January 2005

1. January 2005 Identifying markets Creating sustainable competitive advantage Douglas Abrams

2. Identifying markets and creating SCA • Choose the right market • Create sustainable competitive advantage

3. Choose the right market • Create a value proposition • Understand customer adoption

4. Target an increasing returns business • Up-front costs are high relative to marginal costs • Network externalities • Complementary technologies are important to use • Producer learning is strong • Switching costs are high

5. What problem are you solving for customers? • Start a business with a product that meet a real customer need • Develop a solution to the customers’ problem • Meet customer needs better than competitors • Evaluate customer preferences – traditional market research ineffective – listen to customers

6. Market research for start-ups • Focus groups, market research limited value • Observation-fueled insight makes innovation possible • Watch people using products • What comes naturally to them? • Asking people is not enough – Fine is a four-letter word • Users cannot explain what is wrong or what is missing • It’s not the customer’s job to be visionaries

7. Responding to customer preferences – Kleenex • Originally a cold cream remover • Users started wiping their noses with it • Kimberly-Clark started to market it as disposable handkerchief

8. Talking to potential customers: Igloo • Asked college kids what they liked (more room for six-packs!) • Created Space Mate. • Could fit one and a half six packs more in the same fridge size.

9. Case study – not solving the right problem • RCA’s Videodisc • Superior image quality, but lack of recording capability lost out to videotape. Loss: $500 million • IBM’s PC Jr • The awkward Chiclet keyboard, slow microprocessor, unattractive price and a late launch cost IBM $40 million

10. Case study – not listening to customers • Coca-Cola’s New Coke • This “answer” to Pepsi’s new formula provoked a national uproar; later led to Coke Light • RJ Reynolds's Premier • Smoke-less cigarette with a terrible taste; cost to develop: $800 million

11. Focused observation a source of innovation • Infer motivation and emotion • What do people think and do? • Why do they think and do? • Integrate research, design, marketing and manufacturing

12. The fist phenomenon • Kids grip toothbrush with whole fist rather than fingers • Kid’s toothbrushes should be fatter than adult’s

13. Categorize customer needs in designing product • Things that are necessary • Things that are nice to have • Things that are unnecessary

14. Be realistic • Start a business only if your new product is better than those of competitors. • Be realistic about how your product or service stands against that of the competition. • Consider new products or services that other entrepreneurs are about to introduce.

15. Meet customer needs in an economic manner • Figure out a way to create your product or service for less than you are going to sell it. • Figure our how to make money on at least some transactions regardless of the quantity that you can sell. • Note that new product will not sell itself, but will require personal selling • Note that pricing is important

16. Choose the right market • Create a value proposition • Understand customer adoption

17. The Normal Distribution of Product Adoption

18. Implications for entrepreneurs • Different adopters have different preferences • You must do different things to drive adoption • Proportion of the market adopting at any point in time is not linear – another S-curve

19. Market adoption S-curve

20. Crossing the chasm • Change the way you sell your new product or service when you want to make the transition to the majority of the market. • Focus on the customers with the most compelling need to buy your product or service before you transit to the mainstream market. • Provide customers with evidence of value • Offer a whole product solution

21. Remember the S-shaped adoption curve • Use dynamic estimates to evaluate the size of the market for your new product or service • Include factors that influence diffusion and substitution in calculating the growth of the market for your new product or service • Substitution is an important part of strategy for competing with established firms • Effective when established firms have economies of scale, as substitution erodes their scale economies

22. Factors influencing diffusion • Discrete technologies diffuse faster than systemic • Inexpensive diffuse faster than expensive • Offering greater advantage diffuse faster • Characteristics of target market, external environment, political and regulatory factors, events or obstacles • Easier to understand technologies diffuse faster

23. Simple products - simple as a Frisbee • No moving parts, requires no instructions and delivers fun with very little practice with fifteen cents worth of molded plastic. • People today want more integration and simplicity. • Reality is that it takes time. • Often can’t achieve in the first version of the product. • Version 2.0 may be the best bet

24. Jumping the barrier – fax machines • Fax Machines • In most countries • Unreliable, expensive & few advantages over telegraph • In Japan • Existing telegraph & text based system couldn’t easily handle ideographic Japanese language. • Launched massive research efforts & urged manufacturers to adopt common communications standard

25. Epidemic diffusion – Hush Puppies • Stay in touch with the consumers • Hush Puppies shoes - nearly discontinued • Revived due to sudden grassroots consumer interest

26. Jumping the barrier – Palm pilot • Originally tried to integrate too many features • Realized consumers wanted complement, not replacement for PC

27. Jumping the barrier – answering machines • Answering Machines • Initially considered rude • Within a few years, became rude if didn’t own one.

28. Jumping the barrier - biometrics • Biometrics Access Device (Digital Handprint) • Rough outline of hand, relative length of fingers or spacing of knuckles • Handprints thought of like fingerprints • Seen as intrusive and makes people feel like criminals

29. Jump the barrier – vacuum cleaners • Vacuum Cleaners • America • Loud vacuums associated with powerful motors & suction • Japan • Quieter, less powerful, smaller motors, fuzzy logic, insulation

30. Identifying markets and creating SCA • Choose the right market • Create sustainable competitive advantage

31. Create sustainable competitive advantage • Competing with established companies • Protect your intellectual property • Create barriers to entry

32. Advantages of established companies • The learning curve • Reputation effect • Cash flow • Economies of scale • Complementary assets

33. Established company weaknesses • A focus on efficiency makes it difficult to introduce new products • Effort to exploit existing capabilities makes it difficult to innovate • They need to satisfy existing customers • Existing organizational structure is appropriate to current tasks • Employees generally not rewarded for innovation • Difficult to innovate in a bureaucracy – low communication density

34. Opportunities that favor new firms • Discrete versus systemic technologies • Opportunities that are based on human capital – difficult for existing companies to protect • General purpose rather than specific purpose technologies – provide flexibility • Uncertainty – existing firms’ advantages in market research are neutralized

35. Case study: E-Schwab • Initially their brokers complained about low on-line flat fee • Spread same low web trade commission to all of its customers • Shot ahead of traditional high-end firms like Merrill Lynch

36. Case study - snowboarding • Journalists & ski resorts called it a fad; Time dubbed it America’s “Worst New Sport” • Ski resorts banned boarders • Mainstream ski manufacturers figured it was a passing fancy • Now 90% of US resorts have accepted snowboards and 5 MM Americans are boarding

37. Case study – mountain biking • Schwinn wrote off mountain biking as a fad. • Early mountain bikers tackled rugged mountain paths with souped-up Schwinns. • Today 70% of full-sized cycles sold are mountain bikes; Schwinn is irrelevant

38. Case study – Dell computers • Direct sales • Easy configuration of memory, peripherals • Direct, reliable customization experience

39. Create sustainable competitive advantage • Competing with established companies • Protect your intellectual property • Create barriers to entry

40. Competitors will copy your product • Reverse engineering • Hire ex-employees • Look at patent documents • May be working on similar products

41. Protecting your intellectual property - secrecy • Few alternative sources of information • Limited number of people who could make use of the information • The necessary knowledge is tacit • Process of creation is poorly understood

42. Protecting your intellectual property - patents • A government monopoly • Only possible for a small number of products • Patents must be strong to be useful • Patents require disclosure • Patenting is expensive

43. Create sustainable competitive advantage • Competing with established companies • Protect your intellectual property • Create barriers to entry

44. Capturing the returns to innovation • Control of resources – key sources of supply • Building brand-name reputations • Exploiting learning curves • First mover advantages when market structure allows • Control of complementary assets in manufacturing and marketing

45. Sources and references • Finding Fertile Ground by Scott Shane, Wharton School Publishing • The Art of Innovation by Tom Kelley with Jonathan Littman, Doubleday

46. Contact us • Douglas Abrams • dka@parallaxcapital.com • necadk@nus.edu.sg • 65-9780-5381 (hp)