New Entrants and Incumbents in the Face of Radical Innovations - Research Paper Example

Introduction Technological innovations are widely recognised as major drivers of growth in markets besides playing an important part in determining competitiveness among firms. Particularly, it has been observed that the platform offered by technology presents an opportunity through which new entrants may have a say in the market as it is often asserted that new entrants more typically introduce radical innovations than do incumbent firms. The accurateness of this statement can be studied through undertaking an inquiry into the evidence presented by various studies into it. Before this however, it is necessary that a background is given to establish the concepts of radical innovations and creative destruction alongside the basic differences between new entrants and incumbents in a market. This will then be followed by a conclusion on the statement arrived at from the study. The guiding thesis of this study is that due to several factors inherent to incumbents, they lag behind in introduction of radical changes in comparison to new entrants. Background Preussen (2009, pp. 9) defines innovation as the integrated processes involved in harnessing an invention into a commercial activity. On account of the nature and effects of innovations, they can be classified into two types; incremental or radical. The incremental or competence-enhancing innovations are those that build firmly upon the existing knowledge foundations of an established firm with the aim of improvement to achieve the firm’s objectives in profitability and customer satisfaction. On the other hand radical innovations, usually termed as competence-destructive, are those that are novel in the market and most commonly associated with new entrants and built upon novel knowledge or very new perspectives of existing market knowledge (Hill and Rothaermel 2003, pp. 258). Incumbents here refers to those established firms that are dominant in the market as opposed to New Entrants which are firms that are in the process of making headways into the market, either successfully or unsuccessfully. Incumbents versus New Entrants in Radical Innovation A number of studies, some experimental and others theoretical have been undertaken to establish the accurateness of the association of radical changes with new entrants while incumbents are more inclined to competence-enhancing innovations. This review of literature will take the structure of first analysing the evidence against this perspective and then move to the evidence supporting it. Anderson and Tushman (1990, pp. 604-633) undertook a study into the model followed in technological change on the basis of technological discontinuities and dominant designs. One of the hypotheses in their study which is of interest to this particular inquiry was that new entrants are associated with initiation of dominant designs that arise from competence-destroying technological discontinuities while dominant designs arising from competence-enhancing technological discontinuities are initiated by incumbents. For this specific hypothesis, the researchers identified five pioneering firms in the fields of minicomputers, cement, glass and containers where any other firm that introduced the new technology within the same year as the fifth company was included as an early adopter. To differentiate new entrants from incumbents, any firm that sold its first item following this discontinuity was considered a new entrant while all those which had already been in the market before the technological discontinuity were considered incumbents. The results indicated that it was incumbents that led the way in introduction of competence-enhancing (incremental) innovations with a higher than 3:1 ratio in comparison with the new entrants. More new entrant firms featured among the pioneers of competence-destroying innovations but this was however not statistically significant hence the hypothesis was rejected. The researchers concluded that perhaps the role of the new entrants in creative destruction was only initiation which effectively made old technology obsolete but then the new innovation was stabilized in the market by the incumbents hence giving them a say in radical technology. This study however, as the researchers themselves reckon, was based on a small sample size and population (small set of industries), hence these findings need to be confirmed or refuted through a larger sample study that would guarantee higher statistical power. Tellis and Sood (2005, pp. 152-168) undertook a study into technological evolution and radical innovation where one of their main objectives was to establish the source of platform changes in technology (which they define as distinctly new technology). Data was collected from journals, industry publications, white papers from research and development departments and industry associations. To create another dimension for interpretation of the source of platform changes in technology in the market, they introduced size of the firms being studied as a variable. Their results indicated that out of 14 platform changes, only one was introduced by a small new entrant, seven were introduced by large incumbent firms, six by large new entrants and none by small incumbents. The researchers appreciated that this was in departure from the traditional view that most radical technological innovations originated from new entrants and explained that this may be due to shifts in the technology aspects as they have become more complex in recent times which translates to the need of large capital ventures only available at big firms (considering small incumbents contributed no radical changes). It should be noted however that incumbents and new entrants regardless of size contribute to 7 platform innovations each in this study hence the dominant source of radical innovations cannot be established in this case. A third study that indicates that incumbents are now increasingly playing a considerable part in radical innovations is one that was undertaken by Czarnitzki, Dick and Hussinger (2010, pp. 1-49). They first appreciate that new entrants do have it easier in establishing competence-destroying technologies but then bring in the concept of corporate ventures which incumbents are utilising to contribute significantly to radical technological changes in the market. Corporate venturing involves setting up autonomous or semi-independent units by an incumbent firm. These established corporate ventures bear no constraints resulting from forces of inertia and thus can react quickly and flexibly to opportunities of technological innovation. Furthermore, these corporate ventures are backed by huge financial capabilities from the incumbents and are hence at a better position to pioneer radical innovations. The study analysed 2,500 ventures consisting of new entrants and corporate ventures. The results of the study indicated that corporate ventures contributed more to radical innovations in comparison to independent new entrants hence translating to more radical innovations by incumbents in the market. However, as the researchers note, a critical balance is needed for the success of corporate venturing since full autonomy alienates the venture from the incumbent in terms of commonality of strategy, objectives and direction while monitoring and interference from the incumbent inhibits development of radical innovations as the inertia of the incumbent is transferred to the corporate venture. Due to the latter reason, it was observed that the corporate venture’s contributions to radical innovations in the market declined with a more concentrated form of ownership structure. In support of the view that new entrants are more inclined to offer radical innovations in the market, Teece (2010, pp. 172-194) discusses the case of Dell’s, Netflix’s and Google’s entry into their respective markets. To begin with Dell, adoption of a strategy of selling directly to customers was a departure from the traditional distribution systems practiced by incumbents in the processor markets. This is a case of strategic innovation where Dell chose to sell its computers directly to consumers resulting in faster sales and better services in comparison to the incumbents. It was difficult for the incumbents to establish similar undertakings since it would definitely upset existing distribution partners and also prove cannibalistic to their already established distribution strategies, problems which were absent in Dell’s case since the firm was an entrant. Similarly Netflix which is the current market leader in the movie rental industry established a new strategy based on online subscription to movies which was in departure to the incumbent’s (Blockbuster) strategy of in-store movie rental business model. Although Blockbuster did try to adopt the radical innovation in strategy, it could not find back its way into market leadership mainly because adoption of online movie rental was cannibalistic to its in-store rental system. Netflix managed to take over the industry and hold onto its position since it was the pioneer of online movie rentals and had no worries of upsetting existing strategy. Google’s case was also revolutionary in terms of how search engines function and the business model behind them, where it pioneered web ranking and value addition to the search experience and overthrew the incumbents upon entry. The three cases; Dell, Netflix and Google are manifestations that new entrants are capable of radical innovations in strategy that give them a competitive edge upon entry into the market in comparison to incumbents. Spencer and Kirchhoff (2003, pp. 1-9) describe extensively the positions of New Technology-Based Firms (NTBFs) and incumbents in creative destruction. The researchers explore several cases in which NTBFs contributed to new and radical innovations while incumbents were more preoccupied with competence-enhancement. For example, new entrants into the semi-conductor industry pioneered most of the new technology while the incumbents were inclined to strive for process innovations that increased manufacturing efficiency. Moreover, such firms were observed to have been only creatively destructive during their early years of existence. An area that has seen creative destruction from new firms unparalleled and unachievable amongst incumbents was in the computer world, where new entrants revolutionized the industry through the personal computer while incumbents stuck with the desktop. As a result Control Data Inc., Digital Equipment Corp., Data General and Prime Computer all of which were market leaders and had virtually unassailable advantages in the computer world became extinct, replaced by Apple, Dell, Gateway and HP-Compaq. The only remaining incumbent from then is IBM, which was sold out to Lenovo. The pharmaceutical industry is another area experiencing creative reduction exhibiting decline of traditional incumbents and advent of new entrants. Chemical-based pharmaceuticals and improvements upon these are the mainstay of incumbents. They however now have to contend with new entrants who have adopted radical innovations based on biology, genetics and even nanotechnology which threaten to wipe out incumbents since such innovations are not in line with their development strategies. Christensen, Scott and Roth (2004, pp. 99) undertake a study into the concept of disruptive innovation versus sustaining innovation. They describe disruptive innovation as the innovation which is brought forth by new entrants into a market usually simple, full of convenience and costing lower with the aim of dislodging incumbents from their positions of market leadership. Incumbents on the other hand may retaliate through sustaining innovations which essentially are competence-enhancing on the already existing technologies. Such sustaining innovations may include increasing durability, speed and reliability of already existing items. The authors are however of the opinion that disruptive innovations ultimately prevail over sustaining innovations, sometimes leading to the demise of the incumbent firms. Some of the demonstrations for new entrants’ disruptive innovations include the steel mini-mill by Nucor, discount retail stores by Wal-mart, index mutual funds by Vanguard and Dell’s direct customer interaction approach. Disruption by these technologies may be due to highly developed incumbent products that are overpriced hence creating an opportunity for low-end innovative disruption. Alternative channels of consumption that may require little expertise or bear competitive pricing in comparison to incumbent’s products which make disruptive innovations manifest as can be demonstrated by the Kodak camera, the transistor radio by Sony, Xerox photocopier, the PC by Apple and the web-marketing model established by e-bay. All of these innovations offer consumers alternative convenience in a manner different from incumbents. Factors that Discourage Incumbents from Radical Innovations Several explanations have been put forth to detail the reasons behind failure of incumbents to undertake radical innovations. Hill and Rothaermel (2003, pp. 259) give one of the reasons for this observation of incumbent inflexibility in the face of radical innovation to be economic factors. Incumbents already enjoy market power and would wish to place considerable entry barriers to the market through further developing the products that consumers favour, thus focus on incremental innovations. Besides, radical innovations may ultimately prove cannibalistic to the incumbent’s already established products and strategies. Another reason on the economic front is based on the fact that radical innovations are accompanied by uncertainties to which incumbents are unwilling to commit capital. Organisation theorists explain on the other hand that established firms have to maintain structure and reliability in society, which in turn leads to formalization and bureaucracy that does not offer a fertile ground for radical innovations. A third explanation is based on a strategic viewpoint where established firms usually find themselves deep into a relationship network of suppliers, consumers, partners, complementary firms, investors and the wider community among other market stakeholders. Radical innovations have the capacity to disrupt this orderly setting and place the incumbent in unknown territory, hence such firms would rather keep to this strategic positioning and relationship since it is the major factor behind most of their success. Preussen (2009, 6-7) contributes more insight into the matter explaining that established firms are often in lack of capabilities in entrepreneurship prerequisite for innovation besides facing considerable difficulties in new environments that may result from innovation due to their large sizes and bureaucratic nature. Henderson and Clark (1990, pp. 24) provide the example of firms in the Optical Photolithographic Alignment Equipment industry to provide an explanation of how established firms fail at pioneering or adopting radical technology. The firms exchanged the position of market leadership amongst themselves and with new market entrants over many years with each firm unable to pioneer radical innovations during its period of market dominance. In each case, the incumbent did heavily invest in research into the next generation of equipment but failed in development of radical innovations thereby losing out to entrants. The explanation for this was that in most cases experiential knowledge from previous generation devices interfered with the incumbents’ appreciation of the critical aspects of the new technology hence their product was an improvement on existing technology rather than being new. In essence, they lost out to quality radical innovations from entrants. The Way Out For Incumbents Preussen (2009, pp. 10-30) explores the entire aspect of corporate venture capital as a practical way through which incumbents can undertake radical innovations without facing the barriers explained earlier. Such ventures can occur through seed, start up or first stage investments to an entrepreneur depending on the format of ownership the incumbent is interested in. Corporate venturing can occur either internally or externally; internal venturing involves setting up an organisation’s own venture management team or developing internal entrepreneurship. Externally, venturing may occur in the form of corporate venture capital, venture alliances and transformational arrangements. Most commonly corporate venture capital is undertaken, involving third-party funds, dedicated funds or self manage funds. Conclusion Innovation may take two avenues; competence-enhancing or competence-destructive, where the former is associated with incumbent firms while the latter is associated with new entrants. Most of the evidence available accompanied by efforts by incumbents to undertake venturing is in support of the view that incumbents are to a large extent unable to undertake radical innovations as compared to new entrants. Some of the reasons for this include the fact that it disrupts the delicate relationship with stakeholders that incumbents have already established besides being cannibalistic to existing strategies and items. Corporate venturing is a practical way that enables incumbents to overcome these challenges and take part in radical innovations. Despite efforts to indicate that radical innovations can be undertaken by incumbents on the same scale as new entrants, the evidence in existence tips the balance towards new entrants, whereas incumbents’ dominance on competence-enhancing innovations is not in question. References Anderson, P & Tushman, ML 1990, “Technological discontinuities and dominant designs: A cyclical model of technological change,” Administrative Science Quarterly, Vol. 35, No. 4, pp. 604-633. Christensen, CM, Anthony AD & Roth, EA 2004, Seeing what’s next: Using the theories of innovation to predict industry change, Harvard Business Press, USA. Czarnitzki, D, Dick, MH & Hussinger, K 2010, “The contribution of corporate ventures to radical innovation,” Center for European Economic Research, Vol. 10-060, pp. 1-49. Henderson, RM & Clark, KB 1990, “Architectural innovation: The reconfiguration of existing product technologies and the failure of established firms,” Administrative Science Quarterly, Vol. 35, No. 1, pp. 9-30. Hill, CW & Rothaermel, ST 2003, “The performance of incumbents firms in the face of radical technological innovation,” Academy of Management Review, Vol. 28, No. 2, pp. 257-274 Preussen, A 2009, Corporate venture capital and innovation: An investigation of the relation between CVC and innovation, University Maastricht, Switzerland, viewed 18 October 2011 from http://arno.unimaas.nl/show.cgi?fid=16895 Sood, A & Tellis, GJ 2005, “Technological evolution and radical innovation,” Journal of Marketing, Vol. 69, pp. 152–168 Spencer, AS & Kirchhoff, BA 2003, “Schumpeter and new technology based firms: Towards a framework for how NTBFs cause creative destruction,” IEMJ, New Jersey, 1-19. Teece, DJ 2010, “Business models, business strategy and innovation,” Long Range Planning, 43, pp. 172-194. Read More