation, by George S. Yip and Bruce McKern (MIT Press, 2016), and National Innovation Systems, Social Inclusion and Development: The Latin American Experience, edited by Gabriela Dutrenit and Judith Sutz (Edward Elgar, 2016).

Comprehensive and balanced reviews of the arguments and evidence for product leadership versus follower positions is provided by G.J. Tellis and P.N. Golder: Will and Vision: How Latecomers Grow to Dominate Markets (McGraw-Hill, 2002) and Fast Second: How Smart Companies Bypass Radical Innovation to Enter and Dominate New Markets (Jossey Bass, 2004) by Costas Markides. More relevant to firms from emerging economies, and our favorite text on the subject, is Naushad Forbes and David Wield’s From Followers to Leaders: Managing Technology and Innovation (Routledge, 2002), which includes numerous case examples.

For recent reviews of the core competence and dynamic capability perspectives see David Teece’s Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth (Oxford University Press, 2011), Joe Tidd (editor) From Knowledge Management to Strategic Competence (Imperial College Press, third edition, 2012), and Connie Helfat’s Dynamic Capabilities: Understanding Strategic Change in Organizations (Blackwell, 2006). Lockett, Thompson and Morgenstern (2009) provide a useful review in “The development of the resource-based view of the firm: A critical appraisal,” International Journal of Management Reviews, 11(1), as do Wang and Ahmed (2007). “Dynamic capabilities: A review and research agenda,” International Journal of Management Reviews, 9(1). Davenport, Leibold, and Voelpel provide an edited compilation of leading strategy writers in Strategic Management in the Innovation Economy (2nd edition, Wiley, 2006), and the review edited by Robert Galavan, John Murray, and Costas Markides, Strategy, Innovation and Change (Oxford University Press, 2008), is excellent. On the more specific issue of technology strategy Vittorio Chiesa’s R&D Strategy and Organization (Imperial College Press, 2001) is a good place to start.

The renewed interest in business model innovation, that is how value is created and captured, is discussed in Strategic Market Creation: A New Perspective on Marketing and Innovation Management, a review of research at Copenhagen Business School and Bocconi University, edited by Karin Tollin and Antonella Carù (Wiley, 2008). There was a special issue of the journal Long Range Planning on innovative business models, volume 43(2 & 3), 2011, and a compilation of articles republished in the Harvard Business Review on Business Model Innovation (2012).

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