Business Strategy, Internet Industry, Product Management

Thoughts on Innovation At Established Companies

I spent two plus year working in an innovation group at my prior job and in earlier roles I’ve lead many new product efforts. These experiences have taught me about why many corporate innovation efforts fail. I’m not going to name the places where I’ve worked in this piece. While every organization has its specific challenges, this piece focuses on what I see as common challenges to that any organization pursing innovation.

There’s been much written on why companies miss disruptive shifts in their markets. Clayton Christensen’s The Innovators Dilemma is the seminal work in the genre. As much as I think The Innovators Dilemma is mandatory reading and its recommendations are strong, there are a series of more practical issues which that work and others in the genre do not address.

Venture Capital Exists For a Reason

Many new innovative products are financed through venture capital funding new companies. Venture capital is well structured for financing new innovations and established corporations are not.

One of the primary reasons is the power law nature of returns for new innovations.  Power law distributions have much fatter tails than the “normal” distribution. The main implication of the power law is home runs generate more return than the rest of the fund. Venture funds take a portfolio approach. If they invest in 50 companies, then the odds the home run are greater. To increase the size of their portfolio, venture investors almost always co-invest with other funds, broadening their portfolio.

Except for the largest corporations, it’s not possible to establish a broad enough innovation portfolio to have a decent chance of a home run as it takes too much money. Looking at venture funded companies, in general, it takes at least $50M in funding to get them to cash flow positive. For the home runs, levels of investment are often much much higher to fuel the growth necessary to capture the opportunity.

An established company running an innovation effort typically either does not have the level of funds available or is unwilling to spend it. As a venture funded startup goes through its Series A, B, C, etc financing rounds, its financial statements are showing a sea of red ink. Venture investors expect this. For a public company, this level of spending means lower earnings per share which for most companies is not tolerable.

The other alternative is boot-strapping, using a small amount funds up front and using profits to grow the business. We love a great bootstrap story but there really are not that many of them that generate large scale returns. Boot-strapped businesses, because they are capital constrained, tend to grow slower. With in an established company, the slower growth of a boot-strapping will often result in executives thinking it’s too small a business to be worthwhile.

Long Time Scales

The other area where established companies struggle with innovation efforts is the time frame of returns. Venture investors assume, on that average, returns are years away which is why their investment funds have 10 year lifetimes. Venture investors will set aside money for follow-on investment rounds knowing that it takes years and follow-on investment to build a strong business.

Most established companies lack this level of patience and typically expect to see large returns much quicker which typically is not possible. Even an exponential growth rate doesn’t yield big numbers early on. The returns of the new business always seem puny and irrelevant when compared to the firm’s existing businesses.

Risk Aversion

Startups by their very nature move fast and are willing to take risks. If a startup can not show progress and achieve milestones, it will be unable to raise the next round of funding. The greatest risk is not being able to raise the next round.

By contrast, established corporations, particularly publicly traded ones, are risk minimization machines. There are many high paid professionals whose job it is to reduce risk regardless if it reduces speed. Considering there’s more to lose, this is a rational mindset. But for innovation efforts, it can become a serious obstacle.

This obstacle rears its head when there’s risk of lawsuits or regulatory concerns. A start-up will see a 25% risk of a lawsuit or regulatory action as preferable to the 100% certainty of ceasing to exist if it doesn’t make progress. Extreme examples are Uber or Airbnb. It’s inconceivable to me that any established company could have built those businesses because of the risks involved. YouTube is another example. The risk of being sued for copyright infringement is too large for an established company to take on a nascent product.

Option To Give Up

One of greatest impediments to innovation efforts at established companies is that it’s too easy to give up. Being a risk minimization machine, an established organization will at some level see giving up as a good thing when obstacles and risks arise. Those employees working on the innovation efforts will be moved to some other project. The senior executives are spared the discomfort of having to explain a reduction in profitability or a new lawsuit on an earnings call. For the startup, giving up means shutting down or at least a pivot, both of which are painful.

The Technology Myth

At the core of innovation efforts is the belief that new technology is what will drive future business success. The problem with this belief is not that it values technology, but rather that it discounts all the other pieces that go into building a successful business. The ignoring all the activities a business must get right is a primary factor in dramatically underestimating just how much funding it takes to turn one of these ideas into a real business. The technology is the cheap part. Turning an early stage product into a real business which includes productizing it, marketing it, selling it which all gets expensive.

What Works Better

Given all these challenges, established firms are most likely to be successful with innovations that are connected or adjacent to their existing businesses. The first reason is there’s leverage from the existing business which both plays to the firm’s existing strengths and lowers some of the costs. In adjacent business, many of the assets of the company are valuable such as the brand, the sales and support operations and the channels to market.

The second reason is that executive leadership will be able to recognize the value being created. The most innovation famous story, one which has reached the level of myth in the technology world, is Xerox Parc which in the late 1970’s invented the future of computing but failed to see the value and commercialize it. Malcolm Gladwell has a great essay on Xerox Parc titled the Creation Myth.  Gladwell tells us there’s one innovation from Parc where Xerox recognized the value:

Meanwhile, the thing that they invented that was similar to their own business—a really big machine that spit paper —they made a lot of money on it.” And so they did. Gary Starkweather’s laser printer made billions for Xerox. It paid for every other single project at Xerox PARC, many times over.

This outcome is partially because Xerox could readily understand the value of laser printing because it was similar to their core copier business and partially because printers was a smaller leap to turn into a real business since many of the activities needed to be the copier business are also useful for the printer business.

The underlying goal of most innovations efforts to create a continuous pipeline of profitable new businesses. Note that a pipeline of profitable business is not what the professional venture investors try to achieve.  Rather they focus on the power law and look for the home runs. Pure innovation is not repeatable or predictable.  For better or worse, established firms want a repeatable process for new sources of profits.

The repeatable process for new sources of profits is a system for successfully moving into adjacencies. Cisco does this via acquiring smaller companies and then leveraging its salesforce, customer relationships and brand to increase the value of the acquired product. Acquisition is not an easy model as most acquisitions fail but Cisco has built strengths in acquiring and integrating so it can achieve a high success rate.

Amazon is another great example. Amazon started in books and has systematically expanded to new categories to the point where it covers a huge portion of the retail landscape. These category expansions leverage all the strengths that Amazon has built including its world class supply chain, fulfillment capabilities and strong brand. One of Amazon’s biggest flops was outside its core competencies, the Fire Phone. Amazon has also been successful at consumer electronics, most notably Alexa.

If you read this far, what I want to leave you with is that innovating is an unpredictable endeavor where failure is much more common than success. Established firms are on the whole not suited to this pursuit in areas disconnected to their core business. Even if an innovation effort discovers a great new technology, the constraints that established firms have mean they are unlikely to successfully commercialize it. Instead, established firms should build a system to move into adjacencies where they are most likely to be successful and can leverage their existing strengths and capabilities.

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Product Management

Prioritization for Product Managers

At Product Camp Silicon Valley 2018, I presented on the topic of Prioritization.   Prioritization is at the heart of what Product Managers do. In the talk, I looked at frameworks for prioritization, stepped back to talk about the big picture of value creation which is what product managers are trying to achieve with their prioritization choices and then talked about practicalities of prioritizing effectively.

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Product Management

Product Manager’s Guide to Dealing With Sales People

I spoke at Silicon Valley Product Camp 2016 on “Product Manager’s Guide to Dealing With Sales People”  This was my third year speaking at Product Camp and it’s always a pleasure to share what I’ve learned with the Product Management community.

Talk Description:

If your product is sold to enterprise customers, Sales is a key constituency for Product Management.  Effectively managing your relationship with sales people, whether they be account executives, sales engineers, or account managers, is an important component of being a successful PM.  In this presentation, I’ll address how to get competitive intelligence from sales, deal with common problems and create a roadmap that helps the sales teams.

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Business Strategy, Product Management

My Product Camp 2015 Presentation

I spoke on “Overcoming the Barriers to Building Great Products” at this year’s Silicon Valley Product Camp.  In this presentation, I look at how great products generate superior financial returns even though they have equivalent or lesser functionality to their competition.  I then present a hypothesis that building a great product requires making decisions that run counter to the quantifiable ROI requirements that almost every business endorses.

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Internet Industry, Product Management

The Problem With Uber’s Surge Pricing

Uber’s surge pricing causes a ton consternation among for its customers and while surge pricing is a theoretically correct economic response to a shortage, in practice it makes for service that doesn’t meet the all the needs that Uber is trying to fulfill. The idea behind surge is pricing is sound on paper: when there’s more demand than supply, the price should rise so that market clears. The alternative is a shortage which would mean long waits for an Uber, similar to how its difficult to get a taxi in a period of high demand. The problem with surge pricing is that it forces the customer to be in a spot market for transportation. A spot market is where a transaction is made for immediate fulfillment or in simpler terms, an Uber ride can only be bought when you need it and the price fluctuates so there’s no way of knowing in advance (say a day or even an hour before) how much you’ll pay.

Consumers do not like spot markets in general and most of the time, their transportation needs are predictable rather than of the moment. The number of commodities that the average consumer buys at spot prices is quite small. Ones that come to mind are gasoline and food products like milk, fruits, vegetables, and meat. The amount of complaining when gas prices rise is a good indicator of how much people dislike spot markets. There’s less complaining about food because there are many of substitutes. If the price of beef is high, one can always buy chicken or pork instead.

When it comes to transport, people avoid spot markets. When was the last time you walked into the airport and bought a ticket for plane departing in an hour? The problem with walking into the airport and buying a ticket is that the price could be very high. If there are few seats left, a flight that is usually $400 could be $1000. Since most of us rarely need to fly on short notice, we avoid the spot market and make a reservation in advance. If fares are high the weekend we want to fly to Vegas, maybe we go the next weekend or decide to take a road trip instead.

With Uber, we have none of these options since we don’t know what the price is going to be till right when we need the service. Say I bought an airline ticket for 4 weeks from now. I know 4 weeks in advance that I need transportation to the airport on a particular day and time, but if I want to take Uber, I have no idea what that will cost. If I open the Uber app and see it’s 3x surge pricing, I likely don’t have enough time left to take the bus instead. The same problem exists if I need to be a work at 9am tomorrow and my plan is to take is to take Uber. For much of most peoples transit needs, they know in advance when they will need transportation. That foreknowledge should be useful in making sure that supply and demand are balanced but with Uber, it’s not used at all.

With Uber, the riders are only one-half of the equation. If surge pricing worked as intended, drivers would see the high prices, start driving and increase the supply. For the supply to meaningfully increase, the number of drivers has to be elastic meaning that high prices need to actually significantly increase the supply. Uber drivers have a similar problem to riders in that they don’t know what the rates will be in advance. If an Uber driver is sitting at home in their underwear and watching re-runs on TV then 3x surge pricing might motivate them to put on some pants, get in the car and starting driving. However, if they made other plans or just decided to sleep in, then 3x surge has no effect on their willingness to provide rides. If they had known that it was going to be 3x surge pricing maybe they would not have agreed to go to brunch or stayed out late the night before but with Uber’s current system it’s all guess work. An experienced driver might know when surge pricing is likely and plan accordingly but if it’s unpredictable (either in time or amount), then potential increase in supply is limited to drivers who happen be sitting around doing nothing.

I don’t have access to data on how surge pricing affects supply. Uber certainly has this data but even under heavy criticism, they’ve never (to my knowledge) made any specific claims about how effective surge pricing is at increasing the number of drivers. Even without the data one could presume that if surge pricing was effective at bringing in drivers that surges above 1.5x would be rare as most people would not pass up the chance to earn 50% more than usual. In some geographies, 2x and greater surges are a common event.

New Year’s Eve is surge pricing at its most extreme. On NYE 2013, some riders were paying $500 for rides. Every business that is part of people’s New Year’s Eve festivities, especially bars and restaurants, raises prices on New Year’s Eve which makes sense because demand is so high and supply is fixed so it certainly makes sense that an Uber ride will cost more. Personally, I’m not a huge fan of New Year’s Eve and there’s an amount of income that would at least get me to consider driving for Uber on NYE. However, with the current surge pricing system, I don’t know what I’d make. While some revelers wouldn’t want to pre-plan what time they go home, I suspect many would prefer to book their ride in advance especially if it gave them certainty on the cost. I’m not going to give up my NYE’s because the earning potential might be good but is unknown and I suspect there are many people like me. Predictability would increase supply and make consumer better off.

Allowing reservations and still keeping an element of dynamic pricing so that supply and demand balance isn’t an easy problem. However if ride-sharing services are going to fulfill their vision of enabling people to not own cars, Uber or its competitors will need to create a method where prices are known in advance for transport needs known in advance. While surge pricing might be economically efficient in a purely economic view, that’s too narrow a way to look at the problem. From a product point view, there are customer needs not being met. If Uber can’t figure out how to tell people what it will cost them to get from point A to point B a week now, somebody will come into the market and meet that need.

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Business Strategy, Internet Industry

Strategy Lessons from Cloud Price Cuts

Google cut prices dramatically last week on it’s Infrastructure as a Service (IaaS) offering, Google Cloud Platform.   Amazon followed suit on Amazon Web Services the next day and cut prices to match Google’s price cut.  What business strategy lessons can we learn from these prices cuts and what can we predict about the future prices?

Commodity Products Compete On Price

Even though it takes both access to a large amount of capital and a high level of technical capabilities to run a large scale cloud provider, the cloud computing services especially compute and storage are a commodity as one providers offering is equivalent to another’s in the purchasers mind.  There’s little difference in a virtual machine from Amazon, Google or Microsoft Azure.

As cloud resources are undifferentiated products, it’s not surprising that Google is choosing to compete on price.  As a smaller player (in terms of cloud market share) hoping to take share from Amazon, Google needs to compete on price.  Other attributes such as reliability surely matter but there’s not enough difference for Google to effectively compete on those.

As is frequently the case when when one player cuts prices, the other players respond with their own price reductions.  Amazon responded by cutting prices to match Google for on-demand instances.  Interestingly, there’s a significant difference in pricing structure for heavy usage.  Google gives automatic discounts at 70% and 100% usage in a billing cycle.  Amazon is cheaper when using reserved instances but they require up front payment and thus the buyer loses the option to terminate or reduce usage with out penalty.  The reserved instance approach helps Amazon when comes to capacity planning but is less buyer friendly.

The other piece to note is that Amazon cut prices only on services where Google competes with them.   Amazon left prices alone on services that do not have a Google equivalent such as Dynamo DB or the RedShift data warehousing service.  Services where the competitors do not have competitive offering are differentiated and not a commodity.

What to Expect For Future Prices

For both compute and storage, we can expect costs to fall due to Moore’s law for processing and that hard drives get denser over time.  Even if data center costs stay flat, providers being able to get more yield for a given amount of rack space and power means costs will continue to fall.  The other question is will competition force lower margins over time?  If so, prices could fall faster than costs as competition drives margins and thus prices provider lower.

As providers show no signs of being able to differentiate offerings in cloud storage and compute, I expect prices to continue to fall.  With prices likely to fall, Amazon three year reserved instances become on a gamble since as realized price for Google’s offering may fall over enough over the next 3 years where it’s a better deal to use Google’s pay as you go price especially considering the flexibility to change or reduce consumption as needs change.

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Internet Industry, Mobile

Think Through Your Competitor’s Response Before Acting

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Google Maps Image

Whenever one is evaluating an action to improve or maintain their business’ competitive situation, thinking through the competitor’s likely response is a critical element.  I frequently see companies taking actions and not thinking about competitors response.  A classic move to increase competitiveness is to cut prices.  It’s a huge mistake however to evaluate your offering with lowered prices against your competitors offering with their existing prices.  There will be a new equilibrium once competitors respond to your action.  There maybe several rounds as some initially follow suit, and some wait and see and take action later.  But assuming there will be no response and predicting the outcome using that assumption is foolhardy.

A recent example is Google Maps on iOS.  According to many published reports, Google refused to offer Apple turn-by-turn directions in the Google powered iOS mapping application that was bundled with iOS 5 and before.  Google’s refusal was so they could keep turn-by-turn directions as an Android only feature.  In hindsight, this plan was a strategic blunder as Google  lost a 23 million iOS users as a result. Even in foresight, this was predictably a blunder since it failed to consider Apple’s likely response.  Was it really even possible that Apple would just accept this deficiency in their most profitable product line, the iPhone?  It wasn’t necessarily predictable that Apple would create their own mapping app as there were many companies they could have chosen another partner instead.  But what was predictable was that Apple was going to quit using Google as their mapping provider costing Google many million map users.  Even though Apple’s switch to providing mapping was rocky to a say the least, Google still suffered. And, Google’s response to Apple moving to their own mapping system? To introduce that same turn-by-turn direction feature they originally refused to provide on iOS.  Google had no choice but do so once Apple introduced their feature as losing the entire iOS user base greatly decreases the value of their local content.

It’s entirely possible there were other factors that lead to Apple’s decisions to no longer rely on Google maps which make it difficult to judge how big a blunder this was on Google’s part.  Apple may just not have been comfortable relying on a competitor.  But what is clear is that Google was never going to succeed in gaining any competitive advantage over Apple in the smartphone war by withholding any mapping features as Apple had alternatives for getting these features. The moral of the story is think through the likely response from your competitors when taking any action to boost your competitiveness.  If someone else is proposing a plan, ask them what the competitor’s likely response will be.  If you get a blank look, you know that they haven’t thought it through and their touted benefits are likely fantasy.

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Internet Industry

Does Apple’s secrecy help overcome the Innovator’s Dilemma?

Tonight I saw Adam Lashinksky speak about his book Inside Apple: How America’s Most Admired–and Secretive–Company Really Works.  As he was describing how Apple would erect walls inside its offices to keep projects secret , I realized this extreme level of secrecy solves a core part of the The Innovator’s Dilemma.  It becomes impossible  for one part of the company to impede the disruptive innovations of another when the first part has no idea what the second part is doing.  Other pieces of what Lashinksky described about how Apple operate,s including having being functionally organized rather than having multiple business units, helps keep Apple innovating rather than getting mired in protecting its current businesses.  But I’m wondering if the secrecy that was designed to keep information from getting outside the company also prevents Apple from getting it in own way.

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Internet Industry

Is streaming video a disruptive technology?

Reaction to Netflix’s decision to spit streaming video and DVD rental into separate business has ranged from awe to bafflement.   Clayton Christen who is the oracle when it comes to disruptive innovation says:

And while it’s always worrisome to disagree with a luminary like Clayton Christen, I’m not buying that streaming video is a disruptive technology for Netflix. The key element of a disruptive technology is that it’s performance is much poorer on some attribute that the incumbents dismiss it. Let’s looks at attributes of streaming vs. DVD:

Attribute Streaming Video DVD Advantage
Time to content 30 seconds minimum 2 days Streaming
Content Consumable in Month More than anyone should watch Limited by DVD mailing time Streaming
Video quality HD – depends on bandwidth Full 1080p with Blu-ray DVD
Equipment Needed Streaming enabled TV or Blu-ray player, Broadband internet DVD or Blu-ray player DVD
Payment model Subscription (or pay per at competitors) Subscription (or pay per at competitors) Draw
Cost $7.99/month $7.99 and up, depending on number of discs, Blu-ray Streaming

 

Streaming’s instant access alone means most people find it superior. Given the choice of the same content library and same price, most consumers (at least the ones with solid broadband connections) would opt for streaming.

Many would argue the content available on DVD is far greater so that’s a strong advantage for DVD. However, that’s not an advantage of DVD technology itself but rather an artifact of US copyright law. As a matter of technology, DVD and streaming are both capable of delivering the same content. And the limitation on catalog is not an issue for content producers who want to enter the streaming video market.

Incumbents like Amazon and Apple embraced streaming video quite early on. The TV studios have gone so far as to create their own service, Hulu. Television networks like ABC, NBC and HBO, all offer their content via streaming through their websites and iPad apps. Cable companies like Comcast offer extensive video on demand services. I’m hard pressed to think of an incumbent in the entertainment space who did not see streaming video coming and enter the market. Retailers without the resources and technical know-how of Amazon are the only ones I can think of.

Looking at the combination of streaming technology not seriously lacking in any performance attribute and most incumbents in the entertainment space already entering the streaming market, I can only conclude that streaming video is a sustaining technology and not a disruptive one at least when it comes to Netflix’s existing DVD business.  The cable and satellite TV business models of expensive packages of channels will experience declines as streaming grows and the reluctance to give up the large revenue streams that channel packages provide may cause the TV providers to move less aggressively into streaming content which is a disruption story.

Netflix’s decision to break streaming and DVD into separate brands services is a risky gambit due to the impacts I outline in my last post.  The rational for separating the pricing makes plenty of sense as content licensing costs will grow as Netflix expands it’s content library and as Bill Gurley points out, licensing costs may be driven by the number of subscribers.  But given that the disruptive technology story does not fit for streaming vs DVD, it’s hard to see how side-lining the DVD business is good move for Netflix’s customers or investors.

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