Innovative Strategies That Change the Nature of Competition

Studying this chapter should provide you with the knowledge to:

1. Discuss innovative strategy and the differences among the types of innovation.
2. Identify the different categories of innovative strategies.
3. Describe the accelerating pace of innovation and the product, business, and industry life cycle.

In 1998 Larry Page and Sergei Brin launched Google, a search en- gine that allowed users to search the world wide web for infor- mation. Google used a page-ranking algorithm that worked like academic citations—the more people selected a website page to be viewed, the higher it ranked in the search algorithm. Google quickly became dominant in web searching and began generating revenues using a “free” third-party-pay revenue model. Compa-

nies paid Google to advertise to their users while they were en- gaged in a web search. If the user typed in “ski,” then companies selling skis, ski boots, ski gloves, ski vacations, and so forth would pay to advertise to that particular user. Advertisers were willing to pay more for this type of targeted advertising to customers. In- deed, one study in 2009 revealed that Google made $15.96 per unique user per year compared to Yahoo’s $11.06, Facebook’s
$3.50, and Skype’s $1.60.1 By the end of 2018 Google’s parent company, Alphabet, realized revenues totaling $136.8 billion2 and had achieved a market value of $740 billion,3 one of the highest market values of any public company. Google’s only real chal- lenge in web search had come from Microsoft when it launched Bing in 2009. But even with Microsoft’s vast resources, Bing had only managed to capture 3.4 percent4 of the market. Google’s po- sition in search seemed secure.
But in 2011 Apple launched Siri on its iPhone, an intel- ligent voice assistant that allowed users to simply ask for in- formation, and Siri would provide it via voice or a digital docu- ment. This initiated an innovative approach to web search, allowing anyone to search the web using voice commands. Then in 2014 Amazon launched Alexa, its intelligent voice assistant that came with an echo speaker. The inspiration for Alexa was

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the Star Trek voice computer that would respond to Captain Kirk’s various requests. “Our vision is that it would become like the Star Trek Computer,” says Amazon CEO Jeff Bezos, a big Star Trek fan. “You could ask it anything, and ask it to do things for you—ask it to find things for you—and it would be easy to con- verse with, in a very natural way.”5 But Alexa wasn’t just designed to search for information; it was designed to be the hub of the “connected home.” Alexa could be used to control lights, ther- mostats, appliances, security systems, and more. And, of course, it could be used to order products directly from Amazon. Following closely behind Amazon, Microsoft launched its intel- ligent voice assistant, Cortana, in 2015. The emergence of Siri, Alexa, and Cortana ushered in a new era of competition for Google in search.
Google quickly responded to Amazon Alexa with its own digital assistant speaker called Google Home. Google’s digital as- sistant could be used not only on Google Home smart speakers but also on Android phones and laptops offered by Google (e.g., Pixel) and other consumer electronic companies like Samsung and LG. “On voice search, we are really excited about it,” Google

CEO Sundar Pichai said. “It’s a very natural way for users to inter- act. And for voice, we expect voice to work across many different contexts. So we are thinking about it across phones, homes, TVs, cars, and you know, trying to drive that ecosystem that way. And we want Google to be there for users when they need it.”6 Pichai understood that Google needed to succeed in voice search be- cause by 2020 estimates projected that 50 percent of all searches would be voice searches. But it wasn’t going to be easy. Alexa had captured 66.7 percent of the smart speaker market, compared to
29.5 percent for Google Home.7 Moreover, both Apple, with Siri, and Microsoft, with Cortana, were poised to continue to make sig- nificant investments to be relevant in voice search. Voice-activated artificial intelligence had ushered in a new era of competition that raised a number of questions for Google and CEO Pichai. How would voice search affect the revenues and profits of Google web search? What actions would Google need to take to catch Alexa in the race to control the connected home? Would the availability of Google’s voice assistant on phones, laptops, and other devices provide an advantage relative to Alexa that was not as accessible on phones and laptops?

The opening case illustrates how Amazon (Alexa), Apple (Siri) and Microsoft (Cortana) used an innovative voice-activated search technology to challenge Google in the web search business. Innovation is a powerful driver of competition and competitive advantage. New entrants, in particular, have strong incentives to offer different value propositions than incumbents—and preferably in a way that is hard to imitate. Strategies that offer a different value proposition to customers using different resources and capabilities are often referred to as “innovative strategies,” “revolutionary strategies,”8 or “disruptive innovations.”9 Famed economist Joseph Schumpeter argued that competition is a process that is driven by the “perennial gale of creative destruction.”10 Innovative products and strategies—such as the ones launched by Amazon and Apple—simultaneously create and destroy value. This is what makes strategy a dynamic pro- cess. The strategy that worked yesterday might not work today—and what works today might not work tomorrow. Consequently, companies must be able to innovate and change in order to weather the storms of creative destruction that will certainly come their way. The primary focus of this chapter is to examine innovation-based strategies—that prove to be revolutionary or disruptive in their industries.

What Is an Innovative Strategy?

invention The creation of an idea or method; a novel concept.
innovation The conversion of a novel concept (an invention) into a product, process, or business model that generates revenues and profits.

To understand innovation, it is first important to understand the difference between an inven- tion and innovation. Invention describes the creation of a unique or novel concept, method, or process that is often turned into a tangible outcome—such as new product. An innovation is the conversion of a novel concept (an invention) into a product, process, or business model that generates revenues and profits.11 Innovation differs from invention in that innovation refers to the use of a novel idea or method, whereas invention refers more directly to the creation of the idea or method itself.12
For example, the scientists at Xerox PARC (Palo Alto Research Center) invented the com- puter mouse as a new way to navigate a computer. This invention would allow users to select from images and menus on a computer monitor through a graphical user interface (GUI). But it was Steve Jobs and Apple computer who launched the Macintosh computer—the first commer- cialized microcomputer that came with a mouse and graphical user interface. Apple’s Macintosh

FIGURE 10.1 Definition of Innovation

turned Xerox’s invention into an innovation that could generate revenues and profits. In similar fashion, the Wright brothers invented the airplane at Kitty Hawk, but Boeing and others com- mercialized the idea by designing and building commercial aircraft that could be sold as prod- ucts. As shown in Figure 10.1, an innovation needs to be (1) novel, (2) useful, and (3) successfully implemented in order to help companies succeed in the marketplace.

Incremental Versus Radical Innovation
Innovation enables firms to deliver value in new ways. Innovations fall into two general catego- ries: incremental innovations and radical innovations. An incremental innovation builds on a firm’s established knowledge base and steadily improves the product or service it offers.
For example, when Gillette offers a razor with five blades instead of four, or when Samsung offers a TV with an LED screen instead of a plasma screen, those are incremental innovations. In similar fashion, when any company makes incremental improvements to their operations to accomplish a task faster, better, or with fewer resources, these are also incremental inno- vations. Incremental innovations are also sometimes called “sustaining” innovations because they sustain a company’s current product offering and revenues.
In contrast, a radical innovation draws on a different knowledge base, technologies, or methods to deliver value in a truly unique way. Examples of products based on radical innova- tions include the computer (versus the typewriter), CT scanner (versus the X-ray), cell phone (versus the landline phone), and MP3 player (versus the CD player).
Processes can also be based on more radical innovations. For example, Toyota engineer Taiichi Ohno developed a set of flexible production techniques, often referred to as lean man- ufacturing, that minimizes inventories and waste despite being designed for rapid product changeovers.13 This system of production was significantly different from the mass produc- tion system developed by Henry Ford that was based on standardization, significant automa- tion, and few product changeovers. Toyota’s deployment of its “flexible” or “lean” production system has helped it produce high-quality cars at low cost and propelled it to worldwide lead- ership in the automobile industry.
Strategies that draw on more radical innovations often use new technologies or employ a fundamentally different business model than rivals, meaning they create, deliver, and capture value through very different resources and capabilities. As illustrated in the open- ing case, Alexa and Siri use voice-activated search, enabled through artificial intelligence, to deliver information in a radically different way than Google does when someone types in a web search. Amazon Alexa is embedded in echo devices which are distributed largely by Amazon or

incremental innovation Building on a firm’s established
knowledge base to create minor improvements to the product or service a firm offers.

radical innovation Innovation that draws on a different knowledge base, technologies, or methods to deliver value in a truly unique way.

innovative strategy A strategy that introduces a fundamentally different business model
than rivals.

revenue model The approach, or pricing strategy, a company uses to get paid for the value it delivers through its business model.

Best Buy—a very different distribution channel than Google Search. This chapter focuses on
innovative strategies that are based on more radical innovations.
We define an innovative strategy as a strategy that introduces a fundamentally different business model than rivals. The term business model refers to the rationale of how an organiza- tion delivers and captures value. More specifically, business models typically differ on one of three dimensions:

1. The choice of customer segments to serve and the unique value (value proposition) offered by the company
2. The choice of activities the company performs and the resources used to deliver value to customers
3. The way a company generates revenue streams to get paid for the value it delivers. The term revenue model is sometimes used to refer to the approach, or pricing strategy, a company uses to get paid for the value it delivers through its business model (see Strategy in Practice: Understanding Business Models)

Strategy in Practice
Understanding Business Models bookstores. But this means that Amazon’s value proposition is dif- ferent, as are its primary customer segments. Amazon’s primary
Over the past few years, the term business model has often been customer segment prefers the lower prices that Amazon offers, but used to describe a company’s strategy. Perhaps the most compre- it also likes the convenience of shopping from computers or cell
hensive approach to defining a company’s business model has phones. In contrast, B&N’s customers like the ability to get their books been developed by Alex Osterwalder and Yves Pigneur in their tool, immediately and may enjoy the shopping experience at a B&N store. the business model canvas.14 They argue that there are nine compo- To deliver their value propositions through the distribution channels nents to a business model, and firms can innovate by changing one they’ve chosen, each firm must be good at different activities and have or more of those components as they seek to deliver and capture different resources. For example, Amazon needs to be good at writing value. The nine components are: software and fulfilling orders from warehouses, whereas Barnes &

1. Value propositions. A firm seeks to solve customer problems Noble has to be good at finding the best locations for its stores,
   and satisfy needs with a particular unique value or value designing stores to create a great shopping experience, and efficiently proposition. operating each store. Amazon and Barnes & Noble are described as
2. Customer segments. The value propositions are designed to having different business models because they differ on most, if not
   meet the needs of one or several customer segments. all, of the nine components of the business model canvas.
   In some cases, firms deliver similar value to similar customer
3. Channels. Value propositions are delivered to customer seg- segments—and might even use similar resources and capabilities ments through communication, distribution, or sales channels. to deliver value—but they may differ in their pricing strategy or their
4. Customer relationships. Customer relationships are established approach to generating revenues streams and capturing value. For and maintained with each customer segment. example, Apple, Spotify, and Pandora use different revenue models or
5. Revenue streams. Revenue streams result from value proposi- pricing strategies to generate revenue streams. Apple makes money tions that are successfully offered to customers through pric- primarily by selling songs and albums over the Internet for a specific ing strategies. price. In contrast, Spotify provides consumers with unlimited access
6. Key resources. Key resources are the assets required to offer to all songs in its library for a monthly subscription fee. Pandora uses
   and deliver the company’s value proposition. a “free” revenue model like a radio station, and provides songs via the
   Internet that are tailored to a listener’s preferences. Pandora makes
7. Key activities/capabilities. Value propositions are developed money by selling advertising.
   and delivered through key activities or capabilities. Companies sometimes attempt to change their business model
8. Key partnerships. Some resources and activities that are criti- in response to competition. For example, Barnes & Noble added the cal to delivering the value proposition are outsourced to part- online book retailing business model to its bricks-and-mortar book- ners outside the company. store business model in response to Amazon’s entry into book retail-
9. Cost structure. The business model elements above result ing.15 In similar fashion, Apple launched iTunes Radio in 2013 to directly in the cost structure for delivering the value proposition to compete with Pandora.16 In this way, it has imitated Pandora’s business the customer. These costs must be covered by the revenue model including the revenue model for capturing value. In most cases, streams in order for a firm to be profitable. the company that is first to launch a business model has a first-mover
   advantage because it becomes known as the pioneer. In order to suc-
   To illustrate, Amazon has a different business model than cessfully compete with pioneers, second movers must offer unique val- Barnes & Noble (B&N), with the most obvious difference being ue relative to the first mover—for example, lower prices, more features, channels—Amazon sells books over the Internet rather than through or greater convenience—to lure customers in their direction.

• Value Chain Reconfiguration to Eliminate Activities
• Low-End Disruptive Innovations
• High-End Disruptive Innovations
• Value Chain Reconfiguration to Allow for Mass Customization
• Blue Ocean Strategy—Create New Markets by Targeting Non-Consumers
• Create a Platform to Share Assets
• Free Business Models
FIGURE 10.2 Categories of Innovative Strategies

Innovative strategies based on radical innovations are sometimes referred to as disruptive innovation because companies in the same industry find the innovation so disrup- tive that they can no longer do business as usual.
For example, when Netflix introduced an innovative way for customers to access home entertainment, it “disrupted” Blockbuster’s strategy, and Blockbuster could no longer succeed by doing business as usual. Innovative strategies are disruptive when they offer value that is attractive to incumbent’s customers, and are delivered through a business model that is diffi- cult for incumbents to imitate. Not surprisingly, new entrants with innovative strategies want to disrupt established companies and offer value in a way that is difficult to imitate. We now turn to discussing different types or categories of innovative strategies that have been successfully deployed by various companies.

Categories of Innovative Strategies
Because innovative strategies are about delivering unique value through a business model that differs from the competition, there are many different ways to offer them. It would be impossible to put each new strategy into a predefined category, because new innovative strat- egies are often unique relative to strategies being used by established firms. That’s the power of innovation. However, over the years strategists have noticed that some types of innovative strategies enable disruptive innovation through similar tactics and patterns—or what some strategy scholars have referred to as a similar dominant logic.17 By dominant logic, strate- gists mean the primary logic behind how the company is trying to deliver unique value to customers.
For example, the dominant logic behind the strategies of Netflix (versus Blockbuster) and Amazon (versus Barnes & Noble) was to lower costs by eliminating retail stores and shipping directly to the customer. The categories of innovative strategies we identify in Figure 10.2 can be useful as a guide to launching a disruptive innovation. In this section we examine a few of the most well-known patterns of innovative strategies as identified by various strategy scholars.

Reconfiguring the Value Chain to Eliminate Activities (Disintermediation)
One type of innovative strategy is based on reconfiguring the value chain to eliminate activities or steps. The most typical pattern is to eliminate a step in the path from production to customer, such as eliminating a store, which also eliminates the need for salespeople and inventory. This allows the disruptor—the firm launching the game-changing strategy—to offer lower prices for similar products and services. This is the approach that Netflix used to gain a cost advantage against Blockbuster and Redbox. Amazon used this same approach—selling books over the In- ternet—to offer books at lower cost than Barnes & Noble (see Figure 10.3).

disruptive innovation Radical innovative strategies in which companies in the same industry find the innovation so disruptive that they can no longer do business as usual.

Barnes & Noble

Amazon.com

FIGURE 10.3 Value Chains of Barnes & Noble Versus Amazon.com

The approach of eliminating stores and selling products over the Internet has worked well for products such as books and movies—items that are standardized and predictable. But can this work for a product that people like to try out before buying? What about a mattress? The company 1-800-Mattress has been quite successful selling mattresses online as well as over the phone. Since the company sells mattresses that are similar to models sold in stores, customers can go try one out to see what they like. Their strategy is to sell mattresses for 20 to 30 percent lower than the competition and deliver it to your home. Not only that, but if the customers are not satisfied, they can exchange it for another mattress, satisfaction guaranteed.
Southwest Airlines has used a similar strategy of eliminating steps in the value chain to offer low airfares relative to other airlines. By eliminating meals, seat reservations, and luggage transfers, Southwest is able to lower total costs and offer less expensive airline tickets to its customers.

low-end disruption Producing a low-cost product or service for the low-end or most price-sensitive segment of the market, and then gradually moving upmarket as the product or service improves its technology and processes.

Low-End Disruptive Innovations
A second type of innovative strategy is called a low-end disruption.21 Rather than eliminating steps in the value chain, some firms use a different set of activities or technologies from their rivals to produce a low-cost product or service. Harvard professor Clayton Christensen observed a pattern in a number of industries in which a firm leverages new technologies to launch a product at the low end—the most price-sensitive segment of the market—and then gradually moves upmarket as it improves its technology and processes.
For example, Nucor used this approach to disrupt integrated steel producers such as US Steel. Nucor pioneered a new way to create steel products using small electric arc furnaces to melt scrap metal in mini-mills. This process was much simpler and less expensive than the traditional method of melting iron ore and other ingredients in enormous blast furnaces. When mini-mills first emerged, the quality of their output was poor, which meant they could only make rebar (steel rods) used to reinforce concrete. This was a low-margin market that the big steel makers were happy to abandon because of the low profitability. But as Nucor’s mini-mills improved their processes and product quality, their cost advantage enabled them to offer lower prices than the integrated producers in higher-margin products such as angle iron, structural beams, and sheet steel. Eventually, many of the integrated steel companies such as Bethlehem Steel were unable to compete because of their cost disadvantage, and they went bankrupt.
In a similar fashion, Honda started at the low end in the automobile industry by offering 50cc and 150cc motorcycles. When Honda first launched, Harley-Davidson wasn’t concerned

Strategy in Practice
The Internet as a “Disruptive” Technology after Italian economist Vilfredo Pareto, who observed in 1906 that 80
percent of the land in Italy was owned by 20 percent of the popula- The Internet has frequently been described as a “disruptive” tion.20 The Pareto principle is applied to many situations in business technology—one that has enabled innovative strategies that are but perhaps most notably to sales, where in most cases 80 percent of disruptive—by allowing digitized information and products to be a company’s sales come from 20 percent of its customers. The Inter- easily accessed by anyone throughout the world. By now, we are net provides an opportunity for online retailers to benefit from mar- all familiar with the impact that the digitization of music, books, keting the “long tail,” which is the remaining 80 percent of offerings and movies has had on bricks-and-mortar retailers such as Virgin as outlined in Figure 10.4.
Records, Borders, and Blockbuster. Web applications such as Online retailers can “sell less of more” by taking advantage of
TurboTax and LegalZoom are replacing professional tax account- unlimited virtual shelf space. This is what allowed Netflix to offer ants and attorneys, and online gaming is the fastest-growing 90,000 different movies versus 1,000 at a Blockbuster store, and segment in the $97 billion video-game industry.18 The Internet, Amazon to offer 5 million book titles versus 100,000 at a Barnes & and the online digitization it enables, can be either a threat or an Noble store.
opportunity. The Internet has also allowed more companies to employ a
The primary impact of the Internet on companies is that it free revenue model because the marginal cost (the incremental has become a low-cost distribution channel for anyone wanting to cost of producing one additional unit) of producing and distribut- sell a product or service. As a result it has dramatically lowered the ing most digital products is zero. After a software program has been barriers to entry into new markets. Just when Barnes & Noble and written, it can be copied and shared at virtually zero cost. Skype Borders thought they had created barriers to entry by building large would not be able to provide free phone calls, nor could Zynga pro- book superstores, Amazon entered selling books over the Internet. vide free games, without the Internet.
The business models of Amazon, Netflix, and eTrade would not
have been possible without the Internet. The Internet has enabled new entrants to create new business models and deliver value in innovative ways while lowering costs.
As a result of the Internet lowering the cost of distribution, it has enabled business models that rely on the long-tail phenome- non, where broader inventory can be offered to meet a wider variety of consumer needs. Before the Internet, products and services were usually sold through bricks-and-mortar stores that could handle only limited inventory. As a result, only those products fortunate enough to get widespread distribution were big sellers. The “long- tail” phenomenon explains that 80 percent of offerings in a product category (books, songs, movies, clothing, etc.) are not big hits and only account for about 20 percent of units sold, whereas 20 percent
of offerings account for 80 percent of sales.19 20%
This phenomenon is captured by the Pareto principle, also Number of Different Products Offered
known as the 80-20 rule, which says that roughly 80 percent of effects
come from 20 percent of the causes. The Pareto principle is named FIGURE 10.4 The Long-Tail Phenomenon

about the competition because its market was superheavyweight motorcycles. Harley- Davidson’s CEO even proclaimed that Honda’s entry was good for Harley-Davidson because Honda would get more people riding a motorcycle and eventually they would graduate to a Harley.22 But over time, Honda used profits from its large volume of small motorcycles to invest in the development of larger motorcycles and eventually entered the superheavyweight motorcycle categories with bikes that were less expensive but more technologically advanced than Harley-Davidsons (See Strategy in Practice: Why Incumbents Don’t Respond Effectively to Low-End Disruptions).
Another example is Skype’s cheap—and often free—phone service that has been gradually moving upmarket as the quality of calls improves and the technology allows for video confer- encing and other higher-end business services. Skype has already taken over about one-third of all long-distance international phone calls from AT&T and other long-distance providers.23 It will be interesting to see if Skype’s free phone service will eventually be disruptive to the cell phone giants such as Verizon, AT&T, Sprint, and T-Mobile.

High-End/Top-Down Disruptive Innovations
High-end, or top-down, disruption is as revolutionary as a bottom-up disruptive innovation. But in stark contrast to the low-end variety, high-end disruptive innovations actually outperform existing products when they’re introduced, and they sell for a premium price rather than at a discount.24 History provides a number of examples: Apple’s iPod outplays the Sony Walkman; Starbucks’s high-end coffee drinks and atmosphere drown out local coffee shops; and flash drives fly past zip drives and floppy disks. Products created through high-end disruptive innovations are initially purchased by the most discriminating and least price-sensitive buyers, and then they move steadily downward, into mainstream markets. New entrants launching high-end innovations typically rely on “radical” or leapfrog technological innovations that are expensive initially, but with improvements in technology, and as they are produced in larger volumes with greater scale, the costs gradually decline.
A high-end disruptive innovation may initially serve the specialized, high-end niche of a market for years before it finally trickles down to mainstream markets. Such was the case with cell phones, which originally cost $3,995 and, only appealed to the high-end niche.25 But as the price (and size) of the phones dropped, they became accessible to a much larger segment of the market. Today, almost 36 percent of homes are “wireless only” households.26 The cell phone example also introduces an important point: high-end disruptive innovations don’t need to be superior on every product feature relative to incumbent product offerings. But they do need to be superior on at least some attributes that customers care about. While cell phones offered the superior advantage of portability, they were disadvantaged relative to landline phones in terms of sound quality. But over time, sound quality has improved and is now comparable to landlines. In similar fashion, digital cameras offered advantages of storing thousands of images that can be immediately viewed and edited, but initially offered inferior picture quality relative to 35 mm cameras. As the picture quality improved, digital cameras began to dominate the camera market.
Tesla is another company that is pursuing a high-end disruption strategy. CEO Elon Musk has long maintained that Tesla’s strategy is to sell highly desirable electric vehicles in the high-end niche—such as the Model S and Model X—and then gradually move downmarket, offering more affordable cars such as the Model 3. Indeed, Tesla has already received more than 400,000 reservations for the Model 3, a vehicle slated for production in 2018. By starting at the high end, Tesla has developed a loyal customer base and a premium brand, and has started

Strategy in Practice

Why Incumbents Don’t Respond Effectively to to produce smaller motorcycles in large volumes at low cost. In some Low-End Disruptions cases these new resources and capabilities are viewed as incompatible with the firm’s existing set of resources and capabilities. For example,
In many cases, rivals do not attempt to respond to a new low-cost it would be very challenging for Harley-Davidson to simultaneously offering. Why don’t they respond? They see little to gain by sell- manufacture and sell mostly customized heavyweight motorcycles ing what they view as an inferior, inexpensive product to a price- while producing high volumes of standardized smaller motorcycles as sensitive niche market. After all, why would Harley-Davidson want does Honda. The production processes that Honda uses to produce to offer an inexpensive motorcycle? The margins are small, and millions of motorcycles each year differ significantly from Harley’s Harley might tarnish its brand by offering an inexpensive, possibly production processes that produce fewer than 250,000.
inferior, motorcycle. Instead, companies like Harley focus on the Finally, some companies are afraid of cannibalization. They are needs of their most profitable customers, who tend to ask for more concerned that if they provide a less-expensive offering, customers features and better performance from their products. By the time will switch to it, resulting in a loss in revenues and profits. In the long they realize that the new low-end product has improved its perfor- run, this can be a recipe for disaster as customers eventually move mance enough to attract their mainstream customers, incumbents to the low-end offering and the incumbent loses significant profits. find it is too late to respond. For example, AT&T did not want to offer free phone service over the Some organizations also find it difficult to respond because a Internet like Skype because it would cannibalize the paid phone response would require them to develop a new set of resources and service that AT&T was providing. AT&T didn’t want to do anything capabilities. Integrated steel makers would have to learn how to make to encourage customers to move from paid phone service to free
steel using mini-mill technology. Harley-Davidson would have to learn phone service.

to generate enough volume and scale to make more affordable cars. Some research shows that Tesla is reducing its cost per vehicle by more than 20 percent with every doubling of volume.27 If Tesla can continue to bring down the cost of electric cars at a faster rate than combustion engines improve, then Tesla’s chance of disruptive success goes way up. Whether Tesla can successfully move down to mainstream markets and generate high volumes is still uncertain. But as Tesla builds scale, offers new and cheaper models, and makes charging more convenient with its supercharging stations, the company should be able to follow the path of other suc- cessful high-end disruptors.
High-end disruptions are new products or services that offer either superior performance on some existing product features or offer new features customers are willing to pay for. In most cases, these new top-down products are possible only because of innovations in technology that leapfrog the technologies used in earlier products.

Reconfiguring the Value Chain to Allow for Mass Customization
Some firms, such as Build-A-Bear Workshop, Dell, and Timbuk2, have launched innovative strategies based on a concept that is known as mass customization. Mass customization is an oxymoron, like “jumbo shrimp” or “act naturally.” Until recently, most products in business were either mass-produced OR customized, but not both. However, new technologies and pro- cesses have allowed for the mass production of individually customized goods or services.
Take Build-A-Bear Workshop, for example. Customers “build” their own teddy bear or other stuffed animal by choosing from a large variety of body styles, after which the animal is stuffed at the store to the customer’s liking. Customers can also add a heart or sound box during stuffing, enabling the animal to “talk” or play music. After helping to stuff their animals, customers can dress their furry friends in outfits of their choice from a soccer uniform, or witch costume, to a sequin shirt and jeans, and they can even add shoes. In short, the components of the teddy bear are mass-produced but put together in a customized way by each individual customer. But mass customization isn’t just for children. Online retailer Timbuk2 uses a sim- ilar approach, allowing customers to choose from a set of modules to design their own bag or purse.28 Both Build-A-Bear and Timbuk2 find that many customers enjoy the experience of cre- ating their own unique product.
Dell used a similar strategy when it successfully launched its PC business using the “Dell Direct” model. Dell sells directly to customers and allows them to choose the components that matter most to them; they then custom build and ship the PC to the customer within 48 hours. Dell’s ability to mass-produce customized PCs requires a flexible and responsive assembly system and supply chain.
Mass customization seems to work best in markets in which customers have a variety of different needs and many want a product that is personalized to those needs. It also works best when the product can be broken into modules that offer different features or performance. This requires that the product be designed as separate modules that can be mass produced but that can be quickly and easily linked together to create a functioning product.

Blue Ocean Strategy—Creating New Markets by Targeting Nonconsumers
INSEAD professors Chan Kim and Renee Mauborgne identify another type of innovative strate- gy that they call blue ocean strategy. They argue that a company can succeed by creating new demand in an uncontested market space. Where sharks competing for the same scarce food create a red ocean of blood because of intense rivalry, blue ocean success relies on swimming to empty water—in other words, offering value that is very different from anything on the market. For example, when Cirque de Soleil opened its first show, it was clear that it would be nothing like a Ringling Brothers circus. A Cirque de Soleil show combines elements of a tra- ditional circus, acrobatic troupe, street performers, and a Broadway show to offer a unique

mass customization When a company mass-produces the various modules of the product and then allows the customer to select which modules will be combined together.

blue ocean strategy Creating new demand in an uncontested market space.

entertainment experience. Cirque’s shows are so original that there is no direct competition. The tagline for one of the first Cirque productions was revealing: “We reinvent the circus.” More- over, it attracted a new group of customers who were willing to pay several times the price of a conventional circus ticket for a unique entertainment experience.
As companies try to create new demand, they sometimes target nonconsumption— individuals who do not currently purchase a product or service—with an offering that might induce consumption. For example, more than 70 percent of households in India do not have a refrigerator because they are large, expensive, and require continuous electricity to run. So, appliance maker Godrej decided to try to create an innovative small refrigerator targeted at nonconsumption—those 125 million households without a refrigerator. Using battery tech- nology and solid-state thermoelectric cooling, it created a $59 cooler-size refrigerator—called Chotukool, which translates as “little cool”—to bring affordable refrigeration to everyone in India. One challenge Godrej had to overcome was how to give Indians in the poorer rural areas of India access to Chotukool. Since these potential customers didn’t have access to an appli- ance store, Godrej thought of a unique way to distribute Chotukool: through the post office. Since the postman goes to every home in India and is often viewed as a trusted friend, Godrej partnered with the India Department of Post as the distribution partner for Godrej in many parts of India. By selling a unique product through an innovative distribution channel, Godrej was able to create new demand in a market without any direct competition.
According to Kim and Mauborgne, most companies focus on incremental improvements to existing offerings rather than seeking to create new markets. In a study of business launches in 108 companies, they found that 86 percent of those new ventures were line extensions— incremental improvements to existing industry offerings—and a mere 14 percent were aimed at creating new markets or industries. Although the line extensions did account for 62 percent of the total revenues, they delivered only 39 percent of the total profits. By contrast, the 14 per- cent invested in creating new markets and industries generated 38 percent of total revenues and 61 percent of total profits.29 Clearly, success in new markets brings much greater rewards.
However, organizations don’t necessarily have to venture into distant waters to create new markets. Indeed, many new markets are created from within, not beyond, existing industries. Godrej’s Chotukool represents a good example. Godrej was already in the appliance business but was able to create a new refrigerator market within the industry (see Strategy in Prac- tice: Where Do Innovative Strategies Come From?). Chrysler did the same thing in the automo- bile industry when it launched the first minivan targeted to families who wanted more room than a station wagon but didn’t want a huge van. The minivan—a vehicle that was essentially a hybrid between a sedan and a van—created an entirely new category of vehicle and was the staple of Chrysler’s profits for years.

Create a Platform to Coordinate and Share Private Assets
Uber and Airbnb have ushered in the sharing economy by building coordination apps that help consumers coordinate and share private assets. In the case of Uber, individuals use their per- sonal car as a taxi, receiving requests for rides and getting paid for driving. With Airbnb home owners rent out spare rooms to guests. And while Uber and Airbnb are among the most well- known sharing platforms, more than 9,700 such companies with more than $8.5 billion in fund- ing now exist according to Mesh (meshing.it). Companies have built apps for sharing everything from washing machines and office space to boats, lawn mowers, and cocktail dresses.
To truly transform industries, however, coordination and sharing platforms must target significant pockets of consumption, as Uber and Airbnb have done with transportation and lodging. The companies’ efforts have proven disruptive to incumbents. The San Francisco Cab Drivers Association (SFCDA) reported that one-third of the 8,500 or so taxi drivers in San Francisco—more than 2,800—ditched driving a registered cab in the last 12 months to drive for a private transportation startup such as Uber or Lyft, and taxi use has dropped by 70 percent. And Airbnb, founded in 2008, now offers more rooms (more than 1 million) than any other hotel chain in the world.
Several keys make the strategy to coordinate and share assets work. First, sharing solu- tions seem to work best when asset value is high but use of those assets is low, as is the case

with cars and spare rooms. However, the high asset value must also be combined with a way to effectively manage risk. Existing insurance policies, such as auto insurance and homeowner’s insurance, naturally cover drivers and homeowners even while sharing. But bigger challenges exist with assets that are not insured but that can be easily destroyed by a non-owner (e.g., a designer cocktail dress).
Second, companies that use this approach must build scale in the network itself—through the set of buyers and sellers (peers) who use the platform. To grow, these companies must over- come the classic two-sided market paradox: They won’t have buyers until they have sellers, and they won’t have sellers until they have buyers. That’s why Uber focuses so intently on driver recruitment as it expands to new markets. The company heavily subsidizes drivers while giving steep discounts to riders. This explains the more than $1 billion loss the company incurred as it tried to expand to China. To be successful, companies must have a path to building network scale in local markets.
Third, the sharing economy is fueled by the uniqueness of Millennial culture and attitudes. Millennials value community, authenticity, frugality, and genuine experiences. Therefore, com- panies who wish to transform industries using a platform to leverage private assets will need to create brands and communities that appeal to this Millennial culture.

Free Business/Revenue Models
A final category of innovative new business or revenue models involves offering products or services for “free.”30 During the past two decades, we have witnessed the emergence of “free” products and services in a way never seen before. Free newspapers (Metro), software (Google Docs), stock trades (ZeccoTrading), and telephone calls (Skype and Zoom). Free product strate- gies, once the exclusive province of the digital realm, have also been popping up in markets far removed from the Internet. From free prescriptions for expensive pharmaceuticals, to free airline tickets, and even free automobile leases, the “free” business models popularized by soft- ware companies such as Google, Adobe, and Mozilla are spreading across markets everywhere, in some cases eliminating rivals. One example is Wikipedia, which destroyed Encyclopedia Britannica and Microsoft Encarta.
Although many companies offered short-term “freebies” in the past—for example a 30-day free trial of software—these products and services are perpetually free. What are the character- istics of products or services that are most likely to succeed being offered for free? And how is it that firms such as Google are making lots of money by not charging users? What is their revenue model? Here are three “free” strategies that companies use:
Strategy 1: Cross-Sell (Freemium) Strategy The cross-sell strategy involves offering a free basic product to gain widespread initial use, after which users are offered a non- free premium version (often called freemium) or are sold products not directly tied to the free product. Virtually every app on the iPhone uses the cross-sell strategy (e.g., Zynga games), as does Skype, which offers free phone calls but makes money on the add-ons, such as voicemail and calls to landlines or cell phones. One tactic is to offer a free version of the product to con- sumers to use at home, but offer a paid version with additional features to the enterprise market.
For example, Adobe charges only corporate customers for its Reader software—it is free to all others. Craigslist uses a version of this approach by offering free listings in every category but one—jobs—which is free for job seekers but not for companies.
Large-scale success with this strategy requires either (1) a free product that appeals to a very large product user base (e.g., roughly 1.5 billion people with computers are interested in using Skype to make phone calls); or (2) a high conversion rate, meaning a high percentage of free users are willing to convert to paid customers for premium features. Skype is successful because of the sheer total numbers of customers that use its free product. Even if Skype has a low conversion rate (the general rule is 5 percent of free product users tend to become paying customers), it still can make money because it has more than 400 million product users.
In contrast, Flickr, the photo-sharing site, has a much smaller total market. The number of camera users who want to use a photo-sharing service is much smaller than the market for making free phone calls. Moreover, the conversion rate to Flickr Pro is relatively low because

high conversion rate When a high percentage of free users are willing to convert to paid
customers for premium features.

third-party pay strategy Providing free products to a community of product users as a method of generating revenue from a third party that pays to access those users.

for most users, the free version is good enough. The fact that Skype appeals to more users with a conversion rate that is better than Flickr’s translates into a superior business model. This explains why eBay was willing to pay $2.6 billion for Skype, whereas Yahoo! reportedly paid only $22 to $25 million for Flickr.33

Strategy 2: Third-Party Pay Strategy Firms using a third-party pay strategy— sometimes called a two-sided market—provide free products to a community of product users as a method of generating revenue from a third party that pays to access those users. In the digital age, Google is the poster child for this strategy, offering free Internet search services

Strategy in Practice
Where Do Innovative Strategies Come From? Questioning. Innovators are consummate questioners who
show a passion for inquiry. Their queries frequently challenge the sta- What makes a business innovator such as Thomas Edison, Steve tus quo, or push people to think differently. One of Steve Job’s favorite Jobs, or Jeff Bezos different from a typical manager? How did they questions was: “If money were no object, what kind of product would come up with the innovative ideas that helped them found General we create?” He wanted Apple engineers to imagine the perfect Electric, Apple, and Amazon.com, respectively? Is it genetic? Where product—and then try to design and build it. Innovators ask questions they born intuitive and divergent thinkers? to understand how things really work, why they are that way, and Research by Jeff Dyer, Hal Gregersen, and Clayton Christensen how they might be changed or disrupted. Collectively, their questions
reported in The Innovator’s DNA confirms others’ work that creativ- provoke new insights, connections, possibilities, and directions.
ity skills are not simply genetic traits endowed at birth, and that they Observing. Innovators are also intense observers. They carefully can be developed. In fact, the most comprehensive study confirming watch the world around them, and their observations of customers, this was done by a group of researchers, Merton Reznikoff, George products, services, technologies, and companies help them gain Domino, Carolyn Bridges, and Merton Honeymon, who studied crea- insights into and ideas for new ways of doing things. Steve Jobs’s tive abilities in 117 pairs of identical and fraternal twins. Testing twins observation trip to Xerox’s research lab, the Palo Alto Research 15 to 22 years old, they found that only about one-third of the perfor- Center (PARC), provided the insight that was the catalyst for both mance of identical twins on a battery of 10 creativity tests could be Macintosh’s innovative operating system and mouse and Apple’s OSX attributed to genetics. In contrast, roughly 80 percent of twins’ perfor- operating system.
mance on general intelligence (IQ) tests could be attributed to genet- Networking. Innovators spend a lot of time and energy find-
ics. So general intelligence (at least the way scientists measure it) is ing and testing ideas through a diverse network of individuals. They basically a genetic endowment, but creativity is not. Nurture trumps actively search for new ideas by talking to people who may offer a nature as far as creativity goes. That means that about two-thirds of radically different view of things. For example, Steve Jobs was told our innovation skills comes through learning—first, from understand- by Apple Fellow Alan Kay to “go visit these crazy guys up in San ing the skill, then practicing it, and ultimately gaining confidence in Rafael, California.” The crazy guys were Ed Catmull and Alvy Ray, who our capacity to create. had a small computer graphics operation called Industrial Light & If innovators can be made, then how did Edison, Jobs, and Magic (the group that created special effects for George Lucas’s Bezos come up with their great ideas? Five discovery skills distinguish movies). Fascinated by their operation, Jobsbought Industrial Light & innovators from typical executives.31 First and foremost, innovators Magic’s computer animation group for $10 million, renamed it count on a cognitive skill called associational thinking, or simply Pixar, and eventually took it public for $1 billion. Had he never associating. Associating happens as the brain tries to synthesize and chatted with Kay, he would never have purchased Pixar, and the make sense of novel inputs. It helps innovators discover new direc- creative Toy Story, Monsters Inc., and Finding Nemo films might not
tions by making connections across seemingly unrelated questions, have been produced.
problems, or ideas. Experimenting. Finally, innovators are constantly trying out Innovative breakthroughs often happen at the intersection of new experiences and piloting new ideas. Experimenters explore the diverse disciplines and fields. Author Frans Johanssen described this world intellectually and experientially, holding convictions at bay phenomenon as the Medici effect,32 referring to the creative explo- and testing hypotheses along the way. They visit new places, try new sion that occurred when the Medici family brought together creators things, seek new information, and experiment to learn new things. from a wide range of disciplines—sculptors, scientist, poets, philoso- Jobs, for example, tried new experiences all his life—from meditation phers, painters, and architects—in fifteenth-century Italy. As these and living in an ashram in India, to dropping in on a calligraphy class individuals connected, they created new ideas at the intersection of at Reed College. All these varied experiences triggered ideas for inno-
their respective fields, spawning the Renaissance, one of the most vations at Apple.
innovative eras in history. Put simply, innovative thinkers connect Collectively, these discovery skills—the cognitive skill of associ- fields, problems, or ideas that others find unrelated. ating and the behavioral skills of questioning, observing, networking,
The other four discovery skills trigger associational thinking by and experimenting—constitute “The Innovator’s DNA,” or the code for
helping innovators increase their building-block ideas. Specifically, generating innovative business ideas. innovators engage the following behavioral skills more frequently.

while companies pay Google to advertise to its millions of product users. Google’s approach works well because product users type in key search words and identify themselves as prime candidates for advertisers. For example, typing in “skis” or “snowboards” allows companies selling or servicing those products to advertise to those targeted customers.
The secret to third-party pay is to provide a valuable free service that attracts either (1) a very large community of product users that can then be segmented in a particular way for advertisers (the way Google does with search), or (2) a targeted community of users that com- prises a customer segment, or group of individuals similar on a key dimension (e.g., this simi- larity could be based on demographics, for example “teenagers” or “retired people;” or more need based, such as “video-game players” or “new mothers”). Blyk, a Finnish telecommunica- tions company that was acquired by France Telecom, competes by offering free cell phone ser- vice to 16- to 24-year-olds. Product users in the desired demographic fill out a detailed survey about their preferences and are given 217 free minutes each month if they agree to receive advertisements. Blyk makes money by selling access to that particular demographic and providing information on their preferences.34 Blyk also benefits by using freemium, since many customers go over their free minutes and end up paying a premium for those minutes.
In similar fashion, Ryanair offers a small percentage of its airline seats for free by using a combination of freemium and third-party pay. The company makes money on the add-on services: $25 per customer for checked or carry-on bags, $5 for seat reservations and credit card use, and $4 for priority boarding. Flight attendants sell food, scratch-card games, perfume, digital cameras, and MP3 players. Ryanair also uses the flight as a platform for advertisers. When your seat tray is up, you may see an ad for a cell phone from Vodaphone, and when it is down, you may see an ad from Hertz. Flyers are a captive audience for advertisers targeting travelers. The key to third-party pay is to deliver a captive audience, preferably a specific cus- tomer segment, to an advertiser willing to pay for access to that audience.

Strategy 3: Bundling Strategy A bundling strategy involves offering a free product with a paid product or service. For example, Hewlett-Packard may give away a free printer with the purchase of a computer, or Verizon may give away a free cell phone with the purchase of a service contract. Of course, the “free” effect here is largely psychological, since the customer must actually pay in order to get the product for free.
Offering a free product as part of a bundle works well when the product requires ongoing maintenance or complementary goods. For example, even though Hewlett Packard doesn’t make money when it gives away a free printer with a computer, it makes money by selling high-margin ink cartridges for its free printers. Cable companies will frequently bundle a free phone service when a customer purchases Internet services because, with “voice over IP,” the company uses the Internet to provide the phone service. The phone service can be provided with virtually zero incremental cost.35
Additionally, bundling works particularly well when a company offers a broad array of products. Banks are increasingly bundling free services—free accounts or stock trades—when a customer uses other services (e.g., keeps investment balances above some minimum). But the bundled product doesn’t have to be related to the free product. Banks sometimes give away free products, such as iPods or iPads, to customers opening accounts.

Hypercompetition: The Accelerating Pace of Innovation
During the past 25 years, we have witnessed an accelerated pace of innovation that has had a significant impact on the nature of competitive advantage. In fact, Dartmouth Professor Rich D’Aveni coined the term hypercompetition to refer to his argument that competitive intensity has increased, and that periods of competitive advantage have decreased.36
Recent research provides evidence that the increased pace of change has made it harder to sustain competitive advantage.37 In fact, one study found that in 1950, when a firm reached the Fortune 500, on average it stayed in the Fortune 500 for 12 years. However, by 2000, the average firm that reached the Fortune 500 stayed there for only 7 years because of the emergence of new, faster-growing firms.38 This all suggests that established companies need to be constantly

customer segment Groups of people who share similar needs and thus are likely to desire the same features in a product.

hypercompetition A term coined by Professor Rich D’Aveni to refer to his argument that competitive intensity has increased and that periods of competitive advantage have decreased.

looking over their shoulder for new entrants who might be launching new products with inno- vative strategies. It also suggests that established companies cannot rest on their laurels. They must continue to be inventive and offer new products and services if they hope to continue to grow. If they don’t, their current products and businesses will eventually proceed through the famous “S-curve,” which means that after the growth phase they will eventually mature and decline.

Innovation and the Product/Business/ Industry Life Cycle (S-Curve)
Innovations frequently lead to the creation of new products, businesses, or even industries. New products, product categories, and even industries tend to follow a predictable life cycle, evolving over time through four stages: introduction, growth, maturity, and decline. Figure 10.5 depicts a typical product/business/industry life cycle.

Introduction Stage
During the introduction stage, the company tries to get early adopters—those types of buyers willing to try out the latest new gadget—to test the potential of its new product. The primary goal is to get some reference customers who will seed future growth to increase market accept- ance. Product innovation is much more important than process innovation during this stage; as a result, R&D, product development, and design are key competencies. Virtual reality head- sets, such as Oculus Rift or Sony Playstation VR, are examples of new products in the introduc- tion stage.

Growth Stage
Sales accelerate during the growth stage as the initial innovation gains traction and increased market acceptance. Tablets and smartphones are examples of product categories that are in the growth stage. Demand increases as the early majority, a new group of buyers, is convinced that the product concept works as demonstrated by early adopters in the introduction stage. The company continues to refine the product during this stage as it also looks for innovative ways to reach customers through marketing and new distribution channels. As the product starts to gain widespread acceptance, a standard (or dominant design) emerges that signals the

Introduction

Growth

Maturity Decline

Time

FIGURE 10.5 Product/Business/Industry Life Cycle

market’s agreement about a common set of engineering and design features. Toward the end of this stage, product innovation starts to give way to process innovation.

Maturity Stage
As an industry moves into the mature stage, growth starts to slow as total market penetration increases. What little growth there is comes from buyers called the late majority entering the market, people who want not only a proven concept but also a low price. The limited market growth leads to an increase in competitive rivalry, and cost starts to become more important as a determinant of success. Process innovation and operational efficiency are typically more important to success than product innovation. Laptop computers are an example of a product that is moving from the growth to the mature stage.

Decline Stage
The decline stage is often initiated by new products entering the market that cause demand to fall. For example, demand for Sony’s Walkman didn’t really start to fall until the introduction of Discman and then the iPod. As iPod was taking off in its growth phase, Walkman and Discman were both declining. Similarly, Apple and IBM’s personal computers initiated the decline of the typewriter, and more recently we’ve seen the original desktop PC start to decline with the growth of laptops and tablets. As the market size shrinks during the decline stage, some firms try to minimize competition and consolidate the industry by buying rivals.
Understanding the product life cycle can be useful for identifying the strategic priorities for a product or business. Each stage of the life cycle requires different priorities and competencies in order for the firm to succeed and satisfy that stage’s unique customer group. The life cycle also highlights the importance of innovation—or the ability to launch new product life cycles— because if you don’t, your products and business will eventually be in decline.
Although launching a business with an innovative strategy sounds alluring, it is also risky. Why? Because, by definition, when a company launches an innovative strategy it is offering a unique value proposition using an original business model. Since the organization is trying to do something that has never been done before, there is tremendous uncertainty as to whether it will work. Although we’ve talked about a lot of successful innovative strat- egies in this chapter, there are more failures than successes. For example, Apple launched the Newton, a personal digital assistant (PDA) that hit the market with a thud before the market was ready for mobile computing. The Newton didn’t attract customers and was deemed a huge failure, costing Apple millions of dollars. It was an innovative product, but it wasn’t successful. The same can be said for Better Place, a $1 billion start-up that introduced free electric car leases in Israel. It leased electric cars for free by bundling the car with an energy/ maintenance contract. Customers paid 10 cents per mile (less than the cost of gas) to get their electric car battery packs swapped out at a Better Place service station. Instead of stop- ping for gas, you stop for a battery swap. But the battery swap costs were much more expen- sive than expected, and the innovative start-up turned out to be a spectacular failure.39
The bottom line is that if you don’t innovate, you may eventually “be overrun by a swarm of start-ups,” said Scott Cook, founder and chairman of Intuit, a provider of financial ser- vices software including Quicken, TurboTax, and SnapTax.40 However, innovations must be more than novel offerings to the market. They must be deemed useful by customers and must be successfully implemented. This makes them risky propositions. Launching an inno- vative venture is not for the faint of heart. But for those who are successful, the rewards can be extraordinary.

Summary
• An innovation is the conversion of a new idea (an invention) into a product, process, or business model that generates revenues and profits. An incremental innovation builds on a firm’s established knowledge base and steadily improves the product or service it offers. In contrast, a radical innovation draws on a different knowledge base, technologies, or methods to deliver value in a truly unique way.
• Strategies that offer a different value proposition than incumbents’ strategies using different resources and capabilities (e.g., a different business model) are often referred to as “innovative strategies.”
• One type of innovative strategy is based on reconfiguring the value chain to eliminate activities or steps to offer significantly lower prices. The most typical pattern—used by Amazon.com and Netflix— is to eliminate a step in the path from production to customer, such as eliminating a store, which also eliminates the need for salespeo- ple and inventory.

• A low-end disruptive innovation is where a firm leverages new technologies to launch a product at the “low end”—the most price- sensitive segment of the market—and then gradually moves upmar- ket as it improves its technology and processes. In stark contrast to the low-end variety, high-end disruptive innovations actually out- perform existing products when they’re introduced, and they sell for a premium price rather than at a discount.
• Mass customization refers to an approach of using new technologies and processes to mass produce individually customized goods or services—as we’ve seen Build-A-Bear Workshop do with stuffed ani- mals and Dell do with computers. Blue ocean strategy refers to creat- ing a product or service that targets “nonconsumption,” by creating new demand in an uncontested market space.
• Free business/revenue models are growing rapidly in a wide variety of industries, and they always use cross sell, third-party pay (advertising), bundling, or some combination of the three “free” revenue models.

Key Terms
blue ocean strategy 185 customer segment 189
disruptive innovation 181 high conversion rate 187 hypercompetition 189

incremental innovation 179
innovation 178
innovative strategy 180
invention 178
low-end disruption 182

mass customization 185
radical innovation 179
revenue model 180
third-party pay strategy 188

Review Questions

1. What is the difference between an invention and innovation? What are the differences between incremental and radical innovations?
2. How do companies create an innovative strategy by eliminating steps in the value chain?
3. What is the difference between low-end and high-end disruptive innovations?
4. What does mass customization mean? How do companies use mass customization to succeed in the market?
5. What does it mean to target nonconsumption? How does a company create new markets with a blue ocean strategy?
6. What are four behaviors of business innovators that help them gen- erate ideas for innovative strategies?

Application Exercises
Exercise 1: Understanding the Nature of Competition

1. Find a company that is rapidly stealing market share from incum- bents. How is the business model of the growing company different? What innovative strategy is it employing?
2. Find a company that the media is touting as doing something new or innovative. Do you agree that the company is innovative? Why or why not?
3. Find a company that fits one of the six innovative strategies described in this text. Does the company employ only one innovative strategy, or mix several? Which ones?
4. Compare renting movies from a box store, versus mail, versus stream- ing. How does each successive model eliminate value-chain activities?
5. Find a company that uses a free revenue model. How is it able to per- petually offer the product for free? What kind of free strategy is it using?

References
1J. H. Dyer, “Skype: Competing with Free,” in J. Dyer, P. Godfrey, R. Jensen, and D. Bryce, Strategic Management: Concepts and Cases (New Jersey: John Wiley and Sons, 2016).
2https://www.statista.com/statistics/540128/quarterly-revenue
-of-alphabet/
3https://ycharts.com/companies/GOOG/market_cap
4https://www.statista.com/statistics/216573/worldwide-market
-share-of-search-engines/
5https://www.ibtimes.co.uk/star-trek-fans-can-wake-command
-their-amazon-echo-simply-by-saying-computer-1602704; M. Cavna, “Jeff Bezos, Who Played Star Trek as a Kid, Has a Role in ‘Star Trek Beyond,’” 2016, https://www.washingtonpost.com/news/comic-riffs
/wp/2016/07/16/from-boyhood-to-hollywood-jeff-bezos-who-played
-star-trek-as-a-kid-has-a-role-in-star-trek-beyond/?noredirect= on&utm_term=.bf4635a57fe6
6Alphabet, “Q4 2016 Earnings Call,” https://abc.xyz/investor/static
/pdf/2016_Q4_Earnings_Transcript.pdf
7D. B. Yoffie, L. Wu, J. Sweitzer, D. Eden, and K. Ahuja, “Voice War: Hey Google vs. Alexa vs. Siri,” Harvard Business School Publishing Case, 2018.
8G. Hamel, “Strategy as Revolution,” Harvard Business Review (1996).
9C. Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Boston: Harvard Business School Press, 1997).
10J. A. Schumpeter, Capitalism, Socialism, and Democracy (New York: Harper & Row, 1942). Also see R. Foster and S. Kaplan, Creative Destruction: Why Companies that Are Built to Last Underperform the Market—and How to Successfully Transform Them (New York: Currency/ Doubleday, 2001).