In Search of Best Practice Enduring Ideas in Strategy & Innovation

1. In Search of Best PracticeEnduring Ideas in Strategy & Innovation International Forum on COCOMO and Systems/Software Cost Modeling November 5, 2009 Based on the 2009 13th Annual Clarendon Lectures in Management Studies, University of Oxford Michael A. Cusumano © 2009 MIT Sloan School of Management cusumano@mit.edu

2. Oxford Clarendon Lectures • Task?Write a synthesis of my career research • Focus:Attempt to understand “best practices” • Context:Strategy, operations, & technology or innovation management in the auto, consumer electronics, software/internet sectors • Methodology:Reflection on 25+ years of research, mostly inductive cases, some large sample studies • Lectures Theme:Simple but potential “enduring ideas” • Inspiration? • Some popular books attempting the same, but mostly Theodore White, In Search of History(1978)

3. 1995 1985 1991 1998 2002 1998 In Search of Best Practice 2002 2004 2010

4. “Best Practice” in Management? • Lots of popular books & academic research, though mostly case studies, small samples, or limited analysis • Hard to generalize;what works in one firm, time period, industry or nation may not transfer • Partially a problem of knowledge(what do we really know) as well as context(“controls” & management issues) • Imitation (best to common to non-differentiating practices) • Industry or technology lifecycle (new, mature, disruptive) • Type of technology or innovation (product, process, service) • Industry (industry structure, business or firm differences) • Institution or environment (country, government) • Luck or population ecology (timing, survival bias?)

5. For Example: Japan vs. US/West • US and Europe once center of best practices • Japan in 1950s and 1960s: cheap, low-quality goods, but fastest growing economy • Japan later overtook the West in some areas • “Best practices” in manufacturing, quality, HR, product development, industrial policy • Since 1990, many Japanese “strengths” turned into “weaknesses” • Beyond company practices to government policies and social or cultural characteristics

6. Tom Peters & Robert Waterman, In Search of Excellence (1982) • Of 62 of McKinsey’s best clients, focused on top 43 • Key success factors: (1) action bias, (2) close to customer, (3) entrepreneurship spirit, (4) people focus, (5) hands-on management, (6) focus on what firm is good at, (7) lean staffing, (8) tight centralized values with decentralization • Hard to disagree with these qualities, but … • No statistical or historical analysis; can’t tell which factor impacts what, or what is “enduring” • Many “excellent” firms later struggled or failed • Atari, Data General, Delta Airlines, DEC, IBM, Kodak, NCR, Wang, Xerox

7. Jim Collins, From Good to Great (2001) • Analyzed 1500 companies to find best performers in stock market value; focused on top 11 • Key success factors: (1) Internal CEOs, (2) focus on talent, (3) focus on internal strengths, (4) fact-based performance goals, (5) disciplined commitment culture, (6) reinforcing use of technology, (7) momentum built from early successes • Again, hard to disagree with these qualities, but… • Again, no analysis of what effects what or how other firms with similar characteristics performed • Again, trouble, takeovers, or bankruptcy… • Abbot, Circuit City, Fannie Mae, Gillette, Wallgreens

8. General Observations • Some practices seem more enduring than others • Though unpredictable catastrophes (“black swans”) can disrupt any market and any firm • What is lasting “best practice” surely DEPENDS • E.g., in manufacturing Ford (Model T) “best” until surpassed by GM (variety) and then by Toyota (JIT) • E.g., in various areas, “Japan, Inc.” in 1980s “best” while economy growing & competition limited • Need to state qualifying “conditions” or context • But, for managers, specific practices moderated by formal “contingency frameworks” get complex fast

9. My Six “Enduring” IdeasNot original to me, but underlie my work & have decades of empirical & theoretical research behind them • Capabilities,Not Just Strategy • Pull, Don’t Just Push • Scope, Not Just Scale • Flexibility, Not Just Efficiency • Platforms, Not Just Products • Services, Not Just Products (or Platforms)

10. Enduring Ideas & Competitive Advantage Flexibility Pull Platforms Services Capabilities and Economies of Scope New Way of Thinking About FIRM AGILITY New Way of Thinking About ECOSYSTEM STRATEGY How anticipate emerging customer needs or market change, and lead or adapt quickly ,flexibly – and effectively How move to new capabilities within an industry ecosystem, and influence markets & adapt to commoditization

11. 1. Capabilities, Not Just Strategy • Focus not simply on formulating strategy or a vision of the future (i.e., deciding what to do)but equally on building distinctive organizational capabilities and operational skills (i.e., how to do things) that rise above common practice (i.e., what most firms do). • Distinctive capabilities center on people, processes, and accumulated knowledge. Reflect a deep understanding of the business and the technology and enable the firm to offer superior products and services as well as exploit foreseen and unforeseen opportunities for innovation.

12. “Capabilities” Intellectual History Unique/Distinctive “Resources” (sometimes “Capabilities”) Penrose (1959); Chandler (1962); Richardson (1972), Wernerfeldt (1984); Barney (1991); Grant (1991); Peteraf (1993), etc. Incremental Strategy & Domain Knowledge Bower (1970); Quinn (1980); Hayes and Abernathy (1980); Pascale (1984); Mintzberg (1987, 1994); Hamel and C.K. Pralahad (1989, 1990); Brown and Eisenhardt (1998); Burgelman (2001), etc. How Much Does Industry (vs. Management) Matter? Porter (1980); Schmalensee (1985); Rumelt (1991); McGahan and Porter (1997) “Dynamic” Capabilities & Apsorptive Capacity Leonard-Barton (1992); D’Aveni (1994); Teece, Pisano & Shuen (1997); Markides (1999); Eisenhardt & Martin (2000); Teece (2009). Cohen & Levinthal (1990)

13. My Examples • Strategy and capabilities development at Toyota (“indirect tech transfer”) vs. Nissan (“direct”),laying foundation for Toyota’s revolutionary process innovations (M. Cusumano, The Japanese Automobile Industry, 1985) • Strategy and capabilities development at JVC and Sony, leading to mass-production and design skills used to create the home VCR (R. Rosenbloom and M. Cusumano, “Technological Pioneering and Competitive Advantage: The Birth of the VCR Industry,” California Management Review, 1987) • Strategy and capabilities at Microsoft unique to PC software (M. Cusumano & R. Selby, Microsoft Secrets, 1995)

14. Lessons for Managers (Idea 1) • Essential to couple strategywith distinctive capabilities to implement and evolve that strategy as needed. • Unique benefits to have people at hand who have the knowledge, skills, and creativity to produce the product and process innovations – planned or unplanned – that truly differentiate firms over the long run.

15. 2. Pull, Don’t Just Push • Emphasize a “pull-style” of management that reverses the sequential processes & information flow common in many firms for manufacturing as well as product development, service design and delivery, and other operations and activities. • Link each step in key processes backward from the market to respond in real-time to changes in demand, customer preferences, competitive conditions, or internal operational difficulties. Continuous feedback & adjustment also facilitate rapid learning, elimination of waste, and incremental product & process innovations.

16. “Pull” Intellectual History Push vs. Pull in Marketing, Scientific Invention, Supply Chain (Dodgson, Gann, & Salter (2005); von Hippel (various) Toyota & “Lean” Production – Early: Managerial Sugimori et al. (1977), Ono (1978), Monden (1981 and 1983), Schonberger (1982), Hall (1983), Cusumano (1985), Krafcik (1988), Womack, Jones, and Roos (1990), Oliver & Wilkinson (1992), etc. Toyota & “Lean” Production – Later: Theory, Analysis Lee (1989), Fujimoto (1999) , Holweg and Pil (2004), Holweg (2007), etc. Iterative Product Development – Software & Other Basili & Turner (1975), Boehm (1988), Aoyama (1993), Ulrich & Eppinger (1994); MacCormack & Verganti (1999) , Kelley (2004), Thomke (2004)

17. My Examples • Toyota Just-in-Time (Kanban/Lean) production system (which uses half the workers of conventional manufacturing &minimal inventory, with higher productivity , quality and short-cycle learning dynamics) (M. Cusumano, The Japanese Automobile Industry, 1985) • “Iterative” or prototype-driven software development such as at Microsoft, Netscape, et al., compared to plan-driven sequential or “waterfall” processes for product development (M. Cusumano and R. Selby, Microsoft Secrets, 1995; M. Cusumano and D. Yoffie, Competing on Internet Time, 1998)

18. Lessons for Managers (Idea 2) • The pull concept is a fundamental philosophy of management, emphasizing real-time information and continuous improvement. • Pull versus push in everything from strategic decision making to planning and operations management. • Managers can set the pace of feedback & adjustment with mechanisms that set the “heartbeat” of the processes: kanban exchange or the (daily) build cycle.

19. Process Spectrum Process Spectrum

21. Synch & Stabilize Process Flow

23. 3. Scope, Not Just Scale • Seek efficiencies even in activities not suited to scale economies, such as research, engineering, and product development as well as services. Usually see scope as corporate strategy: synergies across lines of business. But potentially more practical & valuable are scope economies within the same line of business. • Require systematic ways to share product inputs, intermediate components, or other key elements of product, process, or customer knowledge across diverse groups and projects. Scope economies also eliminate redundant activities and are an important source of competitive differentiation.

24. “Scope” Intellectual History Economies of Scope Definitions & Theory Teece (1980), Panzar & R. Willig (1981), Helfat & Eisenhardt (2004) Corporate Diversification (across lines of business) Chandler (1962), Rumelt (1974), Bettis (1981), Ravenscraft & Scherer (1987), Ramanujan & Varadarajan (1989) Limits vs. Benefits of Scale in Manufacturing Abernathy & Wayne (1974), Abernathy (1978), Hounschell (1985) Scope Examples (within a line of business, across activities) Leggette & Killingsworth (1983), Matsumoto (1984), Chandler (1990), Henderson & Cockburn (1996), Hansen, Nohria & Tierney (1999), Hallowell (1999). Hansen et al. (1999), Christensen, Grossman & Hwang (2008)

25. My Examples • Software factories, from US to Japan to India, for building custom applications and standardized products (M. Cusumano, Japan’s Software Factories, 1991; M. Cusumano, The Business of Software (2004); M. Cusumano et al., “Software Development Worldwide: The State of the Practice,” IEEE Software, 2003) • Multi-project management and concurrent technology transfer in product development, at Toyota et al., to balance project management with technology reuse through in-house platforms and knowledge management (M. Cusumano and K. Nobeoka, Thinking Beyond Lean, 1998)

26. Lessons for Managers (3) • Economies of scope potentially as valuable to efficiency as traditional economies of scale, and probably more important to firm-level differentiation – precisely because this is difficult to achieve! • Managers also must be smart enough to balance or eliminate the potential tradeoffs – e.g., with efficiency & quality

27. 4. Flexibility, Not Just Efficiency • Place as much emphasis on flexibility as on efficiency in manufacturing, product development, and other operations as well as in strategy and decision making. Firms need to adapt to change in market demand, competition, and technology, and exploit opportunities for innovation and new business development. • Moreover, rather than always requiring tradeoffs, flexible systems and processes can actually reinforce or facilitate efficiency and quality, as well as encourage innovation.

28. “Flexibility” Intellectual History Organizations, Environments & Strategy Lawrence & Lorsch (1967); Aaker & Mascarenhas (1984), Harrigan (1984). D’Aveni (1994); Tushman & O'Reilly (1996); Volberda (1996, 1999); Brown & Eisenhardt (1997, 1998), Gemawhat & Sol (1998), Birkinshaw & Hagstrom (2002), etc. Manufacturing – Flexibility-Efficiency-Quality Tradeoffs Skinner (1974) , Jaikumar (1986), Krafcik (1988), Garvin (1988), Sethi & Sethi (1990), Pine (1992), Gerwin (1993), Upton (1994), Adler et. al. (1999),Pagell & Krause (2004), etc. Product Development – Autos & Software Examples Womack et al. (1990), Clark & Fujimoto (1991), Sanchez (1995), MacDuffie et al. (1996), Sobek et al. (1998), Adler (2005), etc., as well as the “iterative” literature discussed under “Pull” idea

29. My Examples • Manufacturing : Printed-circuit boards study, with some exploration of Toyota concepts (F. Suarez, M. Cusumano, and C. Fine, “An Empirical Study of Manufacturing Flexibility in Printed-Circuit Board Assembly,” Operations Research, 1996) • Product development: Scaling up flexibility of small, “autonomous teams” for larger projects (M. Cusumano, “How Microsoft Makes Large Teams Work Like Small Teams, MIT Sloan Management Review, 1997; A. MacCormack, M. Cusumano, C. Kemerer, and B. Crandall, “Trade-offs between Productivity and Quality in Selecting Software Development Practices,” IEEE Software, 2003; M. Cusumano, The Business of Software, 2004) • Strategy and entrepreneurship – Netscape (vs. Microsoft)(M. Cusumano and D. Yoffie, Competing on Internet Time,1998)

30. Lessons for Managers (Idea 4) • Flexibilitycomes in different forms and these can be powerful strategic levers • Rather than worrying about tradeoffs with efficiency or quality, use flexible processes and structures to enhance organizational effectiveness when dealing with change – in strategy, customer needs, manufacturing, product development, technology disruptions, and unforeseen opportunities for innovation

31. 5. Platforms, Not Just Products • (At least, for firms affected by digital technologies as well as “network effects”) should move beyond conventional thinking about strategy and capabilities to compete on the basis of platforms, or complements. • A platform strategy differs from a product strategy in that it requires an external ecosystem to generate complementary innovations and build “positive feedback” between the complements and the platform. The effect is much greater potential for growth and innovation than a single firm can generate alone.

32. “Platform” Intellectual History In-House Product Platforms & Product Modularity Meyer & Utterback (1993), Ulrich (1995), Sanchez & Mahoney (1996), Meyer & Lehnerd (1997), Baldwin & Clark (1999), etc. Standards & Dominant Designs to Network Effects Utterback & Abernathy (1975), David (1985), Farrel & Saloner (1986), Arthur (1989), Katz & Shapiro (1992), Shapiro & Varian (1998), Bresnahan & Greenstein (1999), etc. Multi-Sided Markets (Industry Platform + Complementors) Parker & Van Alstyne (2005), Eisenmann (2006), Evans, Hagiu & Schmalensee (2006), Eisenmann, Parker &Van Alstyne (2006), Yoffie & Kwak (2006), Adner (2006), etc.

33. My Examples • Platform leadership, based on Intel case study and comparisons, especially to Microsoft (A. Gawer and M. Cusumano, Platform Leadership, 2002) • Product vs. platform strategy (Sony and Apple vs. JVC and Microsoft) and how to turn a product into a platform (Google, Qualcomm, et al.) (M. Cusumano, Y. Mylonadis, and R. Rosenbloom, “Strategic Maneuvering and Mass-Market Dynamics: Triumph of VHS Over Beta,” Business History Review, 1992; M. Cusumano, “The Puzzle of Apple,” Communications of the ACM, 2008; A. Gawer and M. Cusumano, “How Companies Become Platform Leaders,” MIT Sloan Management Review, 2008)

34. Lessons for Managers (Idea 5) • Enormous differences between a product versus platform strategy – with equally enormous economic consequences for users and entire industry ecosystem • Four Levers: Scope of the firm, Product technology, External relationships, Internal organization • Even if multiple platforms persist, platform thinking useful for in-house product development as well as strategic marketing

35. 6. Services, Not Just Products • (Product firms, or services firms that offer standardized services treated as products) should use service capabilities and innovations to sell, enhance, and even “de-commoditize” product offerings or standardized services as well as create new sources of revenues and profits, such as an ongoing maintenance stream. • The goals should be to find the right revenue balance and then “servitize” products to create new value-added opportunities and “productize” services to deliver them more efficiently and flexibly, using information technology & service automation.

36. “Services” Intellectual History Definitions of Services versus Products Judd (1964). Rathmell (1966), Bell (1973), Levitt (1972, 1976) Theories of Service Innovation Barras (1986), Thomke (2003), Mansharamani (2007) Services/Servitization Strategies & Economic Value Teece (1986), Potts (1988), Bowen et al. (1991), Quinn (1992), Knecht et al. (1993), Gadiesh and Gilbert (1998), Nambisan (2001), Oliva & Kallenberg (2003), Slack (2005), Neely (2009) Computers and Software Industry Example Campbell-Kelly and Aspray (1996), Gerstner (2002), Campbell-Kelly (2004), Cusumano (2004), Campbell-Kelly and Garcia-Schwartz (2007)

37. My Examples • Rise of services among software product and computer hardware/systems firms (M. Cusumano, The Software Business, 2004, and “The Changing Software Business: From Products to Services,” IEEE Computer, 2008; F. Suarez, M. Cusumano, and S. Kahl, “Services and the Business Models of Product Firms: An Empirical Analysis of the Software Industry,” WP 2008) • How services and services innovation help product firms and platform leadership (M. Cusumano, F. Suarez, S. Kahl, “A Theory of Services in Product Firms,” WP 2008; F. Suarez and M. Cusumano, “The Role of Services in Platform Markets,” forthcoming in A. Gawer, ed., Platforms, Markets, and Innovation, 2009)

38. Software Products Business:Extreme Example of Innovation & Commoditization? • Massive Industry Consolidation!! • The data are clear • Decline of Enterprise Sales (or Prices?) • Only exceptions are hits & “platform” products? • Growth of Services & Maintenance Revenues • Freeware/open source driving prices to zero? • Customers rebel against costly products? • Emergence of New Business & Pricing Models  Software as a Service/Cloud Computing – cheaper products, bundled support/maintenance (Salesforce, Amazon)  Free, But Not Free, Again– supported by advertising (e.g., Google) or services (Red Hat), or multi-sided market (Microsoft & Adobe, Facebook et al.)

39. Public Software Product FirmsListed on US Stock Exchanges (SIC 7372)

40. Public IT Services FirmsListed on US Stock Exchanges (SIC codes 7370, 7371, 7373 for computer services, and mgt consulting IT services 8742)

44. Source: M. Cusumano, The Business of Software (2004)

45. DifferentS-Curve Dynamics –Product Platform Disruptions Generate New Services & New Business Models? Maturity Performance Platform Disruption New Services? New Business Models? Takeoff Ferment Time

46. Transaction-based Advertisting-based Subscription/Software as aservice Up-front license fee Bundled aspart of a hardware product Local ClientInstallation Local ServerInstallation RemoteWeb-based Remoteproprietary(e.g. hostedSAP) New Business Model Dimensions Revenue Model Free (revenuesfrom services Free but not free (bundled) Traditional  Delivery Model Mainstream consumers Early-adopter consumers Small businesses Mainstream enterprise customers Early-adopter enterprise cust. Customers Source: MIT student team K. Boppana, A. Göldi, B. Hein, P. Hsu, T. Jones (The Software Business, 15.358), 2006

47. Web-Based Enterprise Software Vendors Source: Andreas Goeldi survey (MIT master’s thesis, 2007) n=108

48. 89 Traditional  29 30 16 7 6 2 Source: Andreas Goeldi survey (MIT master’s thesis, 2007)

49. Software Product Firms and Other Research • M. Cusumano, F. Suarez, S. Kahl and students • Public software “products firms” -- Identifiedca. 500 (listed on US stock exchanges) under US SIC code 7372 – PrePackaged Software • Since 2003, downloaded data from Compustat, Mergent, and directly from 10K reports • Over 3000 yearly usable observations • Average 10+ years of detailed financial data from 1990 • Also now databases on all IT Services firms and S&P 1000 with products and services revenues

50. Excludes video games SaaS counted as product revenue Services include professional + maintenance Note: Services including maintenance (about 55% of services revenues for firms breaking this out)