Montroll lectures April 10-12 2007 University of Rochester

1. Creating Economic Value from Research Knowledge: Value Creation - The Value Delivery Process Charles B. Duke Professor of Physics, University of Rochester VP and Senior Research Fellow retiredXerox Montroll lectures April 10-12 2007 University of Rochester

2. The Big Picture • The Global Economy of the 21st Century • What it is • What it means for the U.S. and for physics • Value Creation: The Value Delivery Process • The Future of Industrial Physics and Physicists

3. Impact on You • Point of View: The creation of value from new research findings to yield products and services in the hands of customers is a complex subject. A firm must do well many diverse activities in order to create a profitable new business from new knowledge. • Today’s Topic: We explore the highlights of how value is created by linking research knowledge at the “front end” of the value creation process all the way to the products and services that emanate from the “back end” of the process. • Value to You: One way or another, this will define the work environment of most new physics Ph.Ds in the 21st century: Learn for success.

4. Today’s Agenda • Why firms perform R&D • Strategic versus economic value: The technology-market matrix • The creation of (economic) value: Options, value chains, business models, product development, technology development and technology pipelines • Consequences of the evolving geopolitical environment : The Open Innovation paradigm • Implications for industrial research • Impact on physical scientists

5. Why Do Firms Perform R&D? • To grow – Through new products and services to new markets • To survive – The onslaught of competitive product performance improvements and pricing cuts in currently served markets • Research and development are very different • Research: New concepts for growth • Development: Technology injection into base product lines for survival

6. Small R Versus Big D • Research • Creates future investment options • Emphasizes discovery • Outcomes cannot be predicted or scheduled reliably • Managed for creativity • Development • Creates product designs and prototypes • Emphasizes performance at cost • Outcomes expected to be predictable and delivered on schedule • Managed to minimize risk to cost and schedule • Development $ ~10X Research $

7. Markets Global Marketer (Coca-Cola, McDonalds) New Old Big Bang (start ups) Technology Exploration (HP, Intel) Evolutionary Universe (Intel, GM) Technology Old New One Size Does Not Fit All • A firm must both protect its current businesses (evolutionary universe) and grow (one of the other three quadrants).

8. The Total Value Model • Economic Value = the value resulting from the firms ongoing businesses. • Value by discounted cash flow • Include development projects and plans designed to support existing businesses and markets • Example: Xerox plans and designs for the next generation of copiers • Strategic Value = the value resulting from strategies, plans and projects to enter new markets or offer fundamentally new product lines • Value by options theory (e.g., Black-Scholes model) • Include strategies, plans and R&D projects designed to enter new markets. • Example: Xerox plans and designs for entering the thermal-ink-jet personal printer market and the office networked systems market in the mid 1980s • Total Value = Economic Value + Strategic Value • Total Value should approximately equal Market Value Reference: F. Peter Boer, The Real Options Solution: Finding Total Wealth in a High-Risk World (Wiley, New York, 2002).

9. How Firms Capture Value from R&D • Use it as an input to create a profitable product or service via a value chain describing how the evolution of the product or service all the way from concept to customer • Sell or license resulting intellectual property • Value capture is described by a business model which • Describes how a firm will make money • Links technical inputs to economic outputs • Converts intellectual property into economic value

10. The Creation of Value • Research creates investment options for further investment to develop products or services that enable growth. • To create value, these options must be exercised all the way down a complete value chain. • “A chain is only as strong as its weakest link”. References: C. B. Duke, “Creating Economic Value from Research Knowledge”, The Industrial Physicist 10 29-31 (June/July 2004); Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance, (McGraw-Hill, New York, 1996), chapts. 20-21. Create Define Design Manufacture Deliver Support Concept Product Product Product Product Customer

11. Managing Product Development • In large manufacturing firms products are developed via a structured phase gate process: • Define product platform and demonstrate technology • Define product and deliver technology • Design product • Demonstrate product • New technology is delivered via a structured technology development sub-process in the first two product development phases. • New knowledge from research meets product development in the initial steps of technology development process.

12. Managing Technology Development • Technology also is developed via a structured phase gate process • Scan for opportunities • Explore potential technologies • Filter and demonstrate technology • Confirm technology platform • Demonstrate technology capability • Establish technology readiness for a specific product • Integrate into product program • The economic value of the technology being developed is established by defining technology investment options that grow in value as phase gates are passed Reference: F. Peter Boer, The Valuation of Technology, (Wiley, New York 1999)

13. Phase Innovation Council I Emergent Market Opportunities II Select Markets III NEB Licensing/Spinout Select Technology Opportunities BG’s Business Incubation Emergent Technology Opportunities Development Project Business Concept Development Opportunity Scanning The Technology Pipeline • Product and technology development are combined with a firm’s strategy and business model to define its technology pipeline: • As a project moves down the pipeline, the cost of moving it though the next phase gate increases—usually a lot. Thus, there are many more projects in the earlier phases where the uncertainties are the largest.

14. It’s The Business Model, Stupid • Product development is not enough. It must be embedded into a successful business model to create profits. • The business model includes how the product is to be delivered to the customer. E.g., Xerox was successful in the 1960s because it leased rather sold Xerox copiers to customers. • Knowledge is converted into potential economic value via intellectual property, but most intellectual property is worthless because it is not embedded in a viable business model to convert it into realized economic value.

15. The Environment is Changing • Creation of a global economy: International outsourcing and pricing • Globally available, mobile technical manpower • Plentiful technical knowledge • Inexpensive, instantaneous global communications • Accessible venture capital • End of the cold war – rise of the war on terror • From military to economic competition: Peace through prosperity

16. The Evolving Context of R&D • Industry structures change from vertical to horizontal (PCs, consumer electronics, autos, ....) • intellectual property (e.g., patents) and sources thereof explode (universities, national labs, small and large firms, consultants,....) • Manufactured products become complex systems (airplanes, autos, consumer electronics,…) built from standardized components • Manufacturing industries consolidate around dominant, often modular, designs and a few large suppliers (e.g. PC’s – Dell, HP, IBM which source components from common suppliers, often in the far east)

17. Is Changing The Innovation Paradigm • From “closed” (vertically integrated) value chains in which all elements are in the same firm • Traditional model: GE, IBM(old), Bell Labs, Xerox, Dupont in the 1960s-1980s • Assumes scarce knowledge, limited mobility of technical talent • To “open” (horizontal supplier structure) value chains in which different firms deliver different elements in the value chain • New model: Intel, IBM(new) • Assumes plentiful knowledge, mobile technical talent, ready availability of venture capital Reference:Henry W. Chesbrough, Open Innovation: The New Imperative for Creating and Profiting From Technology (Harvard Business School Press, 2003)

18. Phase Innovation Council I Emergent Market Opportunities II Select Markets III NEB Licensing/Spinout Select Technology Opportunities BG’s Business Incubation Emergent Technology Opportunities Development Project Business Concept Development Opportunity Scanning Open Versus Closed Pipelines • In a closed innovation paradigm projects flow down the pipeline from within the firm. Technology development is vertically integrated with product development. • In an open innovation paradigm, knowledge, technology, components or subsystems can enter the pipeline from outside the firm. Similarly, these entities can exit the pipeline to be further developed by other firms for their products.

19. Implications for Industrial Research • New product development increasingly integrates knowledge and intellectual property from different firms. • R&D in industry concentrates on conceiving and designing new products and/or new value chains. The “Bell Labs” era of basic research in industry has morphed into the “Intel” era of university-industry collaborations • Technology is not “transferred”; it is incorporated a priori into new product definition and design by cross functional teams using a staged phase gate development process. • Bottom Line: Exercisable options for new products not physical science knowledge are the outputs of industrial research at the dawn of the 21st century

20. Impact on Physical Scientists • Almost all physical science jobs in industry are in development, not research. • The primary role of physical scientists in industrial research is to serve as subject matter experts solving problems as members of cross-functional definition or design teams. The employers of these scientists can be firms, universities, or consulting houses. • In the value creation process, the generation of individual items of intellectual property (e.g., patents) is a less important skill than the ability to incorporate such items into complete value chains.

21. Synopsis • Value is created from research findings via a multi-stage value chain each step in which must be executed well to achieve business success. Successful execution of this process is called “innovation”. • Value is realized though a successful business model; it can be calculated quantitatively: • Economic value via discounted cash flow • Strategic value via options theory • Changes in the innovation environment during the past fifteen years.stimulated a transformation of the dominant innovation paradigm from “closed” to “open”. • As part of this transformation, the era of basic physical science research in industry is over. Modern industrial research creates new investment options, not new knowledge. • Consequently, physical scientists working in manufacturing industries can expect to be subject matter experts working on cross functional teams to design new products or processes. University or government partners may be members of that team.