The Seismic Impact of Technology - Optimize Magazine

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The Seismic Impact Of TechnologySize alone can't help a company stave off threats from disruptive market forces. Technological innovations candestabilize any industry.

Illustration byJoyce Hesselberth

by Jagdish N. Sheth and Rajendra S. SisodiaFebruary 2002, Issue 22

The Eclipse 500 is the next big thing in small jet planes. In contrast to the current industry standard,Cessna's Citation--which seats eight passengers and costs $3.6 million--Eclipse Aviation's 500model will seat six and will cost less than $850,000. Thanks to an ultrasmall engine that weighs only85 pounds, the jet will be significantly cheaper to operate. Even better, it will fly almost as fast andas far as the Cessna. Though the Eclipse 500 won't be ready for takeoff until summer 2003, jet-setters already are lining up to place their orders.

The Eclipse is a great example of a new technology throwing an industry into a tailspin. Nocompany, regardless of its size, is immune to competitive market forces, and technologicalinnovations can rapidly destabilize any industry, no matter how solid it appears. Cessna is ownedby giant Textron Inc., while Eclipse is a startup created to commercialize NASA technology. Thelesson? Competitors that are relatively new and attack from below, as Eclipse is doing, poseformidable threats--even for market leaders. As business leaders well know, any technology thatprovides better price/performance will have an edge. But now IT executives are at the epicenter ofunderstanding these changes.

In many cases, big companies are even more vulnerable, and frequently they must scale back.General Motors has had such traumatic operational difficulties that it recently decided to discontinuethe venerable Oldsmobile line. Although these industry giants wield enormous power, they can't relyon their size, alliances, or command of the market to protect them from aggressive competitors andchanges in their industries.

Industries can be disrupted for a variety of reasons: regulatory shifts, changing consumer tastes,new investment trends. Technological change is among the most common instigators. Like anearthquake, such change can bring major upheaval and shakeouts to an industry, altering the mix

of competitors and the rules of competitive play. The disruption can be the result of productinnovation or of process innovation, in which technology improves manufacturing efficiencies.

Industries allowed to operate without excessive government restrictions--as is generally the case inthe United States--can maintain a relative degree of stability despite continual market entry, change,and growth. Disruptions that come from new technologies, however, can be immediate and deep,often eviscerating players whose foundations are weak.

IT executives need to learn and appreciate the dynamics of technology-induced market disruptionsand their business impact. The best way is to understand how their industry is structured, whatstage of evolution it has entered, and how that evolution is likely to continue. With this perspective,

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IT execs can cultivate strengths, formulate strategies to leverage their company's position, andmaximize the chances for success.

Some executives view themselves as masters of their universe, but forces beyond their control areconstantly changing the structure of their industries. Observing the laws of competitive markets willhelp set objectives that their companies can expect to meet and set strategies to avoid failure.

The rule of three

Left to their own devices--without outside intervention or government controls--industries evolve in afairly consistent pattern. After an initial shakeout, which could last from a few years to a fewdecades, three major players typically emerge in a given industry--what we call the "rule of three" inour new book. With startling regularity, the number of dominant companies in the vast majority ofindustries is confined to three, particularly in the United States where markets are more competitive.

Any other number is usually a temporary aberration.

The Big Three are familiar enough in the North American automobile industry: GM, Ford, andDaimlerChrysler. And there are plenty of other examples: ExxonMobil, Texaco, and Chevron among

petroleum producers; Philips, SCS-Thomson, and Siemens in the European semiconductor market;TRW, Equifax, and TransUnion among credit bureaus; Gerber, Beech-Nut, and Heinz in theproduction of baby foods; Merck, Johnson & Johnson, and Bristol-Myers Squibb among thepharmaceuticals. In the database industry, the Big Three are Oracle, Sybase, and IBM.

The emergence of the Big Three still creates opportunities for new entrants or incumbents withhighly focused strategies. This structure, with three dominant generalists and any number ofspecialists and niche players, offers good balance between efficiency and competition.

This state is likely to continue for some time, provided the companies inside a given industry satisfyall their stakeholders--employees, customers, and shareholders. To achieve that degree ofsatisfaction, they must deliver a high level of efficiency as well as continued growth.

If an industry stops delivering on these essential dimensions, its equilibrium degenerates intostagnation. At that point--facing collapse--either the industry transforms itself or someone outsidethe industry transforms it, often painfully. Microsoft, for example, transformed its product line fromMS-DOS to Windows and then moved Windows to the Internet.

When technological change jolts an industry, the market structure can tilt and rock, demanding tobe transformed from within. If the industry complies, the players have a chance to migrate to a newenvironment to survive. That's what happened in the consumer electronics industry when theincumbents moved to digital technology without a major upheaval in the ranks. Now that it hasevolved from VCRs to DVD players, the industry is moving from picture tubes to flat screens. If,however, an industry is unwilling to make the necessary adjustments, outside forces will gladly takeon the job. When nontraditional competitors enter an industry, as in the photography business,

where digital processing is replacing chemicals, many incumbents will struggle or die.

The forces for disruption can't abide the status quo. They ignite change regardless of the industry'ssize, power, or stability. They cause once-secure players to contemplate life on the brink and shiftthe balance of power. IT executives have to recognize the early warning signs of technologicaldisruptions and know when to take action.

Sudden technological change sometimes eliminates the market altogether or elevates a new set ofBig Three companies. Too focused on their own technologies, leaders may fail to recognizeemerging substitute technologies, such as electronic word processors replacing typewriters.

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On other fronts, radials revolutionized the tire industry, and digital switching transformed thetelecommunications business, opening the way for upstart Northern Telecom to move into aposition of global prominence in the 1980s. Last decade, another upstart, Cisco Systems, thwartedthe telecommunications industry again, enabling development of networks based on TCP/IP. Thechallenger, therefore, must always be prepared to move swiftly when threatened by newtechnology--much like Microsoft does when it quickly brings out its own version of software firstinvented elsewhere.

Typically, companies use information technology to transform their business by infusing intelligenceand other attributes into their products, or dramatically altering production and operating processes.For example, in the late 1980s, Yamaha revived a moribund piano industry by developing a digitalpiano that could play itself, teach a novice how to play, or serve as a traditional piano. As a result,Yamaha altered the core competencies in the industry, and many competitors that lacked therequisite technology were forced to exit. In fact, IT was central to Yamaha's successful strategy,demonstrating that to maintain leadership, IT executives need to determine how to move technologyinto the core of the new product if it isn't present.

In another example, the science of genomics is creating major upheaval in the pharmaceuticalindustry. Some say genomics will change the way medicine is practiced by bringing radically newtherapies to the marketplace. By focusing on the root causes of illness, genomics will eventuallylead to treatments customized to an individual's genetic makeup.

The genome--described as "the operating system for all of human biology"--is the focus of thegovernment-sponsored Human Genome Project begun in 1990 to analyze the 30,000 genesequences in the human genome. Expected to last 15 years, the project was completed in only 10years, about the same time that a competing company, Celera Genomics Group, announced it hadalso finished sequencing the entire human genome.

The mapping of the genome marks the beginning of a new competition to develop sophisticateddrugs that can target thousands of elements in the body, in contrast to today's drugs that addressabout 500 disease-related proteins. The new technology is expected to decrease the number ofone-size-fits-all blockbuster drugs and to increase the number of drugs tailored to the geneticmakeup of different groups of people. A drug that now generates $1 billon in sales could be

replaced with five drugs that generate $200 million each and are much more effective than theantecedent drug.

Millennium Pharmaceuticals, a genomics-centered company with the potential to become a majorplayer in the pharmaceutical industry, hopes to cut in half the time and cost of developing newdrugs. Along with other contenders, it stands to become a leader in the biotech industry, assuminggenomics shifts the balance of power from traditional drug companies to biotech companies.

Big pharmaceutical companies, meanwhile, are trying to modify their huge internal researchprograms to exploit the potential of genomics. However, the technology is so new and so differentthat small biotech firms and academic labs are seen as more likely to achieve breakthroughs inidentifying disease targets. To offset this disadvantage, many large companies are establishingalliances with small biotech firms. Bristol-Myers Squibb is spending more than 50% of its genomics

research budget on collaborations with small companies. Pfizer has agreements both with Celeraand with Incyte Genomics, a Celera competitor. It's a perfect example of large, establishedcompanies realizing their disadvantage in the development of new technology and joining forceswith the young upstarts to avoid being rendered dinosaurs in the industry.

Characteristics Of Corporate Strategies

High Deep Dialog scores correlate with more positive relationships throughoutthe organization.

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Linux and the Windows empire

In 1998, the Linux operating system, with its open-source development model, was relativelyunknown. A year later, its share of the market for server operating systems increased to 25%, morethan that of all competitors except Windows NT, which had a 38% share. In the market for desktopcomputers, Linux trails far behind Windows, but is poised to overtake Apple's Mac OS. By early2000, Linux's market share for Web servers had increased to 31%.

The Linux operating system is truly a disruptive technology, a major headache for Microsoft andother vendors. Linux could become the operating system standard for all kinds of computers, andeventually evolve into corporate data centers. Its popularity is based on several factors: It can bedownloaded for free; it works on any computer; it can be customized for an individual business; andit's highly stable. A version of Linux bought from vendors costs about $80, and it can be copied asoften as needed, whereas a Microsoft Windows 2000 upgrade costs companies $970 to $1,640 percomputer, according to Giga Information Group.

Although not every Linux company has been successful, IBM and others have embraced, ratherthan fought, Linux's surge in popularity, co-opting the disruption to their benefit. IBM has madeLinux available across every platform, including servers, mainframes, and desktop computers. Andnow other prominent companies have joined the movement: Compaq is building Linux-based

computers; Dell Computer uses Linux in its servers and is building Linux notebooks; and SunMicrosystems distributes a version for its workstations and servers. Several companies, includingIntel and Dell, have taken equity stakes in public and private Linux companies.

With the right management mind-set, incumbents such as IBM and Dell not only can survive wavesof disruption like that induced by Linux, but ride them to greater strength. Such companies arecapable of anticipatory management, foreseeing and shaping the future, and becoming changeagents, rather than the victims of the industry's renewal process. The impact on Microsoft isn't hugeyet, but it could grow or force Microsoft to adopt Linux.

The key lesson is that most markets are cyclical in their evolution, and strategizing must thereforebe done with time horizons spanning decades or more, far exceeding current planning norms. Inparticular, managers must constantly be on the lookout for technology-induced market restructuring

in addition to other drivers of change, such as regulatory and market shifts.

Many old-economy industries that are growing only at the rate of population growth are looking forways to trigger expansion. Electric utilities, which grow at little more than 3% annually, are focusingR&D efforts more on next-generation technologies, such as fuel cells.

For many industries, it's a matter of survival. They need to create and participate in the changes.The steel industry, for example, has belatedly organized to fight off threats from aluminum andplastics. Members of other industries form consortia to align with the next wave of change or to fightan external threat. In the mid-1990s, several cable TV companies formed Cable Labs to help them

Specialists Generalists

Focus on high margins Emphasis on service Target markets Focused channels Multibusiness

Innovative products

Focus on high volume Emphasis on product scale,speed Broad markets Hybrid channels

Integrated business Innovative processes

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move into data applications and voice telephony, even as some telecommunications companiescontemplated delivering video signals over their networks.

An industry can often grow by making obsolete the very thing from which it has profited. Cellularnetworks evolved from analog (AMPS) to digital technology (TDMA or CDMA in the United States;GSM in Europe and most of the rest of the world), and will soon evolve to third-generationarchitecture. Meanwhile, camcorders are moving from analog to digital technology. And thepharmaceutical industry, as noted, is now investing heavily in biogenetics.

Understanding the effect of technological innovations in an industry's market evolution is critical todeveloping successful strategies. Natural market structures do exist: Most industries, left to developwithout artificial constraints, reveal a complement of generalists and specialists, two groups thattypically don't compete with one another; each finds customers whose needs and desires it cansatisfy.

Tell-tale signs of industry shifts

Forward-looking companies can anticipate an impending shakeout by observing the leading

indicators of major change, including some that are industry-specific. In the PC software business,for example, sales of software development kits for a new operating system provide a strong signalof coming shifts in the industry.

For the majority of industries, generic indicators of major change, and possibly of an industryshakeout, include technology breakthroughs and a flurry of new-patent activity in a core technologyfor an industry.

The truth is, companies that are No. 1 in their industry are usually the least innovative, althoughthey may have the largest R&D budget. Among the generalists, the typical sequence in mostindustries is that No. 3 innovates, No. 1 copies (and therefore validates), and No. 2 follows. Thisholds true for both product and process innovation.

No. 1 companies should adopt a fast-follower strategic posture when it comes to innovation. Itseems radical and counterintuitive, but for No. 1 firms, the risks of innovating outweigh most of thebenefits the innovation brings. In 1966, marketing pioneer Ted Levitt wrote about the virtues of"innovative imitation," taking an existing idea and creatively expanding it. Evidence is growing thatthis is indeed a smart, if seemingly heretical, way for large companies to grow. Indeed, the imitatormust understand the innovation's application better than its creator does.

Management guru Peter Drucker suggested that creative imitation requires a fast-growing marketand is most appropriate for major products, services, or processes--the domains that put theinnovator at the biggest disadvantage vis--vis the market leader.

When a market is growing rapidly and the No. 1 company

is far ahead, the best strategy for a No. 2 company is tobe smart about how to clone the leader. This strategyworks best when the No. 1 company is constrained bysuppliers and unable to meet demand. In that case, theNo. 2 company can simply ride on the coattails of No. 1.

By far the most important requirement for success for aNo. 3 company is innovation, particularly in a way thatNo. 1 can't readily replicate. The competitor should neverforget that the No. 1 company is always looking to copywhat the No. 3 company has invented. IT executives at

The 1,2,3 Of Business Strategies

Here are some common strategies for eachof the top three leaders in any givenindustry to pursue.

No. 1 companies

Be a "fast follower" ininnovations Push for industry standards Use multiple distribution

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industry-leading companies, therefore, should alwaystake heed of what their counterparts at the No. 3company are up to.

In product innovation, successful No. 3 companies needto differentiate themselves quickly and visibly.

Accordingly, they should outspend the No. 1 players onR&D as a percentage of total revenue.

Meanwhile, market specialists must never stray fromsupplying products that customers can't find anywhereelse, at least not easily. It means always readyinginnovations and channeling assets into productive R&Dand proprietary technologies. For supernichers,exclusivity is the key to market dominance. Where there'soverlap with the Big Three, specialists can expect to loseout, chiefly because they can't match the generalists'prices or scope.

In a constantly changing market, it's critical to know how and when to act, and when to sit still. As

technology transforms more markets, managers have to reassess their corporate positioning andstrategic goals. For some, this will spell a once-in-a-lifetime opportunity to seize the initiative andfirmly establish their companies on a larger stage. For others, it will require hard thinking aboutstrategic choices and finding the courage to make painful decisions about markets not served andproducts not offered.

Jagdish N. Sheth andRajendra S. Sisodia are the authors ofThe Rule of Three: Surviving andThriving in Competitive Markets (Free Press, 2002).

Sidebar: The 90-Day Plan

Executives need to recognize the early warning signals of technological disruptions and know whento act and when to wait it out. As more markets are transformed through technology, executives willhave to reassess their corporate positioning and strategic goals. In this vein, they should take thefollowing steps:

Always be on the lookout for technology-induced market restructuring. Conduct periodicmeetings to share information with colleagues. If possible, designate an employee or employees tobe "market watchers" to report on such changes.

Regularly monitor your industry's leading indicators of major change. For example, in the PCsoftware business, sales of software development kits for a new operating system provide a strongsignal of coming shifts in the industry. Other indicators include technology breakthroughs, both

within an industry and in industries producing substitute products, as well as patent activity in a coretechnology for an industry.

Determine whether your company is a market generalist or a specialist. If the former, are youNo. 1, No. 2, or No. 3?

If you are No. 1 in your industry, consider adopting a "fast follower" strategic posture when itcomes to innovation--take an existing idea and creatively expand on it. For No. 1 companies, therisks of innovating outweigh most of the benefits the innovation brings.

channels Grow the market

No. 2 companies

Focus on value Topple or challenge the leader Close the efficiency gap

No. 3 companies

Innovate and differentiate Take calculated risks Promote vertical partnerships Seek horizontal partnerships

DATA: Rule of Three

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If you are a No. 2 company, clone the leader--ride on the coattails of No. 1 by emulating andimitating.

The most important requirement for success for a No. 3 company is innovation, particularly ina way that No. 1 cannot readily replicate. Differentiate yourself quickly and visibly. Plan to outspendthe No. 1 player on R&D as a percentage of total revenue. Pour money into new technologies, asSprint did with fiber optics. In addition, No. 3 companies should protect their innovations through

patents.

If you are a market specialist, never stray from supplying products that customers can't findanywhere else. Always develop innovations and keep channeling assets into productive R&D andproprietary technologies.

Sidebar: Watching The Watch Industry Evolve

The watch industry presents a fascinating study of many upheavals over decades, triggered bytechnological innovations and dramatic market shifts. The first agent of change was Timex. During

World War I, the U.S. Army asked the company to make the first wristwatches, and after World WarII, the company created the first inexpensive and highly reliable mechanical watch movement. TheTimex, introduced in 1950, was both cheap and rugged.

By the end of the '50s, Timex was selling a third of all watches in the United States. A decade later,the company launched the concept of the watch as a fashion accessory. In 1961, Timex challengedSwiss dominance by developing an unjeweled watch with pin-lever escapement. Timex decided toproduce what essentially was a disposable watch, one so inexpensive that customers would neverhave it repaired. The watches were sold in drugstores rather than jewelry stores, a strategy Swisswatchmakers failed to see as a threat. By the mid-1970s, Timex had sold more than 500 millionwatches and controlled half the U.S. market.

Because of a disruptive technology, the watch industry subsequently underwent a major upheaval:

a shift to electronics and the creation of solid-state digital watches. Texas Instruments and Casioentered the market, and U.S. companies controlled 75% of the fast-growing category before yetanother disruptive force made itself felt: Watches became commoditized. Prices in Hong Kong, fastemerging as a major production center, fell to $1.50 each, while traditional watches cost at least 10times as much.

Still another new development caused more havoc: quartz technology. In 1968, Seiko's earliestmodel, bulky and inconvenient, cost more than $1,000. Bulova contributed advances such as itstuning-fork controller used in the Accutron. By 1978, Seiko was the world's leader in the industry,with sales exceeding $1 billion, double those of its nearest competitor.

By 1980, the fall of Swiss watchmakers was precipitous, and by 1984, Japan and Hong Kong

dominated. All U.S. watchmakers except Timex disappeared in the 1970s--the result of disruptivetechnologies, coupled with fierce price competition from the Far East.

Yet another disruption rocked the industry in 1984, when Nicolas Hayek launched the $30 Swatch,a bold, plastic model that captured a broad share of the market. By 1992, 100 million Swatches hadbeen sold.

By the late 1990s, the Swiss regained worldwide market-share leadership while continuing to thriveat the high end. Brands such as Breguet, Pakek Philippe, and Rolex were at the top of the globalluxury-watch business. Prices for select models approached $500,000, and even the recession ofthe early 1990s didn't depress sales significantly.

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