Strategic Innovation

New Game Strategies for Competitive Advantage

Allan Afuah

• Publisher: Routledge
• Year: 2009
• ISBN:
  9781135840501
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

In today's fast-changing business environment, those firms that want to remain competitive must also be innovative. Innovation is not simply about developing new technologies into new products or services, but in many cases, finding new models for doing business in the face of change. It often entails changing the rules of the game.

Strategic Innovation demonstrates to students how to create and appropriate value using new game strategies to gain competitive advantage. The book begins with a summary of the major strategic frameworks and showing the origins of strategic innovation. Next, Afuah gives a thorough examination of contemporary strategy from an innovation standpoint, including:

• how to develop strategy in the face of change
• a detailed framework for assessing the profitability potential of a strategy or product
• consideration of how both for-profit and non-profit organizations can benefit from new game strategies.

With a wealth of quantitative examples of successful strategies, as well as descriptive cases, Strategic Innovation will complement courses in strategy, and technology and innovation.

Part I
Introduction

• Chapter 1: Introduction and Overview
• Chapter 2: Assessing the Profitability Potential of a Strategy
• Chapter 3: The Long Tail and New Games

Chapter 1
Introduction and Overview

Reading this chapter should provide you with the conceptual and analytical tools to:

• Define strategy, new games, new game strategies, value creation and value appropriation, and strategic innovation.
• Understand the characteristics of new games and how a firm can exploit them to gain and prolong a competitive advantage.
• Begin to understand how to use an AVAC analysis to evaluate the profitability potential of a new game strategy.
• Describe types of new game (regular, resource-building, position-building, and revolutionary).

Introduction

Consider the following business performances:

With a market value of over $160 billion for most of 2008, Google was one of the most valuable companies in the world. Its net income in 2007 was $4.2 billion on sales of $16.6 billion, giving it a net profit margin of 25.4%, one of the highest of any company of its size. This was a remarkable performance for a company that only four years earlier, in 2002, had revenues of $439 million and a net income of $99 million in a struggling dotcom industry.

In 2006, Threadless, an online T-shirt company founded in 2000, had profits of $6 million on revenues of $18 million, from T-shirts that had been designed, marketed, and bought by members of the public.¹ This made the firm one of the most profitable in the clothing retail business.

In 2007, Pfizer’s Lipitor was the world’s best-selling drug with sales of $12.7 billion, more than twice its nearest competitor’s sales (Plavix, with $5.9 billion). This was the third year in a row that Lipitor had topped the best-seller list. One of the most remarkable things about Lipitor is that it was the fifth cholesterol drug in its category (statins) in a pharmaceuticals industry where the third or fourth product in a category usually has little chance of surviving, let alone of becoming the best seller in the industry.

During the 2007 Christmas season, demand for the Nintendo Wii was so strong that Nintendo was forced to issue rain checks to customers. On eBay, bids for the $249 machine were in the thousands of dollars. What was even more remarkable was that each Wii console was sold at a profit, unlike competing consoles from Microsoft and Sony that were being sold at a loss.

Goldcorp, a Canadian gold mining company, offered prizes totalling $575,000 to anyone who would analyze its banks of geological survey data and suggest where, in its Red Lake, Canada, property gold could be found.² Fractal Graphics, an Australian company, won the top prize of $105,000. More importantly, the contest yielded targets that were so productive that Goldcorp was said to have mined eight million ounces of gold worth more than $3 billion in the six years following the launch.³

Between 1994 and 1998, Dell’s sales increased by five times, its profits increased by ten times, its stock shot up by 5,600%, its revenue growth was twice as fast as that of its rivals while its operating earnings were greater than the combined operating earnings of all of its major rivals.⁴

From 2000 to 2005, Ryanair posted after-tax profit margins of 20–28% in an airline industry where most firms were losing hundreds of millions of dollars. These record high after-tax profit margins made Ryanair not only the most profitable major airline company in the world over that period, but also one of the most profitable European companies!

Definitions

New Game Strategies

At the core of each of these remarkable performances are strategic innovations, and new game strategies. A strategic innovation is a game-changing innovation in products/services, business models, business processes, and/or positioning vis-à-vis coopetitors to improve performance. A new game strategy is a set of activities that creates and/or appropriates value in new ways.⁵ It is what determines a firm’s performance in the face of a strategic innovation. It entails performing new value chain activities or existing ones differently from the way they have been performed in the past, to create value and/or position a firm to appropriate (capture) value.⁶ It is about not only creating value in different ways, but also about putting a firm in a position to profit from the value created. It is often about rewriting the rules of the game, overturning existing ways of creating and appropriating value. For example, rather than keep its data-banks of geological survey data on its Red Lake, Ontario property secret, and struggle to find where gold might be located, Goldcorp made the data available to the public and challenged it to locate the gold. Goldcorp was looking to the public, rather than to its employees or a contractor, to solve its problem. Only the winners, those who produced desirable results, would be paid. Contrast this with employees who would be paid whether or not they succeeded in locating gold. Rather than design and market its own T-shirts, Threadless had members of its registered users design and submit designs to the firm each week. Members of the community then voted for the best design, and winners were awarded prizes. The winning design was then produced and sold to members of the community. Effectively, the firm did not perform many of the activities that T-shirt companies traditionally performed, or did so differently.

The winner of a new game can be a first mover or follower; that is, the winner of a new game can be the firm that moved first to change the rules of the game, or a firm that came in later and played the game better. The important thing is that a firm pursues the right new game strategy to create and capture value. Google was not the first to introduce search engines but it played the new game very well—it was better at monetizing search engines. Its new game strategy in the early 2000s included undertaking paid listings rather than pop-ups or banner advertising for monetizing searches, developing those algorithms that delivered more relevant searches to its customers than competitors’ search engines, and placing the paid-listing ads on its website as well as on third-party sites.

New games are not always about product innovation. In fact, some of the more interesting cases of new games have nothing to do with new products or services. Rather, they have been about changing the rules of the game in getting an existing product to customers or in positioning a firm to appropriate existing value better. Take the case of Dell. It introduced direct sales to end-customers, bypassing distributors. It also established build-to-order manufacturing and business processes in which each customer’s computer was built to the customer’s specification and only after the customer had ordered and paid for the computer. Both activities gave Dell some advantages over its competitors. By bypassing distributors, for example, it was moving away from having to confront the more concentrated and powerful distributors to dealing directly with the more fragmented end-customers where it could build switching costs, brand identity, and identify other sources of revenue such as services.

New games do not always have to be about leapfrogging competitors with products that have better product characteristics than competitors’. In fact, some of the more interesting new game strategies are those in which firms cut back some product/service characteristics that had come to be considered sacred cows, but at the same time, they add a few new features. For example, when Nintendo offered its Wii, it deliberately used much cheaper three-year-old microprocessor and graphics technologies, rather than trying to outmuscle Microsoft and Sony, which used the latest and fastest but much more expensive technologies which many avid gamers had come to expect in each new generation of game consoles. The Wii had other features that appealed more to nonavid gamers, such as the ability to play games that enabled people also to get some physical exercise.

Both first movers and followers can also make money during new games. For example, Merck revolutionized the cholesterol-lowering drug market when it pioneered the statin cholesterol drug category, and made lots of money. Warner Lambert, which came into the new game late when it introduced Lipitor (a statin), was able to make even more money using its own new game strategies. It entered an alliance with Pfizer to gain access to Pfizer’s large sales force and marketing might, to sell the drug to doctors and conduct direct-to-consumer (DTC) marketing.

Finally, what is a new game in one industry or country, may not be a new game in another. Take the case of Ryanair. In addition to performing some of the activities that had set Southwest Airlines apart from its US competitors—such as flying only one type of airplane model (Boeing 737s for Southwest and A320s for Ryanair) and operating largely out of secondary airports—Ryanair went further. It sold snacks, advertised inside as well as on its planes, and collected commissions on the proceeds made from hotel and car rental sales made through its website. It also forged lucrative relationships with local authorities of the secondary airports where it established operations.

Usually, a new game strategy entails some type of commitment that is made by the firm pursuing the strategy.⁷ It also involves tradeoffs.⁸ For example, Google invested a lot of money in research and development (R&D) to keep improving the relevance of its searches; and by committing to paid listing ads, it was foregoing banner and pop-up ads and associated benefits and costs.

Value Creation and Appropriation

Since we have defined a new game strategy as the set of activities that creates and/or captures value in new ways, it is only appropriate that we define value creation and value appropriation. A firm creates value when it offers customers products or services whose perceived benefits to customers exceed the cost of providing the benefits.⁹ A firm appropriates (captures) value when it profits from it. For example, if a musician writes, composes, and produces a song that customers want, the musician has created value, provided that the cost of offering the music does not exceed the benefits perceived by customers. The profits that the musician receives from his or her music are the value that he or she captures. As the case of many a musician would suggest, value captured is not always equal to the value created. Before the Internet, recording studio managers and distribution channels usually had the bargaining power over musicians and therefore captured more value from each record sold than they created. Musicians usually appropriated less value than they created, ten cents of every dollar.

Cooperating to Create Value and Competing to Appropriate it

When a customer buys a product, the value that it perceives in the product is not only a function of the value created by the maker of the product, it is also a function of the components that go into the product, the complements that work with the product, and of what the customer puts into using the product. Effectively, the value that a customer perceives in a product is a function of the contribution of coopetitors—of the suppliers, customers, rivals, complementors, and other actors with whom a firm cooperates and competes to create and appropriate value. For example, the value that a customer perceives in an iPhone is not only a function of what Apple puts into designing and getting the product produced, but also a function of the contribution of the suppliers of the chips, LCDs, and other components that go into the product. It is also a function of the quality and availability of the type of phone service on it, of the music and other content that can be played on the machine, and of how well the user can use the product.

Thus, firms cooperate with suppliers, customers, complementors, and sometimes rivals to create value and compete with them to capture the value. Cooperation can be direct as is the case with strategic alliances, joint ventures, and long-term contracts; but often, “cooperation” is indirect as in suppliers contracting with firms to supply products to a firm’s specifications. “Competition” exists not only when a firm has to select a supplier and bargain with the supplier but also when the firm has to bargain with buyers over the price of its products. More importantly, competition also exists in an indirect way during direct cooperation. When firms are in an alliance or joint venture to cooperatively create value, they also have to compete to determine who incurs what costs and who will capture what fraction of the value created. Thus, where there is cooperation to create value, there is nearly always competition to appropriate the value; and where there is competition to capture value, there is probably some cooperation to create the value. Even competition among rivals often has elements that could benefit from cooperation. For example, rivals stand to benefit when their market grows and therefore can cooperate to grow the market where such cooperation is legal. They also stand to profit when they do not get into unnecessary price wars, or get entangled in government overregulation or taxation.

New Games

New Game Activities

Recall that a new game strategy is the set of activities that creates and/or captures value in new ways. The cornerstones of this set are new game activities. A new game activity is an activity that is performed differently from the way existing industry value chain activities have been performed to create or capture value.¹⁰ The activity can be complete...