Value Innovation Case Analysis

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A R T I C L E

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H B R 1 9 9 7

Value Innovation

The Strategic Logic of High Growth

by W. Chan Kim and Renée Mauborgne

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Harvard Business Review

article:

The Idea in Brief—the core idea

The Idea in Practice—putting the idea to work

Article Summary

Value Innovation: The Strategic Logic of High Growth

A list of related materials, with annotations to guide further

exploration of the article’s ideas and applications

Further Reading

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H B R 1 9 9 7

Value Innovation

The Strategic Logic of High Growth

page 1

The Idea in Brief The Idea in Practice

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Struggling to stay ahead of your rivals? No need. Instead of trying to match or beat them on cost or quality, make the other players irrelevant—by staking out new market space where competitors haven’t ventured.

How? Become a

value innovator

: identify radical ideas that make quantum leaps in the value you provide customers.

Value innovators ask, “What if we started fresh—and forgot everything we know about our industry’s existing rules and tra- ditions?” When CNN’s creators asked this question, they replaced the traditional net- works’ format with real-time news from around the world, 24 hours a day.

Value innovators don’t set out to build com- petitive advantage. But their innovative practices lead them to achieve precisely that. Virgin Atlantic, for example, cut first- class airline service and channeled cost sav- ings into greater value for business-class passengers: more comfortable seats and free transportation to and from airports. It attracted not only business-class customers but also full-economy-fare and first-class passengers of other airlines.

To become a value innovator, consider the fol- lowing strategies, as exemplified by French hotelier Accor:

Assume that you

can

shape your industry’s conditions.

In the mid-1980s, the budget hotel industry in France had two markets: in- expensive hotels that had poor beds and noise, and pricier hotels that provided upscale amenities and a decent night’s sleep. Accor redefined the industry by providing inexpen- sive

and

superior accommodations to cost- conscious travelers.

Focus on what the majority of your buyers value.

Accor identified what customers of all budget hotels wanted: a good night’s sleep for a low price.

Consider how you might change your of- fering to capture the market you’ve identi- fied.

Eliminate features that offer no value for customers—or that detract from value. Simplify products or services that have been overdesigned in the race to match or beat rivals. Further improve high-value features so that customers no longer have to make compromises. And create new features that your industry has never offered.

Example:

Accor created an entirely new hotel con- cept: its Formule 1 line of budget hotels. The company eliminated costly restaurants and lounges, reckoning that target custom- ers could do without them. It reduced other features; for example, providing re- ceptionists only during peak check-in and check-out hours, and replacing closets and dressers with a few shelves and a pole for clothing. And it improved several fea- tures—for instance, providing good sound insulation by building rooms with low-cost modular blocks.

For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

E S T

O F

H B R 1 9 9 7

Value Innovation

The Strategic Logic of High Growth

by W. Chan Kim and Renée Mauborgne

harvard business review • top-line growth • july–august 2004 page 2

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What separates high-growth companies from the pack is the way

managers make sense of how they do business.

Most companies focus on matching and beating their rivals. As a result, their strategies tend to take on similar dimensions. What ensues is head- to-head competition based largely on incremen- tal improvements in cost, quality, or both. W. Chan Kim and Renée Mauborgne from Insead study how innovative companies break free from the pack by staking out fundamentally new mar- ket space—that is, by creating products or ser- vices for which there are no direct competitors. This path to value innovation requires a different competitive mind-set and a systematic way of looking for opportunities. Instead of searching within the conventional boundaries of industry competition, managers can look methodically across those boundaries to find unoccupied terri- tory that represents real value innovation. The French hotel chain Accor, for example, discarded conventional notions of what a budget hotel should be and offered what most value-conscious customers really wanted: a good night’s sleep at a low price.

During the past decade, the authors have de- veloped the idea of value innovation, often in the

pages of HBR. This article presents the notion in its original, most fundamental form.

After a decade of downsizing and increasingly intense competition, profitable growth is a tre- mendous challenge many companies face. Why do some companies achieve sustained high growth in both revenues and profits? In a five-year study of high-growth companies and their less successful competitors, we found that the answer lay in the way each group ap- proached strategy. The difference in approach was not a matter of managers choosing one analytical tool or planning model over an- other. The difference was in the companies’ fundamental, implicit assumptions about strategy. The less successful companies took a conventional approach: Their strategic think- ing was dominated by the idea of staying ahead of the competition. In stark contrast, the high-growth companies paid little atten- tion to matching or beating their rivals. In- stead, they sought to make their competitors irrelevant through a strategic logic we call

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Value Innovation

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HBR 1997

harvard business review • top-line growth • july–august 2004 page 3

value innovation. Consider Bert Claeys, a Belgian company

that operates movie theaters. From the 1960s to the 1980s, the movie theater industry in Bel- gium was declining steadily. With the spread of videocassette recorders and satellite and cable television, the average Belgian’s moviegoing dropped from eight to two times per year. By the 1980s, many cinema operators (COs) were forced to shut down.

The COs that remained in business found themselves competing head-to-head for a shrinking market. All took similar actions. They turned cinemas into multiplexes with as many as ten screens, broadened their film of- ferings to attract all customer segments, ex- panded their food and drink services, and in- creased showing times.

Those attempts to leverage existing assets became irrelevant in 1988, when Bert Claeys created Kinepolis. Neither an ordinary cinema nor a multiplex, Kinepolis is the world’s first megaplex, with 25 screens and 7,600 seats. By offering moviegoers a radically superior experi- ence, Kinepolis won 50% of the market in Brussels in its first year and expanded the mar- ket by about 40%. Today, many Belgians refer not to a night at the movies but to an evening at Kinepolis.

Consider the differences between Kinepolis and other Belgian movie theaters. The typical Belgian multiplex has small viewing rooms that often have no more than 100 seats, screens that measure seven meters by five meters, and 35-millimeter projection equipment. Viewing rooms at Kinepolis have up to 700 seats, and there is so much legroom that viewers do not have to move when someone passes by. Bert Claeys installed oversized seats with individual armrests and designed a steep slope in the floor to ensure everyone an unobstructed view. At Kinepolis, screens measure up to 29 meters by ten meters and rest on their own founda- tions so that sound vibrations are not transmit- ted among screens. Many viewing rooms have 70-millimeter projection equipment and state- of-the-art sound equipment. And Bert Claeys challenged the industry’s conventional wisdom about the importance of prime, city-center real estate by locating Kinepolis off the ring road circling Brussels, 15 minutes from downtown. Patrons park for free in large, well-lit lots. (The company was prepared to lose out on foot traf- fic in order to solve a major problem for the

majority of moviegoers in Brussels: the scarcity and high cost of parking.)

Bert Claeys can offer this radically superior cinema experience without increasing ticket prices because the concept of the megaplex re- sults in one of the lowest cost structures in the industry. The average cost to build a seat at Ki- nepolis is about 70,000 Belgian francs, less than half the industry’s average in Brussels. Why? The megaplex’s location outside the city is cheaper; its size gives it economies in pur- chasing, more leverage with film distributors, and better overall margins; and with 25 screens served by a central ticketing and lobby area, Kinepolis achieves economies in personnel and overhead. Furthermore, the company spends very little on advertising because its value in- novation generates a lot of word-of-mouth praise.

Within its supposedly unattractive industry, Kinepolis has achieved spectacular growth and profits. Belgian moviegoers now attend the cin- ema more frequently because of Kinepolis, and people who never went to the movies have been drawn into the market. Instead of bat- tling competitors over targeted segments of the market, Bert Claeys made the competition irrelevant. (See the exhibit “How Kinepolis Achieves Profitable Growth.”)

Why did other Belgian COs fail to seize that opportunity? Like the others, Bert Claeys was an incumbent with sunk investments: a net- work of cinemas across Belgium. In fact, Kine- polis would have represented a smaller invest- ment for some COs than it did for Bert Claeys. Most COs were thinking—implicitly or explic- itly—along these lines: The industry is shrink- ing, so we should not make major invest- ments—especially in fixed assets. But we can improve our performance by outdoing our ri- vals on each of the key dimensions of competi- tion. We must have better films, better ser- vices, and better marketing.

Bert Claeys followed a different strategic logic. The company set out to make its cinema experience not better than that at competitors’ theaters but completely different—and irresist- ible. The company thought as if it were a new entrant into the market. It sought to reach the mass of moviegoers by focusing on widely shared needs. In order to give most moviegoers a package they would value highly, the com- pany put aside conventional thinking about what a theater is supposed to look like. And it

W. Chan Kim

is the Boston Consulting Group Bruce D. Henderson Chair Pro- fessor of International Management at Insead in Fountainebleau, France.

Renée Mauborgne

is the Insead Dis- tinguished Fellow and a professor of strategy and management. She is also the president of ITM, a strategy re- search group in Fountainebleau.

For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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EST

HBR 1997

harvard business review • top-line growth • july–august 2004 page 4

did that while reducing its costs. That’s the logic behind value innovation.

Conventional Logic Versus Value Innovation

Conventional strategic logic and the logic of value innovation differ along the five basic di- mensions of strategy. Those differences deter- mine which questions managers ask, what op- portunities they see and pursue, and how they understand risk. (See the exhibit “Two Strate- gic Logics.”)

Industry Assumptions.

Many companies take their industries’ conditions as given and set strategy accordingly. Value innovators don’t. No matter how the rest of the industry is faring, value innovators look for blockbuster ideas and quantum leaps in value. Had Bert Claeys, for example, taken its industry’s condi- tions as given, it would never have created a megaplex. The company would have followed the endgame strategy of milking its business or the zero-sum strategy of competing for share in a shrinking market. Instead, through Kinepolis, the company transcended the in- dustry’s conditions.

Strategic Focus.

Many organizations let competitors set the parameters of their strate-

gic thinking. They compare their strengths and weaknesses with those of their rivals and focus on building advantages. Consider this ex- ample. For years, the major U.S. television net- works used the same format for news pro- gramming. All aired shows in the same time slot and competed on their analysis of events, the professionalism with which they delivered the news, and the popularity of their anchors. In 1980, CNN came on the scene with a focus on creating a quantum leap in value, not on competing with the networks. CNN replaced the networks’ format with real-time news from around the world, 24 hours a day. CNN not only emerged as the leader in global news broadcasting—and created new demand around the globe—but also was able to pro- duce 24 hours of real-time news for one-fifth the cost of one hour of network news.

Conventional logic leads companies to com- pete at the margin for incremental share. The logic of value innovation starts with an ambi- tion to dominate the market by offering a tre- mendous leap in value. Value innovators never say, Here’s what competitors are doing; let’s do this in response. They monitor competitors but do not use them as benchmarks. Hasso Platt- ner, vice chairman of SAP, the global leader in

Researching the Roots of High Growth

During the past five years, we have studied more than 30 companies around the world in approximately 30 industries. We looked at companies with high growth in both reve- nues and profits and companies with less suc- cessful performance records. In an effort to explain the difference in performance be- tween the two groups of companies, we inter- viewed hundreds of managers, analysts, and researchers. We built strategic, organiza- tional, and performance profiles. We looked for industry or organizational patterns. And we compared the two groups of companies along dimensions that are often thought to be related to a company’s potential for growth. Did private companies grow more quickly than public ones? What was the im- pact on companies of the overall growth of their industry? Did entrepreneurial start-ups have an edge over established incumbents? Were companies led by creative, young radi- cals likely to grow faster than those run by

older managers? We found that none of those factors mat-

tered in a systematic way. High growth was achieved by both small and large organiza- tions, by companies in high-tech and low- tech industries, by new entrants and incum- bents, by private and public companies, and by companies from various countries.

What did matter—consistently—was the way managers in the two groups of compa- nies thought about strategy. In interviewing the managers, we asked them to describe their strategic moves and the thinking be- hind them. Thus we came to understand their views on each of the five textbook di- mensions of strategy: industry assumptions, strategic focus, customers, assets and capa- bilities, and product and service offerings. We were struck by what emerged from our content analysis of those interviews. The managers of the high-growth companies— irrespective of their industry—all described

what we have come to call the logic of value innovation. The managers of the less success- ful companies all thought along conventional strategic lines.

Intrigued by that finding, we went on to test whether the managers of the high- growth companies applied their strategic thinking to business initiatives in the market- place. We found that they did.

Furthermore, in studying the business launches of about 100 companies, we were able to quantify the impact of value innova- tion on a company’s growth in both revenues and profits. Although 86% of the launches were line extensions—that is, incremental improvements—they accounted for 62% of total revenues and only 39% of total profits. The remaining 14% of the launches—the true value innovations—generated 38% of total revenues and a whopping 61% of total profits.

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Value Innovation

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HBR 1997

harvard business review • top-line growth • july–august 2004 page 5

business application software, puts it this way: “I’m not interested in whether we are better than the competition. The real test is, will most buyers still seek out our products even if we don’t market them?”

Because value innovators don’t focus on competing, they can distinguish the factors that deliver superior value from all the factors the industry competes on. They do not expend their resources to offer certain product and ser- vice features just because that is what their ri- vals are doing. CNN, for example, decided not to compete with the networks in the race to get big-name anchors. Companies that follow the logic of value innovation free up their re- sources to identify and deliver completely new sources of value. Ironically, even though value innovators do not set out to build advantages over the competition, they often end up achieving the greatest competitive advantages.

Customers.

Many companies seek growth through retaining and expanding their cus- tomer bases. This often leads to finer segmen- tation and greater customization of offerings to meet specialized needs. Value innovation follows a different logic. Instead of focusing on the differences between customers, value in-

novators build on the powerful commonalities in the features that customers value. In the words of a senior executive at the French hote- lier Accor, “We focus on what unites custom- ers. Customers’ differences often prevent you from seeing what’s most important.” Value in- novators believe that most people will put their differences aside if they are offered a con- siderable increase in value. Those companies shoot for the core of the market, even if it means losing some of their customers.

Assets and Capabilities.

Many companies view business opportunities through the lens of their existing assets and capabilities. They ask, Given what we have, what is the best we can do? In contrast, value innovators ask, What if we start anew? That is the question the British company Virgin Group put to itself in the late 1980s. The company had a sizable chain of small music stores across the United Kingdom when it came up with the idea of music and entertainment megastores, which would offer customers a tremendous leap in value. Seeing that its small stores could not be leveraged to seize that opportunity, the com- pany decided to sell off the entire chain. As one of Virgin’s executives puts it, “We don’t let what we can do today condition our view of what it takes to win tomorrow. We take a clean slate approach.”

This is not to say that value innovators never leverage their existing assets and capabil- ities; they often do. But, more important, they assess business opportunities without being bi- ased or constrained by where they are at a given moment. For that reason, value innova- tors not only have more insight into where value for buyers resides—and how it is chang- ing—but also are much more likely to act on that insight.

Product and Service Offerings.

Conven- tional competition takes place within clearly established boundaries defined by the prod- ucts and services the industry traditionally of- fers. Value innovators often cross those bound- aries. They think in terms of the total solution buyers seek, and they try to overcome the chief compromises their industry forces cus- tomers to make—as Bert Claeys did by provid- ing free parking. A senior executive at Com- paq Computer describes the approach: “We continually ask where our products and ser- vices fit in the total chain of buyers’ solutions. We seek to solve buyers’ major problems

Kinepolis

Company’s Perspective Customers’ Perspective

Industry’s conditions can be transcended.

Economies of personnel and overhead

Cost savings

Cost additions

Low marketing costs

Low cost position

High volume

Expanded market

High growth in revenues and profits

Quantum leap in value

Competitive price

Radically superior cinema experience

Low land costs

Better overall margins

Free and easy parking

Superior screens, sound, and seats

Best pick of blockbusters

Go for a quantum leap in value; competition is not the benchmark.

Go for the mass of moviegoers; let some customers go.

Think beyond existing assets and capabilities.

Think in terms of the total solution buyers seek.

How Kinepolis Achieves Profitable Growth

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For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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HBR 1997

harvard business review • top-line growth • july–august 2004 page 6

across the entire chain, even if that takes us into a new business. We are not limited by the industry’s definition of what we should and should not do.”

Creating a New Value Curve

How does the logic of value innovation trans- late into a company’s offerings in the market- place? Consider the case of Accor. In the mid- 1980s, the budget hotel industry in France was suffering from stagnation and overcapacity. Accor’s cochairmen, Paul Dubrule and Gérard Pélisson, challenged the company’s managers to create a major leap in value for customers. The managers were urged to forget everything they knew about the existing rules, practices, and traditions of the industry. They were asked what they would do if Accor were start- ing fresh.

In 1985, when Accor launched Formule 1, a line of budget hotels, there were two distinct market segments in the industry. One segment consisted of no-star and one-star hotels, whose average price per room was between 60 and 90 French francs. Customers came to those hotels just for the low price. The other segment was two-star hotels, with an average price of 200 Fr per room. Those more expensive hotels at- tracted customers by offering a better sleeping environment than the no-star and one-star ho- tels. People had come to expect that they

would get what they paid for: Either they would pay more and get a decent night’s sleep, or they would pay less and put up with poor beds and noise.

Accor’s managers began by identifying what customers of all budget hotels—no star, one star, and two star—wanted: a good night’s sleep for a low price. Focusing on those widely shared needs, Accor’s managers saw an oppor- tunity to overcome the chief compromise that the industry forced customers to make. They asked themselves the following four questions: Which of the factors that our industry takes for granted should be eliminated? Which factors should be reduced well below the industry’s standard? Which factors should be raised well above the industry’s standard? Which factors should be created that the industry has never offered?

The first question forces managers to con- sider whether the factors that companies compete on actually deliver value to consum- ers. Often those factors are taken for granted, even though they have no value or even de- tract from value. Sometimes what buyers value changes fundamentally, but companies that are focused on benchmarking one an- other do not act on—or even perceive—the change. The second question forces managers to determine whether products and services have been overdesigned in the race to match and beat the competition. The third question pushes managers to uncover and eliminate the compromises their industry forces cus- tomers to make. The fourth question helps managers break out of the industry’s estab- lished boundaries to discover entirely new sources of value for consumers.

In answering the questions, Accor came up with a new concept for a hotel, which led to the launch of Formule 1. First, the company eliminated such standard hotel features as costly restaurants and appealing lounges. Accor reckoned that even though it might lose some customers, most people would do with- out those features.

Accor’s managers believed that budget ho- tels were overserving customers along other dimensions as well. On those, Formule 1 offers less than many no-star hotels do. For exam- ple, receptionists are on hand only during peak check-in and checkout hours. At all other times, customers use an automated teller. Rooms at a Formule 1 hotel are small

Two Strategic Logics

The Five Dimensions Conventional Value Innovation of Strategy Logic Logic

Industry Industry’s conditions are given. Industry’s conditions can be shaped. assumptions

Strategic A company should build competitive Competition is not the benchmark. focus advantages. The aim is to beat A company should pursue a quantum

the competition. leap in value to dominate the market.

Customers A company should retain and A value innovator targets the mass of expand its customer base through buyers and willingly lets some existing further segmentation and custom- customers go. It focuses on the key ization. It should focus on the commonalities in what customers value. differences in what customers value.

Assets and A company should leverage its A company must not be constrained by capabilities existing assets and capabilities. what it already has. It must ask, What

would we do if we were starting anew?

Product and An industry’s traditional boundaries A value innovator thinks in terms of service determine the products and services the total solution customers seek, even offerings a company offers. The goal is to if that takes the company beyond its

maximize the value of those offerings. industry’s traditional offerings. C op

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For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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EST

HBR 1997

harvard business review • top-line growth • july–august 2004 page 7

and equipped only with a bed and the bare necessities—no stationery, desks, or decora- tions. Instead of closets and dressers, there are a few shelves and a pole for clothing in one corner of the room. The rooms themselves are modular blocks manufactured in a fac- tory, a method that results in economies of scale in production, high quality control, and good sound insulation.

Formule 1 gives Accor considerable cost ad- vantages. The company cut in half the average cost of building a room, and its staff costs dropped from between 25% and 35% of sales— the industry average—to between 20% and 23%. Those cost savings have allowed Accor to improve the features customers value most to levels beyond those of the average French two- star hotel, but the price is only marginally above that of one-star hotels.

Customers have rewarded Accor for its value innovation. The company has not only captured the mass of French budget hotel cus-

tomers but also expanded the market. From truck drivers who previously slept in their vehi- cles to businesspeople needing a few hours of rest, new customers have been drawn to the budget category. Formule 1 made the competi- tion irrelevant. At last count, Formule 1’s mar- ket share in France was greater than the sum of the five next largest players.

The extent of Accor’s departure from the standard thinking of its industry can be seen in what we call a value curve—a graphic depic- tion of a company’s relative performance across its industry’s key success factors. (See the exhibit “Formule 1’s Value Curve.”) Accord- ing to the conventional logic of competition, an industry’s value curve follows one basic shape. Rivals try to improve value by offering a little more for a little less, but most don’t chal- lenge the shape of the curve.

Like Accor, all the high-performing compa- nies we studied created fundamentally new and superior value curves. They achieved that through a combination of eliminating features, creating features, and reducing and raising fea- tures to levels unprecedented in their indus- tries. Take, for example, SAP, which was started in the early 1970s by five former IBM employ- ees in Walldorf, Germany, and became the worldwide industry leader. Until the 1980s, business application software makers focused on subsegmenting the market and customizing their offerings to meet buyers’ functional needs, such as production management, logis- tics, human resources, and payroll.

While most software companies were focus- ing on improving the performance of particu- lar application products, SAP took aim at the mass of buyers. Instead of competing on cus- tomers’ differences, SAP sought out common- alities in what customers value. The company correctly hypothesized that for most custom- ers, the performance advantages of highly cus- tomized, individual software modules had been overestimated. Such modules forfeited the efficiency and information advantages of an integrated system, which allows real-time data exchange across a company.

In 1979, SAP launched R/2, a line of real- time, integrated business application software for mainframe computers. R/2 has no restric- tion on the platform of the host hardware; buy- ers can capitalize on the best hardware avail- able and reduce their maintenance costs dramatically. Most important, R/2 leads to

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Relative level

Eating facilities

Architectural aesthetics

Lounges

Room size

Availability of receptionist

Furniture and amenities in rooms

Bed quality

Hygiene

Room quietness

Price

average two-star hotel’s value curve

average one-star hotel’s value curve

Formule 1’s value curve

Low High

Formule 1’s Value Curve

Formule 1 offers unprecedented value to the mass of budget hotel cus- tomers in France by giving them much more of what they need most and much less of what they are willing to do without.

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For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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EST

HBR 1997

harvard business review • top-line growth • july–august 2004 page 8

huge gains in accuracy and efficiency because a company needs to enter its data only once. And R/2 improves the flow of information. A sales manager, for example, can find out when a product will be delivered and why it is late by cross-referencing the production database. SAP’s growth and profits have exceeded its in- dustry’s. In 1992, SAP achieved a new value in- novation with R/3, a line of software for the cli- ent-server market.

The Trap of Competing, the Necessity of Repeating

What happens once a company has created a new value curve? Sooner or later, the competi- tion tries to imitate it. In many industries, value innovators do not face a credible chal- lenge for many years, but in others, rivals ap- pear more quickly. Eventually, however, a value innovator will find its growth and profits under attack. Too often, in an attempt to de- fend its hard-earned customer base, the com- pany launches offenses. But the imitators often persist, and the value innovator—de- spite its best intentions—may end up in a race to beat the competition. Obsessed with hang- ing on to market share, the company may fall into the trap of conventional strategic logic. If the company doesn’t find its way out of the trap, the basic shape of its value curve will begin to look just like those of its rivals.

Consider this example. When Compaq Com- puter launched its first personal computer in 1983, most PC buyers were sophisticated corpo- rate users and technology enthusiasts. IBM had defined the industry’s value curve. Com- paq’s first offering—the first IBM-compatible PC—represented a completely new value curve. Compaq’s product not only was techno- logically superb but also was priced roughly 15% below IBM’s. Within three years of its launch, Compaq joined the

Fortune

500. No other company had ever achieved that status as quickly.

How did IBM respond? It tried to match and beat Compaq’s value curve. And Compaq, determined to defend itself, became focused on beating IBM. But while IBM and Compaq were battling over feature enhancements, most buyers were becoming more sensitive to price. User-friendliness was becoming more important to customers than the latest tech- nology. Compaq’s focus on competing with IBM led the company to produce a line of PCs

that were overengineered and overpriced for most buyers. When IBM walked off the cliff in the late 1980s, Compaq was following close behind.

Could Compaq have foreseen the need to create another value innovation rather than go head-to-head against IBM? If Compaq had monitored the industry’s value curves, it would have realized that by the mid- to late 1980s, IBM’s and other PC makers’ value curves were converging with its own. And by the late 1980s, the curves were nearly identical. That should have been the signal to Compaq that it was time for another quantum leap.

Monitoring value curves may also keep a company from pursuing innovation when there is still a huge profit stream to be col- lected from its current offering. In some rap- idly emerging industries, companies must in- novate frequently. In many other industries, companies can harvest their successes for a long time; a radically different value curve is difficult for incumbents to imitate, and the vol- ume advantages that come with value innova- tion make imitation costly. Kinepolis, Formule 1, and CNN, for example, have enjoyed uncon- tested dominance for a long time. CNN’s value innovation was not challenged for almost ten years. Yet we have seen companies pursue nov- elty for novelty’s sake, driven by internal pres- sures to leverage unique competencies or to apply the latest technology. Value innovation is about offering unprecedented value, not technology or competencies. It is not the same as being first to market.

When a company’s value curve is funda- mentally different from that of the rest of the industry—and the difference is valued by most customers—managers should resist innova- tion. Instead, companies should embark on geographic expansion and operational im- provements to achieve maximum economies of scale and market coverage. That approach discourages imitation and allows companies to tap the potential of their current value innova- tion. Bert Claeys, for example, has been rapidly rolling out and improving its Kinepolis concept with Metropolis, a megaplex in Antwerp, and with megaplexes in many countries in Europe and Asia. And Accor has already built more than 300 Formule 1 hotels across Europe, Af- rica, and Australia. The company is now target- ing Asia.

Ironically, even though

value innovators do not

set out to build

advantages over the

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end up achieving the

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For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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harvard business review • top-line growth • july–august 2004 page 9

The Three Platforms

The companies we studied that were most suc- cessful at repeating value innovation were those that took advantage of all three platforms on which value innovation can take place: prod- uct, service, and delivery. The precise meaning of the three platforms varies across industries and companies, but in general, the product platform is the physical product; the service platform is support such as maintenance, cus- tomer service, warranties, and training for dis- tributors and retailers; and the delivery plat- form includes logistics and the channel used to deliver the product to customers.

Too often, managers trying to create a value innovation focus on the product platform and ignore the other two elements. Over time, that approach is not likely to yield many opportuni- ties for repeated value innovation. As custom- ers and technologies change, each platform presents new possibilities. Just as good farmers rotate their crops, good value innovators rotate their value platforms. (See the sidebar “Virgin Atlantic: Flying in the Face of Conventional Logic.”)

The story of Compaq’s server business, which was part of the company’s successful

comeback, illustrates how the three platforms can be used alternately over time to create new value curves. (See the exhibit “How Has Compaq Stayed on Top of the Server Indus- try?”) In late 1989, Compaq introduced its first server, the SystemPro, which was designed to run five network operating systems—SCO UNIX, OS/2, Vines, NetWare, and DOS—and many application programs. Like the System- Pro, most servers could handle many operating systems and application programs. Compaq ob- served, however, that the majority of custom- ers used only a small fraction of a server’s ca- pacity. After identifying the needs that cut across the mass of users, Compaq decided to build a radically simplified server that would be optimized to run NetWare and file and print only. Launched in 1992, the ProSignia was a value innovation on the product plat- form. The new server gave buyers twice the SystemPro’s file-and-print performance at one- third the price. Compaq achieved that value in- novation mainly by reducing general applica- tion compatibility—a reduction that translated into much lower manufacturing costs.

As competitors tried to imitate the Pro- Signia and value curves in the industry began

Virgin Atlantic: Flying in the Face of Conventional Logic

When Virgin Atlantic Airways challenged its industry’s conventional logic by eliminating first-class service in 1984, the airline was sim- ply following the logic of value innovation. Most of the industry’s profitable revenue came from business class, not first class. And first class was a big cost generator. Virgin spotted an opportunity. The airline decided to channel the cost it would save by cutting first-class service into value innovation for business-class passengers.

First, Virgin introduced large, reclining sleeper seats, raising seat comfort in business class well above the industry’s standard. Sec- ond, Virgin offered free transportation to and from the airport—initially in chauffeured limousines and later in specially designed motorcycles called LimoBikes—to speed busi- ness-class passengers through snarled city traffic.

With those innovations, which were on the product and service platforms, Virgin at- tracted not only a large share of the indus-

try’s business-class customers but also some full economy fare and first-class passengers of other airlines. Virgin’s value innovation sepa- rated the company from the pack for many years, but the competition did not stand still. As the value curves of some other airlines began converging with Virgin’s value curve, the company went for another leap in value, this time from the service platform.

Virgin observed that most business-class passengers want to use their time produc- tively before and between flights and that, after long-haul flights, they want to freshen up and change their wrinkled clothes before going to meetings. The airline designed lounges where passengers can take showers, have their clothes pressed, enjoy massages, and use state-of-the-art office equipment. The service allows busy executives to make good use of their time and go directly to meetings without first stopping at their ho- tels—a tremendous value for customers that generates high volume for Virgin. The air-

line has one of the highest sales per em- ployee in the industry, and its costs per pas- senger mile are among the lowest. The economics of value innovation create a posi- tive and reinforcing cycle.

When Virgin first challenged the industry’s assumptions, its ideas were met with a great deal of skepticism. After all, conventional wis- dom says that in order to grow, a company must embrace more, not fewer, market seg- ments. But Virgin deliberately walked away from the revenue generated by first-class pas- sengers. And it further rejected conventional wisdom by conceiving of its business in terms of customer solutions, even if that took the company well beyond an airline’s tradi- tional offerings. Virgin has applied the logic of value innovation not just to the airline in- dustry but also to insurance, music, and en- tertainment retailing. The company has al- ways done more than leverage its existing assets and capabilities. It has been a consis- tent value innovator.

For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

•

EST

HBR 1997

harvard business review • top-line growth • july–august 2004 page 10

to converge, Compaq took another leap, this time from the service platform. Viewing its servers not as stand-alone products but as ele- ments of its customers’ total computing needs, Compaq saw that 90% of customers’ costs were in servicing networks and only 10% were in the server hardware itself. Yet Compaq, like other companies in the industry, had been focusing on maximizing the price/performance ratio of the server hardware, the least costly element for buyers.

Compaq redeployed its resources to bring out the ProLiant 1000, a server that incorpo- rates two innovative pieces of software. The first, SmartStart, configures server hardware and network information to suit a company’s operating system and application programs. It slashes the time it takes a customer to config- ure a server network and makes installation virtually error free so that servers perform reli- ably from day one. The second piece of soft- ware, Insight Manager, helps customers man- age their server networks by, for example, spotting overheating boards or troubled disk drives before they break down.

By innovating on the service platform, Com- paq created a superior value curve and ex- panded its market. Companies lacking exper-

tise in information technology had been skeptical of their ability to configure and man- age a network server. SmartStart and Insight Manager helped put those companies at ease. The ProLiant 1000 came out a winner.

As more and more companies acquired serv- ers, Compaq observed that its customers often lacked the space to store the equipment prop- erly. Stuffed into closets or left on the floor with tangled wires, expensive servers were often damaged, were certainly not secure, and were difficult to service.

By focusing on customer value—not on competitors—Compaq saw that it was time for another value innovation on the product plat- form. The company introduced the ProLiant 1000 rack-mountable server, which allows com- panies to store servers in a tall, lean cabinet in a central location. The product makes efficient use of space and ensures that machines are protected and are easy to monitor, repair, and enhance. Compaq designed the rack mount to fit both its products and those of other manu- facturers, thus attracting even more buyers and discouraging imitation. The company’s sales and profits rose again as its new value curve di- verged from the industry’s.

Compaq is now looking to the delivery plat- form for a value innovation that will dramati- cally reduce the lead time between a customer’s order and the arrival of the equipment. Lead times have forced customers to forecast their needs—a difficult task—and have often re- quired them to patch together costly solutions while waiting for their orders to be filled. Now that servers are widely used and the demands placed on them are multiplying rapidly, Com- paq believes that shorter lead times will provide a quantum leap in value for customers. The company is currently working on a delivery op- tion that will permit its products to be built to customers’ specifications and shipped within 48 hours of the order. That value innovation will allow Compaq to reduce its inventory costs and minimize the accumulation of outdated stock.

By achieving value innovations on all three platforms, Compaq has been able to maintain a gap between its value curve and those of other players. Despite the pace of competition in its industry, Compaq’s repeated value inno- vations are allowing the company to remain the number one maker of servers worldwide. Since the company’s turnaround, overall sales and profits have almost quadrupled.

By following its first value innovation… …with another …and then another.

Reliability

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1989: SystemPro

1992: ProSignia

1993: ProLiant 1000

Feature innovations

1992: ProSignia

1994: ProLiant 1000

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How Has Compaq Stayed on Top of the Server Industry?

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For the exclusive use of V. Lugo, 2019.

This document is authorized for use only by Vanette Lugo in ENT 4113- Spring 2019 taught by DILEEP RAO, Florida International University from Dec 2018 to May 2019.

Value Innovation

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EST

HBR 1997

harvard business review • top-line growth • july–august 2004 page 11

Driving a Company for High Growth

One of the most striking findings of our re- search is that despite the profound impact of a company’s strategic logic, that logic is often not articulated. And because it goes unstated and unexamined, a company does not neces- sarily apply a consistent strategic logic across its businesses.

How can senior executives promote value innovation? First, they must identify and artic- ulate the company’s prevailing strategic logic. Then they must challenge it. They must stop and think about the industry’s assumptions, the company’s strategic focus, and the ap- proaches—to customers, assets and capabili- ties, and product and service offerings—that are taken as given. Having reframed the com- pany’s strategic logic around value innovation, senior executives must ask the four questions that translate that thinking into a new value curve: Which of the factors that our industry takes for granted should be eliminated? Which factors should be reduced well below the in- dustry’s standard? Which should be raised well above the industry’s standard? Which factors should be created that the industry has never offered? Asking the full set of questions— rather than singling out one or two—is neces- sary for profitable growth. Value innovation is the simultaneous pursuit of radically superior value for buyers and lower costs for companies.

For managers of diversified corporations, the logic of value innovation can be used to

identify the most promising possibilities for growth across a portfolio of businesses. The value innovators we studied all have been pio- neers in their industries, not necessarily in de- veloping new technologies but in pushing the value they offer customers to new frontiers. Ex- tending the pioneer metaphor can provide a useful way of talking about the growth poten- tial of current and future businesses.

A company’s pioneers are the businesses that offer unprecedented value. They are the most powerful sources of profitable growth. At the other extreme are settlers—businesses with value curves that conform to the basic shape of the industry’s. Settlers will not gener- ally contribute much to a company’s growth. The potential of migrators lies somewhere in between. Such businesses extend the industry’s curve by giving customers more for less, but they don’t alter its basic shape.

A useful exercise for a management team pursuing growth is to plot the company’s current and planned portfolios on a pioneer- migrator-settler map. (See the exhibit “Testing the Growth Potential of a Portfolio of Busi- nesses.”) If both the current portfolio and the planned offerings consist mainly of settlers, the company has a low growth trajectory and needs to push for value innovation. The com- pany may well have fallen into the trap of com- peting. If current and planned offerings consist of a lot of migrators, reasonable growth can be expected. But the company is not exploiting its potential for growth and risks being marginal- ized by a value innovator. This exercise is espe- cially valuable for managers who want to see beyond today’s performance numbers. Reve- nue, profitability, market share, and customer satisfaction are all measures of a company’s current position. Contrary to what conven- tional strategic thinking suggests, those mea- sures cannot point the way to the future. The pioneer-migrator-settler map can help a com- pany predict and plan future growth and profit, a task that is especially difficult—and crucial—in a fast-changing economy.

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Current portfolio Planned portfolio

High growth trajectory

Pioneers Businesses that represent value innovations

Migrators Businesses with value improvements

Settlers Businesses that offer me-too products and services

Testing the Growth Potential of a Portfolio of Businesses

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