Competition and innovation path selection

While the ‘one-dimensional’ view of next-generation product development (as in the quality ladder representation of NPD) yields excellent insights into the incentives to invest in R&D effort and into the evolution of market structure, it does not capture one of the most important dilemmas confronting firms in the new product planning phase – where should these efforts be directed? As one sifts through recent management articles and the trade press regarding innovation, one observes that the choice of which new product path to focus on is at the heart of what has been documented to separate winners from losers. For example, in the late 1980s firms in the disk drive industry, such as Seagate and Conner, were contemplating improving memory capacity versus reducing the size of drives (Christensen, 1997); recently firms in the cell phone handset market (Nokia and Motorola) faced a decision on whether to invest in the ‘candy-bar’ style of phones versus the ‘clam-shell’ design (Economist, 2004).

The decision regarding which new product opportunity to pursue is gov-erned by (a) how uncertain a firm is about the rewards to a given innovation path, (b) how uncertain the project is from the standpoint of developing the technology, (c) which path the rival will be taking, (d) what is the initial industry position of the firm. Each of these considerations impacts the risk-reward structure that the firm needs to consider. There is also the possibility of differences in firms’ assessment of the market potential or the techni-cal difficulties of each new product opportunity. Furthermore, the need to incorporate strategic interactions gives rise to other issues, such as whether to pre-announce the path pursued and whether to take more time upfront in market research or rush to develop. We discuss these issues as they relate to specific types of innovation path decisions firms face.

Risky or Safe Path? Different R&D projects can entail different levels of ex-ante perceived risk (as measured by the variance of the random reward).

The substantive question is, given two projects with equal expected return, when would a firm select the high risk–high reward project over the low risk–low reward project? Cabral (2003) studies this problem within the leader-follower paradigm by fixing the R&D budget. The safe path can advance a firm one step forward with certainty while the risky path can advance a firm two steps with some probability less than one; the second path is a mean preserving spread of the first but with greater reward variance. He establishes the conditions for the follower to prefer the risky path (an attitude of ‘having nothing to lose’) while the incumbent chooses the safe path.

Correlated or Uncorrelated Paths? The asymmetry in firm positions, leader-follower, also has implications for the degree of correlation in NPD paths that firms prefer. In a quality-ladder setup (each R&D success moves a firm one step up the ladder), if payoffs are concave as a function of the gap between firms (in terms of the number of steps that separate them), then

Handbook of New Product Development Management

the leader has more to lose from being caught up by the follower than from extending its lead (an attitude of ‘things can only get worse’). The leader prefers to choose a path that is correlated with the follower so that the cur-rent gap between them remains constant (since if both succeed they move concomitantly one step up). The follower, on the other hand, typically has a convex payoff in improving its state from lagging to being level. Hence, it prefers a path that is uncorrelated with the leader’s so that if it succeeds (and the leader fails), it can indeed catch-up (an attitude of ‘things can only get better’). If one path is more promising ex-ante, i.e., is more probable to succeed and hence yields greater expected payoffs, then Cabral (2002) shows that the leader will choose the more promising path while the follower the less promising but uncorrelated path. This will result in increasing dominance on average.

Innovation or Imitation? When considering market entry, a firm faces a decision between developing a product that embodies the same technical sophistication and features as in products currently offered by an incumbent in the market, vis-à-vis attempting to drastically improve on the current state-of-the-art. The innovation-imitation dilemma in some sense endogenizes the question of whether industry structure progresses in a leapfrogging or step-by-step fashion (see Fig. 3.3). Ofek and Turut (2007) examine how an entrant would decide between these paths while allowing the incumbent firm to innovate. They show that the likelihood of incumbent dominance follows an inverse-U shape pattern in the profit levels (duopoly and monopoly) and in the R&D cost factor – this pattern can only arise if the decision between innovation and imitation is endogenous.²¹Another interesting feature is that if the entrant conducts upfront market research (to resolve market uncertainty) – then the entry NPD strategy it pursues may reveal fully, partially, or not at all the information that it has obtained from the market research to the incombent.

In terms of linking back to the previous section: imitative effort can be regarded as developing a product that is close to an existing alternative in the attribute space or that offers a different combination of attribute levels that results in roughly equal profits from (2) (locating in Unoccupied Space). Dras-tic innovative effort can be regarded as significantly improving on an existing attribute(s) or offering a completely new dimension (Attribute Improvement or Pre-empting a New Attribute/Dimension).

Radical or Incremental? A radical product innovation has been classified as that which ‘incorporates a substantially different core technology and pro-vides substantially higher customer benefits relative to previous products in the industry’ (Chandy and Tellis, 2000). By contrast, incremental innovations

21 Interestingly, it is shown that in terms of R&D responsiveness, the incumbent has a reactive approach to R&D-increasing its level whenever it senses the entrant is inclined to choose a higher R&D level- while the opposite is true for the entrant.

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typically build on existing technology and offer only limited additional ben-efits. In the field of innovation, a question that has received much attention is whether to expect incumbents to undertake a radical versus incremen-tal path. Many accounts have depicted incumbents as being sluggish with respect to radical but aggressive with respect to incremental (Christensen, 1997; Henderson, 1993). Common reasons forwarded are: a desire to avoid cannibalizing existing development or marketing assets relevant only for the incremental path, too much focus on existing customers and their inabil-ity to articulate future needs as opposed to focusing on emerging segments, and internal information processing barriers that create a bias towards incre-mental NPD. The point made is that these firms may still invest heavily into R&D but that they direct their efforts towards the incremental rather than radical path. More recent literature, however, has shown that this view may have been based on only selective evidence. A more rigorous sam-pling of new product data reveals that incumbents are responsible for roughly the same proportion of radical innovations as non-incumbents (Chandy and Tellis, 2000).

Turut and Ofek (2006) have examined this topic from a novel perspective.

Assuming that firms are roughly equally competent in terms of development skills, they examine the implications of differences in market potential assess-ment. This is quite realistic; given the huge difficulty in predicting market acceptance for radical innovations, each firm will possibly receive a different private signal for market potential. Moreover, the reliability of such signals can differ across industry position; capturing the asymmetries described in the literature regarding the advantages or disadvantages to leadership in this respect (Jovanovic and Rob, 1987 versus Christensen 1997). Two prominent results in Turut and Ofek (2006) show that an incumbent firm might act counter to the private signal it receives regarding the market potential for rad-ical innovation: (1) if the entrant’s signal is relatively unreliable, then despite receiving a high signal the incumbent might still optimally decide to pursue incremental innovation – the reason is to avoid validating the high market potential to the entrant. (2) Conversely, if the incumbent’s signal is relatively unreliable, then despite receiving a low signal the incumbent might still pur-sue radical innovation – the reason is to be preemptive and avoid letting the entrant think that it is the only firm developing the radical innovation. In both cases, the end result is a less aggressive entrant. When the signal reliabilities of the firms are roughly equal, the incumbent acts on its signal (radical if signal is high, incremental if signal is low).

Linking back to the previous section: incremental innovation can be regarded as improving on an attribute(s) only to certain degree, and radical innovation as significantly improving on an attribute (that consumers place considerable weight on) or offering a completely new dimension (i.e., sig-nificant Attribute Improvement or Pre-empting a New Attribute/Dimension).

Handbook of New Product Development Management

Ex-ante firms might be uncertain about whether the new feature or dimension would be valued or whether consumers care enough about a huge improvement in a given attribute.

Which attribute to innovate upon? Study the market or speed to market?

In many NPD contexts, firms are aware of the possible features or attributes end-users might care about but are not sure which is more important ex ante.

Due to dis-economies of scope in R&D, it is often not economically viable to pursue multiple NPD paths and firms will have to choose a single path.²² Hence, firms need to decide upfront which attribute will be the focus of their innovative efforts. Moreover, firms may have an incentive to conduct upfront market research to resolve market uncertainty prior to making R&D deci-sions (direction and amount). This would correspond to the strategic desire to conduct Step 2 in the framework of the previous section. Lauga and Ofek (2006) examine these issues by looking at identical firms, thus eliminating any asymmetries in capabilities or industry position. They find that asym-metric equilibria in firm actions can arise, either in the decision to conduct upfront market research, the decision on which attribute to innovate upon, or both decisions. When market research costs are low, both firms conduct market research. Because they both discover which attribute is preferred by consumers, they choose the same NPD path. When at the other extreme market research costs are high, neither firm conducts such research. Here, an interplay between market uncertainty and technical uncertainty emerges:

under high development costs both firms choose the same NPD path, while under low development costs and high market uncertainty each firm chooses a different attribute to innovate upon.²³ When the cost of market research is in a mid-range, an asymmetric equilibrium emerges whereby only one firm conducts market research; reflecting the fact that the value of information on consumer tastes goes down when your rival possesses it as well (so at a mid cost level one firm forgoes market research). In this case, the firm that conducts market research selects a higher R&D level than its rival – this is because market research increases the marginal productivity of R&D effort by directing the effort to the higher reward. This asymmetric equilibrium can also hold if market research significantly delays launch. In this case, the firm that forgoes market research and speeds to market may invest more in R&D

22 Consider the decision between improving the passenger capacity or speed of airplanes. Boeing and Airbus made distinct decisions in this regard; Airbus went for capacity and Boeing for speed and fuel efficiency (Economist, 2002).

23 The intuition is that when development is expensive firms can only afford low R&D levels;

hence the likelihood that both firms succeed in their R&D efforts is low and each firm worries more about market uncertainty (which is common). When development costs are low the reverse occurs and firms worry more about launching identical products that compete fiercely and hence they differentiate.

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than its rival that takes the time to study the market. These results help under-stand under what conditions a firm that is more market oriented (by spending resources on learning about consumers; Narver et al. (2000)), is then more or less technology oriented (by spending more or less on R&D; Gatignon and Xuereb (1997)).

3. Limits to existing theory, directions for future