Service Innovation: Organizational Responses to Technological Opportunities & Market Imperatives (Series on Technology Management) (Vol 9)

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SERIES ON TECHNOLOGY MANAGEMENT - VOL 9

SERVICE ORGANIZATIONAL RESPONSES TO TECHNOLOGICAL OPPORTUNITIES & MARKET IMPERATIVES

Editors

JOETIDD FRANK M HULL

Imperial College Press

SERVICE INNOVATION Organizational Responses to Technological Opportunities & Market Imperatives

Series on Technology Management Series Editor: J. Tidd (Univ. of Sussex, UK) Published Vol. 1

Engines of Prosperity Templates for the Information Age by G. R. Ungson (Univ. of Oregon, USA) & J. D. Trudel (The Trudel Group, USA)

Vol. 2

The Knowledge Enterprise Implementation of Intelligent Business Strategies edited by J. Friso den Hertog (MERIT, Maastricht University and Altuition bv, 's Hertogenbosch, The Netherlands) & E. Huizenga (Altuition bv, 's Hertogenbosch, The Netherlands)

Vol. 3

From Knowledge Management to Strategic Competence edited by J. Tidd (Univ. of Sussex, UK)

Vol. 4

Japanese Cost Management edited by Y. Monden (Univ. ofTsukuba, Japan)

Vol. 5

R&D Strategy on Organisation Managing Technical Change in Dynamic Contexts by V. Chiesa (Univ. degli Studi di Milano, Italy)

Vol. 6

Social Interaction and Organisational Change Aston Perspectives on Innovation Networks edited by O. Jones (Aston Univ., UK), S. Conway (Aston Univ., UK) & F. Steward (Aston Univ., UK)

Vol. 7

Innovation Management in the Knowledge Economy edited by B. Dankbaar (Univ. of Nijmegen, The Netherlands)

Vol. 8

Digital Innovation Innovation Processes in Virtual Clusters and Digital Regions edited by G. Passiante (Univ. ofLecce, Italy), V. Elia (Univ. ofLecce, Italy) & T. Massari (Univ. ofLecce, Italy)

Vol. 9

Service Innovation Organisational Responses to Technological Opportunities and Market Imperatives edited by J. Tidd (Univ. of Sussex, UK) & F. M. Hull (Fordham Univ., USA)

SERIES ON TECHNOLOGY MANAGEMENT - VOL. 9

SERVICE INNOVATION Organizational Responses to Technological Opportunities & Market Imperatives

Editors

Joe Tidd University of Sussex, UK

Frank M Hull Fordham University, USA

Imperial College Press

Published by Imperial College Press 57 Shelton Street Covent Garden London WC2H 9HE Distributed by World Scientific Publishing Co. Pte. Ltd. 5 Ton Tuck Link, Singapore 596224 USA office: Suite 202, 1060 Main Street, River Edge, NJ 07661 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

SERVICE INNOVATION Organizational Responses to Technological Opportunities & Market Imperatives Copyright © 2003 by Imperial College Press All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

ISBN 1-86094-367-5

Printed in Singapore by World Scientific Printers (S) Pte Ltd

List of Contributors D. Jane Bower Glasgow Caledonian University City Campus, Cowcaddens Road Glasgow G4 OBA, U.K. [email protected] Evangelia Chortatsiani University of LaVerne, 65 Deligianni Street, 145 62 Kefalari, Athens, Greece [email protected] Tony Clayton Former Director, PIMS Associates, 15 Basinghall Street, London, EC2V 5BR, UK Tony. clayton@ons. gsi. gov.uk Andrew C. Davies SPRU, University of Sussex Brighton BN1 9RF, U.K. a. c. davies@sussex .ac.uk David M. Gann Management School and Civil and Environmental Engineering Imperial College London, Exhibition Road London SW7 2PG, U.K d. gann@imperial .ac.uk

V

vi

List of

Contributors

Christiane Hipp TU Hamburg-Harburg Schwarzenbergstr. 95 21073 Hamburg, Germany [email protected] Frank M. Hull Fordham University Graduate School Lincoln Center Campus 113 West 60th Street New York 10023, USA fhull@for dham. edu Ian Miles CRIC & PREST University of Manchester & UMIST Precinct Centre, Manchester, M l 3 9QH, UK Mbzidm@maill .mcc.ac.uk Paul Nightingale SPRU, University of Sussex Brighton BN1 9RF, U.K. p [email protected] Amnion J. Salter Management School and Civil and Environmental Engineering Imperial College London, Exhibition Road London SW7 2PG, U.K [email protected] Bruce S. Tether CRIC & PREST University of Manchester & UMIST Precinct Centre, Manchester, M l 3 9 Q H , UK [email protected]

Joe Tidd SPRU, University of Sussex Brighton BN1 9RF, U.K. j . tidd@sussex .ac.uk Sandra Vandermerwe Imperial College Management School 53 Princes Gate, Exhibition Road London SW7 2PG, U.K. s. vandermerwe@ic .ac.uk Patrick Vermeulen Erasmus University Rotterdam Rotterdam School of Management FG-Gebouw, PO Box 1738 3000 Rotterdam, The Netherlands [email protected]

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Introduction In the most advanced service economies such as the USA and UK, services create up to three-quarters of die wealth and 85% of employment, and yet we know relatively little about managing innovation in this sector. The critical role of services, in the broadest sense, has long been recognized, but it is still not well understood: "The productive activities of such a firm are governed by what we shall call its 'productive opportunities', which comprise all of the productive possibilities that its 'entrepreneurs' see and can take advantage of. A theory of growth of firms is essentially an examination of the changing productive opportunity of firms ... it is never the resources themselves that are 'inputs' in the production process, but only the services that the resources can render. The services yielded by resources are a function of the way in which they are used — exactly the same resource when used for different purposes or in different ways and in combination with different types or amounts of other resources provides a different service or set of services" (Penrose, 1959, pp. 2 5 - 3 1 , emphasis in original). To date almost all research and management prescriptions have been based on the experience of manufacturing and high technology sectors. Many assert that such practices are equally applicable to managing innovation in services (e.g. Levitt, 1972; Fitzsimmons and Fitzsimmons, 2000; Myer and DeTore, 2001), whereas others argue that services are fundamentally different (Bitran & Pedrosa, 1998; Gallouj, 1998). There is a clear need to distinguish which, if any, of what we know about managing innovation in manufacturing is applicable to services, what must be adapted, and what is distinct and different such is the goal of this book. In this unique collection we bring together the latest academic research and management practice on innovation in services, and IX

x

Introduction

identify a range of successful organizational responses to current technological opportunities and market imperatives. The contributors include leading researchers, consultants and practitioners in the field, who provide rigorous yet practical insights into managing and organizing innovation in services. Two themes help to integrate the contributions in this book: 1. That generic good practices exist in the management and organization of innovation in services, which we seek to identify, but that these must be adapted to different contexts, specifically the scale and complexity of the tasks, degree of customization of the offerings, and the uncertainty of the environment (Tidd, 2001). 2. That innovation in services is much more than the application of information technology (IT). In fact, the disappointing returns to IT investments in services has resulted in a widespread debate about its causes and potential solutions — the so-called "productivity paradox" in services. Instead here we adopt a broader notion of innovation, including technological, organizational and market change (Tidd et al., 2001). The key is to match the configuration of organization and technology to the specific market environment. The book is divided into three parts. In Part I. we introduce a collection of conceptual and analytical frameworks which help us to better understand the organization and management of services. These include a model derived from our own research and consulting, SPOTS (Strategy, Process, Organization, Technology and Systems), well-established and proven approaches such as PIMS (Profit Impact of Market Strategy) applied to services, and more recent concepts such as CAC (Customer Activity Cycle), and Knowledge-Intensive Business Services (KIBS). We apologize in advance for the numerous acronyms, but this is a characteristic of much management research from which we are not immune. In Part II, we explore the empirical evidence from a range of national and sector studies. This features country studies from many advanced service economies, including the USA, UK and Germany,

Introduction

xi

and sector studies of the most significant service industries, including finance and healthcare, as well as less commonly researched but emerging segments of the service economy, such as construction and manufacturing related services. Finally, in Part III, we develop a model of innovation in services, focusing on the development and delivery of services. This is derived from our own extensive research and that of others, and has been applied and tested in practice in a diverse range of service organizations. It is presented as a consolidation of our understanding of innovation in services, rather than any definitive model of "best practice". In this way it represents the start of a new research agenda in service innovation, and the basis for improvement and experimentation in managing innovation in service organizations. We end the book with accounts of leading service organizations which have begun to apply many of the practices and processes identified here, which help to demonstrate the significant potential for improving the management and organization of innovation in services.

Joe Tidd and Frank M. Hull Editors April 2003

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Contents List of Contributors

v

Introduction

ix

Part I Conceptual and Analytical Frameworks for Service Innovation 1 Managing Service Innovation: Variations of Best Practice Joe Tidd and Frank M. Hull 2 Organizing Innovation in Services Patrick Vermeulen and Wietze Van Der Aa 3 Getting "Customer Lock On" Through Innovation in Services Sandra Vandermerwe 4 Services and the Knowledge-Based Economy Ian Miles 5 Service Innovation: Aiming to Win Tony Clayton

3 35

55 81 113

Part II Sector and National Studies of Innovation in Services 6 The Organization of New Service Development in the USA and UK Frank M. Hull and Joe Tidd

137

7 Effects of Innovation in Standardised, Customised and Bespoke Services: Evidence from Germany Christiane Hipp

175

8 Innovation in Healthcare Delivery D. Jane Bower Xlll

211

xiv

Contents

9 Product Development in Financial Services: Picking the Right Leader for Success Evangelia Chortatsiani

231

10 Of Barnacles and Banking: Innovation in Financial Services Paul Nightingale

271

11 Innovation in Design, Engineering and Project Management Services David M. Gann and Amnion J. Salter

301

12 Are Firms Moving "Downstream" into High-Value Services? Andrew C. Davies

321

Part III Applying Innovation Management Good Practice to Services 13 A Composite Framework of Product Development and Delivery Effectiveness in Services Frank M. Hull and Joe Tidd

343

14 Product Development in Service Enterprises: Case Studies of Good Practice Frank M. Hull

371

References

391

Index

429

Part I

Conceptual and Analytical Frameworks for Service Innovation

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Chapter 1

Managing Service Innovation: Variations of Best Practice Joe Tidd and Frank M. Hull*

1.1 Introduction We know a great deal about the organization and management of new product development in the manufacturing sectors, but comparatively little about how applicable this is to the service sector (Miles, 2000; Tidd et al., 2001). In this chapter we identify product development practices that explain variation in performance in a sample of 38 service firms in the UK (Tidd & Hull, 2002). These practices, which were derived from good management practice in manufacturing industries, were found to explain significant variance in performance indicators in the UK sample, a matching one in the USA of 70 firms, and a dataset combining the two (Hull & Tidd, 2002). However, scales measuring sets of "best management practices" constructed from the combined data better fit the USA than UK sample. Therefore, this paper builds new scales from analysis of only the UK data. The objective is to see if some configurations of practice better predict performance outcomes in the UK data than the model of "best practice" based principally on the USA data. A typology of organization design is developed to classify the configurations observed in the UK data. The typology provides a theoretical context for hypothesizing which kinds of configurations are likely to have effects on which kind of performance outcome. Using the typology to classify these service data is challenging because *The authors would like to acknowledge the contributions of Philipp Drost and Kate Banks. 3

4

Joe Tidd & Frank Hull

contingency theory and the related notion of configurations were derived largely from industrial studies conducted prior to the emergence of large service firms and recent advances in information technology. Our study provides an opportunity to update and extend the notions of contingency and configuration to include service enterprises.

1.2 Theoretical Framework The dominant management research and literature on new product and service development seeks to identify and to promote the notion of "best practice" management and organization (e.g. Clark & Wheelwright, 1993; Cooper & Edgett, 1999). In contrast, the notion that different types of organizational structures and management processes are appropriate for different kinds of tasks dates back to the pioneering work of Burns and Stalker (1961) and Woodward (1965), and the development of contingency theory. Central to contingency theory is the concept that no single organizational structure is effective in all circumstances. Instead there is an optimal organizational structure that best fits a given contingency, such as size, strategy, task uncertainty or technology (Donaldson, 1996). Therefore the better the fit between organization and contingency, the higher the organizational performance (Drazin & Van de Ven, 1985; Donaldson, 1999). This relationship between contingency, structure and performance has been supported by a substantial body of research conducted in the 1960s and 1970s, including qualitative comparative case studies (Burns & Stalker, 1961; Chandler, 1966; Lawrence & Lorsch, 1967) and quantitative analysis of large samples (Child, 1972). According to a large number of seminal studies, three contingencies appear to be associated consistently with organizational structure: size, technological complexity, and task uncertainty. Much of the early research examined the relationship between formalization, specialization and firm size, the Aston Group (Pugh et al., 1969; Pugh & Hickson, 1976) being the most influential work on this subject. Woodward (1965) identified technology as a contingency, and discovered a relationship between production

Managing Service Innovation

5

technology, organizational structure and performance. However, Woodward's operationlization of technology was relatively crude, based simply on the flexibility and scale of production processes, whereas Perrow (1970) developed a finer grain typology of technology, based on task analyzability and variability. Similarly, Lawrence and Lorsch (1967) proposed that the rate of environmental change affected the need differentiation and integration within an organization, and found support for this in their comparative study of organizational structures in three different sectors. Galbraith (1977) argued that as task uncertainty increases, more information must be processed, which in turn influences the control and communication structures. The basis of these theoretical typologies and empirical taxonomies are anchored on the dichotomy of the "mechanistic" bureaucracy and the "organic" type of organization design (Burns & Stalker, 1961). Organic designs are best for innovation, mechanistic ones for cost efficiency (Hage, 1980; Hull & Hage, 1982; Hull, 1988). The organic type is optimal for competition in complex, dynamic environments; the mechanistic is optimal for stable, predictable environments (Lawrence & Lorsch, 1967). Finer typologies have been proposed, for example, Donaldson (2001) distinguishes between "mechanistic" and "bureaucratic" types, but we believe that the more fundamental dichotomy is sufficient for identifying the relationships between organization and performance. One reason the dichotomy is so fundamental is because the strengths of each design correspond with the generic types of competitive advantage, cost versus innovative differentiation respectively (Porter, 1980). The basic dichotomy may be expanded into 4-cell typologies as shown in Fig. 1.1. A hybrid type combines the advantages of both mechanistic and organic designs. A simple type lacks the advantages of either. The four types are: (A) Simple Craft-Batch, (B) Mechanistic Bureaucracy, (C) Hybrid Mechanistic-Organic and (D) Organic Technical-Batch. The hybrid type combines the advantages of mechanistic efficiencies and organic organization of professional knowledge to achieve both cost and innovation advantages simultaneously (Duncan, 1976; Hage, 1980; Daft, 1978).

Joe Tidd & Frank Hull

TYPOLOGY Of ORGANIZATION DESIGN

•••••••••••• (a) Technical-batch (b) Organic (c) Ad Hocracy

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PERFORMANCE Innovation

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(a) Customized batch (b) Traditional-craft (c) Simple structure PERFORMANCE Customized Service

(a) Continuous Process (b) Mixed organic-mechanistic (c) Professional bureaucracy PERFORMANCE Cost Reduction Innovation

(a) Mass Production (b) Mechanistic (c) Machine Bureaucracy PERFORMANCE Cost Reduction

Small SCALE & STABILITY Large (a) Woodward, 1961; Collins and Hull, 1986; Hull and Colitis, 1987 (b) Burns and Stalker, 1961; Hagc, 1980; Hull and Hage, 1982; Hull, 1988 (c) Mintzberg, 1979; Mintzberg and Quinn, 1996 Fig. 1.1 Typology of organization design.

Professional bureaucracies employ highly stalled people to perform complex work that is partially regulated by mechanistic standards required for control in large-scale settings (Mintzberg, 1979; Mintzberg & Quinn, 1996). The simple craft batch type offers highly adaptive, customized services as its performance advantage. Its relative simplicity enables it to be flexible and direct in development and delivery. Predictors of these four types include scale, knowledge complexity, and machine technology (Azumi et.,mln 1983; Hull & Hage, 1982; Hull, 1988; Hull & Azumi, 1991). Recently, management researchers (Mintzberg 1979;1983; 1994) and Galbraith (1994; Galbraith & Lawler, 1993) have developed these ideas into more prescriptive management frameworks, which attempt to match organizational structural templates to specific task environments. Activities that are unpredictable or uncertain require relatively more interpersonal methods of coordination and control than mechanistic-bureaucratic methods. A review of 21 innovation

Managing Service Innovation

7

research projects concludes, "environmental uncertainty influences both the magnitude and the nature of innovation... (which) suggests that future research should adopt environmentally sensitive theories of organizational innovation by explicitly controlling for the degree and the nature of environmental uncertainty" (Damanpour, 1996). In particular, perceptions of environmental uncertainty appear to affect the organization and management of new product development (Hauptman & Hirji, 1999; Souder et al., 1998; Tidd & Bodley, 2002). Contingency theory is strongly positivist, and has been much criticized, as it appears to leave little scope for other influences, such as managerial choice or institutional pressures (Powell & DiMaggio, 1991; Tidd, 2001). However, Child (1972) offers some accommodation of the competing theories by allowing some "strategic choice" within boundaries determined by contingencies, an approach developed by Chandler (1990). A significant body of research on the environment-strategy and strategy-structure linkages supports this view (Dess et al., 1993; Miller, 1996). Specifically, the notion of a "configuration" is an internally consistent combination of strategy, organization and technology that provide superior performance in a given environment. For example, the success of the multidivisional structure, or M-form, is associated with a strategy of diversification into related product areas because the volume and complexity of information strains the traditional functional structure (Chandler, 1966; 1990). Most recently, a number of studies have begun to challenge the notion of a single "best practice" and have re-examined the relationships between strategy, organizational structure and management processes (Thomas & Ramaswamy, 1996; AtuaheneGima & Ko, 2001; Kald et al., 2001). We adopt a similar position here, and argue that contingencies influence the strategic configuration of management, organization and technology, but that they constrain rather than fully determine "best practice" (Tidd, 2001; Tidd et al., 2001), what we have referred to as "strategic degrees of freedom" (Tidd, 1993). Much of the best-practice new product development today has been derived from the "lean" approach to product development

8

Joe Tidd & Frank Hull

(Womack & Jones, 1996), based entirely on practices in the manufacturing sector, principally the car industry. From these and studies of Concurrent Engineering (Hartley, 1992; Susman & Dean, 1992; Gatenby et al., 1994), we have distilled an operating core of good practices in new product development, which we refer to as OPTS (Organization, Process, Tools and Systems). This framework is an enlargement of a composite model tested by analyzing 100 industrial corporations in the US (Hull et al., 1996; Collins & Hull, 2002; Liker et al., 1999), and validated during the course of conducting 16 industrial case studies of companies participating in a user group. Each company in the group presented their methods of product development and helped shape the definition of good practices in terms of the OPTS constructs. Varied formulations of OPTS constructs are commonly used in the literature on concurrent engineering (Zirger et al., 1990; Susman & Dean, 1992), organization design (Hage, 1980; Daft, 1995), and as building blocks in models for industrial improvement, such as the Lean Aerospace Initiative (Cusmano & Nobeoka, 1998; Henderson & Larco, 1999). Each OPTS construct plays a different role in performance improvement. Organization provides coordination of people; process provides flexible controls; tools provides transformation/transaction capabilities. Cross-functional teams embody an organic alternative to control by bureaucratic hierarchy. Rigid bureaucratic rules are replaced by flexible, enabling processes (Adler & Boryn, 1996). Hard automation is replaced by soft, programmable automation (Collins et #/., 1996). The integration of the benefits of OPT constructs is hypothesized as resulting in an emergent property system. Concurrent systems are characterized by "reciprocal integration" (Thompson, 1967), which means that work performed by multiple functions along value chains are in a constant state of mutual adjustment as compared with pooled or sequential integration (Liker et #/., 1999). Systems characterized by reciprocal balance among its constructs are presumed to be more capable of achieving a portfolio of competitive advantages, such as both product differentiation and low cost simultaneously. We compare this OPTS model against new service development and delivery in the UK and USA.

Managing Service Innovation

9

1.3 Research Methods Samples UK sample. Respondents were drawn from a network of contacts of the School of Management at Imperial College London. A workshop was held at Imperial College to generate support from these constituents and to refine the questionnaire. Although the sample is one of convenience, the network of Imperial College includes links witli most types of service company in the greater London area. A hundred questionnaires were sent and after a reminder, 38 usable questionnaires were completed and returned. The preferred respondent was someone in the service product development function, but respondents also included staff responsible for TQM (Total Quality Management), BPR (Business Process Reengineering), and performance improvement. The sample is not random or representative, but does not need to be as we are concerned with associations between service management, organization and performance, rather than a simple survey of practices used. USA Sample. From a list of the largest employers in Crain's New York Directory, 120 service companies were identified for mailing questionnaires. Respondents from 70 businesses in 51 corporations returned questionnaires. Most major categories in the service sector were represented except advertising and broadcasting. With such exceptions, survey respondents appear to be reasonably representative of large service companies in the New York area and its diversity, especially financial. Strictly speaking, the UK and USA samples were not matched, but in practice similar businesses were represented in each sample, with the exception of construction and services rendered by divisions of industrial firms (see Appendix A). On average, the firms in the USA sample were larger than those in the UK sample, but in both cases only medium to large organizations were represented (greater than 200 employees). Therefore our sample was unable to capture the effects of the scale of operations.

10 Joe Tidd &• Frank Hull

Analysis Procedures The scales were constructed using factor analyses only of the UK data (Varimax method). The sets of practice items included in each scale are shown in Appendix B along with Alpha coefficients. Factor loadings and Alphas for the USA and combined samples are available (Hull & Tidd, 2002). Multiple regression analysis is used to predict variation in performance measures. The step-wise method was used to maximize variance explained.

Measures The measures were adapted from a 200-page inventory of industrial best practices based on 16 case studies and analysis of 100 American companies (Hull et »/., 1996). Many of the items had to be reconstructed at a more abstract, general level because of the intangibility and diversity of service products. The questionnaire consisted of 150 questions using seven point Likert scales. Pilot surveys were conducted in the USA and UK, and subsequent workshops in New York and London were used to help to refine the questions for the service context. Performance measures. Twelve items loaded in four factors in the UK data. The four scales are labeled: (1) product innovation & quality, (2) improvements in service delivery process, (3) time compression in development & delivery, and (4) cost reduction in development & delivery. Factor analysis of the questionnaire items within each of the OPTS categories resulted in five organization loadings, three for process, three for tools, and three for system. Factor analysis of these 14 sets of practice resulted in five loadings. Four of these included three practice sets and are described below as configurations. A fifth factor contained only two. Each of the 14 practice sets is tagged in Appendix B with the number of its factor within each of the OPTS categories. Best practice summary index. The sum of all 39 items in the 14 sets of practice is calculated to assess the overall relationship between practices and performance outcomes.

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1.4 Results Descriptive Statistics Means and standard deviations are shown for the UK and USA samples in Table 1.1 Performance indicators do not differ significantly between the two samples. However, three of the four configurations are lower in the UK as is an index summing best practices. This contrast suggests a kind of dilemma. How can roughly similar levels of performance be achieved with differing levels of practice? A resolution of this seeming contradiction occurs if system configurations in the UK are more parsimonious in practices because their strategy narrowly focused on selected performance outcomes instead of multiple kinds of advantage simultaneously as in the USA. A system configuration approach might be more efficient for targeting specific kinds of performance outcomes, the best practice paradigm approach being more effective for multiple outcomes.

Performance

Inter-Relationships

Performance indicators are less strongly correlated with one another in the UK than USA data. The index of innovation and quality is significantly correlated with service delivery, but not time compression and cost reduction. The correlation between time compression and cost reduction falls short of significance. By contrast, all four of these performance indicators are significantly intercorrelated in the USA data. This suggests companies in the UK sample may pursue niche strategies that do not require achieving multiple kinds of performance advantages simultaneously.

Practice

Inter-Relationships

Sets of practice are less strongly correlated with one another in the UK than USA data. In the UK sample, 42 of 91 possible correlations among the 14 sets of practice are insignificant and three are negative as shown in Table 1.2. Variation in the strength of these relationships suggests the possibility of polymorphism. By

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14 Joe Tidd & Frank Hull

contrast, only 9 of 91 possible correlations are insignificant in the USA data and only one is negative (not shown). This contrast suggests that the UK data may conform less closely to a best practice paradigm. System Configurations The notion of system configurations is explored as an alternative to an all-encompassing best practice approach to performance improvement in the UK data. Analysis of the 14 sets of practice loaded in five factors. Four of these had loadings with three components and are deemed configurations for the purpose of exploratory research. The fifth, with only two components, is designated as a subsystem. Interestingly, each of the five organization factors loaded in a configuration/subsystem. This result supports the prospect that varied configuration may be represented in the UK data.

Best Practice Summary

Index

A best practice index, the sum of all practices, has an identical coefficient with total performance in both the UK and USA data (r=.66). However, the coefficients are weaker with each of the four components of performance in the UK data and insignificandy so in the instances of time compression and cost reduction. By contrast, the sum of best practices is strongly correlated with all four of the performance components in the USA data. This variation is consistent with the speculation that the UK data conforms less closely to a best practices paradigm than the USA data. Also, the mean of the best practice summary index is lower in the UK than the USA. As shown in Table 1.2, configurations in the UK data have correlations that are as strong or stronger than the best practice summary index for three of the four components of performance: quality & innovation, time compression, and cost reduction. By contrast, none of the configurations in the USA data have correlations that are as strong as the best practice summary index. This contrast

Managing Service Innovation

15

is consistent with the possibility that configurations of practice in the UK are characterized by more selective, parsimonious sets of practices than in the USA data. To assess the relative contribution of each of the configurations to performance in the UK, all four were entered simultaneously into multiple regression analysis. System configurations explain significant amounts of variation in total performance and its four components as shown in Table 1.3. Subsystem E is omitted because it has no significant main effects if entered additionally. The greatest amounts of variance explained are for total performance and innovation & quality. Each configuration has somewhat distinctive relationships with the four components of performance. Eleven of the effects are significant. Nine are positive; two are negative. These relationships are summarized by type of configuration in Fig. 1.2. Also shown

O— Cross-functional collocation (4) p— T-—Shared technology (2) S— Reciprocal integration (3) PERFORMANCE L Innovation & Quality (+) 4. Total Performance • 4. Servici Delivery 4. Cost Reduction (-) 4. Time Compression (-)

O— Project-based Management (2) P—Customer focus (2) T— S—Holistic voice of customer (1) PERFORMANCE 1. Service Delivery (+) 2, Total Performance (+) 2, Time Compression (+) 2. Cost Reduction (+) 4. Innovation & Quality

O—Cellular grouping (3) P_ T—Shared technology (1) S—Knowledge Integration (2) PERFORMANCE 1. Total Performance (+) 1. Time Compression (+) 2. Service Delivery (+) 3. Innovation & Quality (+) 3. Cost Reduction O—Customer involvement (5) P-—Standardization (3) T—External linkages (3) S— PERFORMANCE L Cost reduction (+) 2, Innovation & Quality (+) 3. Total Performance (+) 3. Time Compression 3. Service Delivery

Partnership process subsystem: O—Partner involvement (1) P—Documentation (1) Fig. 1.2. Configurations of organization, process, tools, system and performance in UK services4.

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Managing Service Innovation

17

is their rank order in terms of variance explained in each of the performance measures. Overall, the results are generally consistent with the 4-cell typology built upon the Burns and Stalker continuum. Type D (organic technical-batch) is the most innovative; Type B (mechanistic customization) is the most cost efficient. Type C (cellular hybrid) is best for total performance. Type A (project-based batch) is best at service delivery. However, each of the types have nuances in practice and nomenclature that go beyond the original formulation because of the continued evolution of organization forms and the nature of services versus goods industries.

A. Project-Based Batch

Configuration

Configuration A uses project leaders to organize the involvement of everyone early on to reduce hand-offs (0-2), the essence of concurrent product development (Collins & Hull, 2001). Structured processes, such as QFD (Quality Function Deployment), are used for identifying and migrating customer requirements. Processes are mapped and continuously improved (P-2). The system is integrated by the voice of the customer, holistic thinking, and early involvement of the customer in need fulfillment (S-l). In terms of the OPTS framework, Configuration A is strong in Organization, Tools, and System constructs. The main gap in configuration A is in tools/ technology as none of the measures suggest technological sophistication in either knowledge or computers. However, the art and craft of project management, which is somewhat analogous to batch production in goods industries, may provide a strong yet flexible type of enabling control over the development and delivery of customer focused products. To the extent Configuration A corresponds with a craft batch category in the typology, it is hypothesized to achieve high levels of service delivery. This hypothesis supported by its significant main effect in multiple regression analysis on service delivery. In addition, the organization component of this configuration has unanticipated significant main effects on time compression and cost reduction.

18 Joe Tidd & Frank Hull

These effects on performance are consistent with the flexibility of project-base systems, which is desirable in part because Configuration A is the only one having a significant correlation with an index of environmental dynamism. 1 This profile of the project-based organization add value because this type has received relatively little attention in mainstream management research, particularly in the service sector (Gann & Salter, 1998; Hobday et al., 2000). Type A: Case example Ove Arup is an international engineering consultancy firm that provides planning, designing, engineering and project management services. The business demands the simultaneous achievement of innovative solutions and significant time compression imposed by client and regulatory requirements. Since 1999, the organization has established a wide range of knowledge management initiatives to encourage sharing of know-how and experience across projects. These initiatives range from organizational processes and mechanisms, such as cross-functional communications meetings and skills networks, to technology-based approaches such as the Ovebase database and intranet. To date, the former have been more successful than the latter. For example, a survey of engineers in the firm indicated that in design and problem-solving, discussions with colleagues were rated as being twice as valuable as knowledge databases, and consequently engineers were four times as likely to rely on colleagues. Two primary reasons were cited for this. First, is the difficulty of codifying tacit knowledge. Engineering consultancy involves a great deal of noncodified knowledge and project experience, which is difficult to store and retrieve electronically. Second, the complex engineering and lr

rhe index of environmental dynamism sums six factors (Technological complexity of service products, Rate of service product introduction, Compatibility of service products with other products, Customization, Globalization, and Quality) in terms of increased challenge in market requirements and turbulence, i.e. change regardless of direction. Configuration B has a significant correlation of .33 with this index (not shown in Tables).

Managing Service Innovation

19

unique environmental context of each project limits the re-use of standardized knowledge and experience. B. Mechanistic

Customization

Configuration B is organized by the involvement of external customers in product development and delivery process decisions ( 0 - 5 ) . Standardization is a key factor in controlling the relationship (P-3). Electronic links are used to exchange data with customers and suppliers (T-3). In terms of the OPTS framework, product development and delivery is organized around customers in Configuration B, a key feature of best practice (Hartley, 1992). Setting standards for projects and products is a key method of process control. Presumably customers help set these standards in conformance with their requirements. The electronic interchange between Configuration B and its customers provides the capability for routinely adapting them to market demand. To the extent Configuration B corresponds to a mechanistic bureaucracy in the typology, it is hypothesized as achieving high levels cost leadership. This hypothesis is supported by its significant main effect in multiple regression analysis on cost reduction. In addition, this type also has a significant main effect on product innovation & quality that was unanticipated in the typology. One may speculate that mass customization with programmable technologies had improved the capability of mechanistic firms to innovate, especially in services because the fixed costs sunk in dedicated equipment are relatively lower. Possibly, a goodly chunk of the product innovation decisions originate at the customer's rather than the service provider's location.2 To the extent the locus of innovation is external, the operations of Configuration B conforms somewhat more closely

2

This speculation is consistent with the fact that Configuration B experienced market demand for customized products that was growing and turbulent more than any other configuration ( r = . 2 8 , not shown in Tables).

20 Joe Tidd & Frank Hull

to the hypothesis as machine bureaucracies are typically less capable of indigenous creativity. However, this service type differs appreciably from a stereotypical mechanistic bureaucracy functioning as a closed system. Configuration B has a negative effect with time compression that was unanticipated by the hypothesis. This relationship is consistent with the constraints often associated with machine bureaucracies. It is also possible that there are trade-offs between innovation and quality on the one hand versus time compression on the other. Type B: Case example For example, in British Gas Trading (BGT) standardized documentation and processes are used as an instrument of management control, and yet many different types of contract exist. Within BGT, there are formal procedures for assessing the financial performance of projects, and all projects over a certain threshold require the business owner to prepare a completion report within three months of completion. A project is complete when all physical work is completed, all costs relating to the work have been incurred, and all benefits have been delivered.

C. Cellular Hybrid Configuration C organizes their people as a cross-trained, co-rewarded group, which reinforces their cellular identity (0-3). Electronic tools are distributed to all and enable cell members to map processes, share best practices, and communicate lessons learned on-line (T-l). Cellular systems are typically rather self-contained which may be one reason companies in this configuration are more likely to value knowledge, re-use it, and share it for achieving a balanced portfolio of performance advantages, and (S-2). In terms of the OPTS framework, Configuration C is strong in dimensions of organization, tools, and system integration. Its lack of process may be compensated by the fact that t o o l s / technologies may serve as surrogates, e.g. common software for project

Managing Service Innovation

21

mapping and process mapping. It is perhaps the most well rounded of the configurations in terms of the OPTS framework. Its strategic focus on achieving a balanced portfolio of competitive advantages is consistent with the goal of best practice. Configuration C seems to correspond in some respects to a professional bureaucracy. Knowledge is regarded as a paramount competitive advantage garnered from outside the company as well as cultivated within. However, the extent to which knowledge is professionally based in a way analogous to that held by scientists and engineers in industrial firms is unclear. Perhaps the cellular group holds a kind of knowledge certification capability somewhat analogous to professional standards. For example, its use of tools focuses principally on knowledge management, e.g. distributed databases, templates for process mapping, etc. In any case, knowledge management seems to be a particular strengtli and is managed as part of a continuous process, e.g. on-line lessons learned databases, transfer of lessons learned, etc. To the extent Configuration C corresponds to a hybrid system, it is hypothesized as achieving multiple kinds of performance advantage simultaneously. This hypothesis is supported because this configuration ranks highest in overall performance. It also has significant main effects on product innovation & quality, time compression, and service delivery. Moreover, the organizational component of this configuration is significandy correlated with cost reduction. 3 An advantage of cellular organizations is their self-containment. Although the direct work of cross-trained employees is less efficient from a scientific management perspective of Taylor, cells can be cost effective for the total enterprise because administrative overhead is low. In addition, Configuration C has significant main effects on both time compression and service delivery. One may speculate that the self-containment of quasi-processionals in the cellular group

3

The organizational factor of Configuration C, Cellular grouping, is significandy correlated with cost reduction ( r = . 3 8 , not shown in Tables).

22

Joe Tidd & Frank Hull

enables them to delivery more customer focused services more quickly than if external professional bodies were controlling internal activities. In any case, the cellular configuration, along with its organizational component, has more significant main effects than any other type. This result is consistent with the thrust of the typology that hybrids are capable of multiple kinds of performance. Type C: Case example Cable and Wireless Global Markets (CWGM), a division of the UK telecom operator Cable and Wireless, is a systems integrator and service provider which designs, integrates and operates telecommunications networks for multinational clients. CWGM was established in 1996 to deal with the increasing number of nonstandard and highly complex outsourcing projects. The common processes and standards developed by the parent company were found to be inappropriate for this type of business. In contrast to the formal business processes and matrix structure used for simpler management network services, CWGM has adopted a more flexible teaming approach, which includes a "war room" to help build relationships and promote communication between team members and customers (Davies & Brady, 2000). In this way teams can more easily work closely with customers to develop innovative service packages of standardized products and customized applications to achieve the required service level agreements for outsourcing.

D. Organic Technical Configuration D organizes co-located, cross-functional teams in a flattened hierarchy (0-4). Communications are open regardless of rank, both face-to-face and via E-mail (T-2). Its technical base utilizes expert systems and management information systems. Responsibility for work is shared and partnering is practiced throughout the value chain (S-2). Many of these practices are core to the definition of the organictechnical type of design (Damanpour, 1991). Organic systems have

Managing Service Innovation

23

dense communications facilitated by cross-functional teams and physical collocation (Hull et al., 1996; Collins & Hull, 2002). Cross-functional teaming, whereby different specialists are assigned to work on the same project simultaneously, has been advocated and widely adopted in many companies as a strategy to improve their product development process. Collaboration among diverse functions typically provides better solutions to complex design problems (Gatenby, 1994). Physical co-location involves aggregating project team members in common space to enhance rich communications among group members (Daft & Lengel, 1986). The scale of operations is either small or managed in such a way that cross-functional teams are collocated with open communications within a reduced hierarchy. Everyone in the value chain accepts reciprocal responsibility for the product. The organic design has the advantages for creativity and innovation. Accordingly, Type D ranks significantly higher than other configuration in innovation, but lowest in all other performance measures. The organic-technical configuration in the UK specializes in practices that a lengthy literature associates with innovativeness (Tidd et al., 2001). The organic type continues to be a common organizational configuration for innovation in UK services. But the creativity of boffins involves trade-offs with other kinds of performance outcomes in a way that fits with the niche first described by Burns and Stalker. Type D: Case example For example, in BBC Worldwide (BBCW) speed/timeliness is essential to the processes given its strategic nature, and for this reason timelines are prescribed. Processes are strongly time-driven — indeed, diagrammatically they are captured in a timeline. A series of defined steps are involved from the initial receipt of programme treatment to sign-off by a senior management committee seven weeks later. In BBCW, processes are able to evolve reactively to emergent business needs. For example, if a new means of exploiting programmes arises (VOD, broadband video) these additional media would be included

24 Joe Tidd & Frank Hull

in the necessary documentation. In the case of an emergency item that requires urgent approval, informal contacts are exploited to minimize timescales, which is indicative of flexibility and the use of networking. Within BBCW, approval thresholds are reviewed regularly to ensure that the company is able to devote appropriate management time to investments that have a significant impact on its businesses. The process facilitates effective and efficient co-ordination of offers, the objective being to increase awareness of programmes and products available for investment; to focus investment strategies; and to co-ordinate offer documents to expedite investment decisions. The process documentation at BBCW has in-built financial measures as well as benchmarks against the success of previous programmes. The quality of a bid is dependent on individuals and departments providing the required information on a timely basis, together with robust ROI analyses and sales projections.

E. Partnership Process Subsystem Subsystem E is organized by involvement of external partners/ suppliers in product and delivery process decisions (O-l). Processes are documented, checked for conformance, and benchmarked with best-in-class (P-l). This subsystem is similar to Configuration B except that the organizing focus is on partners or suppliers instead of customers and the process method is documentation instead of standardization. In terms of the OPTS framework, subsystem E is weak in specifics of organization, but strong in process control via documentation. No items measuring tools were included. System integration measures were also absent. Companies in this niche achieve either a kind of backward integration toward sources of supply a n d / or horizontal alliances with partners to provide more holistic services. As such, this subsystem is not viable as a stand-alone enterprise. However, it may be a harbinger of the future to the extent that major service companies serve as solution integrators for clients by bringing together the inputs from diverse organizations. The trend toward providing solutions instead of components is becoming a

Managing Service Innovation

25

fixture in many industrial concerns and an increasing number of service providers.

1.5 Discussion All four configurations had one or more significant effects on specific performance indicators. Examination of the actual measures suggests that each of the four system configurations provided several common elements, including: • Organizational mode of bringing people together; • Control mechanisms, either impersonal (standards, documentation, common software) or interpersonal (collocated teams); • Shared knowledge and/or technical information base; • External linkages, e.g. customers and/or partners/suppliers. Each configuration appears to have parsimoniously evolved or acquired sufficient good practices to be viable at least in niche markets. The viability of these configurations in the UK data argues for updating the standard contingency typologies to encompass advances in technology and making such typologies more generic to better accommodate service as well as manufacturing sectors. A trend that seems to apply to all the systems in the typology is the devolution of business responsibility. The project-based configuration and the cellular are conspicuous additions to the organic-technical type. Mechanistic customization also implies some degree of devolution in that highly centralized decisions about large volumes of standard items build for inventory are no longer the only option. This trend is also illustrated by partnership process subsystems that have such a narrow scope of responsibility they are viable only in alliance with others. In sum, the general trend toward smaller, more decentralized units suggests significant changes in the structure and operations of all the configurations in the typology and fragmentary subsystems. The traditional notion of simple craft-batch organization needs rethinking in light of the project-based organization. Although lacking in tools, the project-based configuration was rather sophisticated

26

Joe Tidd & Frank Hull

in organization and process. For example, its organization involved downstream functions early on. The processes deployed by Configuration A to incorporate the voice of the customer in their products were advanced, e.g. QFD (Quality Function Deployment). This is consistent with the fact that Configuration A made more use of TQM (Total Quality Management) and BPR (Business Process Reengineering) than any other. ( r = . 3 9 and .53 respectively, not shown in Tables). Both goods and service companies increasingly deploy project-based organizations to integrate resources more quickly to serve their customers (Gann and Salter, 1998). In sum, companies in this niche may compensate for a lack of advanced technology with prowess in organizational and process. Moreover, their lack of advanced technology may be relatively less important for adding value in services than in goods industries. The mechanistic customized configuration differs from a traditional machine bureaucracy in two important ways. First, the limitations of dedicated assembly-line equipment during the period when Woodward's mass production type was first described, have been largely surmounted by flexible, programmable automation (Collins et 0/., 1996; Tidd, 1991). Second, the openness of Configuration B to customers contrasts with the closed systems of the past that produced large quantities of standard units to stock (Mintzberg, 1979). Its programmable capabilities enable a degree of mass customization that was impractical in earlier era of dedicated equipment for specialized production. This has enabled mass producers to customize products more easily and respond to the voice of customers in new ways. Professional bureaucracies have often been burdened by conflicting masters, the knowledge-based codes of professional conduct and large-scale administrative requirements. However, the growing volume and specialization of knowledge challenges the boundaries of traditional professions and has weakened external control over internal activities within corporations. A growing number of loosely regulated communities of practice have emerged both within and across different subject-based disciplines. The Cellular configuration enables a relatively self-contained group of people to become experts in

Managing Service Innovation

27

developing and delivering products as qu\asi professionals. Cellular organizations thereby get some of the advantages of codified knowledge with far less hierarchical control by bureaucratic forms. An organic organizational design originally meant little more than the absence of bureaucratic constraints. Today the organic-technical type of configuration has a more active agenda. Relatively more influence and resources are given to project teams instead of functional departments. Open communications are not left to chance encounters, but structured by collocated, cross-functional teams deployed in flat hierarchies so that communications are more horizontal than vertical. Partnership process subsystems are increasingly important because of the vertical disintegration of large corporations into smaller units that no longer have end-to-end responsibility for their value chain. Many kinds of subsystem have evolved with the growth of alliances, partnerships, joint ventures, and electronic networks during the past quarter century. They have core competencies that are viable only in symbiotic relationships (Tidd, 1995). To the extent customers want integrated solutions, many service companies may increasingly emulate industrial practices by building more extensive supply-chain relationships. Subsystems such as Type E may possibly be in ascendancy even though they are more difficult to capture in classic typologies of system design. These contrasting approaches to performance may provide opportunities for service enterprises in each nation to learn from one another. Some USA service enterprises might modify the somewhat monolithic best-practice paradigm by emphasizing selected practices from system configurations. For example, they might more fully implement practices associated with the organic-technical configuration to achieve higher levels of innovation. A similar adaptation of the then best practice Fordist paradigm was required when Toyota adapted this to local requirements and changing product markets (Tidd & Fujimoto, 1985). Alternatively, UK service enterprises might need to place more emphasis on integrated strategies that focus on time and cost as well as innovation to compete in global markets. One possibility that this may be occurring is the fact that unlike OPTS constructs,

28

Joe Tidd &• Frank Hull

the score for a strategy of rapid product redevelopment is almost as high in the UK as the USA data (Hull & Tidd, 2002) and may be a harbinger of subsequent structural changes. In any case, local configurations can continue to provide niche advantages in local markets for a long time, as Souitaris (2001) has demonstrated in the case of innovation strategies in Greece. In the case of services in the UK, many services are not internationally traded or subject to international competition (Krugman, 1997; Turner, 2001), which may make the configurations sustainable for some time to come. Nevertheless, in the longer term, this Balkanized approach to the adoption of best practices in services may prove sub-optimal to the extent markets for services in UK markets become more global. The contrast in practices in the two nations appears to largely pivot around a conceptual change that occurred quite recently in the USA. Many New York area enterprises have redefined their service as a product. Enterprises having formal dedicated product development function are far more likely to comprehensively deploy OPTS practices. Indeed, controlling for this one variable reduces differences in the level of the best practice index between the two nations to insignificance (Hull & Tidd, 2002). So some of the contrast between the two nations is due to the strategic choice of how to view their enterprise.

1.6 Summary and Conclusion The best practice model of new product development as defined by the OPTS framework has applicability in the service sector in both nations. However, USA firms conform more to the model than those in the UK. The four system configurations identified and described above seem to fit the UK data better than the more comprehensive OPTS framework. The four configurations feature different combinations of components of the OPTS model, and appear to confer performance advantages for different environmental niches. Limitations of the study include heterogeneity in the sample, which is partly due to the diversity of the service sector. Although

Managing Service Innovation

29

the nature of the service rendered was not found to affect results much in the USA data (Hull, 1999), this remains a possibility because parallel measures were not collected in the UK. Also, no small service organizations were represented in the two samples, so the effects of scale were not captured. Finally, a single respondent in both nations provided the data. A particular gap in the applying the best practice paradigm derived from industry to services is its weaker capability of explaining service delivery performance. Variance explained in service delivery was less than half that for product innovation & quality. One reason is because much of the value customers perceive in service product may be closely tied to delivery processes, especially to the extent interpersonal exchanges are involved (Gronroos, 1990; Lovelock, 1996; Reichheld & Sasser, 1990; Storey & Easingwood, 1999; Zeithaml et al., 1990). More robust models of product development are needed in both nations that include design for service delivery. To be more predictive of overall service performance, future research needs to be more inclusive of delivery process.

30 Joe Tidd & Frank Hull Appendix l.A Types of companies in samples. UK

US

Financial Services Retail banking Credit Card Lending Private Banking Investment Services

13 1 2 10

18 5 3 2 1 7

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2

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Managing Service Innovation

Fact

Appendix l.B Measures.

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4

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.62

.85

Process: Customer focus P2 a. Using structured processes for identifying customer needs and translating into requirements (QFD) b. Institutionalizing systematic reviews for development projects c. Mapping processes to reduce non-value activities d. Institutionalizing continuous improvement processes

.74

.78

31

32 Joe Tidd & Frank Hull Appendix l.B Measures

(Continued).

W ft * System: Holistic voice of customer SI a. Align competing product requirements by focusing on "Voice of the Customer." b. Cultivate staff to provide holistic, system-wide thinking as well as specialized knowledge c. Involve customers early in the service product development process, pulling the product design in the direction of customer needs

.79

Configuration B: Mechanistic customization

.81

Organization: Customer involvement 05 a. Involvement of customers in decisions about service product development b. Involvement of customers in decisions about delivery processes

.69

.79

Process: Standardization a. Setting performance criteria for projects b. Setting standards for the performance of products

P3

.62

.64

Tools: External linkages: a. Electronic data interchange with customers b. Electronic data interchange with suppliers

T3

.59

.71

.62

.83

03

.70

.69

Tools: Shared technology Tl a. Building on-line databases with lessons learned and best practice templates b. Distributed databases on-line to multiple functions c. Common software for project management d. Common software for process mapping

.71

.80

Configuration C: Cellular hybrid Organization: Cellular grouping a. Cross-training specialists b. Rewarding project teams/groups

.70

Managing Service Innovation Appendix l.B Measures

(Continued).

System: Knowledge integration S2 a. View knowledge as a paramount competitive advantage to be gained from outside as well as inside the company b. Transfer lessons learned from previous activities to succeeding people so that they build upon an existing base to reach ever higher future targets c. Focus on achieving a balanced portfolio of competitive advantages for which customers are willing to pay, e.g. cost with novelty

.75

.(54

Configuration D: Organic technical-batch

.78

.89

Organization: Cross-functional collocation a. Cross-functional teaming b. Collocation c. Flatter hierarchy in the organization chart

04

.69

.79

T2. Internal technology a. Expert Systems b. Management Information Systems c. E-mail

T2

.74

.65

S3. Reciprocal integration S3 a. Involve all functions throughout the development and delivery process with few hand-offs so that every works together reciprocally — sharing responsibility for the service product b. Act as a good partner with others, such as suppliers, external service providers, alliance partners and customers, in creating and maintaining mutual win/win scenarios c. Open communication channels to all functions and ranks in the organization

.67

.67

E. Subsystem: Partnership process

.78

.89

Organization: Partner involvement Ol a. Involvement of external partners/ suppliers in decisions about service product development b. Involvement of external partners/suppliers in decisions about changes in service delivery processes

.86

.84

33

34 Joe Tidd & Frank Hull Appendix l.B Measures

Process: Documentation a. Benchmarking best-in-class companies b. Improving documentation of processes c. Measuring conformance with processes

{Continued).

PI

.73

.70

Chapter 2 Organizing Innovation in Services Patrick Vermeulen and Wietze van der Aa

2.1 Introduction Research on innovation in services has only started to grow in the last fifteen years. Before the second half of the 1980s, publications on developing new services only appeared occasionally, but the number of publications grew rapidly in the 1990s. A large body of literature on innovation in services dealt with various types of new services, success factors, and aspects of the new service development (NSD) process (see Johne & Storey, 1998). The latter stream of research is already more concerned with the organization of NSD, but does not give much attention to issues such as organizational structures, integration and coordination to a large extent. Although there has also been attention for other types of innovation, such as technological innovation (Pennings & Harianto, 1992) and innovations in work organization and new methods of management control (McCabe, 2000), the actual organization of innovation processes in service firms has not received widespread attention in the literature (some valuable exceptions are: Drew, 1995; Sundbo, 1997; Lievens & Moenaert, 2000; Tidd & Hull, 2002). Yet, studies by De Brentani (1991) and Edgett and Parkinson (1994) pointed to organizational factors as the second most important success factors in new service development. Edgett and Parkinson, for instance, claim that successful services exhibited strong inter-functional cooperation and coordination, implying that organizational factors were found to be a major leverage for success. It may be that there are very few differences between the basic processes for developing new products or new services (as argued by Tidd et al., 2001). Nevertheless it seems interesting to consider 35

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Patrick Vermeulen & Wietze van der Aa

if and how the specific features of services affect the broader organizational conditions and prerequisites of innovation in service firms. The first aim of this chapter is to provide more insight in the organization of product innovation processes in service organizations and some of the organizational conditions that facilitate this type of innovation. Many of the innovation processes that are directed at the development of new services, which has by far received the most attention in the literature, seem to fit a generic pattern as depicted by Tidd et al. (2001). The underlying process does not seem to differ to a great extent. Yet, most innovation studies in service firms have not explicitly discussed how processes of other types or modes of innovation (such as architectural innovations or organizational innovation) are conducted (Gadrey, Gallouj & Weinstein, 1996; Gallouj & Weinstein, 1997; Miles, 1997). It seems that the organizational conditions and development of innovations different from pure product innovations is less well understood. Thus, the second aim of this chapter is to explore organizational innovations in service firms and provide some preliminary insights in the organizational conditions and development process.

2.2 Consequences of Service Features for Organizing Innovation in Services 1 The various characteristics of services have been described at length in the services literature (see Zeithaml et al., 1985; van Looy et al., 1998; Gr0nroos, 2000; Normann, 2001). Several authors (Easingwood, 1986; De Brentani, 1991; Thwaites, 1992; Terill & Middlebrooks, 1996) have argued that these specific features affect the new service development process. We would argue that the impact of these differences on the actual organization of innovation processes is only limited (see Table 2.1). The intangibility of services is the key factor that affects the development process of new services. Although this lack of tangibility ^ h i s section is, to a large extent, adapted from Vermeulen and Dankbaar (2002).

Organizing Innovation in Services 37 Table 2.1 Service characteristics and their impact on the organization of innovation processes. Service Characteristics

Impact on Organization of Innovation Process

Intangibility

Need for intensive communication between people involved in innovation, because new product cannot be felt or touched. Creating shared understanding is of highest importance.

Simultaneous production and consumption

Close involvement of front and back office personnel is needed, largely due to simultaneous development of production process.

Heterogeneity

No impact; physical products may also be heterogenous.

Perishability

No impact; new services can be developed in advance.

would appear to make new service development more complex (the people involved in the development process cannot see, feel or touch the new product), de Brentani (1991) argues that developing new services is easier than developing industrial products. Shostack (1984) argues that this relative ease of developing new services is a result of the absence of patent applications, prototypes or major investments in raw materials. The latter two reasons (prototypes and major investments in raw materials) are not necessarily true for financial service companies. Especially banks have relied on prototypes in the development of new payment systems (PIN card and chipcard). Major investments were also necessary in the development of these payment systems, because a new infrastructure with applications for these services was needed. On the whole, however, services are easy to imitate. According to Easingwood (1986) this results in a too casual approach for developing new services, although they are often highly complex (the latter is especially true for financial services). However, copying services that are developed by some competitor does not mean that the organization is capable of organizing a development process. Most organizations will try to adjust the competitors' product. Thus, de Brentani and Shostack are right if

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they refer to the ease of imitating new financial services. However, they overlooked the effects of intangibility for the internal organization of the development process, which will be more difficult because the people involved cannot see, feel or touch the product being developed. Therefore, it will be difficult to understand the new service, even for employees (Ennew et al., 1992). These individuals are representatives from functional departments and have to work together for some time in a project team. It may be more difficult to perceive that different understandings of the same product are used in the group, because there is no physical object on which all can direct their thoughts. Simultaneously producing and consuming services is also of influence on the development process. In financial services the role of front and back office personnel is often crucial. Customers are in direct contact with these departments, meaning that ideas for new products or problems that customers experience arise at the front and back office. Easingwood (1986) claims diat simultaneity has important implications for the organization of new service development activities. Simultaneity has its main impact on the organization of NSD activities. Easingwood refers to the front and back office or "operations staff" that are involved in the decision making process due to the relative proximity to the customer. Simultaneity also means that production and delivery cannot be separated, which implies that more products lead to more work. Consequently, operations may limit the number of product suggestions. The front office needs to be involved in the decision making process due to the relative proximity to the customer. Front office personnel produce the service in more or less close interaction with the customer. The development of the production process (e.g. supportive software in the financial sector) is therefore just as important as the elaboration of the product concept. Close involvement and integration of front (but also back) office personnel in new service development is therefore considered highly desirable (Edgett & Parkinson, 1994). The heterogeneity and perishability of services do not appear to give rise to important differences with physical products in the realm of product development. The fact that quite different perceptions may

Organizing Innovation in Services 39

come to exist of the same service will obviously make it more difficult to develop, but to some extent this also holds for the development of new physical products and is in fact one of the core issues in any marketing exercise. The fact that services cannot be stored (referred to as the perishability of services) obviously does not mean that they cannot be developed in advance at the conceptual level. Although the specific service characteristics seem obvious, the influence on the organization of new service development processes should not be over-emphasized (Easingwood, 1986). Easingwood argued that "not all services are intangible, produced simultaneously, heterogeneous, and perishable and some manufactured goods may possess one or more of these characteristics" (1986, p. 265). This leads to the conclusion that in service organizations similar issues with respect to the organization of innovation processes will arise when compared to manufacturing.

2.3 Organizing Product Innovation Processes in a Service Environment Recent research shows that at first glance few differences in the organization of product innovation processes between manufacturing and financial services exist (Vermeulen, 2001). The majority of companies in the financial services sector, for instance, use multidisciplinary project teams to work on innovative projects. As in manufacturing these teams consist of employees from various departments. An interesting distinction between teams in service organizations and teams often found in manufacturing (see, for instance, Clark & Fujimoto, 1991) is that members of multidisciplinary project teams were most of the times only part-time involved and remained first and foremost representatives from their functional departments. There is no specialized R&D department in service organizations. This also means that project based work is something that many (financial) service firms are not really used to. Dividing work between members of different departments that had to work on a shared task proved to be troublesome, because team members remained representatives of their functional departments and as such

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Patrick Vermeulen & Wietze van der Aa

the project teams could hardly be called a "team". In most project teams there was little communication between the team members outside the formal weekly meetings. Because most project team members are not used to cooperating with people from other departments, they sometimes did not exactly understand what other team members contributed to the team. Especially the more complex work of actuaries was difficult to understand for many team members. In some cases this led to irritations between the team members. Manufacturing firms that have far more experience in cross-functional cooperation will probably suffer less from these problems. The product innovation process encompasses the following phases: idea generation, concept development, building, and implementation. The names of these phases might differ between companies, but all development processes come down to these four phases. As Tidd et al. (2001) have argued, there is a generic innovation process that is equal for both service and manufacturing companies. But again there is an important distinction in the actual execution of the tasks in these phases. In service organizations phases are mainly conducted sequentially and partly in parallel. Integrated product development or concurrent engineering (cf. Clark & Fujimoto, 1991; Berndes & Stanke, 1996) has not found widespread dissemination in service companies. However, it is not possible, nor desirable, to have everybody involved to the same extent during the whole process. When the product specifications have been extensively described, IT personnel has to translate these specifications into a real product by integrating it into the information systems. The other project team members are not involved in this stage because of the complexity of the task, which lies far beyond their knowledge domain. This means that in the development process there is still an important sequential order, which seems impossible to change. Integrated product development, in its purest form, does not seem to be an option for organizations in the financial sector. The similarities between service and manufacturing firms become more obvious when looking at some of the key problem areas in innovation management. A recent study in the financial services sector (Vermeulen, 2001) pointed at problem areas that are by no means

Organizing Innovation in Services 41

specific for service firms, but are probably common to many firms that are inexperienced in product innovation. Firstly, strong tensions between various parts of the organization were identified. With respect to the product development function, these tensions occurred between the department that was responsible for product development and the departments responsible for the daily business. These departments perceived their goals as incongruent, either concerned with short or long term activities. This led to two problems: conflicting priorities and battles for resources. Secondly, people working in the same department tend to have more or less similar backgrounds (education). When they work together for some time they develop thought worlds or mental models that consist of perceptions of how the world looks (cf. Dougherty, 1992). These thought worlds are specific for a group of people and are distinct from other groups in the organization. In product development teams these different thought worlds are brought together. On die one hand these are considered necessary for innovation to occur. On the other hand, however, these are also obstructive to effective interfunctional communication and cooperation. People from different departments sometimes speak different languages and often have very different ideas about new to be developed products (Crawford, 1983; Gupta ct al., 1986; Moenaert & Souder, 1990; Moenaert et al., 1994). Thirdly, the organizational culture appeared to be a huge barrier for product innovation (Kanter, 1984; Tushman & O'Reilly, 1997). In general, the organizational cultures were considered conservative and people in the studied companies mainly displayed risk-avoiding behavior. Taking risks (which is closely related to innovation) was still considered not done. Fourthly, information technology was considered a major bottleneck with respect to the innovative performance of banks and insurance companies (cf. Child & Loveridge, 1990). Besides a shortage of IT personnel which has led many financial companies to outsource parts of their IT to the UK and Ireland, resulting in increased communication problems, the necessary integration of different administrative systems is problematic. Since banks and insurance companies started to combine their products into so-called "combi products" they also had to integrate the administrative systems (Vermeulen, 2001).

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Patrick Vermeulm & Wietze van der Aa

These systems, however, date from the 1970s and 1980s and are not easily adapted, let alone combined with other systems. Furthermore, the complexity of the information systems does not allow people outside the IT departments to judge whether adjustments to the system are possible or not. As such, many new financial products are still IT driven. Product concepts that seem promising, but cannot be developed without major changes in the information systems are adapted. This leads to less innovative new products. Thus, with respect to the organization of product innovation processes, the distinctions between manufacturing and service organizations do not seem to be caused by the specific features of goods or services. However, it seems to be more closely related to the level of experience. Most manufacturers have large R&D departments that specialize on developing new products, whereas these departments are missing in service organizations. This means that "regular" employees also need time to work on innovative activities, which they are not used to.

2.4 Organizational Conditions for Product Innovation The problems in organizing product innovation processes mentioned above are not exactly "discoveries". For years scholars and practitioners have pointed at the problems with innovation management and as a result these (or similar) problems have been described at length in the literature (see, for instance, van de Ven, 1986; Dougherty, 1999). In this section we describe some of the organizational conditions (see Box 2.1) that are favorable to product innovation. Firms that actually implement these solutions are able to protect single product development projects from failure, meaning that these measures can be taken to improve the innovative performance for incidental product innovation.

Clear Project Organization Projects should not necessarily be organized in a complex manner with steering committees, task forces and other interfering parties.

Organizing Innovation in Services 43 Box 2.1 Conditions for product innovation (adapted from Vermeulen, 2001) Conditions for product innovation • Clear (and straightforward) project organization • Top management support during whole development process • Special decision-making unit for screening of projects and allocation of resources • Product champions with formal power and process overview • An integrated product development approach • High involvement teams with right mix of people

T h e project needs to be approved of by top management and preferably one high-ranked manager should be the sponsor. The sponsor tries to find an appropriate project leader (product champion) who will lead the team through the development process. When difficulties arise in the project, the sponsor will discuss these in the N e w Product Committee (see below). There is n o need for additional advisory committees as long as the project leader and the team members communicate their efforts to the rest of the organization. Informal advice can of course be obtained from people outside the project team, but formally only a small number of people should be able to interfere with the development project.

Top Management

Support

Every new product development project needs support from top management during the entire development process (Tidd et a-L, 2 0 0 1 ) . Burgelman and Sayles (1986) argue that additional incentives might be needed for increasing continuous top management support. A senior manager (sponsor) has to be dedicated to the project. Without a strong sponsor it will be difficult to have the necessary technical and h u m a n resources allocated to the project and there will be a serious danger of re-allocating resources to other projects that become more important. Declining support from the top has a deleterious effect on motivation.

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Patrick Vermeulen & Wietze van der Aa

New Product Committee A New Product Committee (NPC) consists of high-ranked managers from different functional disciplines. Every discipline that is involved in new product development should be represented in the NPC. The NPC has to be able to judge whether ideas can be transformed into new products and has to decide about the allocation of resources. When the NPC decides to support an idea and approves its development, commitment will be increased. Ideally the sponsor is a member of the NPC, which means that the NPC is always closely involved with the project's progress. For the NPC to function appropriately it is necessary that the members have a clear and shared vision of where the organization is going. This might be problematic because the NPC consist of members from different functional departments that might have different agendas. Creating a shared understanding and vision is therefore of the highest importance for the NPC to function properly. The shared vision must be clearly articulated throughout the organization in order for it to flow towards the operating levels of the organization.

Product Champions The project should be under supervision of a strong product champion. Most projects in the financial services sector were under supervision of a project leader from a special "project manager unit". However, these project leaders often lacked any formal status to really be in control over a project or the people that are assigned to the project. The product champion should be someone with experience in the organization and enough formal and informal power to control the project (see Chakrabarti, 1974; Maidique, 1980). The product champion needs a good overview over all the activities in the development process. He should be able to connect the various activities, be aware of the interdependencies between the activities, facilitate the development process and remove any obstacle that arises in the process.

Organizing Innovation in Services 45

Integration in the Development Process The traditional "throw it over the wall" phenomenon where individuals work in isolation needs to be changed into an integrated development approach (cf. Flynn et al., 2000). The project team members need to share information as early as possible, development activities show considerable overlap and are conducted in parallel (Clark & Fujimoto, 1991). High degrees of communication and collaboration are needed to develop new products in an integrated way. Due to the intangibility of services the people involved in the development project should communicate intensively and work closely together. It looks like all the ingredients for integrated product development are present in service companies. However, due to certain complex tasks (mainly IT related tasks) it is not always possible to have everybody involved to the same extent during the whole process. Therefore, the development process could be divided into three stages. In the first stage representatives from all parties involved are members of the project team. They share the same location and discuss the initial idea and the product concept that will be transformed into a new product. All the team members make sure that their main tasks are prepared and ready for execution. In the second stage team members partly work alone on their main activities, but still communicate as much as possible. The main reason for reducing the degree of collaboration between team members is the complexity of IT activities. The other team members are not involved in these activities and it would take too much time to organize this stage similarly to stage one. In the third stage, the team converges again. The activities needed for a proper implementation also need intensive communication between the various disciplines. High Involvement Teams A high involvement team consists of people that are, as much as possible, assigned to the team on a full-time basis. A single focus will speed up the development process because team members do not have to switch their attention between projects (see Flynn et al., 2000). They share the same location in order to improve

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Patrick Vermeulen & Wietze van der Aa

the possibilities for communication, co-operation and team building (cf. Flynn et al., 2000). It is important that in the beginning of a development process special kick-off sessions are arranged. These sessions can last one, two or even three days and are mainly aimed at team building. The project leader tries to commit the team members to the project and tries to decrease the departmental differences. When it is not possible for team members to be assigned to the team on a full-time basis other solutions might be considered. The representatives from the various departments involved in the development process work together on the project as an "involved team". The team members are still members of the functional organization and are not available for the project on a full time basis. However, in order for the team to become an involved team, it is necessary that the team members work on the project as much as possible on the same time. For instance, if team members are assigned to the project for 40% of their working time, it should be arranged that every team member can work on the project on Monday and Tuesday. In this case it is also preferred that they share the same location. The members of the (high) involved team also function as ambassadors of the new product. They are the liaisons for the functional departments they represent. A strong emphasis on communication with the rest of the organization is key to effective team working (Tidd et #/., 2001). The new product needs to be accepted by the standing organization, which will be very difficult because of the "not-invented-here" problem. Full-time team members can contribute some of their time on sharing the initial ideas with people in the standing organization and asking them for advice. This might increase acceptance. Up till now we have mainly been concerned with the organization of innovation processes on a more "micro-level" and how these might differ between manufacturing and service firms. We provided insight in the process of product innovation, how these processes are organized and what the main barriers in this process are. Furthermore, we discussed some of the organizational conditions that facilitate the development of new products. These conditions

Organizing Innovation in Services 47

may be viewed of in the light of "good project management". The conclusion so far is that there are very few differences between these firms and that the generic innovation models seem to fit. However, there are other types of innovations that do not directly fit into the current distinctions between types of innovation and therefore might not fit into the generic model of innovation processes.

2.5 Organizational Innovations and Conditions for Innovation As was stated in the introduction the main part of the literature on service innovation focuses on new service development (or "new product development"). Although this category of innovations is certainly of great value for service firms, new services or products are often considered as separate or isolated changes in the offering of the company. By focusing on this category one could overlook innovations with a broader, more system-like character. In this section we introduce two examples of these innovations and discuss a number of potential implications for the organization of the innovation process and organizational conditions facilitating these types of innovation. The first category of innovations we will call "replication innovation" (Normann, 2001; Winter & Szulanski, 2001). Because of the simultaneity of production and consumption services are mosdy produced locally in sites close to the customer and the market. In order to realize growth almost every service firm has to increase the number of sites where the services are offered. Growth of the firm creates the challenge of replication of the service production system (Gronroos, 2000) from one site to another. Service firms in various industries have grown to organizations consisting of hundreds or even thousands units. All of us know McDonald's as the largest foodservice retailer with more than 30,000 restaurants in 120 countries. The same industry has several other large players like KFC (10,800 restaurants), Pizza Hut (12,000 units) or Burger King (11,400 units). The multi-unit organization form also exists in other service industries. Many firms in retailing experienced the same process of growth and multiplication of units

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Patrick Vermeulen & Wietze van der Aa

(e.g. Walmart with 4300 units). This type of organizational growth is not an exclusively U.S. phenomenon. Accor is a French organization in the hotel industry and manages about ten different chains with in total 3600 hotels and about 416,000 rooms. Another European example is Kwik-Fit, with about 2500 service points for car repair across Europe. The multi-unit firm is a wide spread organization form. Replicators are active in over 60 industries, ranging from various types of support services to personal services and professional services (Winter & Szulanski, 2001). One of the innovative aspects of these multi-unit organizations is the development of a replication concept. In most cases this is not a simple formula or recipe for reproduction. The service firm needs to explore "what" and "how" to replicate. This exploration effort precedes the exploitation opportunities (March,1991). Multiunit organizations are created by discovering and refining a business model, by choosing the necessary components to replicate that model, by developing capabilities to routinize knowledge transfer, and by maintaining the model in operation (Winter & Szulanski, 2001). The challenge for the organization is to discover which attributes of the business model are replicable and which do add value. The many failures in replication indicate that the discovery of the replication concept is not an obvious task (Bradach, 1997; 1998). One of the problems replicators face is the causal ambiguity of the success of a unit. What are the sources or activities that lead to good performance? Are those sources available at a new location? Are activities and practices to be copied at the next site? In developing the replication concept one of the crucial strategic issues is to find the right balance between the goals of exploitation and exploration (March, 1991). To create an exploitable replication concept many firms specialize a narrow set of services. Firms with a simple service concept and service management system can control the complexities of an organization with many units. Furthermore, standardization of the service management system enables the service firm to exploit economies of scale and reduce costs (Normann, 2001). Specialization and standardization have to be balanced with the adaptability of the service management system to different business

Organizing Innovation in Services 49

environments. Service firms may fail in replication, for example, because of market segments with expectations that do not match the service concept. Service firms implement various strategies to explore and develop a replication formula. IKEA, for example, institutionalized this organizational learning process by setting up so-called expansion groups and first-year operations groups (Von Krogh & Cusumano, 2001; Van der Aa & Elfring, 2002). In the case of Banc One the replication concept was developed by creating various models of banks that could serve as a benchmark or reference point for the new acquired or established unit (Winter & Szulanski, 2001). One of the challenges for a multi-unit service firm is the management of the learning and innovation experiences throughout the organization. So, what happens to innovation once the replication model is explored and developed? Will innovation come to an end in the large-scale multi-unit organization? In his extensive study on the management of five large restaurant chains Bradach (1997; 1998) focused on the so-called plural form of management: a mix of company-owned and franchised units. The plural form was described as an appropriate form to balance two major management challenges: standardization and maintaining uniformity on the one hand and innovation and adaptation of the system on the other. Bradach distinguished four processes that were essential for keeping this balance: structuring, control, socialization and learning. The independent franchisees played a vital role in the learning and innovation processes of these large chains. We summarize a few results of Bradach's research: • One of the sources of change was called the "ratcheting effect" — the similarity of the units enabled cross-unit performance comparison. Units owned by the chain learned from franchise units and vice versa. Units or groups of units were challenged to improve performance. • Franchisees generated new ideas by proposing products for their local markets that sometimes were later adopted by the entire chain. Usually franchise units took the (legal/formal) opportunity

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Patrick Vermeulen & Wietze van der Aa

to experiment and deviate from the standards (more often that chain units). • Formal market tests of new products were conducted mainly in units owned by the chain. Franchisees could not be forced to participate in those tests and to deliver the necessary data. • In the decision making process on innovations franchisees served as an "institutionalized source of constructive challenges" (p. 296). From this research on the management of large chains in the service industry we conclude that a balanced or mixed organizational form could foster learning and innovation but create uniformity and economies of scale as well. Even in well-developed large-scale chains of service units exploration and innovation can be an ongoing process. The second type of organizational innovation we discuss is labeled as "new roles for the customer". In services customers not only demand for the result of the service production but also play a role as co-producer. There is a scope for the customers to influence parts of the service process, or to do these parts themselves. The borderline between the activities of the producer and the activities of the customer is flexible (Gronroos, 2000). Some service firms are innovative and successful in exploring new forms of co-operation between customers and service providers. Those firms redefine the existing division of activities and functions between customers and service organization. In some cases the customer has to do more himself. All kinds of self-service arrangements exist in various industries. The self service concept of IKEA is a striking example of active customers guided by die company in playing their role as co-producer (Normann, 2001). The opposite development of more self-service by the customer is shifting activities to the service provider. Especially in the area of business services outsourcing has increased (Quinn, 1999). Many providers of business services developed new interorganizational arrangements and took over activities and responsibilities from their customers. The literature on service innovations do give us very limited insights in the development process and the organizational conditions that facilitate this type of innovations. At least one important issue

Organizing Innovation in Services 51

seems to be the contribution by the customer himself. Customers can be perceived and used as a source of competence (Prahalad & Venkatram Ramaswamy, 2000) or even as "part-time" employees (Schneider & Bowen, 1995). Service firms develop various methods and tools to improve the productivity of customers. Von Hippel ( 2 0 0 1 ) discusses interesting cases of customers participating in innovation communities and developing new software. Organizational conditions that favor such communities are various types of incentives (licensing arrangements, fun, customization, control, etc.) and methods of distribution and diffusion of innovations. Some evidence exists that a strong commitment from demanding customers can foster the development of new organizational arrangements (Jallat c.s., 1992; Ulwick, 2 0 0 2 ) . An illustration of this demanding customer was Rank Xerox in the development of new delivery concepts by logistics service provider Frans Maas (Van der Aa & Elfring, 2 0 0 2 ) . Strong co-operation between the two parties n o t only led to new ways of delivering products and exchanging information, but created a new division of tasks and roles as well. F r o m t h e discussion of these t w o types of organizational innovations we conclude that our knowledge about the specific development process is still very limited. Some research gives indications of relevant organizational conditions (see Box 2.2). In Box 2.2 Conditions for organizational innovations Conditions for two types of organizational innovations "Replication" • Organization structure that balances control and learning (plural form) • Mutual learning between chain organization and independent entrepreneurs • Teams dedicated to setting up new sites and diffusing learning experiences "New Customer Roles" • Involvement of customer in innovation process • Commitment of demanding customers

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Patrick Vermeulen & Wietze van der Aa

the case of the replication innovation the design of an organizational structure as the "plural form" seems to create a balance between the needs for both exploration and exploitation. Hybrid forms of organization as the "plural form" create the opportunities and the incentives for mutual learning between the central organization of the chain and the independent entrepreneurs and managers of the local sites. For the development of organizational innovations as "new customer roles" one of the organizational conditions is the involvement of the customer in the innovation process. Co-operation with challenging customers during the development of new service concepts can lead to innovative forms of co-production by customers.

2.6 Conclusions A large proportion of the research on service innovations is focused on the new service development process. Most often these are individual attempts to revitalize current product portfolios. Empirical evidence and data originate to a large extent from the financial services industries, especially retail banking (see, for instance, Reidenbach & Moak, 1986; De Brentani, 1993; Edgett, 1996; Lievens & Moenaert, 2000; Avlonitis etal., 2001). When we compare insights from new product development in manufacturing with the development of new services, our empirical results illustrate that the process of new service development in the (financial) services industry differs only slightly from the same processes in the manufacturing industries. Similarly, many financial service firms suffer from the same problems as their manufacturing counterparts. Most of these problems can be overcome by implementing measures for "good project management". These measures should provide service firms with sufficient conditions for developing new products every once in a while. After the discussion on the organization of the new product development process in the financial service industry, we focused on different types of innovation, namely organizational innovations. We considered two types of organizational innovations that are specific for the service industry. The first innovation is called "replication".

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In order to grow and to extend the number of sites many service firms have to explore and develop a replication concept. The (public) knowledge of the development process of this type of innovation is still limited. Some researchers paid attention to organizational forms (as the so-called plural form) that can foster the development of replication concepts and createo create a balance between the needs for both exploration and exploitation. The second example of organizational innovation is called "new customer roles". Many service firms develop new relationships and organizational arrangements with their clients. One of the organizational conditions that could facilitate the development of this innovation is the involvement of the customer in the development process. Especially close cooperation with demanding customers can lead to new service concepts with new customer roles. Thus, the organizational conditions needed for organizational innovations reach further than merely facilitating "good project management". More radical changes are necessary in order to bring about organizational innovations. Our knowledge of the innovation process in the service industries is limited. The research has shown a strong focus on certain types of innovation (new product development) and certain industries (banking, insurance). Although this research created many useful insights we have to conclude that much work has still to be done. The variety in the service industries and the variety in forms of innovations legitimize the exploration of new directions in the research on innovation processes.

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Chapter 3 Getting "Customer Lock On" Through Innovation in Services Sandra

Vandermerwe

3.1 Introduction Never before has the need for innovation in services been greater, as enterprises everywhere strive to grow and sustainably compete. However, the kind of successful innovation in services which achieves growth and a sustainable advantage in today's environment requires a very different approach. Instead of innovating to make more or better "stuff — i.e. the "service/products" — companies have to instead innovate around the customer concept. While the literature distinguishes between incremental and revolutionary forms of innovation, the focus of most innovation research to date has almost exclusively been on the product — be it tangible or intangible. 1 This paper tries to show the limitation of the so called product approach and present an alternative model which involves articulating and creating new market opportunities which allow companies to "lock-on" customers — both existing and new. 2 And, as the paper will demonstrate, it is customer 1

See, for instance: Lynn, Gary S. "New Product Learning: Developing and Profiting From Your Knowledge Capital," California Management Review, Vol. 40, no. 4, Summer 1998; and Berthon, Pierre; Hulbert, James; and Pitt, Leyland, "To Serve or Create? Strategic Orientations Toward Customers and Innovation", California. Management Review, Vol. 42, no. 1, Fall 1999. 2 Customer lock-on is also different from customer loyalty in that the latter is usually focused on bringing customers back to buy more of the same stuff. For more on customer lock-on see Vandermerwe, Sandra, Customer Capitalism: The New Business Model of Increasing Returns, Whurr Publishing, London, 2001. 55

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"lock-on" which not only allows an enterprise to extract maximum customer value through new revenue streams, but also defend its competitive position over time. Customer "Lock-on" versus Lock-in Customer "lock-on" occurs when customers want the enterprise as their sole or dominant choice. This is a very different notion from customer lock-in, where customers have no choice: even if they are disenchanted by the traditional approach, there is little they can do since everyone in the industry is behaving in exacdy the same way. Given the opportunity, however, these customers will quickly migrate to industry newcomers and rule breakers. An example of the newcomers and the rule breakers are the myriad of non-financial entities who are now entering traditional banking territory because they sense that customers are unhappy with the longstanding players, yet are forced to remain with them since they assume there can be no alternative. There is only one real object of innovation: to get and stay ahead in a way that makes it difficult for others to catch up. However, this can only be achieved when a company is profoundly customer focused — shifting its model from innovating to produce and deliver more service/products, better-quicker-cheaper to take market share from others doing exactly the same thing, to one which changes the rules and creates new customer wealth — so as to achieve customer "lock-on".

3.2 Working on Twin Innovation Tracks Typically innovation can take place on two tracks: let us call them "Track One" and "Track Two". Truck One On Track One, innovation is about improving the core service offering through successive service/product enhancements. While

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this is clearly necessary on an ongoing basis, it does not transform an industry or get and keep the enterprise ahead because others can and do quickly copy the innovation. In the UK, British Airways and American Express created the "British Airways American Express Card" as a co-branding venture, designed to let customers earn free miles each time they used the card; while it may be attractive initially, it is only a question of time before other airlines launch the same or similar cards, just as one loyalty scheme always engenders another.

Dangers of being only on Track One If a company operates solely on Track One, it is in a continuous battle to stay ahead because new service/products and technologies — no matter how innovative — are just too easy to copy. And as others enter the market to cash in on the innovation, margins invariably deteriorate, resulting in diminishing returns overall. Additionally, new service/products are usually seen as discrete and self-standing items, as opposed to being an integral part of the total customer experience. So inevitably these innovations land in a functional silo: employees are driven and rewarded to continue to push their own wares, rather than being motivated to see the innovation as part of an integrated offering, and as intrinsic to locking customers on. Another danger is that an innovation which does not make profits in its own right is often not offered, even though it may be a crucial value piece for the customer experience and make a huge contribution to getting customer lock-on and therefore increased revenues and competitive lock-out. Take Marks and Spencer's (M&S). It refused to accept credit cards as an innovation since management considered the costs involved to be too high. However, they were looking at the wrong set of financials: while there might have been a cost involved in accepting credit cards (they said around 5%), the opportunity cost of not accepting credit cards was much greater, since customers spent only a fraction of what they might have bought otherwise.

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Baxter had a different attitude. Its Renal Division, for instance, decided to make significant investments in home care systems, a cost and not a profit centre, for dialysis patients. But more than just a logistic service for the delivery of renal bags, this enabled the firm to enter peoples' homes; monitor patients' blood toxin levels and adapt solution prescriptions quickly; and deliver drugs to deal with associated diseases — all of which and more led to customer lock-on and lifetime customer value. The point is that in the new model not every service/product is obliged to make money at a specific moment in time. It is the profitability over time (even a lifetime) of customers that the enterprise wants. Track One also involves innovations which change the processes by which service/products are produced or delivered. A good example of this is how E-technology is being used by retailers like Tesco or Sainbury and others for the ordering and delivery of goods to people's homes. But again this does not lock-on customers, it simply automates systems. Customers are constrained by what the store allocated to them has in stock. If goods are not in stock they do not get them and do not end up frustrated and disenchanted, and they will move from one supplier to another. No matter how inventive or radical a new service/product or process may seem at first, it will not take long for others to imitate. Thus a Track One player cannot hope to achieve ongoing growth or sustainable advantage since inevitably the new customer wealth will go to others. The only thing Track One players can do is stay ahead of competitors by winning market share for a while.

Track Two-Customer Concept Innovation Enterprises which have moved to Track Two drive customer concept innovation, and not just service/product innovation. This involves new ways of doing things for and with customers. Customer concept innovation is what ultimately changes the nature of an industry

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itself,3 and it is in Track Two that we see the most dramatic examples of growth and new wealth creation. Direct Line is not simply a brand of auto insurance; it is a total experience brand which begins when the car is bought, and then continues with the customer through maintenance, breakdowns and replacement vehicles. Starbucks did not simply think about selling more coffee, like companies such as Nestle did; instead it focused on creating a "coffee break experience", and all that that entailed, and in the process created a whole new industry around that idea. Examples of Track Two Direct Line, who revolutionalized the automobile insurance industry in 1985 by challenging the traditional way of selling — "We're just a phone call away" — now have two and a half million customers in the UK alone. But Direct Line does not see itself as an insurer only; instead, it has decided to manage its customers' entire automobility experience in a totally different way. Amazon is another example of this: it found a new way to manage people's knowledge and information needs, and the traditional retailers have yet to recover. International Health Insurance (IHI) is a Danish health insurance corporation specializing in offering private medical insurance for the expat and high net worth individuals segments worldwide. Operating in 100 different countries, its new strategy is based on finding innovative ways to help people manage their wellness instead of just getting their claims reimbursed. Building in obsolescence Track Two often involves the complex challenge of having to sell less of one's own core items, and building obsolescence into them 3

Though Gary Hamel first articulated concept innovation, he too focused mostly on products rather than on customer experiences and new ways of doing things for and with customers. See, for instance, Hamel, Gary, Competing for the Future, Harvard Business School Press, Boston, 1995.

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"before someone else does" — to paraphrase Virgin's Richard Branson. This entrepreneur envisages, for instance, that as a result of third generation mobile networks — in which he is a player, through Virgin Mobile — the new customer concept will be to fulfil the role of a "virtual concierge" — letting people, while on the move and via their mobile phones, to book air and rail tickets; get information on schedules; handle their financial affairs; buy books or a variety of other goods; and download any kind of music they desire from the network — even though this may potentially have negative repercussions on the sale of Virgin branded CDs, as well as on sales from Virgin Megastores.

3.2 Step 1: Defining the Market Space Innovating on Track Two is an important core capability if services organizations are to get the customer "lock-on" needed to thrive and grow. Thinking and operations shift from obtaining market share of the stuff — i.e. service/products — which inevitably leads to a situation of declining margins, to "market spaces" which encapsulate the outcome the customers want. 4 By becoming indispensable to the customer in that market space the enterprise extracts value from customers over time rather than making and selling more and more of the stuff in discrete transactions. The focus is thus on making the customer the barrier to entry, not the technology, the invention or the new service/product.

Market Spaces Direct Strategy and Resources The principle holds for traditional mature enterprises as well as startups. Most health insurers still concentrate on the service/products

4

Original publication: Vandermerwe Sandra., "'The 11th Commandment: Transforming To "Own" Customers, John Wiley & Sons, 1996. For more on this see Vandermerwe, Sandra, "How Increasing Value to Customers Improves Business Results," Sloan Management Review, Vol. 42, no. 1, Fall 2000.

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and how to sell them and process claims. International Health Insurance (IHI) recognizes that customers regard health insurance as a necessary cost they would much rather eliminate In rejuvenating IHI, Per Bay Jorgenson CEO, set about redefining the market space which was lifetime health and personal safety and directing strategy and resources to accomplish wellbeing for customers.

Market Spaces Get An Outcome for the Customer Musa Dhalla, founder of Pharmalife, defined medicine performance as the market space for the e-start up. In this new competitive arena the mission became to innovate in order to improve patient outcomes through better medicine management. Working for and with pharmacists in their professional and business lives, the idea was that the by giving end users better advice and service, they would be able to more easily comply with treatment instructions and so get the most out of the medicines they were taking.

Market Spaces Align the Bits of the Enterprise Because market spaces cut across traditional product, company, country, and industry boundaries, people in traditional structures and silos begin to see how and where they fit together to produce the total customer experience. In order to energize growth at BP a series of customer focused initiatives have been undertaken, moving away from the traditional product-led silo based offers, like gas, power, solar, wind, lubrication etc. to one which produces an outcome for the customer in a market space, called integrated energy assurance.

3.3 Driving the Customer Lock-On Loop Defining the market space is the first step to get customer "lock-on". Customer "lock-on" means that customers want the enterprise as their first or sole choice. The longer and stronger the interaction between the enterprise and the individual or firm,

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Fig. 3.1.

the more that enterprise is able to deliver value to them, the more the person or firm wants to do business with the enterprise, the more valuable the enterprise becomes to them and so on and so forth. The Customer "Lock-On" Self Reinforcing Loop This self reinforcing loop (see Fig. 3.1) becomes operative because of dialogue, information and knowledge shared, not to forget the improved relationships based on collaborative rather than transactional behaviour. The service enterprise puts itself in a position where it is best able to offer more value to a customer over time than anyone else, which means the enterprise needs to continue innovating as people and organizations change and/or go through their life stages.

Increasing Revenue Streams on Track Two Proactive intervention continuously reinforces the "lock-on" loop, making it very difficult for competition to enter. Not only are customers "locked-on" and competitors locked out, but better

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financial results are also obtained as revenues rise and costs shrink. This happens through: • Longevity of spend-extended (even lifetime) spend and/or longer contracts with decreased costs of replacement, management and transaction e.g. tenders, marketing, selling, etc. leading to a higher net present value. BP, for example, calculated that a one year $1.5 million fuel deal for a particular customer resulted a net present value of between $36,000 and $126,000, depending on the startup costs. A 10 year deal could boost that value to $8.6 million however, to say nothing of extra business (below) and expertise gained. • Depth of spend-more share of wallet in that service/product category, even though margins on these core items may be diminishing. BP always gets more business once customers commit to a trusted [or fewer] supplier(s) due to its new approach. • Breadth of spend-extra revenues as new services are needed to deliver the outcome. Hali-Ioannou's Easy brand for customers, whom he describes as backpackers and cost conscious people "who spend their own money", has migrated them from Easyjet to Easy Rentacar to Easy Internet cafe to Easydorm, in line with Direct Line's strategy in auto-mobility, as well as that of otiier new players. Traditional companies rather than new start-ups will get breadth of spend from service products not previously sold. For example, IHI's move into wellness has brought revenues from new service/ products like "Bottomline", which involves corporate policy assessment and planning, preventative health planning advice and measurement to help companies keep employees well and in top form. • Diversity of spend-taking customers serially into new "market spaces" without cost of acquisition and only low marginal costs. While Virgin is the icon of this, it is by no means unique. Easyjet, for instance, is moving into Easymoney — providing online credit cards and personal loans — and Easy Cinema. Direct Line has gone from tibe auto-mobility space into home services insurance.

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3.4 Defining the Opportunities to Add Value Once the market space has been defined then (and only then) can the service enterprise begin to identify innovation opportunities for adding value in order to deliver the customer outcome. Opportunities on Track Two occur because of discontinuities in customer activities that prevent, impede or inhibit an outcome from happening. These discontinuities can be the opportunity for the service enterprise to add value through new innovations and so "lock-on" customers. They can also be a gaping hole which competitors — usually from outside the industry — fill. The customer activity cycle is a useful discovery tool for working on Track Two to get an imaginative but structured view of the value adds(s). The object of the CAC is to map all the activities customers go through, and then find and fill the value gaps. The methodology is especially important on Track Two as here customers have difficulty visualizing what the company has in mind, whereas incremental improvements made on Track One are readily understood by customers. 5

What's a Customer Value Gap? Customer value gaps are defined as: • Things not being done for customers which inhibit their ability to get a desired outcome. • Things being done badly for the customer, which impedes the seamless experience that leads to a desired outcome. • Things being done by customers themselves — with concomitant costs in time, money, effort and overall hassle — and which could either be done better by the provider, or be done in an integrated fashion to minimize customer costs. 5

For more on the Customer Activity Cycle, see original work. Vandermerwe, Sandra, "Jumping Into the Customer's Activity Cycle," Columbia Journal of World Business, Summer 1993; and Vandermerwe, Sandra Customer Capitalism: The New Business Model of Increasing Returns, Whurr Publishing, London, 2001.

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• Things being done by other providers, giving them entree to the core business of the innovating enterprise Stages in the Customer Activity Cycle (CAC) The CAC is a generic and therefore universal tool containing three stages: 1. pre: when the customer is deciding what to do 2. during: when the customer is using/doing it 3. post: when the customer is reviewing, renewing, updating, and measuring success A Case in Point IHI looked for all the value gaps in the customer activity cycle for corporations, expats and high net worth individuals in order to achieve lifetime health and personal safety. Relocation for short or long term assignments was one of the opportunity areas they examined where bad decisions and actions can lead to unhappy personnel and high corporate health costs. The activity cycle done by IHI for this covered everything from the time the firm recognized the need to fill a position overseas, to the selected individual's return home, or move onto the next country assignment. (See Fig. 3.2A beginning at the pre-stage at "START" for a simplified version. Each of the points on the diagram could break out into their own sub cycles.) IHI then proceeded to identify the value gaps: 1. Pre: when corporate customers are deciding who should be sent where 2. During: the managing of the contract; the travel experience; the relocation and integration in the host country; managing health, i.e. preventing problems and managing illness and rehabilitation when things do go wrong

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3. Post: Returning home; handling transition health problems e.g. unusual diseases, new relocation decisions; evaluating, renewing, reviewing, updating decisions and actions Once the value gap analysis has been performed the enterprise can then translate these into offerings to be given to customers at critical points in their respective activity cycles. Value gaps at IHI were filled with a series of value adds designed around offering an integrated experience to employer and employee alike, thus obviating the traditional situation in which firms had to hop around from one supplier to another in order to ensure a successful relocation (see Fig. 3.2B for value adds).

Getting in Sooner and Staying in Longer Getting in sooner and staying in longer is crucial to customer "lock-on". Per Bay knew that waiting for a corporate customer to make decisions on what health insurance to buy would eventually relegate IHFs role to that of a commodity player. Dhalla reckoned that if he could start adding value to pharmacists whilst they were still students, Pharmalife could later migrate them to services to enhance their business profitability, which is exactly what happened. This was done through enhanced patient care and not just the dispensing of medicines which in any case is fast becoming a commodity activity. He also helped pharmacists cut costs through the use of advanced information technologies.

Building One Integrated Experience Most outcomes can only happen across service/product, company, country and industry boundaries. Silo-bounded distinctions and structures may have accounting or technical significance for the service corporations of old, but not for the new. Customers need an integrated set of services if they are to get superior value at low delivered cost.

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Banks are beginning to think about this. For instance, "Intelligent Finance" an arm of Halifax, recognized that at any one moment in time, a customer may have several accounts with the same bank and be paying interest for a mortgage and credit card (over 90% of customers who use credit cards pay interest), and still be earning much less on their positive balance current account, be it on an ongoing basis or at that moment in time. Intelligent Finance has put all these products together, treating the bits as one sum total, and charging the customer accordingly — which can save them a good deal. An integrated experience happens over time, not just at a moment in time. Virgin One allows customers to pay for all their financial transactions over their lifetime, including mortgage repayments, payment of bills, credit cards, standing orders, direct debits, salary transfers and deposit accounts. This saves stress, time, effort and money because a single variable rate is calculated daily and charged monthly. There is no tax to pay while customers are in net debt because they are borrowing rather than saving, and Virgin says that over 25 years a customer with an income of £50,000 and a mortgage of £100,000 could gain £125,000.

Taking Non-Value Out This brings us to the point that innovations put value into the customer activity cycle while also taking non-value out. The Tradepharm service offered by Pharmalife provided an online marketplace "to do the work for die pharmacist", which consisted of components like sales order capture tools; product searches; electronic invoicing; and financial reconciliation to improve decision making and reduce process costs-reportedly to the tune of 25% for a pharmacy with a turnover of £500,000. And a stock transfer system allowed stocks to be traded between one pharmacist and another. Tradepharm organized the courier for collection and delivery of the stock, collected payment, held the money for the seller and issued an electronic invoice. Financial transactions such as setting up escrow accounts and holding money in them until proof of delivery

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had been made was also done so as to eliminate as many nonvalue activities for the pharmacist as possible, and turn what had been a hassle into real added value. 3.5 Creating Win-Win for All On Track One the margins on the stuff will inevitably diminish. And there will almost always be adversarial relationships twixt supplier and provider around price. On Track Two, creating win-win for all is fundamental. In making relocation decisions the majority of companies only look at people's skills, without taking individual health and comfort profiles into serious consideration. And they tend to ignore the role of spouses in their decision making, whereas in fact many relocation problems — which increase stress levels and decrease productivity — often stem from family issues rather than specific employee issues. With a more comprehensive view, better decisions can be made. IHI's greater emphasis on prevention on the customer activity cycle means that individuals can stop or anticipate things from going wrong once they know where they are being sent. Value adds include better heath regimes suited to a particular country risk profile; family education on the new cultural environment; knowing what medicines to take in what countries; what diseases to watch out for; what the early warning signals are for specific foreign diseases; where to go if things do go wrong; and how to rehabilitate and prevent a repeat problem. This helps employees feel and stay well and safe, and saves the corporation in total health costs and IHI in unnecessary claims. The same principle of initial prevention and preventing reoccurrence was applied by IHI for employees at home, where research had shown that disease management programs could save up to 30% in costs. Pharmalife also adopted a similar win-win approach in its medicine performance market space. Research had shown that 60-70% of all patients in Europe had to change their prescriptions either because the drugs did not work or because of their side effects. With better

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decisions and compliance everyone could win: UK health authorities could obviate waste and minimize the cost to the overall health care system; patients could get better outcomes; pharmacies could increase their revenues by increasing their stake in the medicine supply chain through better customer relationship management and improving their efficiencies and profitability through e-technology. Even manufacturers could win, by reducing the huge direct sales costs of dealing with large numbers of fragmented pharmacies and the millions thus spent in paperwork.

Cutting Costs and Increasing Service Quality

Simultaneously

Part of the win-win needed on Track Two is that costs are cut whilst simultaneously service quality is enhanced. But fundamental to this is ensuring that the correct costs — either those that customers do not value or those that destroy rather than improve customer value — are being cut. At IHI a cost reduction exercise was launched concurrent to planning the new customer concept innovations. This was done without eliminating staff "so that service capacity was increased and expertise was kept inside the company instead of letting it go to competitors," said Per Bay. The main aim was to get a return on scale. By streamlining the work-flow to eliminate overlaps and duplications, costs were brought down and service delivery to customers was enhanced. Also, people began to work in three, round the clock shifts. Previously only the emergency centre worked at night, whereas today 2 0 - 3 0 people work every night, saving space and money while also providing customers with better service since they can call in from anywhere in the world, at any time of day or night, with any kind of query — and the staff love the flexibility.

3.6 Leveraging from Existing Infrastructure and Skills Many traditional companies have skills, knowledge, and information which they either do not use; do not package and sell; or may

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have just given away in the past because the focus was so firmly on the core stuff. Using What You Know For example, BP is incredibly good internally at risk management; this skill has now become an integral part of their offering to customers in the integrated energy assurance market space. Many of their corporate customers want to eliminate or at least minimize uncertainty and volatility in their energy costs, and a capability in risk management is a vital value add to achieve this. Coupled with this is deciding what to buy, from whom, when, and at what price, as well as using the right products in the correct way, reusing energy and avoiding pollution and consequent legal action. Again, BP excels at this internally. Moreover, emissions trading is one of their core competencies in their own operations, which they are now leveraging as they define their market space beyond traditional core items.

Re-Using the Infrastructure With the new economics of information and technology, reuse is a key ingredient in keeping the costs of innovating down. Fedex, the US based international courier service, was quick to realize back in 2000 that consumer shopping via the Internet, at that point still relatively insignificant, would soon take off. And that the big challenge would be getting the goods from the virtual shops to individuals' homes — when, where, and how those individuals wanted their purchases delivered. Whereas the Web made it much easier for consumers to shop and pay 24 hours a day, seven days week, from anywhere in the country, people still had to rely on old fashioned "snail mail" to get their goods. This was the key hassle for them, since most postal deliveries take place when people are at work, and most packages have to be signed for. Because of this gap, Fedex decided to create FedexHome in 2000, which would guarantee, depending on the individual's preferences, either evening delivery

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or delivery at a time the customer specified, to any home address in the US. Fundamental to achieving this was the existing network of Fedex Ground Services, whose 370 facilities and hubs already covered 100% of US businesses — who had been by far the biggest users of Fedex services to date. By leveraging this existing infrastructure, FedEx Home was able to pick up goods for delivery from any business address in the US. In addition, Fedex's existing ground distribution network was used to move the packages easily and cheaply from one part of the country to the other. Finally, Fedex also used its existing software and Web site infrastructure to allow retailers using its services to integrate ordering, shipping and tracking; thanks to this Web integration, consumers could visit the retailer's site and check their shipment information — when the package was sent, where is was right at that moment, estimated time of delivery, etc. — while also looking at other product offerings on the retailer's site.

3.7 Managing Customer Contact The object of contact management is to build strong interactive and ongoing relationships at the various critical touch points on the customer activity cycle. This requires personalization — offering each unique individual exactly what he or she wants. 6

6

This notion goes beyond beyond mass customization, amongst others see Pine, Joseph, Mass Customization: The New Frontier in Business Competition, Boston, Harvard Business School, 1992; and Pine, Jospeh and Gilmour, James, Markets of One: Creating Customer-Unique Value Through Mass Customization, Boston, Harvard Business School Press, 2000. The concept of mass customization usually results in greater variety rather than exact outcomes for unique individuals and firms. Personalization is also different from one-to-one marketing in that it involves the total experience required to get an outcome rather than just the customization of a product or process. For more on one-to-one marketing, see Dorf, Bob; Peppers, Don; and Rogers, Martha, "Is Your Company Ready for One-to-One Marketing?" Harvard Business Review, January 1999.

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The Amazon.com site went beyond being an extensive catalogue. "We want Amazon.com to be the right store for you as an individual," commented Jeff Bezos, its founder. "If we have 4.5 million customers, we should have 4.5 million stores." The object from the start of the Amazon innovation was that customers come back to the site over and over again. To achieve that, customers had to feel that they were getting superior and personalized value. Customers were signed up through a personal notification service, called "Eyes", which meant that they could indicate what kinds of book — either in terms of subjects or authors — they liked to read. They received regular e-mails with reviews of what Amazon's editors considered "exceptional" books in these categories. Customers could modify or add to their personal reading profiles whenever they wanted by e-mailing the customer service desk.

Personalization Goes Beyond Choice Continuous learning about individuals builds the knowledge base that ensures a personalized outcome for each customer which feeds customer "lock-on". Giving unique individuals exactly what they need is the object, taking the notion of personalization beyond infinite choice, and instead requiring differences in: • Content-what each person requires • Contact-treating and dealing with each person in the way that individual wants and appreciates • Context — using any or all channels in managing the relationship FedexHome Delivery gives residential customers more control over how and when they receive packages, day or night. Retailers ask their customers for special instructions — time of delivery desired, exact address, etc. — which are subsequently printed out on daily delivery sheets for each driver. At Amazon a "recommendation centre" offered individuals personalized reading suggestions based on their specific profiles and interests and on the ratings of other customers. Since many people did not know precisely what they wanted to read next, an "If you like this author" selection gave them a suggested

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list of other authors. Early on, CEO Jeff Bezos and his team also began working on highly sophisticated systems that would help individuals find the precise books that "would change the world for them". "If you can do that you are creating real value," said Bezos. Treating customers as the mythic average can end up penalizing valued customers. The recently launched Easy card will let customers set the interest rate they need to pay, as opposed to treating everyone in the same way. When Easycar rental service was first launched, paying insurance upfront was not part of the package; instead of everyone having to pay for the misfortunes of other drivers, customers were only charged if and when they damaged a car upon its return.

Using Multiple Channels Contact management involves using several channels. At Direct Line the entire relationship may be managed on the Internet. Or a discussion or inquiry may begin on the Internet typically for car insurance and then involve face-to face contact. So Direct Line uses a UK distributor to supply and deliver vehicles, or Green Flag — the roadside assistance company — to handle the breakdowns. Call centres, kiosks, the Website, and digital TV are linked so that the information is found whatever medium the customer chooses when contact is made at different stages in the activity cycle. Since all channels are linked, if, for example, a customer starts to fill out a form for an insurance application on line and then prefers to speak to someone on the phone, the whole process does not have to start from scratch.7

3.8 Building an Extended Delivery Network Service enterprises may be able to use their existing infrastructure and know-how or they may have to extend their capabilities by 7

See Dempsey, Michael, "The Strategic Goal of this CRM Project is Cross-Selling", Financial Times, 7 June 2000.

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building or buying in skills or expertise. Alternatively they may decide to partner and form an extended network community to deliver the value adds which meet customers' needs in a distinctive manner. Choosing Partners Common strategy and customers rather than legal ownership is what creates an organization today and choosing and managing partners is another core competency the enterprise needs in order to get customer "lock-on". Partners chosen should be: • Like minded in terms of the customer vision (this may require education or induction) • Understand and live by the notion of collaboration and win-winso that everyone gains • Understand the concept of lifetime customer value, which may require behaviour different from that of the past • Have complementary skills, with synergies as well • Respect customer ownership, not stealing customers from each other • Prepared to share resources and knowledge, to create and enhance value for all • Prepared to invest in development, if a new innovation is needed Managing Service Quality Fedex Home delivery drivers are independent contractors, many of whom live in the area and therefore know very well the local street maps. Similarly, Direct Line uses nearly 200 subcontractors to do their breakdown and maintenance services. Though they are independent they work to very strict service quality standards. For example, Direct Line expects the provision of a 24 hour recovery service, 24 hour collection and delivery to and from the customer's home, contacting the customer within 30 minutes of a call for help, and recovering the stranded vehicle within an hour.

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Owning the Brand However both Fedex and Direct Line "own" the brand. In other words they take responsibility for the outcome by whatever arrangement this is achieved. Amazon does the same; if a customer reports a non-delivery, Amazon contacts the courier or postal service, gets back to the customers and rectifies the problem with an apology and new delivery which they then follow up on. In addition, since Amazon always provides an "expected date of delivery" with their parcels, even those delivered by the postal service, if a customer has not received the parcel by that time, Amazon will re-send, via courier this time, the same package at its own expense. Partnerships that jointly produce outcomes will have varied types of agreement ranging from contracts to more fluid flexible and collaborative relationships wherever joint decisions are made. Owning the brand and managing the service quality is easier if the arrangement is contractual — a franchise or a subcontract — but more intricate if partners are initiating and implementing a new innovation together, usually if development and delivery is highly knowledge intensive and consultative. Take IHI working with Deloitte Touche in the corporate market. IHI has the expertise and experience in health policy and employee assessment and planning; Deloitte Touche's is in the measurement of what they call "human capital". The two companies have jointly developed the innovations that provide the needed value adds at that critical part of the customer activity cycle in a co-branded effort.

3.9 Technology as the Enabler In this new customer focused model, providing a seamless ongoing experience requires the role of technology to change from that of cost saver to customer experience integrator Mirroring the Customer Activity Cycle To achieve this integrative role the system must mirror the value adds at each critical point on the activity cycle. The customer activity

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cycle analysis must become the starting point for building the technology and e-infrastructure. It also acts as a template for integrating the various touchpoints from the various internal and external partners to produce a seamless set of interventions which lead to a superior experience and outcome. Says Direct Line, "so long as you remain product focused you can only carry on with an operational system for each product. If you want an integrated customer view you must first integrate the information from all systems." This it did from 12 frontline customer facing operational systems with 147 million observations loaded monthly into the customer database, building real time customer knowledge and facilitating market analysis. This connectivity to achieve the integration that leads to the outcome can move up and down the traditional chain, as Pharmalife does in the medicines performance market space, "We identified the value gaps in the traditional process and then built the system needed to fill these gaps." Pharmalife used the new technologies to build processes to get the needed connectivity between the various players throughout the supply chain and creating the interfaces through the entire activity cycle in terms of: • how medicine gets to the pharmacy • how it gets to the patient • how it is used by the patient What is needed by pharmacists in their professional lives is something that Pharmalife also built into one integrated system. Information relevant to the pharmacists which nobody else was doing in electronic form was collected and offered together with recruitment applications personalized for pharmacists allowing candidates to make applications online and submit their CVs electronically to advertised positions. Information was also provided to help pharmacists learn what to look for in employees; how to read a CV; how to screen candidates, how and what to pay; how to judge performance; and how to assess the kinds of new skills they will need in the future.

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3.10 Delivering Performance Managed Delivery When outcomes are offered rather than core items of the stuff, the enterprise must become good at demonstrating the value they generate rather than just quoting a price for the "stuff, or when the outcome is less complex, even guarantee, as Fedex does, delivery of an outcome.

From Quoting Prices to Quantifying

Customer Value

IHI's new approach means that customers — particularly the corporate customers — must begin to regard monies paid to enhance wellbeing for their employees as an investment rather than a cost. And like all investments they expect a return which they may pay for, or may share depending on the arrangement. BP may save their customers money on their energy bill in ways described previously which they too either charge for or arrange a gainshare agreement. Therefore part of the innovation strategy is to measure the quantified benefits customers get that impact their bottom line: in IHI's case, increased productivity decreased stress, decreased absenteeism, and so on; in BP's case, reduced and more efficient and environmental use of energy. So another core competence in achieving customer focused innovation as these examples show is the ability to demonstrate value in a tangible way. This includes measuring and quantifying the results obtained and benchmarking the before and after situation, which requires some upfront investments and the constant accumulation and updating of information and expertise.

3.11 Concluding Remarks Emerging thinking and practice is beginning to portray innovation on Track Two as an alternative to product based innovation — be it incremental or revolutionary — in order for enterprises to capture new wealth, and grow and compete sustainably

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Part of being able to do this is achieving customer "lock-on" where customers want the organization as their sole or dominant choice because they have become indispensable to them in a market space. This paper has presented a framework for devising and implementing this kind of innovation which leads to customer "lock on" which, unlike the old model that inevitably led to diminishing returns, can augment revenue streams, pull down costs and allow an innovating enterprise to get and stay ahead.

Chapter 4 Services and the Knowledge-Based Economy Ian Miles

4.1 The Knowledge-Based Services Economy The Knowledge-Based Economy The term "knowledge-based economy" has been introduced to characterise some of the main developments in industrial societies in the late twentieth and early twenty-first centuries. Some commentators hold that the term is effectively an overstatement. ("If anything is underway, it is more a matter of evolutionary trends than of revolutionary developments.'''') Some commentators are more critical still, seeing the term as misguided. ("All human societies have relied upon knowledge and information: to proclaim ourselves as knowledge-based is to implicitly discount the capabilities of earlier societies and/or to privilege the particular sorts of knowledge and information that our economies prioritise?) Despite these forceful criticisms, the term does have its uses. For instance, it points us to the intersection of several related trends relevant to the themes of this book. Let us consider five sets of trends. 1. First is the development of service economies, which of course is a central theme in this book. It is not that manufacturing has disappeared; economically advanced societies have not stopped being industrial societies. Three developments are involved, (a) The bulk of economic activity, employment, and output is taking place in service sectors of the economy, (b) "Service" is an important management principle in organisations in all sectors. (c) Specialised services (especially Knowledge-Intensive Business Services) are providing critical inputs to organizations in all sectors, 81

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on a vastly increased scale. These developments became highly visible from the 1960s onwards, though they were present on a lesser scale decades earlier. They combine several subtrends — shifts in management philosophy (e.g. towards "leaner" firms, outsourcing more functions, and towards greater emphasis on customer relationships), structural shifts in the composition of demand, and unevenness in the application of new technologies to product and process innovation. KIBS include professional business services (such as accountants and lawyers) and also services with a scientific and technical knowledge base (various sorts of engineering and Information Technology (IT) service, for example). Both groups typically grew in numbers during the last few decades of the twentieth century, with especially high growth among the latter, where many new specialisms emerged (see for example, the accounts provided in the European Competitiveness Report 2000, Murphy and Vickery, 1999; and Rubalcabo-Berenejo, 1999). 2. The development of information societies, based on the largescale diffusion and utilisation of new Information technologies (IT), which have allowed for unprecedented capabilities in "capturing", processing, storing, and communicating data and information. In that new IT is a relatively discontinuous phenomenon, the information society as seen in these terms is a historical epoch much like the steam or electrical eras, and can be dated back to the late 1970s. Information Society has arguably already passed through a number of distinctive phases (Miles, forthcoming), and IT has been particularly heavily used by service sectors of the economy, especially KIBS and financial services. Some see IT as the core of a technological revolution in services similar to that occasioned by the steam engine in nineteenth century manufacturing. 3. More generally than just in the IT case, the increasing importance of innovation (especially technological, but also organizational) as an element in corporate and national competitiveness, and in strategies to increase the efficiency and effectiveness of organizations of all types. This has led to increased emphasis

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on investment in innovation (e.g. investment in Research and Development — R&D — and associated labour forces, efforts to secure intellectual property rights over innovations). Accordingly, some commentators stress the role of scientific and technological (S&T) knowledge in the Knowledge-Based Economy — it is evident that not only is the volume of such knowledge increasing, but also the complexity of innovations in terms of their drawing on very diverse bodies of knowledge is growing. Such a complexification has wide-ranging implications (for example, companies have to collaborate to access knowledge; interdisciplinarity becomes more important.) But S&T knowledge is not the only basis for innovation — for example, knowledge of markets and user requirements is vital; and not all innovations are S&T-based — for example, innovations can be more aesthetic, cultural, social or organisational (example: the ombudsman). KIBS play important roles in producing and intermediating innovationrelated knowledge, as is most apparent in the S&T-related KIBS that have been major growth sectors in recent years. This essay will consider this role in more depth later. 4. Knowledge Management arises as a specific issue, as organizations seek to apply formal techniques and new information systems to help them make more effective use of their data resources (e.g. data mining), information assets (e.g. Enterprise Resource Systems) and expertise (e.g. groupware and collaborative systems). Organizational learning and emphasis on human resources and intangible assets of all sorts also become more of a central concern, with management tools being developed to help effective choice and improvement of systems. Related to this, we see increasing attention being paid to Intellectual Property Rights (IPR) on the part of a wide range of businesses, and a variety of challenges to the long-established IPR systems. 5. There are many other important developments that may be related to the points above. For example, the globalisation of economies is facilitated by new IT, and in turn stimulates more innovationbased competition. It promotes demand for better understanding of diverse cultures and regulatory systems, and allows for new

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avenues of learning from the experience of other organizations and countries. If the nature of globalisation is debated, this is nothing compared to the debates that have ranged around such cultural practices as the "postmodern" moves in arts, architecture and of course many areas of social theory and cultural criticism. Associated with these lines of thought and practice (whether as cause, effect, or something more complex) have been a fragmentation of subcultures and critique of received wisdom in science and technology as well as in the world of aesthetics). Important developments in environmental circumstances and attitudes, in demography (population ageing and migration), also have their implication for services innovation, but will not be at the centre of the present analysis. These are of course highly summarised accounts of developments about which there have been hectares of text written. There has been much dispute about their precise n a t u r e , and the interrelationships between the different elements. Putting this on one side for now, the emphasis on the role of knowledge in economic life is a welcome and long-overdue one, and it is one that has a good deal to say about the study of services and innovation. For, if services are "problem-solvers", as is so often suggested, then they are clearly operating on the basis of some sort of knowledge of problems and solutions, and services innovation implies changes in this knowledge. In parallel with the rise of discussion of the "knowledge-based economy" has been increasing recognition of the role of services in innovation. The long-held view that services were mainly noninnovative — or if they were innovative (like telecommunications), then they were not really services! — has gradually been discarded (see Miles, 2000b, and other articles in the same journal issue). Especially with the adoption of new IT, services are seen as technology users, as sometimes being vanguard users who shape the physical innovations, as creative users who develop new services and new configurations of goods and services. Many specialised services have evolved to support IT innovation too — software, training, Web

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services, etc. The question is now less one of how services can be innovative. A more interesting question is whether there are specific features characterising services innovation (see the discussion of "reverse product cycle and "servuction" approaches in Miles, 2000b). Another is whether we can develop taxonomies to represent the varieties of services innovation (given that services appear to differ in innovativeness just as they diverge in respect of many other features (cf. Tether et al., 2000, who note, for example, the relatively high levels of innovation displayed by KIBS). The issue of the heterogeneity of services suggests that there are limits to any effort at providing a general account of services innovation. We are likely to need several, even many, more or less distinctive models of innovation activities in different sectors of industry, different types of organisation. We may conclude that some manufacturing and service subsectors have more in common with each other than with other branches of their grand sectors; thus Tether et al. (2000) find high-tech firms to be more alike in many innovation-related ways than they are to other firms in manufacturing and services. Since most services feature huge diversity in terms of scale, it is typical to find microbusinesses serving local markets alongside transnational service corporations, nominally in the same sector. This implies that we should also examine different types of firm. (Small firms face many issues in common, whatever their sector — for example, they are liable to be relatively uninterested in committing the resources required to protect their IP by such means as patenting — cf. Blackburn & Etching, 1998.) As well as size, they might also be differentiated in terms of market served, regional location, and ownership structure, for example. One useful approach to thinking about such models of services innovation is provided by Sundbo and Gallouj (2000). Drawing upon case study and other material, they identified six innovation patterns in services firms. We summarise these below, and add some comments about how KIBS, in particular, may follow such patterns. • The classic R&D pattern. Research and development is subject to specialised management and organized in special centres; it is

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a continuous function. (Sundbo and Gallouj further distinguish traditional/Fordist from neo-industrial variants of this pattern.) This is most often found in large firms specialising in the production of standardised operational services dealing with material or information. The examples cited by Sundbo and Gallouj are mainly large firms specialising in mass information processing, building maintenance, etc. However, large software and telecommunications companies, along with other technology-related KIBS, often adopt such a pattern, having much more in common with high-tech manufacturing than with other services. • The service professional pattern. This especially characterises the medium-sized professional knowledge KIBS, who sell their expertise and abilities to solve problems in specialised fields of consultancy and engineering. Here, the professional often follows certain professional norms and methods in a collective innovation process. Our own observations suggest that it is possible that some large and highly technologically sophisticated firms in fields such as accountancy and management consultancy achieve a combination of this structure and more classic R&D. • The organized strategic innovation pattern involves no classic R&D department, but innovation is an overt strategy of the firm, with research seen as a widely diffused task, and development, which requires much time, undertaken by ad hoc project teams. Sundbo and Gallouj consider this to be the most typical pattern with innovative service firms (especially large ones). It is an approach undertaken by many of the larger and more innovative professional KIBS firms, such as global consulting and accountancy firms and financial and market analysts. • The entrepreneurial pattern involves the creation of small service firms around a radical innovation, their main activity is then to sell this. These firms do not have an R&D department, and subsequent innovation processes are generally focused on the improvement of the initial radical innovation. Many IT services, and other KIBS based upon specific technologies (e.g. environmental monitoring) can be interpreted in these terms.

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• The artisanal pattern applies to many small firms involved in operational services (cleaning, guard services, hotels, restaurants, etc.), who have little or no innovation strategy. Where they undertake innovation, they are generally small, non-reproduced changes, or else supplier-driven. Many small KIBS, functioning in local markets, are probably following this pattern. • Finally, the Network pattern applies where a number of service firms have created a common "network firm" with the purpose of innovating on behalf of the member firms or to induce innovations in them. Examples are found in tourism and in some financial services. The service firms put the innovation activity in the hands of a professional organization — similar to the industrial research associations in manufacturing and construction. For KIBS, there may be some element of this where there are (a) needs for support to introduce radical innovations such as ecommerce (though the organization will often also be reaching out to a wider user base); or (b) where a professional association establishes facilities to sponsor innovation. Among the interesting points to emerge from this analysis is that the professional axis emerges as a major source of innovation in professional services activities (this applies to such activities within firms of whatever sector, as well as in specialised services). We see organisations of accountants, lawyers, etc., engaged not just in accrediting members, but also as providing further training, innovation support, discussions of best practice, etc., for example. Innovation extends beyond the individual firm, and diffusion is a social process mediated by a range of support structures. While the taxonomy above focuses on individual firms, a further step would be, not just to study innovation in individual service firms or taking sectors in isolation, but also to consider their location in innovation clusters, networks and systems. A relevant question would be how far and the dynamics of such systems when they are more or less based on different types of services on different sets of core knowledge. Such analyses mean examining knowledge processes that go beyond the individual company or type of service.

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This is particularly relevant to services, in that many service organisations are influential on innovation in their client firms. Some KIBS play important roles as knowledge intermediaries in some innovation systems. Not only are KIBS typically innovative branches of the services sector, with, for example, high levels of IT uptake and pioneering methods of IT use. They provide inputs to client innovation processes, too, by providing knowledge that can aid the development, choice, and implementation of innovative solutions to the problems that their clients face. Understanding this use of knowledge is important if we are to gain a better grasp of the nature and dynamics of the knowledge-based economy.

From Professional to Technological Knowledge-Based Services All economic activities are based on some knowledge, of course. KIBS are knowledge-intensive, in the sense of being founded upon highly specialised knowledge — whether this be the kinds of social and institutional knowledge involved in many of the traditional professional services — or the more S&T- related knowledge that has risen to the fore in recent years. Many other business services are not knowledge-intensive in this way: this would be the case for much of cleaning, catering, security, transport, etc. (In practice the statistics can be problematic here, since it is common for knowledge-intensive specialists to emerge out of— and still be classified within — a more mundane sector. For example, people start selling consultancy or software to other members of this sector; they start to sell value-added services to clients, becoming "systems integrators". Thus, for instance, logistics services may both provide transport and undertake extremely knowledge-intensive activities in the organization of transport arrangements for clients.) KIBS in general are problem-solvers. Some traditional professional services deal with problems associated with social systems and institutions, especially administrative rules and regulations (e.g. legal and accountancy services). Less formally governed problems concerning social groups and interests are at the heart of many marketing and issues consultancy services, for example. Other services

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support inter organizational activities (supply chain management, etc.) Some KIBS have more of a focus on psychological and biological problems, as with medical and veterinary services, educational and clinical psychology and psychiatry, counselling, etc. And yet others are more concerned with the physical world, for example there are engineering services concerned with construction systems or transport infrastructure, laboratory testing and research services concerned witii the properties of materials and artefacts or with the ways of effecting specific physical transformations, and IT services of various kinds concerned with symbol-processing or with the configuration and integration of discrete items of hardware and software. New S&T-related KIBS may emerge from professional services: for example, it is common to find firms emerging to supply software and other products to clients and/or other firms in their sector. The staff profile of KIBS includes many people with higher education and professional qualifications. (This is one indicator that we are dealing with a specialised KIBS and not a service concerned with routine solutions to common problems such as transport and logistics, mass entertainment, postal and telecommunications infrastructure services. Of course, much of what such services do is not routine, but a large share of the effort of their workforce is being expended in routine ways), KIBS are major users of new technologies (not just IT, but other technologies specific to their problem areas). The S&T-related KIBS especially may play a strong role in diffusing new materials and systems to their own clients. Some KIBS are hard to locate as being either S&T-based or more traditional professional services. This is particularly true in fields such as architectural and design services. Here we find many firms carrying out quite routine work, but others who combine aesthetic creativity with technological innovation — or at least with a frequent search for new technologies that they can exploit. KIBS may become involved in their clients' technology strategies (e.g. the many professional service firms in accounting and management consultancy who have developed capabilities in IT consulting for clients). Some KIBS in traditional professional service sectors develop strong competences in technology-related fields.

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For example, some lawyers specialise in IT in patent law, some financial advisors and market analysts become expert in high-tech or consumer innovation fields. IT is particularly useful for many KIBS in processing their information, and they become users of Computer Aided Design packages, systems to transmit rapid intelligence updates to clients, etc. Other KIBS more evidently feature technology as their core activity, as is reflected in the high levels of Qualified Scientists and Engineers typically present in their workforce. Such technology-related KIBS have important roles to play in innovation processes (cf. Miles et al (1995) and Bilderbeek et al. (1998)). There are services that actively conduct research and development into new technologies — R&D services, by the turn of the millennium, were accounting for 10% of business R&D in the UK. Closely allied to these are services that perform testing of various sorts (often for conformance purposes). A ratirier different sort of testing is performed by rapid prototyping services, that construct models or full-size versions of designs so that, for example, difficulties with the production process or finished device can be identified. Some services are directly providing technology support for clients confronted by needs to engage with new technology — examples include as Web and Internet, software and computer services, and equivalent services emerging in the biotechnology sphere. One particular form of support includes training of staff to make use of new systems, while strategic advice may be given as to the choice and implementation of new process technologies. Facilities management services actively handle the task of using the new technologies for the client — managing a "smart building", running a call centre or outsourced computer network, etc. Recent analyses of European Community Innovation Surveys confirm that KIBS sectors, especially technology-related ones, are among the most active innovators in the economy. This is despite evidence that service sectors on average lag slightly behind manufacturing in terms of reported innovation (54% of manufacturing enterprises, 46% of services reported innovative activity — Tether et al. (2000)). But the IT-intensive financial and telecommunications

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sectors have high levels of innovation (58%, 68% respectively), along with computer (72%) and technical services (67% — this group includes architectural, engineering and technical services, but surprisingly excludes R&D, technical testing and analysis together with legal, financial or management consultancy). Human capital and technology investment — rather than formal R&D — are the critical factors for developing and implementing innovations in many service firms (and indeed many smaller manufacturing firms). Only 47% of the innovating services studied in the Community Innovation Survey conducted R&D, with only 24% on a continuous basis — the respective figures for innovating manufacturing firms were 69% and 36% — Tether et al. (2000). But R&D is relatively common amongst computer and technical services (respectively 72% and 58%, or 45% and 33% continuously). These KIBS are more like high-tech manufacturing than they are like other services. The critical knowledge that underpins new activities often derives from the experience and expertise of the firms' employees. Other survey analyses have been able to examine certain features of KIBS in more depth. Many accounts of the specificities of services stress the importance of close interaction with clients. A German survey of service innovation allows one facet of this to be studied: it asked firms how far their activities were standardised, as opposed to being customised to the requirements of specific clients. Hipp et «/.'s (2000) data analysis suggested that technology-related KIBS were especially likely to produce specialised service outputs: 27% of Technical Services, and 18% of Software firms, reported more than a third of their output being specialised. (Comparable figures were 4% for Banking and Insurance (but 18% for Other Financial Services), 5% for Trade and 2% for Transport and Communication, 10% for Other Business Services and 4% for a Residual category.) Overall, smaller firms were also more likely to be more specialised. Firms that provided partially-customised or specialised services, too were more likely to report undertaking innovations than were Wholly Standardised service providers (controlling for features such as size). And while one third of the Wholly Standardised innovators claimed

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that their innovation(s) had an important impact on their users' performance and/or productivity, over 60% of the Specialised and Intermediate firms thought this to be the case. The implication is that the latter firms are adapting more of their outputs to suit specific clients; that they have better understanding of client features and requirements; and that they build this understanding into their services to benefit the clients. KIBS may be producing highly specialised services — effectively new products — for each client but many of the innovations generated "on the fly" are of little subsequent use, remaining highly clientspecific. Of course, there may well be learning about problem-solving on the part of staff, and even the formalisation of routines for dealing with problems of specific sorts — some KIBS firms, especially some of the larger management consultancy and IT services, have elaborated "knowledge management" tools and routines for such organisational learning. Still, much KIBS activity is not generating major innovations, but is rather evolving incremental innovations more or less spontaneously and more or less erratically within the context of continual customisation and reinvention of members of a portfolio of service products. We shall see shortly that the extent of standardisation versus customisation of services is highly relevant to the Knowledge Management strategies that KIBS pursue.

4.2 KIBS, Knowledge Management, and Intellectual Property Knowledge

Management

We would expect to see KIBS as being among the most extensive users of new Knowledge Management approaches. Hansen et al. (1999, ppl08) argue that "because knowledge is the core asset of consultancies, they were among the first businesses to pay attention to and make heavy investments in the management of knowledge". But at least two factors may make the adoption of IT-based "groupware" tools rather problematic for KIBS. First, much of their knowledge is highly complex and "tacit", in the sense that the experts

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have only partly spelled out just what it is that they do and how it is that they work — meaning that it is hard to reflect this knowledge base in the limited sorts of information "captured" in databases or CSCW (computer supported co-operative work) systems. Second, the knowledge interactions with clients are often so extensive that effective Knowledge Management systems would require involvement of many players outside of the KIBS itself. This creates problems of standards, secrecy, and organizational co-ordination. So far we have little data on the use of such tools, in any case. There has been much interest in the ways in which certain large service firms have utilised groupware for locating their own expertise and disseminating knowledge of innovations. In a few advanced firms Web and groupware technologies have been applied in recent years in best-practice databases, and also as means of enabling staff members to locate expertise within the firm, to consult other staff members as to how particular projects can be expedited, and as repositories of techniques, templates, and tools. But there is little examination of the use of such practices more generally in KIBS. Reimus (1997) surveyed a fairly large number of US management consultancies. About 75% of the firms had instituted processes for capturing best practices, sharing information from one project to another and documenting innovative new ways of solving client problems. But these were largely informal initiatives, sharing innovative knowledge from the staff through spontaneous meetings, etc. Fewer than half of the firms had an active best practices database in place. Kautonen (2001) similarly reports that personnel training and mentoring were important ways of diffusing good practice in Finnish KIBS, while other formalised knowledge management remained underdeveloped. Those consultants who were more oriented to the application of codified methodologies were more prone to use formal techniques of knowledge management than those relying more on expertise. Reimus suggests that this tends to lead to standardisation of services. One of the main obstacles to developing improved knowledge management was reluctance from experts to share information and to update material.

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But some firms do extensively use IT-based Knowledge Management systems. In a small set of case studies of large US firms. Including health care services and especially consultancies, Hansen et al. (1999) report on more established use of such systems. They note two main successful use strategies, arguing that while a mixture of the two is common in practice, companies have to decide to make the one most appropriate to their core services the centre of their strategy. They suggest that a balance of roughly 8 0 / 2 0 is effective. The two strategies are: • Codification. Information systems are established to enable rapid reuse of information resources (presentations, templates, algorithms, etc.) developed by staff. Aim to reuse these assets many times, providing minor variants of relatively standardised solutions to frequently-encountered client problems. This makes it possible for there to be relatively many junior and few senior staff (associates and partners, respectively), often working in large teams and generating large overall revenues. Incentive structures need to reward contributions to the pool of knowledge assets. • Personalisation. Information systems are more oriented to facilitating communication among members of staff, who typically work on challenging problems with many new features, requiring bespoke or highly customised solutions. Work is executed through high ratios of senior as opposed to junior staff, working at high fees with a focus on high profit margins rather than volume of business. Systems are developed to allow individual expertise to be located and consulted (and to exercise oversight) as appropriate. Incentive structures need to reward contributions to other's problem-solving. In each case we might anticipate that the use of IT-based systems will lead to more rapid internal diffusion of innovations in service products and processes. Whether the codified strategy may suppress the original generation of innovations, however, by encouraging reuse of earlier work and thus — while limiting needless redundancy — making it less likely that alternative solutions will be sought, is more uncertain. Competitive firms will need to ensure that staff are able

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to creatively generate solutions as well as routinely deploying established procedures. Hansen et al.Js vanguard KIBS may have taken up IT-based Knowledge Management tools extensively. These are the exceptions at present, however. But this is not to say that other KIBS have not developed elaborate — if less formal — practices of knowledge management. With knowledge at the core of the firms' activities, and with so much of the knowledge a matter of the practices of key staff members, the question arises of how KIBS protect their knowledge. Concerning Intellectual Property (IP) protection, again we find that the limited empirical evidence suggests very diverse practices employed across different types of KIBS.

Intellectual Property Miles and Boden (2000; see also Miles, Andersen et al., 2000) conducted a small scale, exploratory survey (around 150 KIBS) in the UK in the mid 1990s. The focus was on how KIBS protected their knowledge. Three sectors — accountants (ACC), architects (ARC), and environmental engineers (EE) — were selected so as to represent a range of relations to technology. Concerning the main IP instruments: • The evidence from these KIBS, and from large-scale survey data such as the Community Innovation survey, confirms that patents are relevant to only a small minority of services, and even of KIBS (Table 4.1). Indeed, standard instruments such as patents and copyrights are only relevant to those services whose products involve a great deal of hardware (patentable), or are embodied in reports and documents (copyrightable). Among these three KIBS, only EE used patents at all — over a third of the respondents in this sector report using patents at least sometimes for protecting their knowledge, and two-thirds of those with more than 50 employees do so. Even for EE, patenting was much less important as a tool for protecting valued knowledge than certain others: more than half of those surveyed "never" used patents.

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• Copyright need not involve any technical innovation, of course, unlike patents — though there is a good deal of evidence to confirm its use to cover such innovations in areas like software. Nevertheless, Torrisi (1998) concluded that software firms find legal instruments far less important than do computer hardware firms, though copyright was increasing in importance to them. Software firms stressed lead time, continuous innovation, and — more than hardware firms — the possession of skilled personnel. ARC almost universally use the copyright mechanism. It appears as the most common method of protecting knowledge cited by ARC firms. This is unusual prominence for such an IPR instrument. ACC use copyright, too, but much less frequentiy. The core service of both ARC and ACC is generally embodied in a document, but in the case of the former this includes creative inputs which may be appropriated by others to undertake competitive bids or to use in other circumstances, while the reports produced by ACC services for their clients are highly client-specific — copying them is unlikely to be a competitive tool among ACC firms, though there can be important confidentiality issues involved. • Trademarks are widely used tools for protection of the brand(s) of a company. They do not feature extensively in this sample of firms' responses — perhaps because we are dealing with relatively small companies, but perhaps also because we have asked about their use as a means of protecting knowledge. Trademarks have little directly to do with the content of innovation at all — though a new name and often a trademark is commonly used to describe a product innovation. Other methods of protecting knowledge are particularly important for KIBS. For ARC, copyright is closely followed by membership of professional associations. This is an important approach for ACC too, coming top for the larger establishments. In contrast, EE, which has not yet forged a strong professional identity, has little recourse to this tool (though some professional associations in related fields may be helpful, perhaps especially for individual service professionals). This is notably a sector that lacks strong

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professional bodies in the UK, with staff spread over several existing professions in the UK. Much the same appears to be true for many other new technology based KIBS, whereas traditional professional KIBS are much more professionalised). Professional associations play several roles. They establish entry barriers that limit the scope for outsiders to supply services, but they do not prevent competition, from other members of the professional association, who are liable to share much of the same generic knowledge base. The most prominent and familiar type of entry barrier is constituted through professional qualifications and accreditation, and delivering training; they also often run self-regulatory systems and may act as pricesetting and recruitment networks. Professionalisation provides support networks for individual professionals and small firms, who often need to co-operate with erstwhile competitors in local markets — for example, referring clients when there is surplus demand or conflict of interests. Recall that Sundbo and Gallouj identified professions as a source of innovation in many KIBS. We could specify this further: very often they play a role in diffusing innovations among their members through training, awareness, etc. But occasionally they also play important roles in organising research, standardsdevelopment, and other activities that may make innovations possible in the first place — more of a network innovation pattern. Professional accreditation also provides a measure of quality assurance for clients. With the exception of architects' reliance on copyright, KIBS in these three sectors indicated that management of internal working practices and social relationships with staff and business partners tended to be the primary ways of protecting knowledge. The specific approaches vary considerably, from informal relationships with staff members based on cultivation of trust, through careful design of division of labour and "need to know" such that few staff members possess sufficiently broad knowledge for their departure to imply a competitive threat, to through formal arrangements using employee law (regulating "trade secrets") or specific contractual frameworks between business partners. There are differences in emphasis on specific approaches by sector and size of firm, which suggest that more analysis is required to fully grasp the dynamics here. But the

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results highlight the need for KIBS to establish reliable and trustful relations with their staff and their clients. Trust may well be necessary not only for the protection of knowledge but also for the successful "transfer" of knowledge between the producer and consumer. Internal working practices are, not surprisingly, a concern for larger KIBS of all types — the threat of losing knowledge embodied in key members of staff becomes increasingly important (and increasingly deliberately managed) in larger bodies. The critical knowledge resources that differentiate one KIBS firm from another in its sector reside are less a matter of the core practices, techniques and technologies of the service, and more to do with knowledge about its own and its clients' organizational practices and service encounters. Understanding of the sorts of problems that clients face, the ways in which the service solves these, and the personal relationships and networks established with specific clients and other professionals, is critical. The departure of senior staff, taking with them knowledge of, and links with, the client base, can thus be a major challenge to KIBS firms. Reputation is very important for KIBS in attracting and retaining staff, as well as clients. The knowledge bases and related activities of these KIBS — quite probably a small part of the whole spectrum of technology- and non-technology related KIBS — vary tremendously. They are liable to contribute to innovation in clients, and to participate in innovation networks, in quite different ways. Consider links to "gain knowledge" from universities, research laboratories, government programmes, etc. This UK survey of three types of KIBS tends to support the idea that new technology based KIBS display better links than the more traditional firms, though clearly more research is required to fully substantiate this suggestion (see also Miles 1999a). Larger firms generally appear better-networked than smaller ones, and accountants were less well-linked to other sorts of organisations than the more technologically-oriented KIBS. Again, professional and trade associations are, however, important links, playing vital roles in legitimising and quality controlling the profession (similarly for architects).

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4.3 Knowledge and KIBS The term "Knowledge-Based Economy" is one sign of a growing interest in the roles of knowledge in economic life — what knowledge is produced and how, how is it used and to what effect? Indeed, what is knowledge? It is more than information, itself understood as data arranged into a meaningful pattern. For some analysts, knowledge represents a higher level of organization, putting information into context or application. Sometimes this approach leads to talk of "codified knowledge" that is written down in books, manuals, software. But while this is a higher form of information than just arraying data in usable ways, making use of this information still requires some awareness or understanding of relevant contexts and structures (even if this need not be as some management theorists talk of knowledge as being the capacity to use information effectively with meaning). Knowledge is thus more of a practice than a thing: whereas reports and other texts may carry information, knowledge really requires active deployment of conceptual structures and methods of analysis. It could then be misleading to talk of "flows" of knowledge — when knowledge is reproduced, this is a matter of people having to do work to absorb information usefully. Service providers may well be experts in facilitating this process (for example by "translating" information in such a way that it can be utilised, or by actively seeking to change cognitive structures through dialogue or experiential methods). For a relevant discussion, see Roberts et al., 2000. The analysis of KIBS also leads us to these questions. What are the sorts of knowledge that KIBS are producing and processing, and how are these produced and used by KIBS and their clients? KIBS are problem-solvers. Thus, their knowledge has to concern the problems faced by their clients, and solutions to these problems. Their roles can involve effecting solutions, providing clients with the tools and skills to do this themselves, or providing clients with resources that will enable them to better understand their problems and develop means to overcome them. We can label these roles, and provide some examples, as follows:

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• Informative, providing information on features of the companies' environment, from which the client will itself define its problems and strategic responses. Such KIBS produce or locate information using research, etc., and process it for clients, usually with a service product involving reports or presentations. Such information may be about the organisation itself, about its environment, or about its position relative to its environment (e.g. how do its practices compare to those of competitors, and what are its levels of emission of pollutants). Many KIBS firms provide financial analyses, market intelligence, digests of regulatory and similar issues for their clients. These range from rather standardised newsletters to bespoke analyses such as environmental scanning for single clients. (Contrast conventional publishing, which is a manufacturing activity in standard statistics, and involves a large labour force in printing and distribution activities — though online publishing may change this.) • Diagnostic, helping the client define and understand the nature of a problem. An environmental monitoring service may point to specific emissions from a factory chimney; and auditing service may detect fraud in the accounts coming from a branch of a firm; a market research organisation may point to a problem with the image of a company's products. (It is hard to think of nonKIBS equivalents of diagnostic services, apart from areas like consumer and public-oriented health, education and counselling.) • Advisory, suggesting and evaluating possible solutions for a client. Such KIBS may be active in prioritising, recommending choices, and similar activities, for practically any of the topics of knowledge discussed above. This typically involves active dialogue with the organisation. It may require a mediating role where different views and objectives are held by different members or branches of the organisation, and sometimes this is precisely why KIBS are employed to recommend and promote courses of action already favored by some parties in the firm. Eco-design services can help firms select between alternative energy systems for reduced environmental footprint; computer services can advise on systems and combinations of systems and services to acquire; and financial specialists and

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brokers can suggest insurance and investment options. (Again there are consumer-oriented advisory services, from kitchen design to mortgage brokers — though these are often involved in other service functions as well.) • Facilitative, helping the client with elements of implementing solutions. Training services provide skills required to operate the firms' systems, and may be required even where there are no technological innovations — for example to provide linguistic or cultural training for new markets, or to train a new workforce in the event of expansion or staff turnover. Training may involve preparation of documentation and other material for client employees to undertake specific tasks and use specific technologies (increasingly this involves tools such as CD ROM learning aids). Face-to-face training is often employed where more generalised knowledge needs to be developed, to help staff members develop skills and capabilities (and sometimes motivation) required for their jobs. A very different sort of facilitative service is provided by rapid prototyping firms, who have the capability of quickly producing full-size or scale model products from the client's designs, allowing for testing to see whether the designs are internally consistent, meet required standards, are aesthetically satisfying, etc. • Turnkey, effectively creating (or acquiring) and installing the means to achieve the solution for the client, and providing the necessary know-how to continue to use (and possibly even to upgrade) it. Systems integrators, for example, are able to combine and configure elements of existing and new IT hardware and software to provide the operating facilities that the client requires. Many manufacturing companies supply turnkey solutions, too, and when a client is first acquiring a system, at least, there is liable to be a good deal of KIBS-like service provision in such circumstances. (One non-KIBS equivalent of this may be having basic maintenance of equipment and plant performed by an outside contractor.) • Managerial, effecting the solution for the client, on a one-off, irregular, or routine basis. Advanced waste disposal services (not just taking garbage away to deposit it in a pit!), facilities management services, building management, and outsourced computer and

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telecommunications services are examples of KIBS here. In facilities management, the KIBS maintains an ongoing role in managing the resource that the firm requires — providing the client with a capability to which it is reluctant to devote its own staff and management time. (The service may be highly strategic, for example telecommunications network supply and management — but to require expertise and effort that the client is unwilling to make a long-term investment in, perhaps because of following the business edict of focusing on core competences.) Temporary managerial staff may be provided to work with the client by personnel services — the more specialised of these are used to helping clients deal with changing conditions such as a product launch or entry to new markets, or a merger or demerger process. The KIBS who offer knowledge-intensive temporary work services (e.g. contract management services), may locate and sometimes train and support the new staff. Such services effectively implant human-embodied knowledge, as the jargon has it, into the organisation as it is needed, rather than trying to cultivate it among existing staff. (Of course, many non-KIBS business services are providing external services that are not knowledge-intensive to their clients. Transport and storage, basic waste disposal, and many other physical services are examples.) Table 4.1 sets out some of the implications of these distinct service functions for innovation, both in the KIBS firms and in their clients. (Note that Knowledge Management methods could be applied in all of the cells — and potentially in the linkages between KIBS and their clients.) The distinct service roles may seem rather exaggerated, since many firms supply a bundle of such services as a package — and there may be economies in so doing, since the service interaction requires learning a great deal about the client, at least where a non-standardised service is being supplied. But in some KIBS branches — perhaps relating to the evolution of the market and of knowledge about the problems it is addressing — the services are fairly well demarcated across different suppliers. (We found this for different environmental services in the UK in the mid-1990s, for example: Miles, 2000a.)

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Table 4.1 KiBS roles in services and innovation (Examples) KIBS Role

Innovation in KIBS

KIBS-related Innovation in Client

Informative

KIBS may innovate in methods of searching for synthesising and presenting relevant information. (Examples: use of patent analysis and bibliometric methods in technology watch type of environmental scanning, and use of visualisation techniques to represent such results.)

Service may alert clients to scientific and technological possibilities or trajectories — for example, from analysis of underpinning literature, of competitor strategies, and of regulatory developments.

Diagnostic

KIBS may innovate in methods of monitoring and analysing data, and presenting relevant information. (Examples: development of new sensors in monitoring environmental impacts, of computer models for modelling such impacts, of I n t e r n e t - b a s e d communications for accessing data from and delivering results to client, and use of various means for r e p o r t i n g to clients.) Interaction with client in problem definition provides opportunities for mutual learning and even coproduction of innovations.

By clarifying the nature of the problem, a client's innovative strategies can be focused more effectively on search for solutions. Interaction with KIBS in problem definition provides opportunities for mutual learning and even coproduction of innovations.

Advisory

As Informative and Diagnostic services.

Reduce risks of adopting innovations by using service's superior knowledge of alternative possibilities, prior experience, best practice, etc.

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Table 4.1 KiBS roles in services and innovation (Examples)

(Continued).

KIBS Role

Innovation in KIBS

KIBS-related Innovation in Client

Facilitative

KIBS may innovate in the service they supply, and the processes they use to produce it. Thus training services have extended the range of subjects and types of skill they tackle, as well as innovating both in the use of multimedia and in face-to-face instructional settings. Rapid prototyping services are using computer links to exchange designs and results with clients, and new equipment to construct their models.

Reduce risks of implementing innovations by reducing need for (or accelerating process of) learning by doing. Opportunities to learn from a wider knowledge base than provided in-house, and sometimes to experience solutions tried out elsewhere.

Innovation in the elements of As facilitative. systems being combined together, and in the applications to which these capabilities may be applied. Opportunities to learn from doing in concrete circumstances. Managerial

Specialisation on the service can allow for learning from diverse applications, for specialised innovative efforts; knowledgeintensive elements may evolve out of relatively routine services as more knowledge of strategic application of services to client functions, beyond the immediate problem, is acquired.

Reduces need for detailed knowledge of service, freeing resources to concentrate on core competences (though sufficient knowledge to ensure appropriateness of service provision is still required). Increases opportunities to benefit from scale economies and KIBS' innovation.

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Table 4.2 Illustrative knowledge roles of KIBS. Areas of KIBS activity (examples)

Objects of Knowledge

Knowledge of External

Types of Knowledge

Environment

Consultancy, Intelligence Reports, Financial Analysis, Forecasting

Competitors and (Financial) Market Environment

Business and Technology Intelligence

Creditworthiness Rating, Client Relationship Management

Clients

Processing data on client characteristics and transaction histories

Market Research, PR, Advertising

Consumer and Client Markets

Demographics, Attitude and qualitative research

Supply Chain Management

Suppliers

Logistics, Ecommerce

Consultancy, PR

Regulators, Financiers, Collaborators

Organisational intelligence, corporate communications, lobbying

Environmental Auditing, Consultancy, etc.; Waste Management

Physical Environment, physical products and waste products of firm, physical resource inputs and sources

Environmental Intelligence; product husbandry; eco-efficient business processes

Knowledge of Internal

Environment

Systems Integrators, Technology Advice Services

Technological options, implementation

Technology choice and implementation

Management Consultancy

Techniques, best practice benchmarking

Development and use of organisational techniques

Training, Personnel, Recruitment

Human resources

Labour force, skills, training, employment practices, negotiations

Strategic Planning

Routines

Management routines in short-term and strategic planning

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KIBS use and supply business knowledge, knowledge concerning the problems of businesses (and sometimes of public sector organisations). Table 4.2 provides an illustrative classification of the sorts of knowledge with which KIBS are involved. The functions may be supplied in-house, within client companies by their own internal services. It is difficult in practice to outsource a knowledgeintensive service function completely. In any case, the client still has to play a role in managing the service relationship. Some ability to make use of the knowledge inputs from the KIBS will often be required to ensure that it is receiving what it needs, at the appropriate cost, as circumstances change, and that it is able to respond appropriately to the KIBS inputs. This is like the "absorption capacity" that innovation researchers talk about. The discussion above has only indicated a small part of the total range of knowledge (and of problems) with which KIBS deal. Earlier we saw that KIBS may contribute to problem-solving by doing different things with their knowledge. In addition to these knowledge roles discussed earlier, we can now also add some roles concerned with relating the client to its social environment: • Information Outputs from the Client. KIBS may serve clients by seeking to mediate information flows from the client to its environment, presenting material about the company and its operations to external and/or internal audiences. In some cases this may be largely a matter of processing data handed directly from the organisation, though even public relations firms are liable to engage in a great deal of interchange with the client as they seek to clarify what the message is, how it corresponds to available evidence, and how it relates to audience perceptions and preconceptions. In other cases (e.g. financial and environmental auditing) it may involve substantial efforts being put into locating a n d / o r producing information. There will often be some negotiation between the KIBS and the client as to precisely what messages are to be conveyed, how, and to whom — and there is quite possibly some information flow and learning back to the client as a result of this.

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• Communications management. KIBS may be employed to organise the media used as interfaces between the organisation and its internal and external environments, and to helping to establish the routines whereby the organisation (and/or the KIBS) will continue to monitor and shape the flows of information into and out of the firm through these media. • Interfacing with third parties. KIBS may be involved in terms of locating, testing, negotiating with the suppliers of external resources. For example, in technology choice the KIBS may need to trial and compare different packages — this is a systems integration role, in part, but the KIBS is liable to be involved in negotiations with third party suppliers, commissioning designs and even orchestration cooperation among them. Another role is network management (not specifically telecommunications networks!), where the KIBS organises a forum of some kind for different parties to come together. In specialised personnel recruitment, the KIBS may need to be active in headhunting and "selling" the opportunities to viable candidates. A number of recent studies have begun to ask how these sorts of use of different kinds of knowledge are structured, how knowledge about them is accumulated and acted upon by KIBS firms and their clients, and to what effect. Thus Strambach (2001) depicts KIBS as developing knowledge through their interactions with clients, "codifying" this knowledge by turning it into information and routines, and then using it to enter into new client relationships. She sees KIBS as integrating different types of knowledge for particular clients, as adapting the information to their demands and requirements. This can help explain how it is that clients entrust KIBS with strategic information (sometimes — in some other cases this is certainly not the case), knowing that they may also be servicing other firms in the same sector. They stand to gain from the KIBS' application of knowledge that has been generalised out of the experiences of the sector more broadly, and contributing their own experience is part of the necessary trust relationship. And in any case, they will not get the right solution to their problems

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if they withhold important information — and the best solution is likely to come from KIBS with that generalised knowledge. Strambach uses a model of transformation of knowledge from tacit to codified forms that is reminiscent of the approaches to organisational learning developed by Nonaka and Takechui (1995). The management scientist and consultant Dawson (2000) suggests that the patterns of movement identified by Nonaka et al. are very appropriate to thinking about the processes whereby professional KIBS create knowledge from interaction with clients, turn this into products that the clients can benefit from, and participate in helping their clients internalise this as in-house knowledge. In working with Nonaka's model, Dawson — rightly in our view — distinguishes between "knowledge" and "information" rather than using the terminology of tacit and explicit knowledge (Table 4.3). The activities at stake, then, are a matter of effecting transformations within information and knowledge, and of using each to further develop the other. The idea that knowledge development takes place through a (typically clockwise) movement through these different categories is a powerful heuristic that may be useful in understanding how KIBS operate with their clients.

Table 4.3 A reworking of Nonaka's model. TO: -» FROM: i

Knowledge

Information

Knowledge

Socialisation: Externalisation: Transfer of knowledge between "Capturing" people's knowledge people (through interaction rather by rendering it as documents or than mediated through captured structured processes information)

Information

Internalisation: "Knowledge acquisition" — learning how to use models, formulae, equipment, methods etc.

Combination: Systematising and/or translating formalised concepts into new frameworks, procedures, etc.

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• Socialisation: A process of sharing experiences between clients and KIBS, wherein the KIBS in particular create such knowledge as mental models (shared with clients at this stage, for example in problem definition) and technical skills. Within the KIBS there may also be the synthesis of different types of knowledge that Strambach refers to. Socialisation tends to be underpinned by professional group processes and KIBS organisational culture. • Combination: There is a process of development of information resources from this knowledge — this involves the conversion of one system of formalised concepts into another, translation of ideas into a form that the client can absorb, production of documents and videos, reports and material for presentations. • Internalisation: this involves converting the information products into specific know-how. Internalisation may involve "learning by doing", or tuition or mentoring of some sort; the process of making presentations and reporting back to clients is an opportunity to align mental models, to make sure that information is being used in the appropriate way. • Externalisation: Nonaka and Takeuchi suggest that this, though neglected by organisational theory, is at the core of the organisational knowledge creating process. Within the client, externalisation may involve the learning that has been achieved as a result of the interaction with KIBS taking concrete form in mission statements, codified organisational concepts, new metrics for accounting, new decision models, etc. A similar process may be underway in the KIBS, too, as it seeks to reproduce the learning and innovations attained through the interaction with specific clients. Dawson (2000) argues that professional KIBS often need to develop strategies not to standardise their products, but to engage in more sophisticated knowledge sharing with clients. His book is packed with examples of different ways in which this can be done, adding value to the KIBS-client relationship. These seem to be highly promising approaches to better understanding the (changing) roles of KIBS — and perhaps to add

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some much-needed depth to analysis of the knowledge-based economy. There have been several studies suggesting that KIBS do benefit their clients, based on macro-data of one type or another {European Competitiveness Report 2000, Muller, 2001; Tomlinson, 2000). But there has been much less analysis of what happens at the interface of individual firms. Studies of the benefits of using new technologies show that these benefits are as much a matter of user strategy as of the technologies themselves. It is highly plausible that, similarly, we are likely to find that the capacity to interface with KIBS effectively will be an important determinant of the impacts of their use. As in the case of the business use of IT, it may be that inadequate use of KIBS can hinder the clients' adaptation processes, rather than forwarding them. Industry criticism of consultants — which is not infrequently encountered! — may not only mean that some service firms offer poor quality products (some certainly do). It may also reflect firms' difficulties in using these services in an informed way. Work on this topic is only just beginning (see Hislop, 2002 and Mason & Wagner, 1999, who point to cross-national differences in KIBS use).

4.4 Concluding Remarks The rise of KIBS illustrates the growing centrality of (some sorts of) knowledge, and the ways in which the increased variety of technological and administrative knowledge, and the complexity of the combinations of knowledge that are required, requires new agents for creating, integrating and bearing knowledge. Alongside this are other new practices for mobilising knowledge, including Knowledge Management systems, formalised and otherwise. The staff of KIBS are instrumental in generating novel solutions to the problems of the client firms, and novel processes within the KIBS itself. They act as the interfaces with clients, so that KIBS become intermediary agents in innovation systems. Their skills have to be severalfold: they typically carry some generic knowledge that is represented in their expertise; they have to be able to apply this and perhaps develop it further in order to meet the requirements and solve the problems

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of the client (eliciting and organising client-specific knowledge, fusing this local and the more generic knowledge into a solution); implicit in the above is the possession of skills in interpersonal communication, presentation of materials, "impression management", and the like. These are fairly rare capabilities, and their combination is rarer still: for this reason labour costs and wages are high in most KIBS. Tomlinson (Tomlinson and Miles, 1999) suggests that KIBS staff may be in many ways exemplars of "life long learning". UK survey data suggest that — despite concerns about job instability and pressured work lives — these workers are more likely to learn new things, to receive training, work with computers, and to move between different types of work. Taking up this last point, he argues that KIBS provide an alternative route to promoting labour mobility as a means for diffusing knowledge around the economy. If people are the main carriers of knowledge, then bringing new knowledge into organisational learning processes is liable to require that these carriers are able to interact at some length with the firms into which the knowledge is to be embedded. The stress on labour mobility assumes that this happens by way of employees' changing jobs. A KIBS perspective indicates that it can also happen through the interface between service and client, where learning processes may be engendered — in both parties. This confirms the importance of the human resources that embody and carry this knowledge. Policies need to be directed toward developing workforce skills appropriate to KIBS. Training systems will need to adapt in order to equip people for the volatile new career structures of the twenty-first century, and the particular demands of KIBS. This involves equipping people with skills to search for work and create it themselves, and, in addition to technical and cognitive skills, to possess the sorts of social, interpersonal, and self-organisational skills required for effective KIBS (see Toivonen, 2001). Traditional disciplinary structures are probably inadequate to this challenge. Vocational systems will need to develop much better intelligence as to the changing skill demands of KIBS. KIBS firms need systems of governance that can increase the quality of human resources, rather than the control of the workforce.

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(This may involve, for example, more professionalisation of some of the newer forms of expertise; it may require more use of semi-professionals in service production and delivery.) It is liable to push knowledge management systems in new ways, that can accommodate the concerns and highly complex characteristics of knowledge professionals, and that can interface the systems of KIBS themselves with their clients. And the need for clients to be informed as to good practice in recruiting and using KIBS is important is this use is to contribute to innovation and dynamism more generally. These are activities that (parts of) the private sector have awareness of, and should be taking responsibility for. But support from public policy may prove helpful to smaller firms (KIBS and KIBS' potential clients) and peripheral regions (where access to KIBS may be a crucial developmental resource). The rise of KIBS means that important knowledge-producing and -using activities are being effected outside of the long-established structures that have governed the quality of science and the integrity of professions. These structures are of course themselves evolving in the knowledge-based economy. But the rise of KIBS means that action may also be required to support the professionalism of some types of expert — who may come under particularly heavy financial or moral pressure in their work. This is a general issue of corporate governance, but may have implications for innovation both directly (poor advice on systems to acquire, for example) and indirectly (diverting resources and destabilising the economic environment).

Chapter 5 Service Innovation: Aiming to Win Tony Clayton

5.1 Why Service Innovation is Difficult to Measure There is little statistical evidence on what drives service innovation — or on its results. Economists, and business strategists, came late to the services revolution. Even now, official statisticians are still wrestling in UN committees with the complexities of measuring the output of service businesses in "real" terms, so they can compare them against manufacturing where the new products are easier to count. In the meantime, services output grows apace, accounting for over twice the contribution of manufactured physical products to GDP in the UK, and even more in some OECD economies. But the economic models by which finance ministers chart our future are still heavily dependent on concepts that owe more to products you can see and touch, than to intangibles and services. Policymakers have recognised the importance of innovation as a driving force for growth and productivity improvement across h economy. But measuring innovation in services compounds two problems. Not only is it difficult to measure prices, and therefore output, but defining innovation in service businesses is even more problematic than it is for physical products. For over a decade economists and statisticians have used the "Oslo manual" defining innovation primarily in technological terms, and this paradigm has been measured and elaborated in official statistics such as the Community Innovation Survey (CIS), as well as in various private data collection and analysis programmes. But for service businesses it is often the case that innovation is relatively difficult to define purely in terms of the technological criteria developed during the 1980s for official surveys. Frequently 113

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service innovations, which make significant differences to the ways customers use and perceive the service delivered, and which demand major investments from service providers, do not require the acquisition of new technology by the supplier. But they do demand investment in skills and methods of working to change the business model, as well as major marketing changes. Fortunately, as the Oslo convention has been applied over the years, some surveys have taken a more "inclusive" view of the innovation process. The UK version of the Community Innovation Survey carried out in early 2001 was one of these (Stockdale, 2002).

5.2 UK Innovation 2000 The Community Innovation Survey is carried out in most EU countries every four years, as a way for policymakers to track the level of innovative activity over time, and to compare differences across sectors, and national markets. In the UK it asks several thousand firms about their inputs to, and outputs from, the innovation process. Its main measure of innovation is the value, and percentage, of sales by the firm which comes from products or services which are genuinely new over the three years leading up to the survey date, plus the value of those which have been the subject of major improvement over the same period. The definition used is therefore consistent with that developed and applied by PIMS over the last two decades, and which we will refer to later in this chapter. The UK innovation survey results were released in mid 2002, and have subsequently been researched by a number of academic teams. The analysis presented is concerned only to discover whether earlier work using CIS in the UK and other countries here (Clayton & Waldron, 2002), and from private sector data (Clayton & Turner, 1996), showing a strong relationship between innovation and business growth is born out: • by the evidence in the UK CIS data for the most up to date period 1998-2000 • for the service sector as well as for manufacturing.

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The simple approach adopted in this initial analysis is to separate out the businesses survey into three groups, depending on their degree of innovative activity: • those who report no new or improved products at all • firms which innovate, but whose proportion of new or improved output is less than the median (excluding non-innovators) in their two digit SIC category • innovators whose new or improved output equals or exceeds median for businesses in the sector which make some effort. Against these three categories we have looked at the percentage growth performance of businesses relative to the mean growth of their two digit sector — effectively relating relative innovation activity to change in share of sector. The results are shown below in aggregated format, in broad sector groups, to conform to data confidentiality rules. Data for the manufacturing sector shows strong positive relationships between relative innovation and relative growth. But a sector breakdown shows that the impact is greatest in the food/drink area, in which branded product manufacturers bring together both innovation and a substantial investment in commercial communication. This combination was a particular feature of the

0.251 0.2 0.15Food / Drink 0.1-

I

0.05-j n

Textiles

|j

j

•»

|| H

j§

—

wm m M

• Machinery - Electrical / optical

-0.05 None

Below

Above

Median

Median

Fig. 5.1. Innovation and growth by sector.

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second half of the 1990s, which this data covers. Further work will be required to validate this connection for CIS data, although earlier PIMS analysis (Clayton & Turner, 2000) has demonstrated the cumulative effect of innovation and communication. However, the innovation-growth link is clearly demonstrated across the whole manufacturing sector, and in individual sectors; more innovation goes with higher growth. For most of the service sectors, similar relationships are apparent. The impact of innovation on growth is almost everywhere positive and consistent. The major exception in the evidence for CIS 2000 is in the financial services sector; given the period covered by this survey in the UK, this is perhaps understandable. Not many areas show the exceptionally strong impact evident in the branded manufacturing sector, but the pattern across retail and wholesale distribution, transport and communication services, and the broad range of business services is convincing. The innovation-growth relationship is clearly a powerful influence across the CIS sample, including well over 2000 UK service businesses.

0.2

0.15 0.1

ll ll

0.05 0

• Distribution • Transport • Business Services

-0.05 None

Below

Above

Median

Median

Fig. 5.2. Innovation and growth in the service sector.

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5.3 W h o are the Innovators? While official statistics — like the Community Innovation Survey — make it plain that there are innovators around in all sectors, there are limits to what can be done to identify them. In part this is because of confidentiality conditions on official data, and partly because such data contains relatively little on the "typology" of businesses — relying instead on standard industrial classifications. PIMS data on the other hand contains only limited data on sectors, but good information on market characteristics, types of customers, competitive strategies — all in terms that can be compared across sectors. This approach to analysis was used to research profit behaviour of service businesses in earlier work (PIMS, 1992). To identify common characteristics of service innovators, we have looked at over 100 service businesses from the PIMS database in 2001 (excluding retail and wholesale distribution for which the innovation characteristics are demonstrably different), and separated out those which have the highest sustained new service content in their revenue stream over four years. The answers are — in some cases — counter intuitive. Two clear indications from the data point to different aspects in which "focus" is an important discriminating factor between high and low service innovators. First, those businesses with the highest level of new service content tend to avoid overcomplicating their customer base. They are usually firms for which fewer key customers account for a higher proportion of their total revenue. More significantly, they are usually more dependent on fewer, bigger, customers than are their direct competitors. This suggests that customer complexity can be a barrier to effective innovation in service businesses, just as earlier research showed that it can be a barrier to realising profits. Second, it seems that focus in the procurement and service delivery process is also an aid to stronger innovation performance. High innovators tend to focus their purchases on fewer, larger suppliers. They also tend to have more purchases, as a percentage of their sales, and significantly lower cost added. This suggests that they

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Business Descriptor

No/Low Innovators

High Innovators

<1%

17%

>0

5%

Average Similar to competitors

High More focused than competitors

Average 72% 36% Same or more

High/strategic 60% 25% Same or less

Innovation input • "What" R&D • "How" R&D • Fixed Assets/sales • Overheads/sales %

0.1% sales 0.1% sales growing at 10% pa 8%

0.7% sales 0.5% sales growing at > 20% pa 11%

Innovation context • Recent technology change • Time to market

20% > 1 year

40% < 1 year

Competition • Competitor entry • Imports/Exports vs. market

10% 2%

40% 12%

Declining Just below competitors

Improving Better than competitors

Output • Real sales

9%

15%

and dogs that don't bark... significant differences for • Growth in share • ROS • ROI

+0.3% 14% 23%

+0.2% 18% 27%

Innovation Outcomes • % sales from services introduced < 3 years ago • % new services vs. competitors Customer Base • Focus on key customers • Relative customers base Value Chain • Focus on key suppliers • Value added/sales % • Operating cost added/sales • Vertical integration vs. competitors

Quality of offer • Relative quality vs competitors • Value for money

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are less vertically integrated and therefore focused on fewer internal processes within the overall value chain. Not surprisingly, high innovators spend more on R&D, to change both what they deliver to customers, and how they deliver it. In addition they have often experienced technology change, and invested in fixed assets to do so. They usually take less than a year to bring new service concepts to market. Firms that have a good value for money position to start with, compared to competitors, are more likely to be successful innovators, and they often manage to further improve customers' perception of their offer by innovating. Competition is also an important factor. The highest innovating firms are more than likely to have experienced entry into their markets by a significant new competitor (more than 5% market share). They are also much more likely to compete in open markets where international trade — both imports and exports — play an important role. Although die high service innovators show higher real sales growth than their non-innovative peers, this appears mainly due to overall market growth differences. There are no systematic advantages in market share performance, in return on sales, or in profits as a percentage of capital employed. So the benefit gained from high innovation in the PIMS service sector sample is not necessarily sustainable; it does not, of itself, guarantee an improving competitive position.

5.4 Which Firms are the "Innovation Winners"? If high absolute levels of innovation are not enough for service businesses to underpin competitive success, perhaps we should look at those businesses which out-innovate their competitors. These are the firms which, over a four year period, manage to stay furthest ahead of their immediate competitors, within their target markets, in terms of new service content. To do this they will often have to innovate more than once, as an "innovation" only counts as new in PIMS' definition (as in the CIS) for three years, and for this analysis we are counting over four years.

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Many of the characteristics of such firms are the same as those seen above for the "high innovators" group. Focus on key customers, on strategic suppliers, and on core business processes within the value chain are at least as important. Even more R&D investment to change both what the business delivers ("service product") and how it delivers it (process) are required to sustain an advantage in innovation output, rather than the less demanding goal of a consistently high level. What also seems to help is a consistently higher level of business infrastructure support, in the form of overhead costs. Speed to market and a good starting perception of value for money by customers are also important assets, and a competitive environment is an aid, rather than a threat. Differences that can be seen in the characteristics of "innovation winners" are in the even greater degrees of concentration on key customers services delivered and key suppliers. Not only do they focus on fewer immediate customers than those businesses which are less successful, they also have a more restricted set of target end users. The average size of immediate or end user contract is greater. This suggests that "repeat innovators" are more likely to be found among business to business service suppliers than in those providing consumer services — unless they can operate through distributors. Innovation leaders have the best chance of success when their starting offer is seen as good "value for money". Strong innovation performance in these circumstances more often than not leads to further perceived quality improvement. But persuading customers to buy new services at a premium is clearly difficult. Most of our "innovation winners" operate with a policy of parity pricing, with a policy of using their service advantage to go for growth, rather than to exploit it for maximum immediate profits. The outcomes over the medium term justify their patience. Business performance indicators for these innovation leaders show that, while they may not have a clear advantage in terms of return on sales they are successful in the three measures most important for shareholder value. They grow real sales significantly faster. They grow share of their target markets faster than their direct competitors

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Table 5.2 Characteristics of "innovation winners". Business Descriptor

L o w / N o Innovators

Innovation Outcomes • % new services vs. competitors < 0 • % sales from services introduced < 3 years ago 1%

Out-Innovators 7% 12%

Customer Base • Focus on key customers (immediate or final) • Typical customer contract size • Relative customer base

Average

High

Mixed Similar to competitors

• Range of services

Broader than competitors

High value More focused vs. competitors Same or narrower

Value Chain • Focus on key suppliers • Value added/sales % • Operating cost added/sales • Vertical integration vs.

Average 70% 35% Same or more

Over 50%, strategic 62% 25% Same or less

competitors Innovation input • "What" R&D • "How" R&D • Fixed Assets/sales • Overheads/sales %

0.1% sales 0.1% sales growing at 11% pa 8%

0.9% sales 0.7% sales growing at > 21% pa 11%

Innovation context • Recent technology change • Time to market

20% > 1 year

30% < 1 year

Competition • Competitor entry • Imports/Exports vs. market

10% 2%

40% 10%

Offer to customers • Value for money • Relative quality • Price position

Behind competitors Static Premium

Better and improving Improving Parity

Growth • Real sales growth • Market share growth%

8% 3%

15% 8%

Returns • ROS (not significant) • ROI

9% 21%

10% 30%

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and non-innovators generally, and in addition they increase return on capital employed to levels which are almost certainly above the cost of capital. The evidence suggests that this improved profit performance is driven by asset turns. 5.5 H o w Effective Innovation is Turned to Growth While the evidence shows convincingly that the most innovative businesses in service markets grow, innovation may not be a necessary and sufficient condition for growth. The next step in our analysis is to look at what the fastest growers have in common. Our definition of growth is based not on sales, but on value added — which makes sense on two counts. First, value added represents what businesses contribute to output and GDP in the economy. Second, we have already seen that innovation advantage itself is related to lower value added/sales profiles of business, so this format for analysis is more useful than one which might look at successful sales growth — while value added could be falling. The fastest growing service businesses, which add around 25% to their output each year in nominal terms, are indeed mostly "innovation winners" — businesses that are, and stay, ahead of their competition on new service activity. They also have higher overhead/infrastructure costs — but, surprisingly, not higher R&D expenditure relative to sales value. The value for money proposition offered by rapid growth businesses is higher than others, and more likely to increase over the four year period over which growth is measured. The fastest growers spend more on commercial communication, both advertising and sales force costs suggesting that communicating innovation advantage, and superior value proposition is a critical success factor for rapid growth, even where technology development costs may not be. Like the earlier groups of service innovators, fast growers are more likely to focus on specific groups or types of customers. They tend to be more dependent on fewer end users for the bulk of their sales. They are also less likely to have product ranges broader than their competitors, or vertically extended value chains. This

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Table 5.3 Characteristics o f fast growth service businesses. Slowest Growers

Fastest Growers

4%

25%

2% -1%

15% 6%

< 0

>0

More fragmented

More focused

Broader than competitors High

Similar to competitors Average

6 months plus Broader than competitors

More frequent decisions Same or narrower

40% Same or more

34% Same or less

Innovation input • R&D (not significant) • Marketing cost/sales • NBV fixed assets/sales • Overheads/sales %

0.6% sales 5% 47% 8%

0.6% sales 9% 30% 10%

Innovation context • Time to market • Position at entry

> 1 year Leader

< 1 year Close follower

Competition • Competitor entry • Share of top 4 in market

10% 69%

30% 78%

Offer to customers • Value for money • Relative quality • Price position

Behind competitors Static Premium

Better and improving Improving Parity

Profits/Margins • Margin on sales (yr 1) • ROI (yr 4)

15% 21%

10% 33%

Business Descriptor Growth • Value Added growth pa (current prices) • Real sales growth • Market share growth % Innovation Outcomes • % new services vs. competitors Customer Base • Focus on key customers (immediate or final) • Range of customer types • Purchase importance/cost critical to customers • Contract length • Range of services Value Chain • Operating cost added/sales • Vertical integration vs competitors

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processes (by trying to produce too many outputs or manage too many steps in the value chain) and of a complex customer interface (by meeting the needs of too many different users) can slow down the business of turning new ideas into growth. There are some areas where the fast growth businesses show characteristics which are different from — or even in conflict with — those of the high innovators. While the lead innovators tend to have high value, long term, relationships with their customers, the fast growers more usually deal with frequently repeated transactions, and lower value contracts. The evidence suggests that cost criticality to users, and longer intervals between purchase decisions, can help in the development of new ideas, but also act as barriers to take up of service innovation. Speed of growth also seems to be inversely related to business fixed capital intensity. The fastest growers have lower gross and net book value of assets to sales, but without any evidence that this is caused by higher levels of capacity utilisation. It seems likely that the growth limiting effect of capital intensity is related to business flexibility and willingness to take risks, rather than the physical problems associated with investing fast enough to keep pace with increasing demand. The reward for fast growth, based on the competitive advantages outlined above, are worthwhile for business managers and owners. Although the "fast growers" start out with inferior margins, perhaps due to the investment required in marketing and infrastructure, they typically end up with higher returns on invested capital to add to their growth advantage. This combination guarantees a higher return to shareholders.

5.6 Combining Growth and Margins PIMS' initial work on service business profit drivers in the 1990s (5) found that: • the major competitive measures, of quality, market share and productivity were as important for service businesses profits as for the wider business population

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• capital productivity could cause as much damage to margins in the service sector as in manufacturing • complexity, both of market approach and of services delivered, are much more likely to damage margins and asset turns than in other business areas • growth brings higher and more sustained margins for service businesses, probably because entry by competitors from outside national markets has historically been difficult. Updating this work has confirmed that all these conclusions remained true over the 1990s (PIMS, 2003). The importance of product and customer focus has not diminished. The evidence shows that, service businesses focusing on a more restricted range of outputs than major competitors usually achieve a significant profit advantage compared to those that do not. This does not necessarily mean niche service businesses are more profitable, as PIMS businesses define the scope of their target markets in the light of specific situations. But it does mean that the most successful service businesses in profit terms are those whose own managers define their target more precisely — and narrowly — than their competitors. Analysis of the most profitable service businesses in the PIMS database in 2002 shows that tJiey share the following characteristics:

HAII businesses M Service businesses

Narrower

Same

Broader

Fig. 5.3. Return on investment (ROI)% versus product/service range in market.

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• a more concentrated customer base (both immediate customers and end users) • more restricted product/service range • a less vertically integrated value chain • lower commercial communication costs, reflecting the easier job they have to do in the market • faster sales growth, partly as a result of better value offer to customers • faster asset turns, and better employee productivity • they face weaker competitors, but more competitive markets. None of these characteristics is incompatible with the business profiles associated with competitive growth. So we can expect the "focus" principle to apply equally well to the competitive dynamics driving the growth of new service businesses and to the profit streams that determine which ones survive long term.

5.7 Interpreting Statistical Evidence in the Real World All the PIMS evidence outlined so far confirms that specialisation pays in services. Complexity slows innovation, reduces the ability to turn it into growth, and adds cost which reduce profits. These effects are more powerful than the influence of competitive scale or critical mass, which might be expected to have greater effect on both innovation and profit outcomes. However, there is plenty of anecdotal evidence which fits the statistics.

Making it "Easy" The "focus" philosophy as a route to strong sustained margins is well demonstrated by the rise of "no frills" air services in Europe since the mid 1990s. The development of a simple business model was based on: • a limited product offer, based initially by Ryanair on point to point shuttle service

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single class, limited flexibility pricing no extra on board services, or connection with other flights rapid turn round and excellent capacity management subcontracted support services

The above model produced a set of operators able to offer very clear value propositions, based on low cost for a simple product — initially aimed at marginal customers to grow the market. But the simplicity of their operating model soon led to a situation where these operators were able to offer more punctual service than the full-fare competition. Without all the complexities of catering, reserved seats, segregated classes, or loyalty schemes, the low cost operators were also able to respond relatively well to short term air scheduling problems and recover lost time. One of them was named as "most punctual airline" in 2001, which means a significant quality advantage for regular business travellers. The growing number of business travellers using Easyjet or Buzz do not get preferential treatment compared to the "marginal traveller", they buy the basic package. The simplicity of operation is not compromised, and neither is the marketing approach. Whether this offer of a "basic" service in die air travel market qualifies as innovation is open to debate, but it certainly involves the construction of a new business model, creation of new routes to market, and the development of new groups of target customers. It clearly makes the hurdle defining "process" innovation, and is at least as innovative as much that goes on in the branded consumer goods field. On top of that, this service development follows most of the "rules" outlined in our review of the statistics.

Effective Focus An example of a sector where innovation is all can be found in one of London's most successful (though unstable) business clusters. For well over a decade, the UK has been a centre for special media effects, delivering tailored software effects for films and TV. The structure of this industry follows much of the evidence we have

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reviewed. It consists of many specialists, who each focuses on a specific step in the chain in constructing a moving image, for example figure design, movement, fitting the figure into context, and so on. Each specialist is able to innovate within his or her area, building up a reputation for inventive work, and in the media effects business, the value of good innovation to the film maker can be very large. In a film production, this chain of Soho specialists — each completing a step in the process from concept to finished image — can look chaotic. But in this case the specialisation delivers real advantages in control, and in the ability to manage change flexibly. While there are giants in this business, the specialists have also succeeded, while others (such as Disney's large special effects team responsible for Dinosaurs) have been wound down. Another case of the survival — and growth — of the focused.

Focus in Bunking John Kay has drawn attention to the serious problems experienced by Midland in the early 1990s, when it tried to innovate without addressing fundamental problems of segmentation and business control (Kay, 1993, p. 111). Midland's initiatives came in the days when the drive towards the "financial supermarket" was common among those operating financial retail and payments systems — a strategic movement which was very much at odds with addressing the needs of specific customer groups. In the UK market there were, at the time, two much more successful examples — now acquired but still with a brand presence. TSB, with a very strong focus on relatively simple savings and loans products for lower income households, managed to beat all its UK competitors to "real time" banking by several years. In addition, it built one of the most successful and innovative unit trust based savings businesses in the market — again focused round relatively "easy to understand" products, and managed completely separately from the core banking business. In the end, it was unfocused acquisition in markets outside its main area of expertise

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(Hill Samuel in merchant banking) that cost the company its independence. C&G building society, which managed to build up a customer base strongly focused on specific demographic groups, as well as geography, shared some of the same characteristics. C&G deliberately kept its range of products restricted to mainstream customer needs in savings and investment, an as a result achieved some of the highest customer satisfaction ratings, and lowest cost/ income ratios, in the industry. As financial services move on-line, again the most successful are those with a very clear view of which customer segments to aim for. In the words of the MD of Charcol On-line (one of the UK's largest internet mortgage companies (Strauss, 2002). "Segmentation is key to any business seeking to transform itself, and its market, through e-commerce. Understanding how groups of consumer behave, and what they are most likely to value, is a critically important factor for the business in gaining competitive advantage in constructing offers to customers." Charcol's strategy in creating a successful on-line business has been to move incrementally, from its original base in traditional mortgage broking, and maintaining its focus on higher net worth individuals, while developing methods for communicating with them in different ways. The firm has created relatively simple on-line advice systems, easy to use and designed to build trust in the brand, and then to offer a limited range of options, with selected, high quality product suppliers. Understanding customer needs, in terms of the preference for personal advice versus the ability or inclination to use "self service" is one important dimension for Charcol in filtering its customers to on-line purchasing or towards direct contact with a sales adviser. Another is the requirement for a simple transactional product, versus more complex overall solutions, which depends on the clients circumstances. In the "self service/transactional product" corner of this matrix the possibilities of delivering reliable service are high, and the strategy behind Charcol's innovation approach is to offer this group the best value proposition in the market. Growing the business depends on new propositions to extend the envelope, rather

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Charcol The Independent financial experts

Transactional production based

Broad advice/ tailored solutions Customer need

Fig. 5.4. Evolution of Charcol on-line.

than attacking directly the traditional customers with very different needs. Innovation in Public Services The traditional model for many public services — in the UK and elsewhere — has been the vertically integrated "command and control" model, in which organisations undertake most of the steps involved in delivering not just the service to final consumers, but also many of the intermediate and support services required. In addition, most public services are — in principle — available to all. The concept of customer selection is in many cases either inappropriate or difficult to enforce. Given the evidence we have shown about private sector success rules for innovation, we should not be surprised if these structural characteristics of public sector organisations have made the delivery of innovation difficult, and slow.

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In the process of privatising UK public sector services, in energy, telecommunications and transport, and in attracting private capital into health, education and administrative support, some of these issues have been addressed. For example, in energy the electricity and gas industries have been "vertically disintegrated", with primary energy assets separated from transmission, distribution and end user supply. In transport, track ownership was split from maintenance, train ownership and train operation. The record of achievement across these examples has been — to say the least — mixed. Comparing the successes with the failures, it seems at least arguable that the best performing services are those which have used their new structures to innovate and improve customer value. This is true of some of the energy and telecommunications supply businesses, which have chosen to focus on specific customer groups through targeted marketing, and deliver a set of modular services which can be tailored through "mass customisation" and sourced from a limited range of suppliers. The most spectacular failure — rail — was saddled with a new business structure which was itself much too complex, because of the number of relationships created by cutting the service into so many small entities. Some of the train operating companies have succeeded in creating new and improved services by targeted investments and new operating practices. However, for the most part they have been handicapped by the strategy of the main infrastructure owner — Railtrack — to concentrate on cost reduction rather than value creating innovation. Railtrack also miscalculated the importance of intangible assets — information, knowledge and skills — which were essential to improve the quality of its offer to immediate customers. The case of rail illustrates the necessity, in designing new business models for the public sector, to ensure that participants at every step in the value chain have clear incentives to innovate, and to develop the means to do so.

5.8 Conclusions The evidence and examples quoted above point to some general conclusions for successful service innovation — most related to the

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critical importance of focus and complexity avoidance. Business and economic rationale for these findings can be summarised under three headings Customer Knowledge Businesses with clearly defined and well understood customer characteristics are much less likely to incur risk through innovation; the probability that they will make the wrong offer to their customers is much reduced, and their knowledge base for bringing products is likely to be better, reducing research and development cost. Time to market is likely to be faster, with fewer pilots required. Focused marketing is usually less costly.

Experience Without Scale Clear focus on products and customers gives the organisation the chance to learn more quickly — to work down the experience curve with repeated operations, or transactions, without having to be market leader. Where a firm is able to innovate under these conditions, the scope to learn more quickly can be especially valuable, not just for cost reduction, but to learn in the market how customers react to propositions. With on-line services this can be particularly important — enabling businesses to react in real time to consistent feedback from customer groups with homogeneous needs.

Simple Architecture Successful service innovators tend to have simpler — and therefore lower cost — routes to market, as well as simpler supply structure and internal processes. Reducing the number of external partners, and internal operations to control, may well help the business to concentrate on die most important customer facing elements of change, and to speed up innovation processes.

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Each of these elements is a measure of how effectively business managers are able to define their aims, for customers, for developing important process competences, and for relationships with suppliers. The evidence shows that clear aims in each of these areas are critical for winning performance in service innovation.

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Part II

Sector and National Studies of Innovation in Services

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Chapter 6 The Organization of N e w Service Development in the U S A and U K Frank M. Hull and Joe Tidd*

6.1 Introduction We know a great deal about the organization and management of new product development in the manufacturing sectors, but we know comparatively little about how applicable this is to the service sector (Miles, 2000; Tidd et al., 2001; Tidd & Hull, 2002b). In this paper we explore the extent to which a framework for organizing and managing new product development, derived from good practice in manufacturing, predicts variation in performance in service companies in the USA and UK. The framework we developed is based on proven good practice in the manufacturing sectors, and adapted to encompass services as well as goods. A generic framework is potentially useful because large corporations increasingly offer and bundle products and services, e.g. field installation, after sale upgrades and add-ons, support, and maintenance (Chase & Garvin, 1989; Chase & Hayes, 1991). Large, high-tech companies employ as many people in service as manufacturing jobs. Moreover, the proportion of non-manufacturing jobs is growing as many industrial leaders are diversifying into services (Wise & Baumgartner, 1999). The framework we propose is based on the principle of concurrent or simultaneous product development. Concurrency emerged as a paradigm for industrial product development because simultaneous contributions by disparate functions along the value-added chain *The authors would like to acknowledge the contributions of Philipp Drost and Kate Banks. 137

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proved faster and more effective than serial contributions (Takeuchi & Nonaka, 1986; Nevins & Whitney, 1989; Clark & Fujimoto, 1989; Stalk & Hout, 1990; Hartley, 1992; Susman & Dean, 1992; Clark & Wheelright, 1993; Gatenby, 1994; Ward et al, 1995; Gerwin & Susman, 1996; Zirger & Hartley, 1996; Fleischer & Liker, 1997; Liker et al., 1999). A framework of concurrency is needed in large service corporations as well as goods companies because functional differentiation occurs with growth in size and complexity, regardless of sector (Blau & Schoenheer, 1971; Blau et al., 1976), and inhibits enterprise integration (Tidd, 1993; 1995).

6.2 Theoretical Framexwork There is a well-established literature on the organization and management of new product development, and we will not provide yet another review of this here. Although the disciplinary perspectives and methodologies differ, there is a significant consensus regarding the factors that contribute to new product success (Brown & Eisenhardt, 1995; Tidd et al., 2001). However, almost all of these factors are derived from studies of new product development in the manufacturing sectors. There are similarities between the organization and management of manufacturing and services (Meyer & DeTore, 2000), and some authors have argued that manufacturing good practice should be applied to services (Bitran & Pedrosa, 1998; Boone, 2000). There is good reason to believe that researchers and practitioners should question the direct application of manufacturing good practice to a service context without significant adaptation (Fitzsimmons & Fitzsimmons, 2000). For example, service and manufacturing differ in terms of the tangibility of outputs, the relationship between processes and products, and the interaction with end-users. However, the organization and management of new product development in services is still not well researched or understood (Mentor et al., 2002). In this paper we propose to test the applicability of manufacturing good practice in new product development (NPD) to services.

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The organization and management of NPD may be summarized by five constructs: Strategy, Process, Organization, Tools/Technology, and System. This framework is an enlargement of a composite model of NPD effectiveness tested by analyzing 100 industrial corporations in the US (Hull etal., 1996; Collins & Hull, 2001; Liker aal., 1999), and validated during the course of conducting 16 industrial case studies of companies participating in a user group. 1 Each company in the group presented their methods of NPD and helped shape the definition of good practices in terms of the five constructs. Varied formulations in this framework are commonly used in the literature on concurrent engineering (Zirger et al., 1990; Susman & Dean, 1992), organization design (Hage, 1980; Daft, 1995), and as building blocks in models for industrial improvement, such as the Lean Aerospace Initiative (Womack & Jones, 1996; Cusmano & Nobeoka, 1998; Henderson & Larco, 1999).

National Context

Environmental Dynamism

• •

Strategy of RRR Process Organization Tools/Technolog

Fig. 6.1 Performance, SPOTS model, environmental and national context.

*A Concurrent Engineering group, formed to exploit a CE database and transfer best practices, included: AT&T Bell Labs, Black & Decker, Chrysler, Eaton, Ford, GE, HP, Lockheed-Martin, Lucent Technologies, Motorola, Sun Microsystems, 3M, Unisys, US Army, Westinghouse, and Xerox.

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Each of the five constructs plays a different role in performance improvement. Strategy provides focus; process provides control; organization provides coordination of people; tools provides transformation/transaction capabilities, and system provides integration. Each can be expressed on a continuum ranging from a mechanistic bureaucracy to an organic-professional organization (Burns & Stalker, 1961; Lawrence & Lorsch, 1967; Duncan, 1976; Daft, 1978; Mintzberg & Quinn, 1996; Hage, 1980; Hull & Hage, 1982; Hull, 1988; Damanpour, 1991; Susman & Dean, 1992; Leonard-Barton, 1992; Liker et al., 1999). The mechanistic form is best for cost efficiencies, the organic for innovative product differentiation. But to simultaneously achieve both kinds of generic competitive advantage, cost and innovation, organic and mechanistic design elements need to be combined in an integrated system (Tidd & Bodley, 2002; Tidd et al., 2001). The need for combined organic and mechanistic practices is one reason why our constructs are defined below in ways that are relatively harmonious in terms of mechanistic and organic compatibility.

S — Strategy The particular mode of strategy hypothesized as most congruent for concurrent systems is one of RRR (Rapid, Reiterative, Redevelopment). This approach to product differentiation accumulates numerous incremental innovations instead of striving for a risky radical (Dewar & Dutton, 1986; Mintzberg & Quinn, 1996). The RRR approach has enabled many companies to achieve greater cumulative novelty per unit of time than more radical approaches to innovation (Clark & Wheelright, 1993; Tidd & Fujimoto, 1995; Tidd, 1995). Short, repeat development cycles are hypothesized as making it easier for systems to maintain closely integrated relationships while making continual adjustments because multiple functions have opportunities for concurrent instead of serial input. The strategy of RRR is also hypothesized as improving performance because its focus on time compression and knowledge reuse provides a stimulus for both up and downstream functions to engage in frequent, constructive

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exchanges. Partly because the RRR approach entails conservatism and improvement, its strategic intent is to achieve both kinds of generic competitive advantage simultaneously, low cost and innovation. Hypothesis 1 The greater the practice of a strategy of RRR, The higher the level of performance improvement. P — Process Processes for controlling product development in a concurrent mode are more flexible and enabling than those of a coercive, mechanistic bureaucracy (Hull et al., 1996; Adler & Borys, 1996; Liker et a-L, 1999). Concurrent practices of product development involve external benchmarking, structured methods for translating customer needs into requirements/specifications, setting standards for project/product performance, and systematic reviews (McCabe, 1985; Melan, 1985; Garvin, 1995; Yearout, 1996; Tidd & Bodley, 2002; Tidd et al., 2001). By providing road maps and boundary conditions, crossfunctional teams may be given more responsibility and stage gates less rigidly enforced in design reviews. Product development controls are abetted by general methods of process improvement, such as mapping to identify ways activities are conducted, show wasted steps, and eliminate unnecessary handoffs in product development as well as other kinds of activity mandated by ISO 9000 (Lovitt, 1996). Best processes are then documented as standards for helping to keep product development projects on track and continuously updated. This approach to control is in stark contrast to the rigid, mechanistic use of static manuals of standard procedure. One reason is because cross-functional teams are often involved in the creation, maintenance, and continual improvement of processes, thereby melding mechanistic and organic practices. Hypothesis 2 The greater the practice of continuous process improvement in product development, The higher the level of performance improvement.

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Frank M. Hull <& Joe Tidd

O — Organization A cornerstone of NPD good practice is organizational, which is the simultaneous integration of work performed by functions along a value chain of product development and delivery. The notion of organic team structure enables people to cut across bureaucratic barriers due to size and structural differentiation (Hull et al., 1996). Concurrent product development involves multiple functions simultaneously at early steps of decision-making to maximize opportunities and preclude downstream problems, such as difficulties with manufacturability, marketability, and serviceability (Hartley, 1992; Susman & Dean, 1992). Early simultaneous influence exerted by downstream functions fosters continuing cross-functional communication patterns among diverse people to develop better products that are well thought-out from early stages, thereby avoiding costly late changes (Collins & Hull, 2001). Heterogeneous input typically results in better solutions to complex, dynamic problems. A spate of articles extol the virtues of cross-functional teaming (Hull, 1990; Meyer, 1994; Kahn, 1996), especially to the extent products are novel (Olson et al., 1995; Collins & Hull, 2001; Liker et al., 1999; Tidd & Bodley, 2001). One reason for its benefits, relative to serial approach where each specialist hands-off to another, is that the group exerts some degree of control over individual behaviors, thereby melding some of the equivalents of mechanistic design elements with organic ones (Takeuchi & Nonaka, 1986). Hypothesis 3 The greater the level of cross-functional organization, The higher the level of performance improvement. T — Tools/Technology Despite their intangibility, many service products are knowledgebased a n d / o r are heavily dependent upon IT (Information Technology). Significant improvements in computers and software for storing and sharing information have increased capabilities for

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conceiving of new kinds of products as well as for managing development and delivery processes (Rayport & Sviokla, 1995). Tools that were once hard to change and difficult to distribute are now soft, flexible, and easily shared via electronic networks. IT is an enabler of continually updated processes and instant exchanges among cross-functional team members, regardless of distance. The mechanistic constraint of tools is thereby softened by the greater flexibility it permits in controls and increased frequency of communications. IT tools are hypothesized as having a positive impact on system integration because of the speed and scope of data distribution. The lower cost of data transmittal and greater reliability are hypothesized as improving performance. However, data is not information. IT is presumed to be more effective to the extent that it supports mature processes and cross-functional organization (Mitchell & Zmud, 1999). Hypothesis 4 The greater the implementation of Information Technology tools, the higher the level of performance improvement. System Integration System integration is an emergent property involving mutual adjustment among multiple functions and adaptive practices that have become institutionalized (Thompson, 1967). An example is provided by industrial systems in which ongoing, complementary exchanges, such as DFM (Design for Manufacturability) is practiced by product design engineers concomitant with plant initiatives in FMS (Flexible Manufacturing Systems). Such a system is more capable because reciprocal integration enables design and manufacturing engineers to be mutually responsive to the needs of one another than serial integration (Liker et al., 1999). Systems characterized by concurrency are integrated by a number of such reciprocities, particularly those that align resources so as to rapidly respond to customer needs.

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In terms of the framework presented herein, a concurrent system has a balance of deployment of the sets of practices in the model. Each of these constructs offers a particular kind of advantage, not only solo, but also in concert. For example, an industrial study found interaction effects among constructs defining concurrent practice (Hull et al., 1996). Synergy is lost if a single construct is overemphasized to the exclusion of others (Tidd, 1991; Tidd et al., 2001). Holistic thinking and robust knowledge enable concurrent systems to deliver customers products with a balanced portfolio of advantages, e.g. novelty and cost. Hypothesis 5 The more integrated the product development system, The higher the level of performance improvement. Service Product Development Function Concurrency as defined by the framework is a product-focused managerial initiative largely derived from industrial methods. For example, a major New York bank created its product development department after benchmarking with industrial companies. The lesson learned was that the people who manage products are seldom able to dedicate enough focus on development. This case is consistent with studies showing that financial service companies with a formal process for product development were usually more successful (Cooper et al., 1994; Cooper & Edgett, 1996). Hypothesis 6 The more formal the function of service product development, the greater the adoption of concurrency as defined by the framework, and the higher the level of performance improvement in product development and service delivery.

Concurrency versus Process-Focused Managerial

Interventions

The product focus of concurrency differentiates it from alternative interventions to improve service performance that are principally

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process focused. These include: (1) TQM (Total Quality Management), (2) ISO 9000 certification, and (3) BPR (Business Process Reengineering). Process approaches to performance improvement represent a viable alternative to product-focused strategies such as concurrency because service delivery is sometimes tantamount to the product itself. For example, a significant proportion of the value of a service product as perceived by the customer is likely to be affected by delivery processes when product generation and consumption are coterminous or extensive interpersonal exchanges are involved. TQM provides a foundation for concurrency, which is one reason it requires evaluation as an alternative Concurrency differentiates itself from TQM by focusing on product per se and the improvement of a particular benchmark, cycle time the cost benefits associated with its reduction throughout the value chain and the opportunities of early to market. By contrast, TQM applications are broadly scattered. Its more general applicability may be one reason for its value to performance in services because they are highly diverse and involve considerable value beyond the design of the product itself. For such reasons, TQM has been increasing deployed in the service sector (McCabe, 1985; Garvin, 1988; Reichheld & Sasser, 1990; Graessel & Zeider, 1993; Yearout, 1996). Most recently, such major financial corporations as GE capital have adopted the 6 Sigma approach to quality improvement. ISO 9000 has increasingly found application in the service sector (Yearout, 1996). In some instances, its standards include product development processes. Because concurrency as defined by the framework has a heavy emphasis on product development processes, there is potential overlap between the two initiatives. BPR achieved considerable popularity during the 1990s (Hall & Wade, 1993; Davenport, 1995). Mapping processes in general sometimes included product development processes in particular. To this extent, BPR and concurrency have potential overlap. However, the adoption of BPR was has sometimes focused on operations and their automation by computer technology without including the people in the organization as part of the process. By contrast,

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our framework is more broadly inclusive of strategic and organizational practices as well as system integration. Environmental

Context

Environmental dynamism is a contingency presumed to stimulate the adoption of concurrent practices and/or alternative initiatives for improving performance (Atuahene-Gima & Ko, 2001; Tidd, 2001; Tidd et al., 2001). Many services businesses have been increasingly affected by so-called "hyper-competition" (D'Aveni, 1994). Measures of environmental competitiveness and turbulence were found to be correlated with the adoption of concurrency as defined by the framework in the USA data. These dynamics included increased technological complexity, faster rates of service product introduction, higher customization, globalization and demand for new and better services.

6.3 Research Methods Background The feasibility of adapting industrial methods of concurrent engineering to service sector businesses was explored in the US using varied qualitative methods, informal and formal. Discussions were held for a year with a small group of executives from prominent service companies, e.g. American Express, Bell Atlantic, Chase Bank, etc. Two classes of MBA students were tasked with conducting 22 case studies that required adapting a 200-page industrial interview schedule into one that was appropriate for services. Many of the items had to be reconstructed at a more abstract, general level because of the intangibility and diversity of service products. Feedback on the initial attempts to make the principles of CE generic was obtained during two conferences/workshops on concurrency in services for 130 representatives from 75 companies in the New York during 1996-97. A parallel conference was held in London in 1997 for actual and prospective participants in the UK replication study.

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A user group of ten service enterprises was formed in 1997 to apply principles of concurrency. Each company shared their product development processes with others in the group and ongoing experiences in implementing concurrency. Five of these companies were new to the research program resulting in a total of 27 cases studied from 18 corporations. 2 These case studies helped ground the formulation of hypotheses and the interpretation of statistical results.

Methods US Sample. Participants in the survey were companies in the New York metropolitan area. Large companies were targeted because structural differentiation increases the need for integration provided by concurrent methods of product development. From a 1996 list of the 100 largest employers in Crain's New York Directory, 58 service companies were identified for mailing questionnaires to chief executives. Accounting/consulting, legal, manufacturing and universities were categories excluded from the list of 100. Smaller service businesses ranking in the top 25th percentile of their category, such as advertising, also received questionnaires to attempt to capture the diversity as well as size of enterprises within the region. Non-profits were included, but not pursued. Approximately 120 questionnaires were mailed to potential key informants in service companies with whom contact had been made by phone or in person. The preferred respondent was someone in the service product development function. Alternatives included persons in business development, TQM (Total Quality Management), BPR (Business Process Reengineering), or Productivity Improvement. Members of professional societies, the American Society of Quality

2

American Insurance Group, American Express (3), Bankers Trust (2), Bell Atlantic (2), Bank of NY, Chase-Manhattan (4), Chubb Insurance, Citibank, GE Capital, Gemini Consulting, Jewish Charities, Mercedes-Benz, Merrill Lynch, Milliken (2), Morgan Stanley, New York Times (2), Paine Webber, and TIAA-CREF Insurance.

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Control and the Association for Quality and Participation, were contacted for assistance in identifying appropriate respondents within target corporations. Respondents from 70 businesses in 51 corporations returned questionnaires. These included 11 of the 12 largest publicly held corporations. Lines of business surveyed within a single corporation did not overlap, such as private banking and syndicated banking, which operate as separate companies for all practical purposes. All but four employed more than 500 people. The distribution of categories of the US service sector sample is attached as Appendix A.l. Approximately 34% were in financial services or insurance. The next largest category was health care. Most major categories in the service sector were represented except advertising. Some were not represented, such as broadcasting. With such exceptions, survey respondents appear to be reasonably representative of large service companies in the New York area and its diversity, especially in financial services. UK sample. Respondents were drawn from a network of contacts of the School of Management at Imperial College. Appropriate respondents were reached via constituents of Imperial College, both students and company representatives serving on various committees. A conference/workshop was held at Imperial College in 1997 to garner respondents among these constituents. Although the sample is one of convenience, the network of Imperial College includes links with the bulk of service companies in the greater London area. In total, 100 questionnaires were mailed, and after a reminder 38 usable questionnaires were returned. The sample included 39% financial services or insurance. Most of the same kinds of business as in the USA were at least represented with the exception of construction and services rendered by divisions of industrial firms, such as financial credit groups. Although the size of the businesses represented is inexactly known, the average is lower than in the USA sample.

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Measures Framing the questions. The questionnaire focused on the development and delivery of service products. Respondents were asked to describe a typical service product to be used for the purposes of answering the questionnaire. An introduction to the questionnaire provided the following statements because the view of service as a product was not universally understood. Its purpose was to focus the attention of the respondent on the development of a typical product with which they were familiar. "Service products are something a customer pays for receiving even though it may be intangible (i.e. not a physical object. The service may be attached to a tangible product, e.g. warranty agreement, field repair, insurance, etc. However, a great many service products are intangible even though they may have a physical manifestation, e.g. bank check, an insurance policy, a charge card, etc. Often inter-personal experiences are critical to the delivery of service products, e.g. airline travel where the customer and employees are in relatively constant contact..." Factor analysis and scaling. Questionnaire items were factor analyzed (Varimax rotation) for the combined data. Scales based on these factors are shown in Appendix B. A factor loading is also shown for measures in both the US and UK sub-samples. All items within each of the five categories are summed. The Alpha coefficients are within acceptable ranges except for strategy in the UK data. A factor analysis of the scales within each of the five categories results in a single overall factor except in the instance of organization in the UK data. A unique analysis of the UK data is reported in a separate paper (Tidd & Hull, 2001). Dependent Variable. Twelve questions were asked about product features, quality, time, cost, and service delivery. All 12 were significantly inter-correlated and are scaled in a single index of total performance improvement, Alpha = .90. The 12 items are also analyzed in three subscales corresponding to loadings in three factors

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Frank M. Hull &• Joe Tidd

in the combined data: product innovation and quality, time and cost in development and delivery, and service delivery. The three sub-scales load in a single factor. Predictor Variables Strategy is a matter of intent. Questions were asked on a range of options, from a focus on minor changes to existing service products, to a strategy of developing novel service products. An intermediate strategy, termed RRR (Rapid, Re-iterative, Redevelopment) was measured using two questions on intended focus during the past five years: making major changes to existing service products and making rapid changes to existing products. Their inter-correlation was .58 in the combined data, Alpha =.75. Process is measured as the average of all nine items from the page of the questionnaire dedicated to this topic, Alpha = .86. These items are unified by the themes of in-process design controls and continuous process improvement, e.g. benchmarking, Quality Function Deployment, process mapping, etc. The first set of five questions is specific to product development processes, e.g. setting performance criteria for development projects. The second set of four questions dealt with general process improvement initiatives, e.g. mapping processes to reduce non-value added activities. The product specific and general questions loaded in separate factors. As their inter-correlation was .62 in the combined data, all nine items were averaged as a single scale. Deleting any item in the combined data or either sub-sample did not improve Alpha. Organization was measured as the average of 12 items from a page of the questionnaire dedicated to this topic, Alpha = .87. The items are unified by the theme cross-functional integration. The first set of eight questions dealt with the extent to which activities were organized as cross-functionally instead of within a hierarchy. The second set of four questions dealt with the extent of change in involving external organizations in the product development and delivery process, e.g. customers and suppliers. The first set of questions on cross-functional practices loaded in two factors, not one as in

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the US sub-sample. The three sub-scales load in a single factor that is more strongly correlated with the four performance measures than any one separately. Tools/Technologies was measured as the sum of nine items of the Information Technology page, Alpha = .72. These items were unified by the theme of the capabilities of computer information technology and its distribution internally and externally. The first seven items dealt with the use of software for decision support and information management in general, as well as on project management in particular, e.g. common software. The last two items dealt with EDI (Electronic Data Interchange) with external customers and suppliers. The first set of questions loaded in two factors, not one as in the US sub-sample, and the external questions in its own factor. The first factor dealt with computer capabilities in general the second on their distribution. While this is a conceptually valid distinction, the strength of the correlations among these two factors was high and they are combined in a single scale and the Alpha was not increased by deleting any item in the combined data or either sub-sample. The three sub-scales load in a single factor that is more strongly correlated with the four performance measures than any one separately. System Integration was measured as the sum of nine statements contrasting concurrent versus non-concurrent operations, Alpha = .87. These questions are unified by the theme of holistic thinking to balance and align competing interests along entire value chains over time. These statements were condensed from 13 graphs with accompanying text that were co-developed with participants in a CE user group to envision system maturity. The goal was to have a CE analog to the Carnegie Mellon system maturity model for software development. These questions were then correlated with performance outcomes in a follow-on survey of samples of employees in over 50 companies to validate their predictive capability (r = .51, Collins & Hull, 1999). Good practice index. All five constructs are summarized in an index for comparing concurrency with other change initiatives. The five constructs load in the same factor in the combined, US, and UK data.

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SPD (Service Product Development). A single item measures creation of a function for service product development, "Do you have a job title for persons who are responsible for differentiating your service products from those of competitors? If yes, please specify". The most common job title specified was Vice-President or Director of Product Development. Process focused Change Initiatives. Respondents were asked to rate the extent to which their company had adopted initiatives to improve the development and delivery of service products during the past five years. Options included: (1) TQM (Total Quality Management), (2) ISO 9000, and (3) BPR (Business Process Reengineering). Environment change is measured by adding two standardized indexes on the same six items. One summarizes the extent to which changes in six items have resulted in greater competitiveness. The other counts the absolute change, regardless of direction, or turbulence. Three Studies Study I explores the extent to which the framework transcends national boundaries by analyzing combined data from 70 USA with 38 UK service businesses. A dummy variable is used to assess the extent to which the USA and UK results are like and unlike. Study II assesses the extent to which practices as defined by model are like and unlike in the two nations. Study II replicates the methods used in the combined analysis for the US and UK sub-samples for concurrency as defined by the framework. Study III analyzes the context within which NPD methods are deployed in the two nations. The product-focused strategy is compared with alternative process-focused interventions such as: TQM (Total Quality Management), ISO 9000 certification, and BPR (Business Process Reengineering). The impact of each of these interventions on performance is compared in the context of environmental changes, such as increased technical complexity, globalization, etc. However, conclusions from Study III are somewhat

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speculative because some of these contextual measures were added late to the questionnaires and are unavailable for total samples. All three studies use the same framework (Strategy, Process, Organization, Tools, and System) to predict variation in performance improvements in service products development and delivery processes. Performance is analyzed as a total index and as three subscales: (1) innovation and quality, (2) time compression in development and cost reduction in development/delivery, signature indicators of CE effectiveness, and (3) service delivery. The first two factors roughly correspond to generic strategic alternatives, differentiation versus cost (Porter, 1980). The third factor is conceptually important because it distinguishes service delivery process from product features. Delivery processes often comprise a significant proportion of value added by services, especially if interpersonal exchanges are involved (Gronroos, 1990; Reichheld & Sasser, 1990; Zeithaml et «/., 1990; Lovelock, 1996; Storey & Easingwood, 1999).

Correlations and Descriptive Statistics The performance sub-scales are significantly inter-correlated as shown in the first rows of Table 1 for relationships in the combined data. The inter-correlations among the performance indicators are stronger in US than UK sub-sample. Product innovation and quality has an insignificant negative correlation with time and cost in the UK sub-sample. The constructs are significantly inter-correlated with one another in the combined data. The constructs are significantly inter-correlated with one another in the USA sub-sample. The correlation between process and organization is so strong in the combined and USA data that they are either added together or entered separately in multiple regression analyses. In the UK sub-sample, these intercorrelations are all positive and statistically significant except for two, strategy with organization and tools/technology. Each of the constructs is significantly correlated with all performance indices in the combined sample. However, the correlation between tools/technology and service performance is weak. In the

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US sub-sample, the constructs are significantly correlated with all performance indices. In the UK sub-sample, the correlations of constructs with performance are weaker, but statistically significant in all but two instances, tools/technology and system with time and cost. The correlations of the dummy variable representing UK cases are consistently negative as shown in Table 6.1. A comparison of means show that these differences are significant for product innovation and quality, process, tools/technology, system and the good practice index. This result suggests that concurrent practices as measured by the framework are less implemented in UK than the USA samples.

6.4 Study I: Combined Analysis Strategy, process, organization, and tools explain about 40% of the level of system integration for the combined sample as shown in the top row of Table 6.2. If process is entered without organization, its contribution to R 2 = .07 (Not shown in Table). If organization is entered without processes, its contribution to R 2 = .17. One reason organization is the stronger of the two may be that it is more akin to the notion of system in concept and measurement. In the top row of Table 6.3, variance SPOTS constructs explain in performance is shown as .47 for overall, .42 for innovation and quality, .31 for time and cost, and .30 for service delivery. These results are generally supportive of the SPOTS model as predictive of performance improvement in services. Strategy. A strategy of RRR has significant relationships with all indicators of performance improvement in the combined data except for service delivery. Given that questions were only asked on strategies of product development, but not on strategies of service delivery, this result is hardly surprising. These results support Hypothesis 1, for innovation and quality and time and cost, but not service delivery. Process summed with organization, has a strong main effect on three of four performance indicators, innovation and quality being

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Table 6.3 Regression of performance measures on spots. Top = Combined Sample ( N = 1 0 8 ) • Middle = US ( N = 7 0 ) • Bottom = UK (N=38) Performmance

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and quality being the exception. If organization is entered without process, it explains significant variance in the overall performance, R 2 = . 0 4 ; time and cost, R 2 = . 0 6 ; and service delivery, R 2 = . 0 3 . With the exception of product innovation and quality, these results support hypothesis 3.

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Tools/Technology. In the combined data, Tools/technology has a significant effect on innovation and quality and time and cost. This result provides support for hypothesis 4 except for service delivery. However, the coefficients are not as strong as for other constructs in the SPOTS model. System. In die combined sample, the system has at least significandy weak relationships witii three of four performance indicators, time and cost being the exception. Otherwise these results support hypothesis 5. In summary, a strategy of RRRis particularly predictive of product innovation and quality and time and cost. Process and organization are strongly predictive of time and cost and service delivery. Tools/ technology has significant relationships with product innovation and quality and time and cost. System integration had strong significant effects on all performance indicators except time and cost. Nation as a category had little impact in any of the regression models shown in Table 6.3 despite several significant differences in means shown in Table 6.1. This suggests that differential implementation of practices as measured by the constructs in the SPOTS model explains significant differences in the two samples instead of unique cultural factors.

6.5 Study II: Concurrency in the USA and U K Strategy, process, organization, and tools explain a little less than 40% of the level of system integration in both the USA and UK samples as shown in the second and third rows of Table 6.2 respectively. However, strategy is insignificant in both. Process and organization in combination have roughly similar effects in both nations. If each is entered separately, the effects for process are almost identical. The effects for organization are strong in both, but more so in the USA data. The relative effect of tools is appreciably greater in the UK. SPOTS constructs predict approximately half of the variance in the overall performance index in both nations. The regression coefficients with performance for the USA and UK samples are

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remarkably similar as shown in the second and third rows of Table 6.3. However, the significance levels are somewhat lower in the UK data because of the smaller sample size. Moreover, concurrency as measured by SPOTS explains somewhat less variance in the UK data. The greatest variance explained in performance in both nations is for innovation and quality, 47% and 29% respectively. Variance explained in time and cost is much greater in the USA data at 43%. In the UK data it is only 16%.3 Variance explained in service delivery is relatively low in the USA and UK data, which are 30 and 22% respectively. Strategy is the exception to parallel effects in the two nations. Strategy has a significant relationship with service delivery in the UK, but not the USA. Interestingly, strategy is the only one of the SPOTS constructs that is not significantly lower in the UK than the USA. Process summed with organization has roughly similar relationships with performance in both nations. If process is entered without organization in the USA data, it adds significant amounts of variance explained to the overall performance index, R 2 = . 0 3 , and service delivery, R2 = .02 (not shown in Tables). If process is entered without organization in the UK data, it adds significant amounts of variance explained to the overall performance index, R 2 = .06, time and cost, R 2 = .06, and service delivery R2 = .07. Although the pattern of relationships for process is roughly similar in the two nations, it is relatively stronger in the UK than USA data and includes an impact on time and cost. Organization entered without process in the USA data adds significant amounts of variance explained to the overall performance index, R2 = .04, time and cost, R2 = .02, and service delivery, R2 = .05 (not shown in Tables). If organization is entered without process in the UK data, it adds significant amounts of variance explained to the overall performance index, R 2 = . 0 3 , and time and cost, R2 = .11. Moreover, this increases Multiple R Square in the instance of time and cost to .22. Thus, organization is relatively more important in the UK for predicting time and cost. It is relatively

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Frank M. Hull & Joe Tidd

more important than process in the USA data for predicting overall performance and service delivery. Tools/Technology has only two weak relationships, one with product innovation and quality in the USA, and another in the UK with time and cost (mostly the former). However, the coefficient for tools in multiple regression analysis may be artificially strengthened somewhat because of its correlation with system (.63) which has an insignificant correlation with time and cost. System has significantiy positive effects in the US data with all performance indicators. In the UK data, the only strongly positive relationship of system integration is with product innovation and quality. By contrast, the relationship of system with time and cost is weakly negative partly because of its correlation with tools noted above.

6.6 Study III: Context of Concurrency Study III compares methods of performance improvement in the two nations. Concurrency is a product-focused initiative. Alternatives to concurrency that are relatively more process-focused include: TQM (Total Quality Management), ISO certification, and BPR (Business Process Reengineering). Each of these initiatives is significantly correlated with overall performance as shown in Table 6.1. Depicted in Fig. 6.2 are interrelationships among measures of the following concepts: environmental dynamism, the formalization of the product development function as a job, the deployment of concurrent methods as defined by SPOTS, and alternative processfocused methods of improving performance. Arrows depict statistically significant correlations in the USA data. Arrows in the bottom half depict relationships in the UK data. The average level of SPOTS deployment in the USA was higher than in the UK. One reason may be that USA enterprises were more likely to formalize the product function as a job. 44% of companies in the USA sub-sample of 27 for which this question was asked had a job title for product development. Only 7% (a single company) in the UK sub-sample of 15 had such a job title.

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Fig. 6.2 Context and performance: USA top, UK bottom.

In the USA data, companies with this job title were not only significantly more likely to deploy concurrency as measured by the SPOTS index (.52), but also to achieve high levels of performance overall (.44), innovation & quality (.40), time & cost (.47), and service delivery (.40) as shown in Table 6.1. Hypothesis 6 is supported only by the USA data. The formalization of the product development function appears to be pivotal in comparisons of the two nations. For example, controlling for job formalization of product development in analysis of the sub-sample of 42 companies for which this information is available reduces differences in practices between the two nations to insignificant levels. The deployment of concurrency in the USA data was correlated with all three process-based initiatives: TQM, ISO, and BPR. By contrast, SPOTS in the UK data had a strongly significant correlation with BPR, but not the others. This suggests that USA enterprises were more likely to invest simultaneously in both product and processbased initiatives. By contrast, UK firms were significantly more likely than their USA counterparts to invest in ISO.

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Frank M. Hull & Joe Tidd

Table 6.4 Regressio Top = Combined Sampl (N=38)

of performance measure :s on spots and TQM. ( N = 1 0 8 ) • Middle = US (N = 70) • Bottom = UK

Performmance

Innovation & Quality

Time & Cost

Service Delivery

SPOTS

58** .52** .65**

.63** .58** .62**

.57** .71** .28t

.38** .31** .47**

TQM

.21** .23** .13

.07 .11 .22

-.11 -.19t -.11

.33** .40** .15

ISO 9000

.08 .10 .10

.01 .07 -.21

.05 .04 .08

.10 .09 .22t

BPR

-.21** -.24** -.09

-.21** -.23** -.18

.09 .06 .21

-.26** -.21** -.13

Environment

.25** .24* .28*

.21** .32** .05

.12 .07 .14

.21** .20* .25t

Nation (UK = 2 , U S = 1 )

-.02

-.05

.09

-.05

R2 Unadjusted

.56 .55 .64

.49 .59 .41

.38 .48 .22

.38 .40 .44

R2 Adjusted

.54 .51 .58

.46 .56 .31

.34 .44 .09

.36 .35

21.6** 15.4** 11.2**

6.3** 18.6** 4 4**

10.2** 11.6** 1.8t

11.1** 8.6** 5.0**

F-Ratio

**p = . 01 *p = . 05 t = p. 10 (two-tailed significance)

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165

The impact of concurrency as measured by SPOTS compared with more process-focused initiatives is shown in multiple regression analysis in Table 6.4. Results of these comparisons should be considered as exploratory because SPOTS is measured as an index of many practices while only a single scale measures each of the process initiatives. The SPOTS index has main effects on all performance measures in all samples when entered simultaneously with each process alternatives controlling for environmental dynamism. TQM is positively related to overall performance and service delivery in the combined and USA samples. However, it has a weak negative relationship with time and cost in the USA sample. ISO has a weak positive effect in the UK sample for service delivery. BPR has negative effects in the total and USA samples for overall performance, innovation and quality, and service delivery. One may speculate that the implementations of BPR in the USA have been relatively more one technology focused than in the UK. Comparing correlations of BPR in the two nations is consistent with this speculation. BPR is relatively more correlated with tools in the USA, but more strongly correlated with strategy, process, organization, and system in the UK. This inference is also consistent with observations in the qualitative studies in the USA that adopters of BPR typically focused on computer technology without including the people in the organization as part of initiatives to improve processes (Hull, see Chapter 14). TQM, and to a lesser extent ISO 9000, complement concurrency as measured by SPOTS in improving service delivery. The gap concurrency has in explaining service delivery performance suggests that its product focus may limit its applicability to delivery processes. Environmental change is not significantly different in the two nations. In both it is significantly correlated with concurrency as measured by the SPOTS index. However, the relationship is slightly stronger in the USA than the UK, .35 vsersus .29. The correlation between environmental change and processfocused initiatives is insignificant in the USA data. By contrast, environmental change is strongly correlated with BPR in the UK

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Frank M. Hull &• Joe Tidd

data and more strongly so than for the SPOTS index, .52 versus .29 respectively. Response to environmental change appears to be relatively more process-focused than product-focused in the UK than in the USA data.

6.7 Summary The SPOTS model, derived from the Concurrent Engineering practices in industrial firms, appears to have applicability in the service sector in both nations. The model is relatively robust, yet parsimonious for explaining why some service sector companies develop product features faster, cheaper, and better than others. The paradigm of concurrency in product development appears to have been at least partially adopted by many service enterprises even though seldom is this specific term used. The promise of concurrency is that it achieves multiple kinds of performance advantage simultaneously. Concurrency measured as SPOTS predicts multiple kinds of product advantages (innovations, quality, time compression and cost) in the USA data and to a lesser extent in the UK data. However, SPOTS explains much less variance for service delivery in both nations, which suggests that a greater focus on processes is needed. Despite strong parallels, the UK data differ from the USA in several ways. These contrasts are summarized below: 1. A formal job function for product developers is far less common in the UK than USA and is related to the adoptions of concurrent practices. 2. Concurrency as measured by SPOTS constructs less deployed in the UK except for strategy. 3. All five of the SPOTS constructs load in a single factor in both nations. However, the positive correlation of the strategy with organization and tools is statistically insignificant in the UK data. 4. In the UK, concurrent practices were deployed in a greater variety of patterns than in the USA as indicated by a larger

The Organization of New Service Development

5. 6. 7. 8.

9. 10.

11.

12. 13.

167

number of factors, especially for organization. This suggests that forms of organization are less unified by the concurrency paradigm in the UK than the USA. The strategy of RRR has a low Alpha coefficient (.59) in the UK. The correlation between process and organization is lower in the UK. The effects of process are generally similar in both regions, but relatively stronger in the UK in terms of variance explained. The effects of organization on overall performance are slightly weaker in the UK. However, it is stronger for time & cost than in the USA. Tools/technology relationships with performance are weaker in the UK. System is positively associated with all performance indicators in the USA. In the UK all relationships are similar except that its beta with time and cost is negative. Change initiatives in response to environmental dynamism in the UK are relatively less product than process focused, e.g. TQM and ISO. SPOTS constructs explain more variance in performance indictors in the USA than the UK. Correlations among performance measures are weaker in the UK and load in four instead of two factors as in the USA, e.g. insignificantly negative correlation of product innovation and quality with time and cost. This suggests that concurrency is delivering less of its promise of simultaneously achieving multiple kinds of performance advantage.

6.7 Discussion and Conclusion Given that environmental dynamism in the two nations does not differ statistically, one may speculate on reasons for somewhat different responses to this stimulus for change. One possibility is that USA service companies are more focused on time compression, a kind of national obsession. This option is consistent with the weak

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Frank M. Hull & Joe Tidd

relationships of time compression with other variables in the UK data. A related possibility is that UK service firms lagged in their initial adoption of concurrency, but are catching up. This option is consistent with the fact that environmental dynamism was significantly correlated with the adoption of a strategy of RRR in the UK and that this is the only one of the SPOTS construct that was not significantly below the USA average. Adopting a concurrent focus might be a harbinger of more systemic changes in ways of doing business because strategy is quicker and easier to change than systems. An alternative line of speculation is that UK service companies pursue niche strategies and have adopted multiple kinds of systems to compete effectively in them (Tidd, 1993). Consistent with this line of reasoning is the many more factors for practices and performances were observed in the UK data. For this reason, a follow-on analysis is reported in a separate chapter that builds the analysis from a uniquely UK perspective without imposing the concurrency paradigm as defined by SPOTS onto the data (Tidd & Hull, Chapter 1). Limitations of the study include difficulty in matching the two national samples in terms of type of service and size of establishment. Although the nature of the service rendered was not found to affect results in the USA data, the possibility remains that differences in business type between the two nations is a factor. As size is a strong predictor of structuring, difference might partly account for lesser coalescence of formal product development practices in the UK data. A single respondent reported answers about each enterprise. Respondents in the two nations could have interpreted the same questions differently. Measures of process alternatives were based on single items in comparison with the SPOTS index. Some measures were available for only portions of the samples. Research opportunities including making additions to product development paradigms measures that better predict delivery processes in services. For example, a subset of Concurrent Engineering practices includes DFX (Design for manufacturability, service, etc.). This set of practices could be enlarged to include service delivery. Although

The Organization of New Service Development

169

human factors play a relatively greater role in services than goods industries, both include some mix of intangibility and things. A more robust model therefore offers an opportunity for adding value both to theoretical understanding of systems and practical applications to a wider scope of activities within a greater variety of systems.

Appendix A: Types of companies in samples. US

UK

Financial Services Retail banking Credit Card Lending Private Banking 1 Investment Services

18 5 3 2

13 1

7

10

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8

2

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4

5

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1

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W £ °= ^ ON 00 so u bO G u U • G -3 . 3 Ui x; -G U S O •a'S.u3 2 S .a » e a1 G s 2 " | • § £ oo 5 o 3 £* K <s •s •S< S a Si H & Electro ic da1 Electro ic dal 8 OJ ti * 43 ri 0 0 l-S ** *** *5 >' on-li ldin 174 U X pq a '•B o a, i~H Co Frank M. Hull & Joe Tidd ~0 ^ 00 <© -Si ^ N M * O H N Chapter 7 Effects of Innovation in Standardised, Customised and Bespoke Services: Evidence from Germany Christiane Hipp, Bruce S. Tether and Ian Miles 7.1 Introduction It is well known that in the advanced economies of the OECD, services account for roughly two-thirds of value added and employment, a share tJiat is growing, whereas that of manufacturing is in decline. In the European Union in 1995, "market services" accounted for 45% of employment and 50% of EU GDP, whilst "non-market services" accounted for a further 21% of employment and 14% of EU GDP (Eurostat, 1998). Even in Germany, a country famous for its manufactured products, services account for a significantly larger share of GDP (68% — OECD, 1998) and employment (59% — OECD, 1998) than manufacturing (31% and 37.5% respectively — OECD, 1998). During the past years it has at least been increasingly attempted to push the service sector and its peculiarities into the centre of economic-political research. The roles of innovation, technology and know-how in the context of economic development and technological change are here of growing interest. This chapter, too, examines the wide-ranging topic of services from the innovation research point of view. This raises both simple and complex questions. How does innovation in services relate to the received understanding of innovation in manufacturing? What is the relationship between innovation and economic performance in services? 175 176 Christiane Hipp, Bruce S. Tether & Ian Miles Because services are not usually producers of new or technically improved tangible artefacts, analysts have had difficulties applying the received understanding of innovation to services1 and much of the literature on innovation in services is concerned with services as adopters and users of new technologies, particularly information communication technologies, rather than as creative innovators in their own right. In recent years, however, considerable efforts have made through the use of case studies and, more rarely, large-scale surveys to gain a handle on innovation in services. This chapter reports results based on one of the first large-scale surveys; the 1995 survey of innovation in German commercial service companies.2 This survey was carried out, on behalf of the German Ministry for Research and Technology, by the Centre for European Economic Research (ZEW), the Fraunhofer Institute for Systems and Innovation Research (FhG-ISI), and the Institute for Applied Social Research (INFAS). The survey focused on the innovative activities of the firms, and was based on the approach to surveying innovation suggested by the OECD's Oslo Manual (OECD, 1996). The survey also served as a pilot exercise for the second European Community Innovation Surveys (CIS II), which were carried out in 1997. In this chapter we consider the relationship between innovation and firm-size, sector of activity, and the "standardisation-particularisation" of the output of the firms.3 We begin with a short review of the literature concerning innovation in services. We also briefly review the relationships between firm size, sector of activity and the "standardisation-particularisation" X A number of exceptional services do produce tangible artefacts. Other similar surveys, have been carried out, including several as part of the Community Innovation Survey, in Denmark (Sundbo, 2000), Finland (Marklund, 2000), Italy (Evangelista & Savona, 1998; Sirilli & Evangelista, 1998), the Netherlands (Brouwer & Kleinknecht, 1995), and Switzerland (Arvanitis et al., 1998). 3 This chapter builds on another paper (Tether et al., 2000) in which we discuss at length these background characteristics and in particular the "standardisationparticularisation" classification of the firms by their service outputs which we employ in this chapter. Interested readers are referred to that work. 2 Effects of Innovation 177 of the firms' outputs. 4 In this chapter, the analysis focuses on the relationship between "standardisation-particulation" characteristics and the firms' innovative activity. We also consider the reported effects of the innovations. As an economic phenomenon, innovation is primarily of interest because of its effects, and we are able to consider the effects of the innovations in relation to their impacts upon the firms that produced them, upon the services provided, and upon the service users. Finally, some conclusions are provided. 7.2 Innovation in Services Gallouj and Weinstein (1997) assert that the analysis of innovation in services is difficult because (1) "innovation theory has been developed essentially on the basis of analysis of technological innovation in manufacturing activities" (p. 537 — emphasis in original) and (2) the "fuzzy" nature of service outputs. Meanwhile, Sirilli and Evangelista (1998) summarise the peculiarities of services commonly recalled in the literature as: • Close interaction between production and consumption — or the coterminality of service production and consumption. This is thought to provide difficulties in distinguishing between product and process innovation. Gallouj and Weinstein (1997) concur, pointing out that in services the term "product" frequently denotes a process, such as a service package, a set of procedures or protocols, or an "act". However, in an Italian empirical study, Sirilli and Evangelista (1998) found only a quarter of the innovating firms in their sample were unable to distinguish between product and process/delivery innovations. • High information content and the intangible nature of the service output. Gallouj and Weinstein point out that whilst goods usually have autonomous physical existence, exterior to both their producers and consumers or users, this is, generally speaking, not true of 4 These relationships, depicted are examined in detail in Tether et «/., (2000). 178 Christiane Hipp, Bruce S. Tether & Ian Miles services (Gallouj & Weinstein, 1997, p. 540). There is therefore a much hazier relationship between what is produced, and the process of production, in services than in manufacturing. This "intangible" nature of services has led researchers to focus on information technologies in the organization of production and innovation in services, but it should also encourage consideration of the ways in which service outputs are customised or adapted to the needs of particular users. • The key role of human resources in the provision of services. Service production, and service innovation, is usually thought to depend heavily on the knowledge and skills of the people involved in the processes of production and innovation. As Gallouj and Weinstein (1997, p. 543) argue: "One of the major features of service activities is undoubtedly the fact that the 'technologies' involved usually take the form of knowledge and skills embodied in individuals (or teams) and are implemented directly when each transaction occurs, rather than in physical plant or equipment". The emphasis on human capital in the creation of services induced some studies look at this aspect more closely. They found that innovation activities in the service sector are accompanied by investment in additional education and training (Licht etal., 1995). Based on that finding, the definition of innovation was expanded and separated from purely technical innovations; the general importance of organizational and non-technological elements in the innovation process contributed to this change, too (Hipp et al., 1996, Hauknes 1998). Other forms of knowledge like experience or extensive customer contact now become relevant for describing the efficiency of a service company. However, many services, such as transport and communications, banking and insurance and (large scale) retailing — principally what Soete and Miozzo (1989) call "production-intensive, scale-intensive and network sectors" — depend just as heavily on physical plant and equipment technologies as do manufacturers. • The critical role of organizational factors in firms' performance. This again relates to the intangible nature of most services, as well as to the question of whether "product" innovations can Effects of Innovation 179 be distinguished from process innovations in services. Arguably, services achieve short-term gains through "product" innovations which are related to improving the relationship between what is provided and user needs. These "product" innovations are related to "front-office" operations. However, innovation in "back-office" activities, which relates primarily to the process of service production, may be more important for the long-term efficiency of the service provider. Here, the terms "front" and "back office" have both figurative as well as literal meanings. • The role of traditional R&D. A lot of innovations in the service sector use technological developments very often merely as a means of creating new and improving existing products and processes rather than offering technological progress in the narrow sense. Of at least equal importance are the methods of research in selling and marketing close to the market and the customer. Accordingly, the organization of the innovation process concentrates not just on the R&D departments known from industrial companies but covers a number of functional units of the company (Preissl 1997). This is further reflected in the low research intensity of service companies from the traditional R&D statistics' point of view. The analysis presented in this chapter will address some of these issues. In particular, the analysis will assess the extent to which service (product) innovation can be distinguished from process innovation — and the extent to which the effects of these types of innovation are distinct. It will also assess the extent to which there is a close understanding of the impact of innovations on the service users. This chapter does not assess the role of human capital in the provision of services, or in innovation in services, and nor will it examine directly the role of organizational forms as well as the role of R&D in the innovation process.5 differences in the structure of employment by qualifications, a proxy for human capital, have been examined in another research paper (Tether et al., 2000) which we build upon for this analysis. 180 Christiane Hipp, Bruce S. Tether & Ian Miles 7.3 Analysis of the Evidence of Innovation in German Services The data set used in this chapter is the response to the 1995 survey of innovation in German services companies, which provides empirical evidence on the incidence of innovation in commercial service firms. The sectors included in the survey were: wholesaling and retailing (here referred to as "Trade services"), transport and communications, banking and insurance, other financial services, scientific and technical services, software, other business services (such as accountants, advertising agencies and consultants) and a miscellaneous collection of "other" business related services that includes cleaning and waste disposal, publishing, and rental and real estate services. Amongst the service sectors excluded from the survey were public administration, education, health care, hotels and catering, personal services, and other non-business oriented services. More than 11,000 service companies were sent the questionnaire, of which 2900 responded (see Licht et al., 1997 for a detailed discussion of the sample). The overall response rate of 26% is reasonable for a voluntary postal questionnaire survey to companies in Germany. The response was slighdy higher than average amongst banking and insurance, technical services and software firms (at around 30%), and below average amongst trade services firms (24%). Participation also increased (slightly) with firm size — thus there is some bias towards larger firms — which tend to be more likely to innovate (see below), and firms operating in the more innovative sectors (see below). For the analyses in this chapter, we treat the data-set as a simple sample. Service, Process and Organizational Innovation We begin with an analysis of the patterns of innovation amongst the responding firms, which were asked: (i) Whether they had introduced any new or significantly improved services between 1993 and 1995 (hereafter referred to as "Service Innovation''') Effects of Innovation 181 (ii) Whether they had introduced, between 1993 and 1995, any new or significantly improved methods of service production (hereafter — "Process Innovation''') (iii) Whether they had introduced any major improvements to their organizational structure or intra-company procedures between 1993 and 1995 (hereafter — "Organizational Innovation'''). Only a quarter of the firms did not claim to have introduced any of these types of innovation. Thus, roughly three-quarters declared themselves to be innovators, a remarkably high proportion. As mentioned above, the response to the survey was slightly biased in favor of larger firms, and firms operating in the more innovative sectors. Hence, if the survey did not have these biases the proportion of innovators would have been slightly less.6 Surveys of innovative activity in service firms in other countries have tended to find between a quarter and a third of the responding firms declare themselves to be innovators (Australia — Gault & Pattinson, 1995; Italy — Sirilli & Evangelista, 1998, Evangelista & Savona, 1998; the Netherlands — Brouwer & Kleinknecht, 1995). Although national differences and differences in timing may have played a role, one of the reasons for the considerably higher proportion of German firms identifying themselves as innovators is that most of the surveys undertaken previously in other countries asked firms whether they had introduced "technological innovations", whereas the German survey dropped the term "technological". 7 A broader definition of innovation was therefore permitted in this 6 A non-response analysis suggested there was not a strong bias in favour of innovating firms amongst the firms which responded to the survey, although there was some evidence that, particularly amongst the smaller firms, process innovators were underrepresented, whereas service innovators may be over-represented. 7 The Dutch study also excluded the term "technological" from the definition of innovation (Brouwer and Kleinknecht, 1995). In the German case, this was done partially because the term "technological innovation" is interpreted more narrowly by German speakers than the definition formulated in the Oslo Manual (Licht et al., 1997) 182 Christiane Hipp, Bruce S. Tether & Ian Miles Service Innovation Non-Innovators 28% Service Innovators 61% Process Innovators 49% Organisational Innovators 51.5% / / / Only Process 3% Process Innovation Process & Organisational 3% Only \ Organisational^ 5.5% \ Organisational Innovation Fig. 7.1 Firms' self classification of their innovative activity. survey, reinforced by the inclusion of organizational innovation, which the other surveys did not consider, although only 5% of the sample claimed to have introduced only organizational innovations (see Fig. 7.1). Innovation and Standardisation-Particularisation In this section, we examine the relationship between innovation and the extent to which the firms adapted their outputs to suit particular users' needs. We do this through a survey question which asked about the "standardisation" or "particularisation" of the firms' services, by asking them to divide their sales in 1994 into three components, according to whether the sales were earned from: (1) "standard services" (i.e. "those without customer specific changes"); (2) "partially customised services"; and, (3) "bespoke (one-off) services". Of the 2,900 firms which responded to the survey, 2,151 answered this question (74%). Effects of Innovation 183 The proportion of firms indicating all of their sales were due to "standardised services" (i.e. their services involved no customerspecific changes), was substantial, at 24%. A further 42% declared that at least two-thirds (but less than all) of their sales were due to "standardised" services, and only 17% stated less than one third of their sales were due to "standardised" services. In contrast, the proportion which declared all of their sales were due to "partially customised services" was small, at 4%, whilst not a single firm declared all of its sales were due to "bespoke services". Moreover, only a small proportion of the firms (17%) indicated a high proportion (i.e. more than two-thirds) of their sales were due to "bespoke" and/or "partially customised" services. This is remarkable, since the emphasis in the literature on services' close relations to their clients might lead to a quite different distribution being anticipated, with large proportions of the firms indicting that all (or the larger part) of their sales were due to "bespoke" or "partially customised" services. Instead, the firms tended to emphasise the predominance of standardised services as their main source of income. 8 For further analysis, we classified the firms into four groups based on their responses: (i) " Wholly Standardised" (WS) service providers — where the 535 firms that declared all of their sales were due to "standardised services". (ii) "Largely Standardised'''' (LS) service providers — where the 900 firms which declared at least two thirds, but less than all, of their sales were due to standardised services. (iii) "Bespoke'" (BS) service providers — where the 159 firms that declared more than a third of their sales were due to "bespoke services". (iv) "Customised'' (CU) service providers — where the 567 remaining firms, mainly those that earned a relatively large proportion of their income from "partially customised" services. 8 Tether ct al. (2000) examined this result in more detail, discussing the problems of interpretation associated with die results of this question. In particular, the difference between partially customised and bespoke services can be problematic. 184 Christiane Hipp, Bruce S. Tether & Ian Miles Table 7.1 Firm size, sector and standardisation-particularisation. Customised Standardised Wholly Largely Categorisation 24% 42% 27% Size and Sector 1 - 9 employees 1 0 - 4 9 employees 27% 24% 30%T 28% 50-249 employees 22% 34%U 39%l 48%TT 250+ employees Other Services Trade 27% 31%TT 29%TT 26% 22% 46%T 42% 44% 18%U 14%U 11%U 6%U 24% 45% 22%U 35%l 33%44 42% Transport & Comm. Banking & Insurance Other Business Services Other Financial Services Technical Services Software All Firms 44% 49%T 24%i 24% 24% 21%U 27% 23% 28% 46%TT 28% 44%TT 26% Bespoke N. 7% 2,150 io%T 8% 387 747 7% 5%U 4%U 5%i 2%i 4%i 10% 18%TT 27%TT 18%TT 7% 588 423 482 602 314 189 204 100 149 110 2,150 The arrow symbols indicate significant differences between the observed proportions and those "expected" if there were no difference between size classes and sectors in the distribution of firms by "standardisation-particularisation" classification. Upwards arrows (T) indicate the observed proportion was significantly greater than that "expected", whilst downward arrows (si) indicate the observed proportion was significantly smaller than expected. Single arrows indicate the significance was between 10 and 5%, and double arrows indicate the significance was between 0% and 5%. The distribution of firms according to this categorisation as well as the relationship between this classification and size and sector of the firms on the data set is shown in Table 7.1. The relationship between innovation and standardisationpar ticularisation is not simple. While it would tempting to describe any firm which declared that less than all of its output to be standardised as an innovator, there is an important distinction between variety of output and innovation. For example, a garage which repairs Effects of Innovation 185 Table 7.2 Innovation, "standardisation-particularisation", firm size, and sector of activity. Process Innovators Organizational Innovators Innovators of Any Type Service Innovators Wholly Standardised Largely Standardised Customised Bespoke 56%* 79% 77%i 80% 42%* 68% 69% 67% 34%* 52% 54% 61%t 39%* 58% 55% 54% 1-9 employees 10-49 employees 50-249 employees 250+ employees 58% 70% 80% 89% 46% 58% 66% 76% 32% 45% 54% 68% 31% 47% 58% 74% Trade Transport & Comm. Banking & Insurance Other Fin. Services Software Technical Services Other Bus. Services Other Services 66%U 72% 53^^^^l' 60% 41%sU 50% 47%U 52% 89%TT 83%TT 67%TT 66%TT 75% 64% 49% 88%TT 82%TT 60%TT 75% 78%T 71% 58% 63% 58%4, 54% 53% 46%l 51% 58% 56% 56% 51% All Firms 74% 61% 49% 52% Notes: (i) * t-tests on proportions revealed the "Wholly Standardised" firms were significantly less likely to innovate (at the 5% level), generally and for each type, than the sample as a whole. With the Wholly Standardised firms removed, no significant differences (at 5% or higher) were found in the propensity to innovate, generally or of any type, between the other three firm types, (ii) Both classifications found the propensity to innovate (in general and for each type) increased significantly with firm size, (iii) For the "standardised-particularisation" classifications and for the sectors the arrow symbols indicate significant differences between the observed proportions of innovators and those "expected" if there were no differences between the firms in their propensity to innovate. Upward arrows indicate firms of particular types were more likely to innovate; downward arrows that they were less likely to innovate. Single arrows indicate this significance was at the 5%-10% level, double arrows that it was at 5% or above. 186 Christicme Hipp, Bruce S. Tether & Ian Miles cars provides, by definition, a customised (or bespoke) service, and therefore a variety of service activities. But such variety would not normally be described as innovation. Innovation requires more than the provision of variety, particularly if that variety is routine. Firms that customise their outputs, or even those that provide bespoke outputs, are not necessarily innovative. The "standardisation-particularisation" classification did, however, relate empirically to the firms' propensities to innovate (see Table 7.2). In particular, the "Wholly Standardised" service providers were significantly less likely to innovate, both in general and according to each of the innovation types, than firms in the sample as a whole. No other significant differences were found between the three other groups of firms in either their general propensities to innovate, or their propensities to introduce each of the individual types of innovation. Understanding the innovation dynamics of Wholly Standardised service providers poses problems, however. Are these firms wholly standardised because they are unimaginative and moribund, or are they successful service firms who have hit upon a successful formula that they are now exploiting (e.g. McDonalds)? One explanation for the lower propensity of Wholly Standardised firms to innovate might be that their service life cycles are longer, reducing the frequency of replacement and thus service innovation. 9 And even if Wholly Standardised firms innovate less frequently than those in the other groups, their innovations may be, on average, of greater commercial significance, affecting a wider range of clients. Unfortunately, the available data provide limited purchase on such matters. Innovation, Firm-Size and Sector of Activity Firm size has repeatedly been related to levels of innovation in surveys of manufacturing firms: does the same apply to services? Generally, 9 Whilst this might explain the lower incidence of service innovation amongst these firms, it does not explain the lower incidence of process and organizational innovation amongst these firms, unless the "production platform" of skills, equipment and routines used to produce the services is also more stable amongst these firms. Effects of Innovation 187 the propensity to innovate among firms in the survey increased with firm size. This increasing propensity to innovate was also apparent for all three individual types of innovation. Most probably this relationship is simply a reflection of the fact that larger firms tend to have more lines of activity and therefore more areas in which to innovate. The propensity to innovate also varied across sectors of activity. Specifically, Trade firms were less likely to innovate, whilst Banking and Insurance firms were more likely to innovate. Software firms were more likely to introduce service product and process innovations, but not organizational innovations. These are results of univariate analysis however, and while they provide a useful first mapping of innovation dynamics across the economy, their interpretation is not straightforward due to the interaction of size, sector and the "standardisation-particularisation" of the service outputs, which affects the patterns of innovation in services. Innovation and Size, Sector and a Standardisation-Particularisationv Multivariate analysis is required to explore the relationship between innovation and the firms' characteristics such as size, sector and "standardisation-particularisation". Below we present the results of logistic regressions that explore interactions between size, sector and "standardisation-particularisation" in "explaining" the discovered patterns of innovation. (The full models are presented in an appendix to this chapter.) The results of the analysis are summarised in Table 7.3. At the top is the estimated relationship across all the surveyed firms between firm size and the likelihood of innovation, both in general and for each specific type of innovation considered. We then considered the estimated likelihood that specific types of firms were innovators, and compared these with the general relationship amongst all the firms. If a specific type of firm was found to be more likely to innovate, this is indicated in the table with a "+" sign. If a specific type of firms was found to be less 188 Christiane Hipp, Bruce S. Tether & Ian Miles Table 7.3 Estimated relationships between the propensity to innovate, firm size, sector of activity and "standardisation-particularisation". Any Type of Innovation All Firms — Firms 63% 72% 80% 85% 61% 66% 71% 75% 38% 45% 52% 59% 44% 53% 61% 69% T&C WS T&C LS T8cC CU and BS _ 0 0 0 _ 0 0 0 - _ _ 0 0 0 - 0 0 0 0 30 100 300 10 30 Organizational Innovation 10 WS LS CU BS 100 300 10 Process Innovation Firm Size — Employees Trade Trade Trade Trade 30 Service Innovation 100 300 10 30 100 300 _ - 0 0 0 0 0 0 - 0 0 0 0 - + + + + - 0 0 0 0 0 0 0 0 0 0 0 0 + + + + 0 + + - 0 0 0 0 + + _ 0 0 0 + + + + + _ - 0 0 0 0 + + B&I WS B&I LS B&I CU and BS + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + + 0 0 0 + + + + + + + + + OFS OFS and OFS WS LS CU BS + + + + + + + + 0 + + + + + + + + 0 0 0 0 0 0 0 0 + + + + 0 - + + + 0 0 0 0 Software WS and LS Software CU and BS + + + + + + + + + 0 0 0 0 + + + + + + + + + + + + Technical W S 0 0 0 0 0 Technical LS + 0 and CU Technical B S + + 0 00 0 0 0 0 0 0 0 0 OBS WS OBS LS OBS CU and BS Other WS Other CU and BS + + + _ 0 _ 0 + + + + + + _ 0 0 0 _ 0 0 0 0 0 0 00 0 0 0 0 _ 0 _ 0 0 - 0 - + + 0 0 - + - _ 0 - 0 0 - - + + + 0 0 0 0 0 0 0 _ _ _ 0 0 0 + 0 0 0 0 0 0 0 0 0 0 Notes: "All Firms" provides the estimated probabilities, for each classification, that firms with 10, 30, 100 and 300 employees, regardless of sector or "standardisation-particularisation", were innovators. The lower part of the table summarises whether firms of particular "sector-standardisation-particularisation" classifications (where WS = Wholly Standardised: LS - Largely Standardised; CU = Customised; BS = Bespoke) were more, less, or equally likely to be innovators than firms in the sample as a whole. Here, "+" indicates the firms of the particular type were more likely to be innovators than firms in the sample as a whole, " - " indicates they were less likely to be innovators, and " 0 " indicates there was litde difference between these firms and the sample as a whole. Effects of Innovation 189 likely to innovate, this is indicated by a " - " sign. If a firm of a specific type was close to the average across the whole sample in terms of its propensity to innovate, this is indicated by the " 0 " symbol.10 Turning to the results, these indicate a complex inter-relationship between firm size, sector of activity, and the extent to which the sales of the firms are derived from standardised, partially customised or bespoke services, and the influence of these on the pattern of innovative activities. Some of the main conclusions are that: • The Wholly Standardised Trade, Transport and Communications, Technical Service and Other Business Service firms are less likely to innovate (in general, and in service and process innovation in particular) than the average. • Other Trade, Transport and Communications and the "Other" service firms are close to the average, although there is some evidence that the Customised and Bespoke service providing Transport and Communications firms are more likely to innovate, particularly in process innovation. • Banking and Insurance and Software firms (including the Wholly Standardised firms in these sectors) are more likely to innovate. This holds true in general, and for service and process innovation in particular. Banking and Insurance firms also seem more likely to introduce organizational innovations than other firms. • Technical Services appear unusual. Apart from the sector's Wholly Standardised firms, the smaller Technical Service firms are more likely to innovate than similarly sized firms in other sectors, but there is less evidence that large Technical Service firms are more likely to innovate than similarly sized firms in other sectors. Thus, the propensity to innovate in Technical Services appears to have a flatter profile across the size distribution of firms than in the other service sectors examined. 10 Note also that when two types of service providers within the same sector provided exacdy the same summary conclusions their results have been combined in the table (for example, Wholly and Largely Standardised service providers in the Software sector). 190 Christiane Hipp, Bruce S. Tether & Ian Miles • Other Business Service firms and Other Financial Service firms, particularly after excluding the Wholly Standardised firms, were more likely to innovate, controlling for firm size, than service firms in general. Multiple innovators Multiple innovators — firms that claimed to have introduced all three types of innovation — are especially interesting, because (as we will show shortly) they tend to be particularly aggressive with respect to sales growth, and because they appear to have the most wide ranging understanding of the effects of their innovations. Consequently, we examine the distribution of this sub-set of firms, and compare it with the distribution of all the firms in the sample. Overall, just over a third of the firms in the sample claimed to have introduced all three types of innovation. Table 7.4 shows, for each of the size categories of firms, the proportion of such firms, cross-tabulated against their "standardisation-particularisation" classification and against their sector of activity. Cells with significantly smaller or larger proportions than the average are identified with upward and downward arrows respectively. This shows that, unsurprisingly, the multiple innovators were more likely to be large firms, and were less likely to be micro or small firms. They were also more likely to be Largely Standardised or Customised service providers, and were less likely to be Wholly Standardised service providers. They were also more likely to be in Banking and Insurance, and to some extent Software, but were less likely to be Trade firms. However, these multiple innovators were widely diffused within the sample of firms. So whilst they were more or less likely to be of a certain size, of a certain "standardisation-particularisation" category, or in a certain sector, it is important to appreciate that these multiple innovators were found amongst service providers of all "standardisation-particularisation" types, were of all sizes, and were active in all sectors. Effects of Innovation 191 Table 7.4 Distribution of firms which claimed to have introduced all three types of innovation. 1-9 employees Wholly Standardised 6%44 10-49 employees 50-249 employees 13%44 27%i 250+ All firms employees 46%TT 22%44 Largely Standardised 21%44 35% 39% 54%TT 38%TT Customised 22%44 35% 44%TT 69%TT 41%TT Bespoke 30% 27% 56%H 45% Trade 11% 44 25%44 40% 47%TT 30%44 Transport & Comm. 17%44 19%44 42% 72%TT 37% 39% 50%TT 69%TT 50%TT Banking & Insurance 8% x x x 37% 80% x 35% 67% x 44%T x 34% Other Fin. Services 23%4, 50% x Software 20% x 42% 63% x Technical Services 42% x 33% 31% 29% Other Business Services 19% x 36% 25% 43% 32% Other Services 16%44 25/0-^4/ 35% 52%TT 32% All Firms 18%44 29%44 39%T 55%TT 34% 41% The arrow symbols indicate significant differences between the observed proportions of multiple innovators and those "expected" if these were evenly distributed across the sample. Upward arrows indicate firms of the particular type were more likely to have introduced all three types of innovation, whilst downward arrows indicate they were less likely to have introduced all three types of innovation. Single arrows indicate this significance was at the 5%-10% level, double arrows that it was at 5% or above. "X" indicates the number of observations was not adequate for the statistical test. 7.4 The Effects of the Innovations In this section, we examine the effects of the innovations. As economic phenomena, innovations are primarily interesting because of their effects. It is therefore important to establish whether the innovations identified by the survey were of economic significance, 192 Christiane Hipp, Bruce S. Tether & Ian Miles at least at the level of the firms which introduced them. The many recent surveys of innovation (in b o t h services and manufacturing) have focused on the incidence of innovation, but have been much less successful in providing an understanding of the commercial/economic consequences of innovation. In this chapter, we examine the effects of innovations first by looking at the relationship between innovation and sales growth, then by looking at a broader set of effects identified through the questionnaire. Innovation and Sales Growth The relationship between innovation and the growth of firms is not entirely straightforward, especially because here we only assess growth in terms of sales, rather than in terms of value added or employment. Furthermore, whilst the introduction of a service innovation might generally be associated with sales growth, or expectations of future sales growth, this conclusion is not so clear for process or organizational innovations, which might be introduced to improve profitability in the face of static or declining sales. The picture is complicated further by the fact that most firms introduced more than one type of innovation, so it is difficult to isolate the effects of service, process and organizational innovations, given that the measures of firm performance are not tied to specific innovations. Just over half the firms declared their sales had increased in the period before the survey (1993-1995); 22% declared no change in their sales over that period, and 23% reported a decline in sales. (This was also the period over which the firms were asked whether they had introduced any innovations.) In relation to expected sales in the period after the survey (1996-1998), the proportions were remarkably similar. Just over half the firms expected their sales to increase, a quarter expected them to remain unchanged, and 17% anticipated a decline in sales. Apart from the substantial cluster of firms (39%) which had grown and which expected to grow in the Effects of Innovation 193 future, there was not a strong relationship between past experience and future expectations of sales growth/decline. 11 In relation to innovation, innovating firms were both more likely to have increased their sales, and to expect future sales growth, than non-innovators. 12 However, as Table 8 shows, only about 60% of the innovators had grown or expected to grow in the future. This leaves roughly 40% which had neither grown nor expected to grow in the future. The proportions were reversed for non-innovators, with about 40-45% achieving growth without innovation in the period, 13 and a similar proportion expecting to grow in the future. Thus, there appears to be a weak association between innovation and sales growth: innovation increases the likelihood of sales growth (and expectations of future sales growth), but there is not a high probability that sales growth will follow innovation. However, we can analyse the relationship between innovation and sales growth further, by relating the different types of innovation to actual and expected sales growth. For each of the three types of innovation (i.e. service, process and organizational) comparisons were made between the proportion of innovators that claimed to have increased their sales (and the proportion which expected to increase their sales in the future), against the proportion of noninnovators which had grown (and the proportion that expected to grow). In every case, the result was the same. Innovators (of whatever type) were more likely to grow, and were more likely to expect to grow, than non-innovators. As noted above, a difficulty with this analysis is that most firms had introduced more than one type of innovation, so the n T h e fact that two out five firms had grown in the recent past and expected to grow in the near future suggests the sample may be biased to more successful firms. 12 This positive association between innovation and sales growth, and expected sales growth, was true of both classifications of innovators/non-innovators. 13 Of course, one or more innovations may have been introduced in the period before 1993. 194 Christicme Hipp, Bruce S. Tether & Ian Miles individual effects of the different types of innovation may have been confused. In order to examine the relationship further, we therefore separated out those firms which had introduced only one type of innovation and compared their propensity to grow (and to expect to grow) with the other firms, particularly the non-innovators. This led to an interesting finding. Those firms which introduced only one type of innovation, be that service, process or organizational, tended to be more likely to have grown (and were more likely to expect to grow) than the non-innovators, but they were also less likely to have grown (or to expect to grow) than those firms which had introduced more than one type of innovation. Extending this analysis, we found that it was the multiple innovators, those firms which claimed to have introduced all three types of innovation that were the most likely to both have grown, and that were the most likely to expect to grow in the future. These patterns suggest sales growth and innovation are related, but that this relationship is not simple, so sales growth cannot be confidently predicted from (simple) innovation indicators. Furthermore, sales growth is not associated with any one type of innovation, particularly service innovation (as hypothesised above), and not with other types of innovation (i.e. process or organizational innovation). The results also hint at strong interactions between these different types of innovation, such that it can be difficult to separate out their individual effects; and they suggest the most aggressive firms with respect to growth introduce multiple types of innovation. Of course, we do not know the direction of causation. Do firms innovate in order to grow, which might be expected of service innovation, or do they innovate (particularly in process or organizational terms) because they are growing? The Identified Effects of the Innovations In addition to asking the firms' about sales growth, the survey also asked about a range of effects the innovations may have had. The firms were not restricted in the number of effects they could identify Effects of Innovation 195 as important, 14 and we began by attempting to distinguish different types of effects, particularly seeking to distinguish between those that primarily benefited the service provider, those that improved the quality or availability of the service provided, and those which provided benefits to the service user. We divided the effects in this way in order to differentiate between primarily process innovation effects, and service quality effects, and within the latter group to distinguish those service quality effects related to the services themselves, and those more related to the service users. Effects associated with process innovation Of the set of effects considered, "improvements to the service provider's productivity and flexibility" are primarily associated with process innovation. The "motivation of the service provider's employees", as well as "the more rapid production and/or delivery of services" are also effects which can be linked to process innovation, although the second especially might also improve the quality of service provided, and may therefore also be a "service innovation type effect". Similarly, "increased market presence" — through increasing the temporal or spatial availability of the services, a n d / or providing a "wider range", or a more "user-friendly", set of services — whilst strongly related to improvements in service quality, and thus "service innovation type effects", might also have been the result(s) of process innovation(s) within the firm. Overall, a third of the innovating firms claimed that improvements to their own productivity had been a "very important" effect of their innovation(s), and a further 46% of the firms claimed this was an "important" effect (Table 7.5). Only 20% of the innovating firms did not claim this as an important effect of their innovation(s). Similarly, 42% of the innovating firms claimed their innovation(s) 14 The firms were asked to rank, on a Likert scale, the importance of these effects. A ranking of 5 indicated the effect was "very important", whereas 4 indicated it was "important", and 1 indicates it was "not relevant". 196 Cbristiane Hipp, Bruce S. Tether & Ian Miles Table 7.5 Effects of the innovations. Benefits to the Service Provider a. Improved Provider's Productivity b. Improved Provider's Flexibility All Only Service NOT Service Firms Innovators Innovators 34% [80%] 18% [57%] 33% [80%] 42% [77%] 43% [76%] 32% [68%] 56% [93%] 50% [85%] 51% [92%] 24% [65%] 15% [44%] 20% [61%] 38% [73%] 26% [51%] 34% [70%] One or more of the above effects (a. to d.) e. Increased Market Presence* 65% [97%] 57% [89%] 60% [96%] 59% [92%] 62% [95%] 41% [83%] One or more of the above effects (a. to e.) 76% [99%] 76% [99%] 66% [99%] 37% 36% [75%] [72%] 35% 26% [68%] [54%] 29% 31% [66%] [69%] 46% [81%] 54% [89%] 25% [55%] 65% [95%] 66% [97%] 48% [87%] 38% [73%] 26% [51%] 34% [70%] 70% [97%] 69% [99%] 57% [94%] 16% [41%] 11% [32%] 7% [24%] 13% [35%] 10% [25%] 6% [18%] 11% [28%] 6% [22%] 5% [17%] 27% [61%] 21% [54%] 13% [41%] One or more of the above effects (a. to b.) c. Motivated Provider's Employees d. Improved Speed of Production/Delivery* Improvements to the Service Provided p. Improved Service Quality q. Increased Temporal/Spatial Availability r. Improved Range/ User-Friendliness One or more of the above effects (p. to r.) s. Improved Speed of Availability* One or more of the above effects (p. to s.) Benefits to the Service User x. Improved Customers' Performance y. Improved Customers' Productivity z. Provided Pleasure to the Customer One or more of the above effects (x. to z.) Number of Firms 1834 123 258 Notes: (i) The main numbers are proportions indicating the effect was "very important". The numbers in parentheses are proportions indicating the effect was "very important" or "important", (ii) "Combines improved temporal/spatial availability, with improved service range/user-friendliness of services, (hi) * "Improved Speed of Production/Delivery" and "Improved Speed of Availability" are the same effect. Effects of Innovation 197 had "very important" consequences for their internal flexibility, and a further 35% claimed this as an "important" effect, with less than a quarter failing to recognise this as an important effect of their innovation(s). Taken together, just 7% of the innovating firms saw neither of these effects as being "important" or "very important" effects of their innovation(s). Consequently, virtually all of the innovating firms claimed their innovations had had "important" or "very important" process-innovation type effects on their activities, and if those that claimed their innovation(s) had important or very important consequences for the motivation of their employees a n d / or the speed of service production/delivery are added in, then 97% of the innovating firms claimed their innovation(s) had had important consequences for the internal aspects of service production a n d / or delivery. Adding those that claimed important effects in terms of market presence leaves only 1% of the innovating firms that did not recognise any of these effects as important consequences of their innovations. The proportion of firms claiming important process-innovation type effects for their innovation(s) was therefore remarkably high. This is especially striking given that a significant proportion of firms had not claimed to have introduced a process innovation, nor an organizational innovation that might also have had process innovation type effects. To examine the relationship between the types of innovation introduced and the effects of those innovations, we identified the sub-set of 123 firms — "Only-Service Innovators" — that introduced only (a) service innovation(s). We also identified the sub-set of 258 "Not-Service Innovators" that introduced only process and/or organizational innovations. Our expectation was that the "Only-Service Innovators" would be much less likely to identify as important the process innovation type effects discussed earlier, whilst the "Not-Service Innovators" would be much more likely to identify these effects as important consequences of their innovation(s). This was, however, not the case. Although 92% of the "NotService Innovators" did indeed claim that improved productivity or flexibility were important consequences of their innovations, 198 Christiane Hipp, Bruce S. Tether & Ian Miles 85% of the "Only Service Innovators" made the same claim. Thus, only 15% of the firms which only introduced service innovations did not recognise these process innovation type effects as being important consequences of their innovations. These results may indicate a high level of confusion between the type of innovation and its effects. Not only do "service innovations" tend to have process innovation effects, but we will also show shortly that "process and organizational innovations" tend to have effects normally associated with service (product) innovation. Effects associated with service innovation: to the services provided Improvements "Improvements to the quality of the services provided", as well as "an increased spatial or temporal availability of the services provided" and an "improved service range", or the "improved userfriendliness" of services were considered by us to be effects associated with improving the service (product) offered, and were consequently considered as "service (product) innovation effects". Amongst all the innovating firms, two thirds identified one or more of these as "very important" effects of their innovation(s), and a further 30% considered one or more of them as important effects of their innovation(s). If the "improved speed of service production a n d / or delivery" is also considered a "service innovation effect", then the proportion of innovators identifying one or more of these as (a) very important consequence(s) of their innovation(s) increased to 70%, with just 3% failing to recognise any of these as important effects of their innovation(s) (see Table 7.5). This suggests again that almost all of the innovations had service innovation type effects, although a substantial proportion of the firms did not claim to have introduced a service innovation. We examined this further by investigating the pattern of response amongst the "Only-Service Innovators" and the "Not-Service Innovators". The result was that all but 1% of the "Only-Service Innovators" claimed at least one of the above mentioned service innovation type effects as an important consequence of their innovation(s). More Effects of Innovation 199 remarkably, all but 6% of the "Not-Service Innovators" also claimed one or more of these effects to be important consequences of their innovations. Even if the "improved speed of service availability" is omitted, almost half of the "Not-Service Innovators" claimed their innovations had "very important" service innovation type effects. Consequently, where previously we found that "service innovations" tend to have "process innovation effects", now we find that "process/ organizational innovations" tend to have "service (product) innovation effects" alongside their expected "process innovation type effects". Effects associated with service innovation: Impacts upon the service users Lastly, we considered the effects of the innovations on the service users. The possibilities here were that the innovation(s) "improved the users' performance", "improved the users' productivity", or "provided pleasure to the customer". One of the supposed peculiarities of service activities (as opposed to manufacturing) is a close interaction between service production and service consumption — so called coterminality (Sirilli & Evangelista, 1998). Because of this close connection, it might be expected that service firms typically have a much fuller understanding of the consequences of their products (services) for the users than do manufacturing firms. Our evidence suggests, however, that amongst these service sector innovators the level of understanding of how their innovations impacted upon their users was remarkably low — or alternatively the firms were remarkably modest as concerns their contributions to clients. Overall, only 16% claimed their innovation(s) had had a "very important" impact on their customers' performance, and only 13% claimed their innovation(s) had had very important consequences for their customers' productivity (Table 7.5). Roughly a quarter of the innovating firms did claim that both of these had been "important" effects of their innovations, but half considered that their innovations had no important effects on either their customers' performance or productivity. Given that only a few of the innovations were declared important in providing pleasure to 200 Christiane Hipp, Bruce S. Tether & Ian Miles the customer, we are left with 39% of the innovations without an identified "important" effect on their users. This is a large proportion — particularly as the innovating firms tended to cite multiple process and service quality effects as important or very important consequences of their innovations. Are the innovations really of limited significance to users, or do service firms have a less clear understanding of the relationship between their (innovation) activities and how do these impact upon the service users than is often supposed in the literature? Investigating further, we again examined the response to this question amongst the "Only-Service Innovators" and amongst the "Not-Service Innovators". Amongst the "Only-Service Innovators" the proportion that recognised at least one of the above effects as a "very important" consequence of their innovations was strikingly low, at just 21%, with a further third recognising one or more of these effects to be "important". This left almost half of the "OnlyService Innovators" failing to recognise any of these user orientated effects as important consequences of their innovations. This proportion was larger than the corresponding proportion amongst all the innovating firms combined, with the firms that introduced both service and process/organizational innovations being more likely than the "Only-Service Innovators" to claim their innovations had an important effect on their service users. Of the "Not-Service Innovators", 41% claimed the introduction of their innovations had important implications for the service users. This is unexpected, since the effects of process or organization innovations might have been expected to be confined to the organization that introduced them, and thus isolated from the customer/user. Instead, it would appear that many process and organizational innovations have effects normally associated with service (product) innovation. These results finding overlapping effects of different types of innovation may simply reflect the difficulty in practice of differentiating between product and process innovation (effects) in services. Changes in production processes involve changes in the delivery and quality of services, and vice versa; and the involvement of clients in the Effects of Innovation 201 service process means that such "process" innovations may impact directly upon the service users. Even though service "product" innovation may not be recognised by the service supplier, changes in service technology may well affect service users who have to interface with the technology in one way or another. (Consider, for example, the shift in power technologies within transport services, or the computerisation of many business services.) Innovation Effects by Standardisation-Particularisation and Sector of Activity Before concluding our analysis of the effects of the innovations, we assess how these varied according to the "standardisationparticularisation" classification of the firms and according to their sector of activity.15 The levels and significant differences for four sets of effects are shown in Table 7.6. We do not discuss the results in detail, but concentrate on the last of these effects — the innovation(s) having "improved the service users" productivity a n d / or performance. 16 Half of the innovating firms in the sample as a whole claimed that their innovation(s) had an important impact on their users' performance and/or productivity. However, this proportion varied significandy across the "standardisation-particularisation" classification. Only one third of the Wholly Standardised innovators made this claim, compared with over 60% of the innovating Bespoke and Customised service providers. This is readily explicable: since the Bespoke and Customised service providers adapt the largest proportion of their outputs to suit specific users' needs, it follows that they should have a fuller understanding of these needs than 15 We also investigated whether there was any variation in the effects by the size of the innovating firms, but no statistically significant variation was found. 16 Note that in addition to the four effects in Table 6 we also investigated whether "improved the provider's productivity a n d / o r flexibility" varied with the "standardisation-particularisation" classification, sector of activity, or firm size, but found it did not. 202 Christiane Hipp, Bruce S. Tether & Ian Miles Table 7.6 Effects of the innovations by "standardisation-particularisation" and sector of activity. Temporal/ Spatial Availability Service Service Range/User Quality Friendliness User's Productivity/ Performance Wholly Standardised Largely Standardised Customised Bespoke 74% 75% 73% 70% 72%ii 72% 81% 90%TT 86% 77% 79% 73% 33%U 52% 61%TT 63%TT Trade Transport & Comm. 75%T 73% 73% Banking & Insurance Other Financial Services 71% Software 70% Technical Services 64%U Other Business Services 77%T Other Services 67%4- 76%U 82% 77% 84%TT 87%TT 90%TT 92%TT 77% 83% 78% 66%U 63%44 87%TT 76% 74% 73% 48% 40%U 49% 83%TT 51% 56% 44%U All Firms 81% 75% 51% 71% 54% The arrow symbols indicate significant differences between the observed proportions citing these "effects" as important, and those "expected" if there were no difference in these proportions by "standardisation-particularisation" classification or by sector. Upward arrows indicate firms of a particular type were more likely to identify the identified effect as important, whilst downward arrows indicate they were less likely to identify the identified effect as important. Single arrows indicate this significance was at the 5%-10% level, double arrows that it was at 5% or above. do the Wholly Standardised firms. The sectoral analysis shows that the Software firms were by far the most likely to claim important effects for their innovations on their users' performance and/or productivity. It is surprising that firms in other sectors with a large number of specialist supplier type firms, such as Technical Services, had merely an average propensity to make this claim. Less surprisingly, the sector least likely to identify an important effect of their innovations on their users' performance and/or productivity was the Banking and Insurance sector. Effects of Innovation 203 7.5 Conclusions This chapter reports on analyses of a survey, carried out in 1995, of German service firms' innovative activities between 1993 and 1995. The pattern of innovation was related to the size of the innovating firms, the broad sector of their activities, and by the extent to which their sales were due to "standardised", "partiallycustomised" or "bespoke" services. The effects of innovations, first in terms of the relationship between innovation and the (sales) growth, and then in terms of the wider, subjectively identified, effects of the innovations, were also considered. The study has examined the relationship between the propensity to innovate and the characteristics of the firms, in terms of their size, (broad) sector of activity, and the extent to which their services (by sales) were standardised, partially customised or bespoke. We undertook this analysis both with respect to the overall propensity to innovate (i.e. the propensity to introduce any type of innovation), and in terms of the propensity of firms to introduce each of the individual types of innovation. In general, and unsurprisingly, the propensity to innovate increased with firm size — as earlier studies have repeatedly found for manufacturing firms. This result held for innovation in general, and for each individual type of innovation. The firms that produced only standardised services — the Wholly Standardised firms — were less likely to innovate than firms that provided some partially customised or bespoke services. This was true of innovation in general and for each of the individual types of innovation. However, and less expectedly, the incidence of innovation was not in general higher amongst the Bespoke and Customised service providers tlian amongst the Largely Standardised service providers. The interpretation of these results, particularly with regard to the Wholly Standardised firms, is not straightforward. Although it is tempting to conclude that the Wholly Standardised firms were less dynamic and under-performing firms, this connection is difficult to prove. An alternative interpretation (about which we have reservations) is that die Wholly Standardised firms are those that have found a "recipe for success" and are busy exploiting it, whereas 204 Christiane Hipp, Bruce S. Tether & Ian Miles (some of the) providers of partially customised or bespoke services are still searching for their own "recipe for success". There seems to be an implicit assumption in much of the analysis of innovation, and especially that which exploits firm level survey evidence of innovation activity, that innovation directly relates to success and the more firms claim to innovate the better. Unfortunately, these surveys, including the recently undertaken Community Innovation Surveys, provide few avenues through which the relationship between the incidence of innovation and commercial/economic success can be assessed. This too is an important area for future research. Concerning the (broad) sector of activity, Banking and Insurance and Software firms appeared to be more likely to innovate than firms in other sectors, whilst Trade service firms appeared to be less likely to innovate. This pattern was true of innovation in general and of each of the individual types of innovation, with the exception that Software firms were not significantly more likely to introduce organizational innovations. Again, these results provide some difficulties of interpretation, for we do not know whether the economic significance of the innovations tended to vary with the sector of activity. For example, innovative activity may be widespread in one sector, but the innovations introduced may tend to be minor, whereas there may be a lower incidence of innovate activity in another sector, but the innovations introduced may be of greater commercial/ economic significance. Survey instruments need to be improved so that not only the incidence but also the significance of innovations is recorded. Turning to the identified effects of the innovations, our initial analysis found a weak association between innovation and sales growth. Firms that had innovated were more likely to have increased their sales, and were more likely to expect to increase their sales in the future, than non-innovating firms. However, a substantial proportion of the innovating firms had not grown and/or did not expect to grow in the future, and a substantial proportion of the noninnovating firms had grown and/or expected to grow in the future. Moreover, the relationship between sales growth and innovation was not related to one particular type of innovation — such as Effects of Innovation 205 service innovation. Instead, firms that had introduced multiple types of innovation, rather than one type of innovation, were the most likely to have increased their sales and to expect to increase their sales in the future. This suggests success — as measured by sales growth — in services tends to be associated with a strategy of innovating in processes as well as services, and perhaps also organizationally, rather than through service or process innovation alone. This said, process and organizational innovations may also be a consequence rather than a cause of sales growth. Lastly, we assessed the firms' claims with respect to the impacts of their innovations on their own activities, on the services they provided, and on the service users. From that analysis, three principle conclusions can be drawn: (i) The effects of innovation in services do not separate neatly into service type effects and process (and/or organizational change) type effects. Service innovations frequently have effects on the service provider's productivity or flexibility, effects which might normally be associated with process innovation. Similarly, process or organizational innovations frequently have effects on the quality and availability of services provided; effects that are normally associated with "product" innovation. Virtually all of the innovations, whether service, process or organizational, had an important effect on the service provider and on the service provided. (ii) However, service firms seem less assertive or knowledgeable about the effects of their innovations on their customers' performance and/or productivity than the literature tends to suggest. This is puzzling, because most of the service innovators adapted at least some of their outputs to suit specific customer needs; only a minority were "Wholly Standardised" service providers. The service innovators do appear to recognise important improvements to the services they provide, which must relate in some way to (perceived) user needs. But they appear less confident about the consequences of their innovations on the service users. Perhaps this apparent modesty reflects an accurate perception that their inputs only constitute a small 206 Christiane Hipp, Bruce S. Tether & Ian Miles part of the inputs and internal efforts that their users require in order to achieve major gains in performance a n d / o r productivity. (iii) Firms which introduced more than one type of innovation, and particularly those that introduced both service innovations and non-service innovations, were the most likely to identify each of the different sets of effects as important. This pattern suggests innovation in services tends to be more effective when a combination of service and non-service innovations are introduced, rather than when only one type of innovation is introduced. Furthermore, the firms that introduced multiple (types of) innovations tended to be most the aggressive (or, reversing the causation, the most aggressive firms tended to introduce multiple types of innovation). The firms which claimed to have introduced all three types of innovation were both the most likely to have grown (in terms of sales) and were the most likely to expect to grow in the future, suggesting a link between growth and the introduction of multiple types of innovation which (are intended to) have multiple effects. Clearly, these results demand replication and illumination with further survey work and case study analysis. It is unfortunate that the second Community Innovation Survey (CIS 2), which will provide Europe-wide evidence on services innovation, does not include organizational innovation nor evidence on the standardisationparticularisation of the firms' services. However, this study has demonstrated the need to improve our measures of each of these parameters — and arguably to explore other indicators which bear on client-intensity, coterminality, and service delivery innovation. Analyses of this and other pioneering surveys of innovation in services have thus opened up something of a Pandora's Box for innovation researchers. Appendix This appendix provides the results of the logistic regression models which estimated the likelihood that the different types of firms would Effects of Innovation 207 be innovators. This was done for innovation in general and for each of the three types of innovation. The results of these models are summarised in the text and in Table 7.3. For each model, a dummy variable identifying innovators (coded 1) and non-innovators (coded 0) was used as the dependent variable. The independent variables were as follows: (i) The natural log of each firm's total employment (E in the tables below). (ii) Simple dummy variables identifying firms in each of the sectors, except "other services", which acted as the base. (Thus, S_TR = 1 for Trade firms; 0 otherwise. S_TC = 1 for Transport and Communications firms; 0 otherwise. S_BI = 1 for Banking and Insurance firms; 0 otherwise. S_OF = 1 for Other Financial Service firms; 0 otherwise. S_SO = 1 for Software firms; 0 otherwise. S_TS = 1 for Technical Services firms; 0 otherwise. S_OB = 1 for Other Business Service firms; 0 otherwise) (iii) Multiplicative dummies which multiplied the simple dummies described in (ii) above by E, the natural log of the firms' employment. (Thus, E_TR = E for Trade firms; 0 otherwise. E_TC = E for Transport and Communications firms; 0 otherwise. E_BI = E for Banking and Insurance firms; 0 otherwise. E_OF = E for Other Financial Service firms; 0 otherwise. E_SO = E for Software firms; 0 otherwise. E_TS = E for Technical Services firms; 0 otherwise. S_OB = E for Other Business Service firms; 0 otherwise) (iv) Simple dummies identifying Wholly Standardised (WS), Customised (CU) and Bespoke (BS) service providers in each sector, although in some cases the Customised and Bespoke service providers were combined into a single category due to the small number of Bespoke service providers in some sectors. Thus: S_TR_1 = 1 for WS Trade firms; 0 otherwise. S_TR_3 = 1 for CU Trade firms; 0 otherwise. S_TR_4 = 1 for BS Trade firms; 0 otherwise. 208 Christiane Hipp, Bruce S. Tether & Ian Miles S_TC_1 = 1 for WS Transport and Communications (T&C) firms; 0 otherwise. S_TC_3&4 = 1 for CU and BS T&C firms; 0 otherwise. S_BI_1 = 1 for WS Banking and Insurance (B&I) firms; 0 otherwise. S_BI_3&4 = 1 for CU and BS B&I firms; 0 otherwise. S_OF_l = 1 for WS Other Financial Service (OFS) firms; 0 otherwise. S_OF_3 = 1 for CU OFS firms; 0 otherwise. S_OF_4 = 1 for BS OFS firms; 0 otherwise. S_SO_l = 1 for WS Software (SO) firms; 0 otherwise. S_SO_3 = 1 for CU SO firms; 0 otherwise. S_SO_4 = 1 for BS SO firms; 0 otherwise. S_TS_1 = 1 for WS Technical Services (TS) firms; 0 otherwise. S_TS_3 = 1 for CU TS firms; 0 otherwise. S_TS_4 = 1 for BS TS firms; 0 otherwise. S_OB_l = 1 for WS Other Business Service (OBS) firms; 0 otherwise. S_OB_3 = 1 for CU OBS firms; 0 otherwise. S_TR_4 = 1 for BS OBS firms; 0 otherwise. S_OT_l = 1 for WS Other (OT) services firms; 0 otherwise. S_OT_3&4 = 1 for CU and BS OT firms; 0 otherwise. (v) Multiplicative dummies which multiplied the simple dummies described in (iv) above by E, the natural log of the firms' employment. (Thus, E_TR_1 = E for the Wholly Standardised Trade firms; 0 otherwise, etc.) (vi) A constant was included. We estimated and reduced the models, that is in each case we began with the full model and gradually removed the insignificant variables before arriving at the final model. For some models we combined categories when the original coefficients were similar (in particular, Customised and Bespoke Software firms were sometimes combined into a single category, as were the Customised and Bespoke Trade firms). Some insignificant variables remain in the final models where their removal would alter significantly other coefficients or the overall strength of the models. Effects of Innovation 209 Appendix Table 1. Logistic regressions for innovation of any type and for service innovation (reduced models). Intercept E S_TR E_TR S_TR_1 S_TR_3&4 E_TR_3&4 S_TC E_TC S_TC_1 E_TC_1 S_TC_3&4 S_BI E_BI S_BI_1 S_OF E_OF S_OF_l S_SO S_TS E_TS S_TS_1 S_TS_4 S_OB E_OB S_OB_l S_OT_l E_OT_l S_OT_3&4 E_OT_3&4 N. Log Likelihood Model x2 (d.f.) Pseudo R2 Any Type of Innovation Coef. S.E. Service Innovation S.E. Coef. -0.30** 0.36*** 0.16 0.04 0.05 0.18*** -0.39*** 0.16 0.03 0.15 -0.90*** 0.18 -0.62 0.27** -0.91*** 0.41 0.11 0.31 -0.88*** -0.83** 0.25** —1 19*** 0.31*** 0.20 0.45 0.12 0.35 0.09 -0.30*** 0.07 0.15*** 0.05 -1.05** 0.49** -1.88*** 1.18*** 0.54 0.21 0.75 0.29 -1.33*** 0.53 -1.90*** -2.54*** 0.36*** 0.40 0.56 0.13 0.22*** 0.07 0.15 0.10 1.43*** 1.82*** -0.37*** -1.69*** 0.34 0.53 0.14 0.56 0.57*** 0.23 -1.69*** -2.05*** 0.29** 0.42 0.58 0.14 2,122 -1,058.9 333.5 0.136 (15) 2,130 -1254.3 327.7 0.116 (17) ""Significant at 1% of higher; "significant at 1.01%-5%; 'significant at 5.01%-10% 210 Christiane Hipp, Bruce S. Tether & Ian Miles Appendix Table 2. Logistic regressions for process innovation and for organizational innovation (reduced models). Organizational Innovation S.E. Coef. Process Innovation Coef. S.E. Intercept E S_TR E_TR S_TR_1 S_TR_4 S_TR_3&4 E_TR_3&4 S_TC E_TC S_TC_1 E_TC_1 S_TC_3&4 S_BI EJBI S_BI_1 E_BI_1 S_BI_3&4 E_BI_3&4 E_OF S_OF_4 E_OF_4 S_SO E_SO S_SO_3&4 E_SO_3&4 S_TS E_TS S_TS_1 S_TS_4 S_OB E_OB S_OB_l S_OB_3&4 S_OT_l E_OT_l E_OT_3&4 N. Log Likelihood Model x2 (d.f.) Pseudo R2 -1.10*** 0.26*** 0.16 0.03 -0.92*** 0.30*** 0.14 0.03 -0.66*** 0.18 -0.74*** 0.18 -0.89* 0.27** -1.23*** 0.32*** -0.60* 0.47 0.12 0.42 0.09 0.33 -0.99** 0.22* -0.82** 0.23*** -1.06*** 0.46 0.13 0.37 0.09 0.30 0.84*** 0.31 0.13*** 0.04 0.09** 0.04 -0.13*** 0.05 0.82** 0.37 -0.79** 0.36 -2.20*** 0.36*** 0.61 0.14 0.15* -4.85* 1.70* 1 ]Q**t 0.08 2.64 0.99 0.36 -0.74* 0.44 1.66*** -0.36*** -0.91 0.87** 0.47 0.12 0.58 0.42 -1.27*** 0.64*** -3.09*** 0.55*** 0.42 0.26 0.74 0.16 2,119 -1298.6 337.6 0.115 (21) 2,123 -1321.0 293.5 0.100 (13) •Significant at 1% of higher; "significant at 1.01%-5%; *significant at 5.0196-10% Chapter 8 Innovation in Healthcare Delivery D. Jane Bower 8.1 Introduction Healthcare is a very ancient area of professional service. During the 20th Century its capabilities and prestige expanded enormously thanks to the successful application of science and technology. In industrialised countries it is now a vast modern industry. Customer demands appear to be insatiable. However, its success has bred expectations which are as limitless as the demands. In this environment Healthcare Delivery has become a very complex process. It must integrate the expertise of teams of highly trained professionals operating in specialised, high technology facilities. They must select and deploy technologies for diagnosis and treatment from an everexpanding range of innovative products. Their activities are facilitated (or constrained) by cadres of managers, regulators, and others. The detailed processes and outcomes of service delivery attract intense, often critical, public interest. This exerts pressures on all who play any part in the delivery process. Patients and their families are the end users of healthcare services. They have some ability to exhibit direct preferences as customers but this is limited. Most of the direct control over healthcare innovation is channelled through other routes. Thanks to its unique combination of great promises, high risks and high costs, the healthcare industry has become highly politicised, and subject to extensive government regulation. Its growing high technology content has contributed to this and increased the need for extensive specialist input to decision-making, from many areas of expertise. Hence there are several levels of decision-makers in government agencies and 211 212 D. Jane Bower healthcare organisations and purchasers, public and private, and also clinical professionals, who play important roles in approving the component products, services and delivery modes of healthcare interventions. However the general public and particular pressure groups such as fundraising medical charities can exert considerable indirect influence over prioritisation of funding and adoption of specific innovations (see e.g. Bower, 1996). Before attempting to generalise about innovation management in healthcare it should be noted that that national healthcare delivery systems differ widely in terms of the relative importance and power of the various local stakeholders, and the attitudes and expectations of their public/clientele. However, in all developed countries at the present time three forces currently drive powerful, often conflicting demands for innovation in every aspect of Healthcare: • Technology opportunity — the vast capability to develop novel methods of diagnosing, treating and monitoring patients. • Growth in demand — past success in producing "medical miracles" has boosted demand. • Growth in costs — has put pressure on public purses and also private insurers. These forces dominate a dynamic and testing environment in which service innovation must be managed. At times they form a triangle in which conflict between them threatens to cancel out benefits to patients. In this chapter these three forces are discussed and their patterns of interaction in service innovation are considered. A number of current UK cases are considered which have close parallels in other societies with modern healthcare systems. They illustrate some of the risks and the problems of defining "success" in this context. Pervasive themes are the importance of communicating expertise effectively and the central role of the expert individual or team in integrating diverse knowledge flows. Innovation in Healthcare Delivery 213 8.2 Technology Opportunity Healthcare innovations draw on advances in science and technology in many generic areas, such as genomics, electronics and IT. Indeed there are probably few fields of science and technology which are not being milked for their healthcare potential by the inexorable pull of popular demand. They offer possible improvements to a wide and diverse range of services. This has opened a Pandora's Box of problems for decision-makers in healthcare. These include basic questions about clinical effectiveness. They also include highly contextual questions about resource deployment, patient acceptability and wider ethical acceptability of a new service. In other words, innovation in healthcare services demands careful attention to a range of factors on several levels. These include levels relating to the product and service components of the service. They also include the ultimate systemic level. This is the level of their effective integration into the specific context of the part of the system in which the service will be delivered. This latter is often overlooked but is the ultimate determinant of the success of the innovation. Those managing the innovation processes of the components should ideally design their activities with a mind to the exigencies of this final level, but this is not always the case. Categorising Healthcare Innovations Innovations in healthcare services usually have several components. These components may themselves be innovations. They fall into very different categories in terms of the problems of developing them. In order to facilitate the process of service innovation it is helpful to unravel the main categories of innovation (Bower, 1996) which may form the components. "Embodied" innovations such as pharmaceutical products and medical devices embed new knowledge in their design. They are tangible products which are subject to extensive regulatory testing and approval processes. These lead to detailed prescription of how, when and by whom they may be used, their reliability and safety 214 D. Jane Bower under prescribed conditions, factors which contraindicate their use, etc. This information is publicly available. Information about costs, at least to some major users, is also available. These tangible innovations may be contrasted with "disembodied" innovations, in which new knowledge has informed changes in surgical techniques, new combinations of interventions and nursing care, etc. These involve procedural changes rather than a tangible product. For example, greater understanding of the physiological consequences of long periods of immobilisation has led to shortened periods of confinement to bed of elderly patients and postpartum mothers. These "disembodied", procedural changes have not traditionally been formally regulated. They are now increasingly being subjected to approval processes by professional bodies and by organizations which control the purse strings. However they can only be monitored as part of a complex pattern of service whose other elements are difficult to control precisely in order to evaluate components precisely. Costing is often difficult, particularly where changes impact on demand in unpredicted ways, both for the innovation and for other services. A service innovation may involve purely "disembodied" components, or it may be a "complex" innovation, which contains both embodied and disembodied elements, involving the use of new products and procedures integrated into a treatment regime. Another example of the complex innovation is the use of minimally invasive surgical techniques. This involves both "embodied" hardware technology and the deployment by the surgeon of novel "disembodied" skills, to achieve the desired outcomes using the novel tool. ICTs in Healthcare Health Informatics ( H I ) , the application of information and communication technologies (ICTs) to enhance services, is having a major impact on services. In recent years it has become a central plank for improving healthcare delivery in the UK (NHSE, 1998). It has given rise to many innovations with embodied and disembodied Innovation in Healthcare Delivery 215 elements. On the most general level, ICTs have an impact across the range of service provision through informing clinical judgment more fully. This offers the prospect of better service through better management over the lifetime of the patient of information about (a) the individual patient; (b) general epidemiology; (c) the links between knowledge about the patient and the relevant epidemiological knowledge. The emerging reality is a good deal more complex and ambiguous than the original vision. Thanks to the accessibility of the Internet and also to legislation in different jurisdictions about Freedom of Information, on the one hand, and Data Protection, on the other, many unforeseen complications have arisen in relation to HI. The public has easy access to a vast amount of health-related information which would formerly have been difficult to locate. Individuals have rights to privacy, but also to demand confidential medical information about themselves. As technology in this area advances, legislators struggle to keep up. The situation is subject to ongoing change, and this is creating great uncertainties in terms of what is permissible and the costs of compliance. This has created a challenging environment for managers and other decision makers. In addition to more general uses in HI, ICTs are becoming available which link into healthcare delivery in ways which constitute quite specific "complex" innovations. For example, the introduction of remote monitoring and data transmission devices which can allow patient information to be transmitted from another clinical site or from the home using telephone lines is being officially encouraged in the UK (NHSE, 1998), the USA (US Federal Government Telecommunications Act, 1996) and most other countries with good telecommunication infrastructure. Such devices range from simple heart monitors to instruments which mediate several types of information flow, including interactive video links. The hope is that these services will reduce travel time for clinicians and patients, reduce the time spent by patients in high cost facilities and generally improve the quality of care. It is not yet clear how extensively such services will be adopted into routine service, nor whether they will meet all the expectations 216 D. Jane Bower laid on them. There are still few data on the effectiveness and costeffectiveness of telemedicine (rev. Roine et al., 2001). They involve investment and varying degrees of organizational change. They offer additional communication possibilities but the extent to which they will be used to substitute for face-to-face interaction is still uncertain. This is partly because the precise content and process of clinical encounters between patient and clinician is not fully understood and codified. Recent studies have indicated that some applications are highly acceptable but others fail, for reasons which are hard to predict before testing in a routinised setting. May et al. (2001), in a study of the failed introduction of videoconferencing in telepsychiatry, concluded that psychiatrists, who had initially been highly receptive to the technology, had found it impossible to "shoe-horn" their own model of practice into it. They reported a number of barriers to communication in the tele-context which they had not anticipated. These were often points at which they were accustomed to reassure or reorient patients with a touch, but there was also a comment that it was dehumanising to ask a person to talk to a machine when they were in a state of distress. May et al. point out that there is a diffuse and taken-for-granted body of expertise which forms an essential component of the doctorpatient encounter. These findings and others (see e.g. Bower et al., 2000) suggest that careful piloting of individual applications in specific settings is required to give these issues visibility and to determine if and how the application can be contextualised usefully in a given setting before making a commitment to routinise an application on a wide scale. The introduction of a specific innovation in healthcare delivery often encounters problems which relate to the "embodied" a n d / or the "disembodied" components, as well as problems which relate to the management issues of introducing a new service into the ongoing context of a busy healthcare delivery system. Hence in planning service innovation it is important to take a simultaneously analytic and synthetic approach — analysing the issues surrounding the components bit also considering the systemic impact on the local and wider service environment. Innovation in Healthcare Delivery 217 8.3 Growth in Demand The relentless growth in demand for more and better healthcare worldwide is the subject of daily press commentary. This demand is accompanied by popular endorsement of expenditures on biomedical research in the industrialised world. Government and charitable funding are important hinders, but this has led to an imbalance between expenditure on research and the much more expensive development phase, which, in the case of pharmaceuticals and medical devices, has mainly been funded by companies. There are substantial gaps between the potential created by new knowledge and its translation into services which can actually meet the end user demand. This problem has been the subject of government concern for many years (see e.g. ACOST, 1993). In the UK this has led to a number of programmes aimed at providing public funding for the early stages of development, such as Proof of Concept, SMART and SPUR, which can be applied for through central and devolved government and economic development agency offices (e.g. application information for Scotland at Scottish-enterprise.com/ proofofconceptfund; www.scotland.gov.uk/who/elld). The objective of these schemes has been to support projects beyond the riskiest early stages to the point at which they might be able to attract private development finance for the increasingly costly later stages of development. However, until recently, there has been little recognition that the integration of innovative products into routine service delivery might be itself a discrete development phase which requires a further stage of organizational innovation and product modification. There has now been a move towards funding projects which address this critical stage of the innovation process. This is in response to the common observation that services offered as part of a research project often fail at this point even where research results have been favourable. They do not necessarily articulate smoothly with the system into which they are inserted. The kingpin in healthcare delivery is the medical professional or team, whose diagnostic and treatment skills are integrated with the aim of delivering the outcomes. 218 D. Jane Bower For the healthcare professional or team, individual innovations in one part of the healthcare delivery process must normally be capable of integration into the process as a whole and supportable by the available infrastructure. This is an important constraint on innovation, and gives innovation in healthcare delivery the general characteristics of innovation in complex systems (Gann & Salter, 1998; Bower et »/., 2000). In other words, innovations in any one of diagnosis, treatment and monitoring of a patient's condition is likely to have implications for the others, and for the supporting infrastructure. Where this is the case, or perceived to be likely, it may cause reluctance to adopt because of concerns about undesirable and costly effects on the wider system. This problem is not unique to healthcare services, and its resolution shares common features with comparable situations in other industries. Where the task is to manage the integration of several bodies of knowledge, some or all of which may be novel and untested, effective communication is a primary requirement for identifying and overcoming barriers (Quintas, 2001). The specific demands of the "research into routine service" phase are beginning to gain recognition. A current example of this is the STAF project. The NHS in Scotland is currently funding this £5m programme which aims to fund the transition of several different research applications of videoconferencing and other image transmission applications into routine service. This programme, the Scottish Telemedicine Action Forum (STAF — www.show.scot.nhs.uk/ telemedicine/Staf/) is supported by a team of monitors which helps the individual projects address the special problems of routine service introduction. Communication between the projects is coordinated. Some of the key areas which are addressed in this routine service introduction stage are the issues of (a) project planning and management; (b) acceptance of the innovation by several levels within the NHS as well as by patients, (c) time for training, (d) reorganization to meet the changed priorities, (e) project evaluation. The recognition by a research funding body of this need for a "systems" approach to this distinct and problematic phase which requires proactive management, an evaluative approach, and, above all, a dedicated budget, is an important advance. If this view is widely adopted, Innovation in Healthcare Delivery 219 successful management of healthcare service innovation should become easier. The Physical Environment Service settings are themselves a focus of innovation. A "systems approach" is being increasingly adopted to enhance the whole healthcare delivery environment. Until recently, most healthcare organizations focused almost exclusively on medical requirements. However, there is a growing realisation that satisfactory service outcomes are affected by the characteristics of the environment in which they are delivered in a number of ways. Fottler et al. (2000) have grouped these characteristics under the collective term "the healing environment". Identifying "the customers" as patients, their families, and employees working in the healthcare setting, they have discussed the diverse requirements of these customers. For patients and their families, homelike settings combined with hotel-type services reduce stress and provide a nurturing atmosphere. For staff, a clean, safe, well-organized and comfortable work environment is psychologically supportive, and reinforces their sense of competence. These aspects need to be functionally congruent with purely medical requirements to create an optimal healing environment. It is increasingly appreciated that the issue of healthcare delivery settings goes beyond the case of service delivery in purpose-built accommodation. Although home-based care is no novelty, it is becoming a greater focus of interest as the introduction of new services supported by advanced ICTs has become a policy priority. There is growing awareness of the complex issues of acceptability, quality and integration with other delivery modes, which surround services delivered directly in the patient's home from remote locations through the use of telephone or videolinks, and services delivered using remote telelinks for doctor/patient consultations. Different delivery modes can be combined in many permutations, with resource implications which can vary considerably depending on geographical location, local infrastructure, skilled staff availability, etc. With so many factors to take into account, most of which are subject to 220 D. Jane Bower change, and bearing in mind the importance of the tacit factors discussed by May et al. (2001) it is unlikely that detailed principles for optimising the home-based healthcare environment will emerge in the near future. However, a combination of analysis of the components with a holistic, systemic synthesis of how they can be integrated provides a practical starting point for deserting and piloting services. The Changing Nature of the Demand The nature of the demand for healthcare is also changing over time. On the one hand urgent new health problems arise, and public expectation is that they will be solved. On the other hand, the breadth of the area which health services are expected to address is widening. These are quite distinct problems. The great successes achieved over the last 100 years through the application of science and technology have led to the expectation that science has the power to solve all problems. In fact, innovation to order has proved elusive in a number of areas. Even where resources have been effectively unlimited, science has not always been able to deliver — promises that an effective AIDS vaccine was just about ready have been made by a series of large and small companies over the last 20 years but it is still out of reach. Similarly for AIDS treatments, combinations of antiviral compounds which mitigate the effects of the disease are used, but they are expensive, side effects are unpleasant, and their limited effectiveness is under challenge from resistant strains of the virus. In other cases, while science can provide a solution, costs are the barrier to meeting demand, in what is inevitably a resourcelimited context. This is considered in the section which follows. 8.4 Growth in Costs Growth in costs of national healthcare systems has led governments and private reimbursement organizations to use their purchasing power to control prices. Faced with lower margins and increasing Innovation in Healthcare Delivery 221 development costs, companies have had to focus increasingly on products with large markets. This has driven business decisions to avoid products which addressed markets too small to give a return on investment. Since development of a new therapeutic is costly, this means that those which target relatively rare conditions may not be developed even when they are technically feasible. This has implications for the considerable expenditures which are currently going into genomics and proteomics research, because their rationale is that they will allow the development of much more specific therapeutics tailored to the genetic profile of the patient. This would necessitate changes in service delivery because it would have to be accompanied by the introduction of much more specific diagnostic and monitoring procedures, most likely incurring additional expense. The introduction of many highly-targeted therapies would in fact would divide the small number of large markets for profitable drugs into a large number of small markets for unprofitable drugs. An increasing number of industry analysts are now concluding that this implies that the much-heralded revolution in healthcare through applications of genomics may turn out to be less significant than predicted (Horrobin, 2001; EFPIA, 2001). However, where the markets are large enough, for instance breast cancer (for which Herceptin, a therapeutic which is effective in only a proportion of genetically identifiable cases, is already being introduced), genetically targeted treatments are likely to be approved. Another effect of the growth of costs has been to force difficult resource allocation decisions on major purchasers, often governments. This is inevitably resisted by the groups which believe their demands are receiving a low priority, who then put pressure on politicians. Policymakers have thus been unwilling to admit to making costs an important factor in decisions to refuse funding for specific services. Where these have obviously been more cosdy and have been approved elsewhere, this has fed the suspicion that official rationales conceal a cost-cutting agenda. In the UK what began as a general awareness that cost was becoming an important factor in resource allocation decisions is becoming a widespread fear that cost has become the main determining factor in official decisions. It is not clear how 222 D. Jane Bower far this fear is justified. However, official communications have not always been well-handled and have sometimes exacerbated a growing popular distrust of official pronouncements. In the following section material drawn entirely from UK national news reports published in the last twelve months (Times, Independent, Scotsman, Sunday Times, Scotland on Sunday) illustrates how official communication has exacerbated this problem. The Case of MMR The case of the MMR (measles/mumps/rubella) triple vaccine in the UK has been a subject of extensive public debate in the national press as well as in other fora for several years and is still unsettled at the date of writing (May, 2002). This vaccine has been widely administered in several countries for many years with apparently high levels of success in reducing the incidence of these three infectious diseases. Over the same period the level of a behavioural syndrome, autism, has been rising, or at least the number of cases diagnosed has risen greatly. Public worries were aroused a few years ago when a study carried out at the Royal Free Hospital in London was published which appeared to link autism with the MMR vaccination. This study was widely regarded by experts to be seriously flawed. Parents became concerned about the possible link and were reluctant to have their children vaccinated. A number were able to obtain single vaccines privately and parents began to demand that this should be available freely on the NHS. Initially there was no official attempt to provide clear information about all the evidence relating to the safety of the vaccine. The official response was to announce that the vaccine was safe and to rule out the possibility of single vaccines. This policy was continued for several years as the uptake of MMR declined. During this period a number of statements were released citing evidence in support of the policy. Press commentary of the government approach became increasingly critical, with calls to the Prime Minister, Tony Blair, to reveal whether his youngest child had received the MMR vaccination. In 2001 in Scotland, in which Healthcare is a devolved responsibility, an Innovation in Healthcare Delivery 223 "independent" panel of experts was set up by the Scottish Executive, charged with reviewing the evidence. At the end of April 2002, two months later than the scheduled date, and after numerous press reports of infighting among members of the panel, the supposedly unanimous verdict was announced : "the triple vaccine should remain Scotland's policy". Commentary the following day in the Scotsman (1.5.02) challenged the independence of Panel members and quoted the numerous leaks which had occurred which had indicated that Panel members were far from unanimous in their support of the official statement. Vaccination rates had by that date fallen to 86.6%, against 92% for tetanus, confirming that parents were distrustful of the official recommendation. This figure included the growing numbers of children whose parents had chosen to pay privately for a series of expensive single inoculations and so the number who had received the triple vaccine was less than the 86.6% figure. Official responses up to this point had produced negative effects. Several reasons for this emerge from the text of their pronouncements. One was that they repeatedly addressed the questions from a public health perspective, arguing on the basis of the benefits to the population at large, and the costs of using three single vaccines, and rarely addressed parental concerns directly. Parents' primary commitment was to the wellbeing of their own child. This was rarely addressed in official communications. The official responses which did address questions of the risk/benefit ratio to the individual child, failed to convince, because they were seen to be biassed: a number of studies had been carried out which failed to find a link between the vaccine and autism, but they were not all of high quality. However, they were all cited in support of the official line, while the results of a study which appeared to show a link was rejected. The latter study was also of poor quality. Unsurprisingly the inclusion of a weak study by the official advocates but only where it supported their case led to disbelief and a loss of trust by parents. The Scottish Panel's (April, 2002) report stated more cautiously that "the current scientific evidence does not support the hypothesised link between the MMR vaccine and autism". This careful statement is a retreat from the stronger statements issued previously, which in itself would 224 D. Jane Bower tend to reinforce the general impression that the initial statements were intended to mislead. Public distrust is now unlikely to be diminished and opposition parties are already calling for a further enquiry. This has unfortunate implications for the introduction of officially sanctioned innovations in the future, which face a more sceptical public. Resistance to services such as vaccination, which are preventive rather than therapeutic, is likely to be particularly persistent. Unlike interventions which alleviate an immediately distressing or life-threatening condition they do not produce a direct, positive effect and it is consequently easier to decide to forgo them. This case illustrates some of the difficulties of gaining public acceptance for service innovation, particularly in preventive services. It underlines some key issues about the importance of creating and maintaining an atmosphere of trust between the public and healthcare decision makers at all levels. It also unpacks some of the dilemmas faced by managers and decision-makers. There is potential for insoluble conflicts to arise. The public has high expectations. These cannot always be met, sometimes because the technology is not good enough, sometimes because safety considerations and demand have driven costs up too far, often for a combination of these reasons. Because such different factors may be involved this raises questions of how to manage expectations including questions of choice, in order to achieve acknowledged service improvements in harmony with demand. Resources are inevitably subject to limits, but this is never a welcome message. Risk Management MMR was introduced to reduce health risk and it achieved this according to objective criteria. In spite of this it encountered the problems of the public perception of risk. Managing perception of risk is as pressing a management issue in healthcare as managing services and becomes itself an area for risk management. Much of the work of policymakers to devise measures to control and reduce health risks has wide public acceptance. However some types of Innovation in Healthcare Delivery 225 risk pose special problems. Heightened perception of specific risks to health and novel risks which emerge as a consequence of medical treatments are particularly intractable members of the general category "health risks". In such situations objective criteria indicate that risk has been reduced, but the perception is that risk has increased. Miscalculated attempts by policymakers to allay concern can quickly lose the confidence of the public. This is the greatest risk to health of all — the loss of credibility in one or two cases which can spill over into other areas and create a general climate of mistrust of officially sanctioned expert advice and services. There is a general public consensus that policymakers should reduce and progressively remove health risks. Measures taken to achieve this are largely taken for granted. However, any flaws in their implementation are heavily criticised. This leads to a situation in which the implementation of a policy which effectively reduces a health risk can lead to a heightened perception of the health risk. This can occur even with non-invasive procedures. Cervical screening provides an example of this. Cervical Screening The widespread introduction of cervical screening in the UK has reduced the risk of cervical cancer to the population at large. However tests are not 100% accurate, and there have been a number of widely reported cases of administrative error leading to individuals receiving incorrect information about their health status. Large numbers of women who had not thought they might have cancer because the test was a routine population screen, became worried that their negative test results might have been erroneous. This has led to strong criticism of service management. More recently it has led to demands to use a much more expensive test which claims higher accuracy, but might not necessarily achieve statistically greater health benefits if used in a general screening service. This case illustrates the key problem that even where preventive measures result in reduced risk of a disease, situations can arise in which their delivery can actually heighten the perception of being 226 D. Jane Bower at risk, relative to what it was before the preventive service was introduced. Responding to the resultant demands for changes in service and management is likely to be costly without any assurance of an accompanying reduction of health risk. Contingency planning, speedy corrective action and effective communication between healthcare professionals and the public is important to minimise problems of this type, but they cannot be completely abolished in an imperfect world where human error occurs. 8.5 Resolving the Three Forces What conclusions can be derived from this complex picture? The foregoing sections have common threads about the importance of perceptions, atmosphere, shared understandings, pervading much of the commentary about regulation, acceptability, and satisfactory healthcare outcomes. This suggests that confidence/credibility of expertise is critical to the effectiveness of service delivery. Shared understandings between stakeholders and mutual trust are required. Circumstances, events and actions which reduce these at the level of individual interactions impact directly on the quality of outcomes. Risk to Credibility When public concern is voiced in relation to perceived risks associated with a particular procedure, official responses designed to reassure can exacerbate rather than reduce the problem. The case of the MMR vaccine illustrates how official miscommunication produced negative effects. The case of cervical screening has also impacted on the whole UK system. In both the impact has not only been to reduce confidence in NHS expertise and trustworthiness in relation to these services, it has also contributed to a progressive loss of public confidence in NHS decisions and health advice which is likely to affect public interpretation of future policy measures. No matter how well managed, problems will arise in the introduction of new services and errors will be made. These always threaten the credibility of policymakers. The cases cited here Innovation in Healthcare Delivery 227 demonstrate how the threat to credibility can be compounded. This in itself is probably the most serious risk to health, because as credibility is eroded, there is a progressive knock-on effect. In other areas where members of the public are well aware that they do not have the knowledge or expertise to judge matters for themselves, their confidence in the pronouncements of policymakers is reduced. Tests are never 100% accurate, human error can never be entirely eradicated, and scientific evidence is often incomplete or ambiguous. The climate of opinion is not prepared for the emergence of novel health risks. It moves quickly to blame policymakers for failing to foresee and forestall new problems. This raises difficult questions of how to communicate effectively with stakeholder groups about policies which cannot completely eradicate risks, and how to manage them when problems arise. Some of these questions are considered in the following sections. Perceived Risks and Benefits The cases discussed here are striking examples of how acceptance and satisfaction depends on stakeholders perceiving net benefits to themselves from an innovation. The same general principal applies in all service innovation. Innovations in Healthcare must be beneficial to patients and so perceived. But patients are not the only stakeholders. Benefits to themselves must be perceived by all the gatekeepers to the innovation. In order to surmount all the hurdles on the way to routine service, innovations must be perceived to be beneficial according to the criteria of each stakeholder group. For the pharmaceutical company benefits tend to be associated with profits — an effective drug which targets a niche market is unlikely to be regarded as beneficial to the company. Benefits for the purchasers involve a trade off between costs, health gain real and perceived, and risks. At the level of the clinician or team, benefits to them are a combination of improvements in their operating conditions, as well as benefits perceived by patients, which give positive feedback about their performance to the clinical staff. When all the stakeholders 228 D. Jane Bower perceive benefits to themselves, the innovation process has at least a chance of a positive outcome. Communication Effective communication across all the interfaces between the participants in service innovation has been a major success factor in the innovations considered here — between different groups on the delivery side, between clinicians and patients, and between "official expertise" and the public. This is communication in its broadest sense. Communication is a set of practices embedded in a larger sociohistorical network of activities (see Spinuzzi, 2000; Zachry, 2000) which must fit the requirements of all the participants and also the nature of the communicanda, i.e. the content to be communicated, if it is to lead to a shared understanding. This necessitates the emergence of a practice community (Brown et »/., 1991; Cook & Brown 1999) encompassing all stakeholders including patients. The members have a shared understanding of the desired outcomes and between them have the body of knowledge which allows them to achieve them. In the case described above May et al.'s (2001) patients have expectations of what their therapist will deliver, and the therapist has developed a particular routine which delivers this to the patient's satisfaction. Cook & Brown (1999) have coined the phrase "epistemology of practice" to encompass this body of knowledge, which cannot by its nature be fully articulated and includes inevitable tacit elements, hence must be developed and communicated through doing and experiencing. The shared understandings of this "community of practice" must also mediate the debate about human errors, the incompleteness of scientific knowledge, and the other thorny issues which threaten it. Evaluating performance It is concluded, then, that a successful innovation must benefit some or even all of the stakeholders. Services which clinical staff find disruptive to valued aspects of service delivery are unlikely to be Innovation in Healthcare Delivery 229 adopted (May et al., 2001). And individuals will reject services which they fear benefit "Public Health" rather than themselves and their families (e.g. MMR vaccine). At first sight, this is a discouraging situation. There are many stakeholders with different agendas and this is likely to thwart many attempts at service innovation. What yardstick, then, should be employed to evaluate the effectiveness of innovation management? Perrin (2002) has argued that innovations should be measured in terms of the "true gains" they deliver, not in terms of percentages: "If one project out of 100 results in a cure for AIDS, surely the funding of the other 99 attempts does not represent a failure?" This approach is in accord with popular expectations. The demand for innovation in Healthcare has shown itself to be strong enough to overcome considerable obstacles and many failures. The three forces — technology opportunity, growth in demand, and growth in costs — are still driving an expanding repertoire of healthcare services which continue to set new challenges for those charged with delivering them. This page is intentionally left blank Chapter 9 Product Development in Financial Services: Picking the Right Leader for Success Evangelia Chortcttsicmi 9.1 Introduction Product development is important, as indeed both several chapters in this book and the literature in general suggest. Its contribution on both turnover and profitability is significant in most industries and particularly in services whose tremendous growth in recent years could not have come without it (Birley & Westhead, 1994; Channon, 1976; 1978a,b; 1986; Cowell 1988a,b; 1994; Davidson, Watkins & Wright 1989; Edgett 1991; Lovelock, 1996; Wright & Watkins, 1987). It is therefore important that product development is both pursued sufficiently and managed well (Edgett, 1993; Easingwood & Percival, 1990; Wright & Watkins, 1986; Vermaak, 1994). Much work has so far sought to explore various aspects of the product development process, identifying for example ways to improve it by minimising defects or shortening the cycle and reducing time to market. It is not, however, just the right process that makes good product development, but also the organizational and interorganizational setting within which this takes place. Anthony (1988), Ansoff (1965, 1979), Barclay and Benson (1990b), Burgelman and Sayles (1986), Burns and Stalker (1961), Channon (1997), Dawyer (1990), Ennew, Wright and Watkins (1990a,b), Goold and Quinn (1990a,b), Easingwood (1986), Hall (1991), Hinings and Greenwood (1988), lohnson and Scholes (1993), Larson and Gobeli (1988), Mintzberg (1973), Peters and Waterman (1990), Rothewell (1977), Thwaites (1992), Thwaites and Edgett 231 232 Evangelia Cbortatsiani (1991), Urban and Hauser (1980) have all argued that organizational aspects such organizational size, bureaucracy, culture, complexity and communication systems do affect in a significant way both the product development process and its success. Bart (1991), Bass (1990a,b), Burns (1978), Hall (1991), Quinn (1985), Hegarty and Hoffman (1990), Harvey-Jones (1988), Mintzberg (1973), Tichy and Devanna (1986), Tushman and Nadler (1986), Yukl (1989), Van de Ven (1986), Vroom and Yetton (1973), Zaleznik (1992) and others have argued that organizational leadership and management in general are also important. This chapter is about leading product development projects in services. As Fiedler and Chemers (1984) said, changing an individual's leadership style is quite difficult, but organizations should put individuals in situations that fit with their style. We present the results of a research project completed recently that set out to identify the types of leadership most suitable under different circumstances. A theory is developed and subsequently tested in the UK financial services industry, as it is both sufficiently representative of the entire services field at least in terms of size and innovativeness (particularly after the late 1980s deregulation and the non price-based competition that erupted) while also remaining in need of research both as far as product development is concerned (Easingwood, 1986; Edgett & Thwaites, 1990a; Thwaites, 1989) and with regard to management style (Edgett & Jones, 1991; Hughes, 1992; Vermaak, 1994). It is argued that leadership matters as far as the successful development of new products is concerned, with leadership style and top management involvement being factors significantly affecting a product development project's success. Moreover, it is found that different types of leadership are more suitable for different types of product development projects, such choice also having ceteris paribus a direct influence on the project's success. Product Development in Financial Services 233 9.2 Linking Management Style with Project Type and Product Development Project Success The Impact of Management Style on Product Development Project Success A brief review of the literature reveals a number of good reasons why leadership style would be a significant determinant of product development project success (Bart, 1991; 1993; Burger, 1989; Hinings & Greenwood, 1988; Manz, Bastien, Hostager & Shapiro, 1989; Van de Ven, 1986). It appears to affect process (speed) and product and commercial success (time to market, sales and profit) among others. Effective leadership can help in developing product development plans and checking progress against objectives; co-ordinating product development activities; handling conflicts and disagreements; encouraging participation and teamworking; increasing communication between senior management, project leaders and team members; initiating and implementing changes; risk taking; encouraging experimentation, trial and error; guiding and directing people; and creating the appropriate environment which helps people feel comfortable and satisfied with their work, among others (Gordon, 1993; Dwyer & Mellor, 1991a; McDonough III, 1990; Thamhain, 1990; Thamhain & Wilemon, 1987; Van de Ven, Angle & Poole, 1989; Yukl, 1989; Zaleznik, 1992). Frischer (1993) for instance found a relationship between influential (empowered), open, flexible, creative, problem solving and a trusting style of leadership with successful product innovations; Bruce and Scott (1994) found that managers able to understand their role expectations, improve the quality of the managersubordinate relationship and solve problems with a systematic or intuitive manner had a positive effect on the adoption and implementation of successful innovative ideas, products or processes; Barczak and Wilemon (1989) found a particular style (similar to leadership style as subsequently used in this study) may have a positive impact on the performance of two types of team, operating and innovating ones; Thamhain (1990) and Thamhain and Wilemon (1987) found that a similar style may have a positive impact on 234 Evanjjelia Cbortatsiani team performance and, as a result, on project success; McDonough III and Barczak (1991) found that a participative or delegative style, when used to manage internally developed technologies may prevent unnecessary and time-consuming activities, may facilitate the (technical) problem solving process through teams and so speed up the development of the project. Interestingly, the same style was not found to be appropriate for speeding up the development of projects where technological developments occurred from external sources; House, Spangler and Woycke (1991) found that a charismatic (transformational, ecological) style was appropriate for those organizations that need to proceed with major changes and innovation, while a high degree of adaptation was found to be appropriate for enabling people to deal more effectively with environmental changes; Chakrabarti (1974), Knight (1987), Maidique (1980) and Souder (1981b) found that an informal, communicative, interactive and risktaking style may have a positive impact on successful innovation and change. Finally, Barry (1991) found a link between the effect of the envisioning, networking (communicational), social and organizing leadership and successful product development. Such being the evidence, two observations can be made. First, leadership is perceived differently by different investigators, a somewhat different aspect of it being explored on each occasion. Second, although many of the above studies have considered similar questions, the emphasis has not been to establish management style as a significant factor affecting product development success in principle, and specifically for the financial services industry (Barczak & Wilemon, 1989; 1991; McDonough III, 1990; 1993; McDonough III & Barczak, 1991; McDonough III & Leifer, 1986). This study will attempt to do so. On the Operationalization of Management Style In searching for a measure for management style capable of being applied in the widest possible range of projects, we draw on the extensive literature on leadership itself and identify several dozen of its component aspects (legitimate power, power (delegated), Product Development in Financial Services 235 support, influence based on exchange, risk taking, inspiration, motivation, envisioning and energizing people etc), each of which could be considered independently (Barry, 1991; Bart, 1991, 1993; Birley, 1996; Cole, 1996; Frischer, 1993; Gordon, 1993; Hegarthy & Hoffman, 1990; House, 1988; Hurst, Rush & White, 1989; Mintzberg & Westley, 1989; Norburn, 1989, 1995; Quinn, 1985; Sun Tzu, 1963; Tichy & Devanna, 1986; Yukl, 1989; Zaleznik, 1977, 1992; Van de Ven, 1986; Vroom & Yetton, 1973). Observing however that these aspects are seldom encountered independently from each other but tend to appear in clusters (Barclay & Benson, 1990a,b; Bass, 1998; Burns, 1978; Goold & Campbell, 1987; Gordon, 1993; Hinings & Greenwood, 1988; Norburn & Schoenberg, 1992; Mintzberg, 1973, 1979; Vroom & Yetton, 1973; Yukl, 1989), two compound measures were adopted, each defined using several of the above aspects and combining much of the information identified by each of these. Indeed, and largely based on the work of Bass (1998), Burns (1978), Gordon (1993), Hinings and Greenwood (1988) and Yukl (1989), the constructs selected for identifying management style are leadership style and top management involvement (TMI). Leadership style is said to be either transactional or transformational. A transactional style is a "mutual influence between leaders and followers" working on the basis of "a reciprocal exchange relationship of costs and benefits" (Burns, 1978; Van de Ven, 1980). Decision-making takes place in a stable and certain framework where bureaucratic authority, formal rules, regulation, procedures and legitimate power are all visible and regularly exercised. The basis for guiding work is exchange, such as work done for money, security or other rewards but also effort, responsibility, honesty and fairness. Transactional leadership according to Ansari (1990), Bass (1985), Burns (1978), Hall (1991) and Hinings and Greenwood (1988) characterizes managers that are detached and manipulative. Transformational leadership on the other hand is based not on physical rewards, but on motivation. It works through a process in which leaders and followers raise one another to higher levels of morality and motivation (Burns, 1978; House, 1977; Yukl, 1989). 236 Evtmgelia Chortatsiani Transformational leaders often initiate and implement changes in the structure and strategy of the business and to people, challenging and changing the core beliefs, culture, structure and strategy, outcomes, careers, products, markets of the company (Ansari, 1990; Hall, 1991; Hinings & Greenwood, 1988; Vandermerwe & Birley, 1997) and sometimes an organization from one design archetype to another (organizational transformations) (Hall, 1991; Hinings & Greenwood, 1988; Tichy & Devanna, 1990). Transformational leadership formulates defines and restates overall values, vision and mission, strategic directions and organizational forms (Gordon, 1993; Hall, 1991; Van de Ven, 1986); it empowers and mobilises commitment to new directions, energises people in action and converts followers to new leaders and leaders into moral agents (Bass, Waldman, Avolio & Bebb, 1987; Bennis & Nanus, 1985; Burns, 1978; Ramanujam & Mensch, 1986; Tichy & Devanna, 1990; Yukl, 1989). According to Ansari (1990), Bass and Avolio (1990, 1991, 1993), Bradford and Cohen (1984), Burns (1978), Hall (1991), Hinings and Greenwood (1988) and Yukl (1989), transformational leadership is often exhibited by managers with vision and charisma, willing to undertake high personal risk, who use innovative strategies and communicate self-confidence and enthusiasm among employees. Top management involvement on the other hand considers such aspects as control exercised and formality of roles and rules (standardisation), decision making style, centralisation and centrality of power and authority and can be tight or hose (Hall, 1991; Quinn, Mintzberg & James, 1988; Pearce & Zahra, 1991; Vermaak, 1994). Tight control would involve senior intervention and supervision, checking in day-to-day operations, frequent contact with subordinates, tightness of operating activities and/or budgets (hands on versus hands off approach) and the provision of prompt g o / n o go decisions. Formality takes the form of a reliance for detailed reports, rules, policies and procedures for the purpose of monitoring and evaluating activities, the use of written goals, instructions and communications, written confirmation of decisions, formal job descriptions and roles, plans, frequent formal meetings held by senior management (standardisation), bureaucracy. Centralisation refers to power retention Product Development in Financial Services 237 by senior management over activities and the degree of dependency on the centre in the decision-making process. Power refers to the existence of concentrated force or coercion (centrality of power), while formal authority refers to budgetary and administrative authority and the use of resources and support provision, as made possible by hierarchical position. Top management involvement refers according to Abell (1975), Andrews (1980), Barclay and Benson (1990a,b), Drucker (1974), Hall (1991), Hollander (1971), Hambrick (1981), Johne (1984), Johne and Snelson (1990), Porter (1987), Ohmae (1982), Quinn, Mintzberg and James (1988), Van de Ven (1986) and Vermaak (1994) to the various ways in which senior management immerses itself to the details of the tasks to be carried out and is used for the purposes of this study to complement the leadership style measure. Having identified good reasons to expect management style to affect product development project success and selected two suitable constructs to measure it (leadership style and top management involvement), in view of the fact that leadership style has not yet been firmly established in the literature as a determinant factor for product development success in the financial services sector and given the theoretical and practical significance of the question, a testable hypothesis can now be formulated as follows: Hypothesis 1 Product development projects managed by transactional leaders will have a significantly different success than product development projects managed by transformational leaders (2-tailed hypothesis). The Relevance and Consequences of Product Newness In considering the quite extensive literature on product development and the requirements, processes and resources needed, product newness was found to have wide-ranging implications (Hart, 1996; Henderson & Clark, 1990; Johne & Snelson, 1990; Tidd, Bessant & Pavitt, 1997; Urban & Hauser, 1980; Utterback, 1971; Utterback, Mayer, Roberts & Reitberger, 1988; Van de Ven, Angle & Poole, 238 Evangdia Chortatsiani 1989). Indeed, the characteristics of new product development projects (NPD, major innovations, new product lines) and old product development project (OPD, minor innovations, product modifications) differ substantially in terms of expense, risk involved during the process, uncertainty process complexity and pursue of profitability (Bart, 1991; 1993; Johne, 1993; Johne & Snelson, 1989; 1990; Hegarty & Hoffman, 1990; Kotler, 1991; Urban & Hauser, 1980; Hart, 1996), while these two types of project appear to have different managerial, marketing and technical requirements (Johne & Snelson, 1989). This raises the question of whether a different management style would also be best suited for the two types of project (Bart, 1991; Barczak & Wilemon, 1989; McDonough III & Barczak, 1991; Johne & Snelson, 1989; 1990). This is a pertinent question, particularly in view of the burden of inputs to the innovation process, such as time and cost, and the risk and uncertainty involved (Johne, 1993; McDonough III, 1993; Piercy & Morgan, 1989; Tushman & Nadler, 1986; Vermaak, 1994) while at the same time pursuing profitability (Hart, 1996; Van de Ven, 1986; Wind, 1982). Precisely for these reasons newness should indeed make a difference. The expense, risk, uncertainty and process complexity involved in product development varies with newness, and so will the demands on senior management (Takeuchi & Nonaka, 1986; Tushman & Nadler, 1986). This argument is now taken further, by considering the two cases of NPD and OPD separately. The Case of NPD In the case of new product development, the R&D, forecasting, production, marketing, promotion, sales and all other costs are substantial and working capital and perhaps licensing requirements are high (Crawford, 1983). Project complexity, risk and uncertainty are also higher in the case of major innovations (McDonough III, 1990; Mensch & Ramanujam, 1986). NPD project difficulty, complexity and proper risk and cost assessment create a need for attention to the project, cautious progress in both the development Product Development in Financial Services 239 and launch stages and also the communication of vision, direction, good guidance, support and creative problem-solving (Johne & Snelson, 1989; 1990; Bart, 1991; 1993; Takeuchi & Nonaka, 1986; Tushman & Nadler, 1986). On the basis of its characteristics, therefore, NPD can be expected to flourish given an open, creative, supportive and visionary environment (Chakrabarti, 1974; Knight, 1987; Maidique, 1980; Mensch & Ramanujam, 1986; Quinn, 1985; Souder, 1981b; Takeuchi & Nonaka, 1986; Tushman & Nadler, 1986; Urban & Hauser, 1980). These are all transformational leadership characteristics and, therefore, there might be a case for arguing that transformational leadership would indeed be more suitable under the circumstances (Barclay & Benson, 1990a,b,c; Johne & Snelson, 1989). Indeed, the literature (Barczak & Wilemon, 1989; McDonough III & Barczak, 1992; Tushman & Nadler, 1986) suggests that transformational leaders are in a position provide better direction, guidance, support, motivation, create the appropriate climate, build and sustain morale and values, handle complex and difficult situations, minimise conflict, face resistance to radical change, undertake risk, solve problems which may occur during the process and guide and enable people to achieve the desired results, and also seek a wide variety of non-traditional, creative techniques for getting members to do their job. Transformational leaders are also better than transactional leaders in assessing the long-term horizon (based not only on their knowledge and expertise but also on their intuition and feelings), able to see and capture emerging product and market opportunities and assess the various changes which may occur in the environment properly and quickly (e.g. products, markets, technologies, processes etc) and can enable and energise key participants in the NPD process (Burns, 1978; Gordon, 1993; Van de Ven, Angle & Poole, 1989; Van de Ven & Tushman, 1989; Yukl, 1989). With NPD often only paying off in the long run, transformational leadership with its high visibility, ability to mobilise resources and properly assess the environmental changes and risks associated with change and innovation once more appears a better choice (Johne & Snelson, 1990; Tushman & Nadler, 1986). 240 Evangdia Chortatsitmi Transactional leadership, on the other hand, does not appear as suitable for those tasks and in those environments. Transactional leaders are attracted to the use of formal rules and procedures, rewards systems, performance incentives, skilful timing and the use of legitimate power (Burns, 1978) and rely less on such methods as employee commitment, influence or inspiration. Transactional managers concentrate on compromise, intrigue and control and tend to focus on the process, not the substance of issues. Managers' exchanges take place within a basically stable and known framework on the basis of routine decision-making (formality), rewards and security, an environment that does not foster an organizational capacity for change but, instead, stability and inertia. Similarly, vision in NPD cannot be obtained through an exchange of incentives that induces the compliance of followers, while the compliance associated with transactional leadership sometimes hinders the emergence of creative ideas and may simply be inadequate to overcome barriers to significant innovation. Transactional leadership, as a result, may negatively affect NPD project success (Van de Ven & Tushman, 1989; Manz, Bastien, Hostager & Shapiro, 1989; Yukl, 1989). A second hypothesis can therefore be formulated as follows: Hypothesis 2 New product development (NPD) projects managed by transformational leaders will be more successful than new product development (NPD) projects managed by transactional leaders (1-tailed hypothesis). The Case of OPD Old product development often requires only minor changes with regard to existing processes, technologies or markets. Therefore, the entire process entails lower risk and less uncertainty. Those working on the project know better what they are starting with and what they need to achieve. Product Development in Financial Services 241 Involvement Requirements Successful OPD can therefore run more easily by less senior people such as brand or technical project managers or operating teams (Barczak & Wilemon, 1989; Johne & Snelson, 1989; 1990; Mensch & Ramanujam, 1986), although some top management support would still be needed to ensure if nothing else that people lower in the hierarchy do not become exposed to responsibilities for which they have no authority to implement (Thamhain, 1990; Thamhain & Wilemon, 1987). In fact, detailed day-to-day top management involvement and control in OPD projects has little to add. It could meddle the process or limit the speed with which a project is undertaken. As Johne and Snelson (1990) argued that "staff energy may become wasted in briefing senior managers on problems faced during the process, rather than in applying control via the clear strategic objectives against which progress is checked". Leadership Requirements OPD projects have little need for transformational leadership either. What a product modification project typically needs is less imagination and enthusiasm and a lot of systematic work. Rules required for OPD are already established and are part of the daily activities of the business. In OPD, leaders tend to utilise a narrow range of familiar policies, activities or skills in fulfilling their objectives. This is perhaps why research conducted by McDonough III and Barczak (1992) found that when (transformational) leaders became involved in OPD (that involved familiar technologies), their presence was not a significant factor contributing to product development success. Achieving production efficiency or beating imitators in OPD cases often makes sticking to the schedule more important than eg. creating a sense of purpose (Johne & Snelson, 1989). It might be possible, in this case, that the use of transformational skills could even reduce an OPD project's chances of success although, as the literature argues (Bass, 1985; 1998; Burns, 1978) transformational leaders may, if they need to, lead using the methods of the transactional leader. 242 Evangelist Chortatsiani Transformational leaders for example, may well have no difficulty imposing their view or using their hierarchical authority, or bargain with employees, but they simply choose not to (Bass, 1985; Bass, Waldman, Avolio & Bebb, 1987; Gordon, 1993; Yukl, 1989). If a transformational leader needs to manage an OPD project, therefore, he* could very well realise that transformational skills are not what is required. Instead, he could use, for as long as is required, more transactional skills. However, as Bass (1985; 1998) argue, the opposite does not hold true, and a transactional leader would find it very difficult to lead in transformational ways. Involvement Requirements, again Much more likely, however, a transformational leader charged with an OPD project may decide not to lead it at all (Barczak & Wilemon, 1989; Johne & Snelson, 1989). He may consider that the leadership required is not to his liking; that the tasks/issues involved are not sufficiently challenging to warrant the amount of attention required; or that he is not really making good use of his time. As a result, he could, instead, delegate many of his responsibilities (Barczak & Wilemon, 1991; Bass, 1985; 1998; Gordon, 1993; McDonough III & Barczak, 1991; McDonough III, 1993; Van de Ven, 1989), perhaps to a more transactional manager or the project manager (Bass, 1998; Burns, 1978; Grint, 1997; Manz, Bastien, Hostager & Shapiro, 1989), trying to prevent unnecessary and time consuming co-ordination activities (e.g. whereby he would request reports that he would not really be using) and thereby accelerating the product development process (Dumaine, 1989; Hinings & Greenwood, 1988; Johne & Snelson, 1990; McDonough III & Barczak, 1991; McDonough III & Leifer, 1986). In doing so, he would not be delegating anything he was particularly good at, or that others could not do equally well. *To avoid awkward phrasing using "he or she", the term "he" is used instead to refer to both sexes. Product Development in Financial Services 243 This is consistent with Bart (1991; 1993), who argues that an organization's ongoing or established products or businesses (OPD) need to be managed and controlled differently than NPD projects. For OPD to be successful, less control and involvement would be required, with general [senior] managers using a "looser" style. Bart attributed this to their familiarity with products, processes or technologies, lower risk and uncertainty and, therefore, also a reduced need to be close. Transactional leaders, on the other hand, prefer stable environments and maintaining competitive positions in existing businesses with existing products/markets, using formal and familiar methods and techniques (Bass, 1985; Barczak & Wilemon, 1989; 1991; McDonough III, 1990). As a result, they see their own activities as defined and limited in scope and approach them administratively (Manz, Bastien, Hostager & Shapiro, 1989). Transactional leaders, therefore, find it in their nature to lead OPD projects. They will not delegate as much responsibility to project managers and, instead, they will make sure that they are kept informed at every step. Quite possibly, too, they may go as far as try to avoid NPD projects, which they may see as requiring quite a different style for success. If that is so, transactional leaders will have one more reason not to delegate in OPD projects, as these would then necessarily take up most of their attention (McDonough III, 1990). Further, keeping a close watch on the implementation of the (often pre-determined) incremental steps required for OPD, cannot be expected to adversely affect the project's success either. The fact that they do not delegate as much, therefore, is neutral to positive, but not negative as far as project success is concerned. Consequendy, a third, hypothesis can be formulated as follows: Hypothesis 3 Transformational leaders managing old product development (OPD) projects will delegate more of their responsibilities than transactional leaders managing old product development (OPD) projects (1-tailed hypothesis). 244 Evangelia Chortatsiani Table 9.1 TMI as a function of leadership style for successful OPD (H.3). Product Newness OPD NPD Leadership Transactional Tight > Style Transformational Loose > It should be stressed again here that the same does not also hold for NPD projects, where a clear argument about delegation cannot easily be made, one way or the other. This must be left for another study with a different focus. Such a study could perhaps begin by trying to resolve the apparent conflict between the findings of Johne (1984) and Johne and Snelson (1989), who found that tight and formal control is required for N P D projects, and McDonough III and Leifer (1986), who supported that a more delegative style is required for managing the same projects. Leadership Requirements, again This leaves the scope open to consider the effect on OPD project success itself. On the basis of the arguments just developed and the literature just cited, both transactional and transformational leaders can be expected to manage these projects with a reasonable (and not substantially different) degree of success, albeit each in a different way. Indeed, Barczak and Wilemon (1989), Manz, Bastien, Hostager and Shapiro (1989), and Johne and Snelson (1989, 1990) argued that senior managers with administrative, co-ordinating and control skills and abilities (equivalent to this study's transactional leaders) would be successful when managing OPD programmes, precisely because it is those skills that are required in such projects. Transactional leaders are also more competent when they have to operate in a more stable organizational environment and deal with low risk activities, which makes them suitable for OPD projects (Johne & Snelson, 1989; McDonough III, 1990; McDonough III & Leifer, 1986). Product Development in Financial Services 245 Transformational leaders cannot be argued to have a particular problem with these projects, either (Bart, 1991; 1993), as the tasks and skills required for the management of an OPD project are known and within the repertory of transformational leaders (Bass, 1985; Bass & Barrett, 1981; Burns, 1978; Hater & Bass, 1988; Yukl, 1989; Hollander, 1971). Transformational leaders, many of whom have spent time managing in the way that transactional leaders manage, will find it easy to switch back to transactional style should the need arise (e.g. if they have to improve an OPD project which is important for the corporation (Bass, 1998). The opposite, with transactional leaders turning transformational at short notice would not be that easy (Bass, 1998; Burns, 1978; Hollander, 1971; 1978; Gordon, 1993). Much more likely, however, as already argued, transformational leaders in charge of OPD projects will delegate many of their responsibilities to the project manager or other project people, able to do the progress checking and budget reviewing necessary and certainly selected in a way that does not compromise project success. Overall, therefore, both kinds of leader can be expected to do well, each working in their own way (TMI) and there is no reason to expect that OPD projects managed by transformational leaders will be more successful, or indeed less successful, than those managed by transactional leaders. A final hypothesis can, therefore, be formulated as follows: Hypothesis 4 Old product development ( O P D ) projects managed by transactional leaders will not be more or less successful than old product development (OPD) projects managed by transformational leaders (2-tailed hypothesis). The table below summarises hypotheses 2 and 4, which test the relationship between the two rows in each of the columns, bearing in mind that the Hi's and LO's are only comparable within each column and not horizontally. This is the case not only as the two horizontal relationships do not correspond to any hypothesis developed, but also because different measures of success would 246 Evtmgdia, Chortatsiani Table 9.2 Project success as a function of leadership style and newness (H.2 & H.4). Product Newness OPD NPD Leadership Transactional HI LO Style Transformational HI HI apply; a product modification would probably be considered to be a failure if it did not turn a profit within few months, but a longer pay-back horizon would normally be allowed for a NPD project. Measuring Product Development Project Success In order to complete this discussion and proceed to testing the hypotheses, what remains is for product development project success to be operationalised. By setting the objective to be successful product development, one immediately comes across the difficulties created by the multidimensional nature of the concept. Indeed, a quick review of the literature reveals a large number of operationalisations for the dependent variable, which can be classified in four basic categories with a very different orientation (Barczak & Wilemon, 1991; Cooper & Kleinschmidt, 1987a,b,d; Cooper & de Brentani, 1991; Craig & Hart, 1992; de Brentani 1989a,b, 1991; Easingwood & Mahajan, 1989; Graig & Hart, 1992; Griffin & Page, 1993; Hauschildt, 1991; Hart, 1993, 1996; Hultink & Robben 1995; Johne & Pavlidis, 1991; Kimball, 1997; Maidique & Zirger, 1985; McDonough & Barczak 1991; Nystrom & Edvardsson, 1982; Tidd, Driver & Saunders, 1995; Yoon & Lilien, 1985): • Financial and cost criteria • Customer r e s p o n s e / m a r k e t criteria/competitive opportunity window posture/ Product Development in Financial Services 247 • Technical criteria (quality of product, speed of development) • Other (leader's career etc.) Given that the broadest possible measure would be desirable for the purposes of this study, suitable for use with all kinds of projects, Craig and Hart (1992) and Hart's (1993; 1996) approach was adopted and success was measured as a multi-dimensional concept combining all the above aspects working cumulatively; the more ways in which a project was found to be successful, the higher the overall score awarded (Hart, 1993; Pavlidis, 1993). 9.3 Methodology and Data Collection In order to explore the above relationships and test the hypotheses developed, data were collected using a survey-based methodology. A detailed, 12-page research questionnaire was developed, piloted with six carefully selected respondents and then administered to 170 programme managers responsible for 85 old product development projects and 85 new product development projects. A programme manager was defined as the person (typically at the senior divisional/SBU or programme level) in the organizational hierarchy who has responsibility for managing at least two product development projects simultaneously. As it is the programme/SBU level where new product development actually takes place, leadership has been chosen to be measured at this level (Datta, 1991; Hunt, 1971; Johne & Snelson, 1990; Johne & Vermaak, 1993; Leontiadis, 1984; Souder, 1981b). The unit of analysis was the (individual) product development project, taking place in the selected programme or business of an UK-based financial services companies, while the population was defined as the number of product development projects carried out by British and foreign owned, large and small in size, financial services companies in the UK, which have also been completed with the relevant product being launched at least a year before the study began so that its success could be properly measured. 248 Evangelia Chortatsiani A large (well over 30 cases), heterogeneous but still representative sample was aimed for. This was done using a quasi-stratified selection process (Churchill, 1995), trying to maintain a balance between NPD and OPD projects, successful and less successful projects and projects from each of the three sectors of the industry (banks, building societies and insurance companies). No effort was made however to maintain a balance between transactional and transformational respondents or those exhibiting tight and loose involvement, simply because determining a manager's style along these dimensions is a complicated process that can only take place once full data from that manager has been collected. Out of the 170 questionnaires mailed out, 60 questionnaires were returned from 25 companies. Some key sample characteristics are shown in Table 9.3. Table 9.3 Key sample characteristics. Classsification/Cases Characteristic Sample Number of replies % of Total 170 60 53 31% Total questionnaires sent Replies Usable replies Industry Banks Insurance companies Building societies 15 5 5 60% 20% 20% Product Newness Major innovations (NPD) Minor innovations/modifications (OPD) 25 47% 28 52% Project Success Successful or reasonably successful Less successful or failure 40 13 75.5% 24.5% Leadership Style* Transactional Transformational 29 24 54.7% 45.3% Top Management Involvement (TMI)* Tight Loose 38 15 71.7% 28.3% *Identified as such during data analysis, as explained below. Product Development in Financial Services 249 9.4 Data Analysis Overview The sample was analyzed using quantitative, mostly statistical techniques (means comparing t-tests and chi-square tests were chosen as the primary mode of analysis, while multivariate regression was subsequently used to built a predictive model). The steps taken to analyse the data are outlined in Table 9.4 and then described in more detail. Once the results were collected, the first task was to perform some validation tests, to ensure that it was indeed a program manager that had provided the information. Of the 60 questionnaires received, 53 passed the test. Data Reduction The data collected needed to be reduced and the answers to the 175 questions distilled down to assign values to the four key variables needed for the purposes of the research. Each questionnaire (describing a style and a project) was classified according to whether it described the style of a transactional or transformational leader (leadership style); of a tight or a loose controller (TMI); whether the project was a major (NPD) or a minor innovation (OLD) (project newness) and whether the project was successful or not (project success). This critical step was performed in two ways, qualitatively and quantitatively (using factor analysis) and the results of both methods were compared. Data reduction was performed qualitatively by carefully reading each completed questionnaire and assigning, based on experience, the literature and expert and peer discussion a score to each of the four variables. Variables were given values on a 1-5 scale with one decimal point, without ever assigning the value of 2.5 (5.0 corresponded to (very) transformational, loose involvement, NPD, successful, respectively). Each variable was also assigned a binary 0 or 1 value according to which side of the 2.5 mid point the 1-5 value fell, facilitating tabulations without loss of accuracy. 250 Evangelia Cbortatsiani Table 9.4 Outline of analysis techniques. Purpose of Analysis Data reduction Nature of Analysis Details-Variables Researcher's perception, Leadership style, TMI, review of the literature project newness, project review & discussions success with experts (qualitative) Correlation analysis, Bartlett's test of sphericity, factor analysis (quantitative) Control variables, leadership style, TMI, project newness, project success Consistency checking for above two analyses — Scatter plots, correlation analysis, significance tests, linear regression Leadership style, TMI, project newness, project success Overview of data collected Tabulations Leadership style, TMI, project newness, project success Hypotheses testing (univariate) Tabulations, ?-tests, chi-squared tests (quantitative) Leadership style, TMI, project newness, project success Analysis of open-ended data collected Tabulations, frequency analysis As provided by respondents (factors contributing to project success & failure) Model building (multivariate) Logistic regression Leadership style, TMI, project newness, project success The scoring was performed twice, on different occasions, to enhance reliability. The number of questionnaires falling in each category was described in the data collection section. The same was carried out quantitatively, by performing four factor analyses with varimax rotation, one for each of the key variables Product Development in Financial Services 251 considered. On the basis of correlation analysis, some variables from the instrument were found to be closely related to each other and these were not included in factor analysis. The factors generated for each of the variables were then interpreted and named and it was verified that they were indeed measuring what the qualitative procedure had already measured. Any discrepancies were analyzed and resolved. Factor analyses were conducted for the control, leadership style, TMI and success variables, as follows: Table 9.5 Control variables factors. Factor Factor Description (Control Variables) % of variance explained Factor 1 Informal, project cross-functional communication and co-operation (quality of task and interpersonal relationships, collaboration, shared values and beliefs) 17.5% Factor 2 Project risk and uncertainty 12.2% Factor 3 Whether the product is subject to regulation (the absence of a regulated environment is a further cause of increased risk) 10.0% Factor 4 A company's preferred organizational arrangement for innovation (i.e. whether the company as a whole has institutionalized product development e.g. through job rotation, training etc., or whether most innovation efforts are carried out on the basis of individual people's initiative and effort) 8.5% Factor 5 Internal and external risks (i.e. market sources of risk) 7.8% Factor 6 Flexibility during the latter stages of the NPD process 7.5% Internal sources of risk and uncertainty (i.e. dangers that may arise during project implementation or launch stage) 7.1% TOTAL 70.7% 252 Evangdia Chortatsicmi The control variables analysis itself generated seven components (factors) with an eigenvalue above 1. Together, these explained 70.7% of the total variance in the variables to be reduced, as shown in Table 9.5. As far as management style is concerned, two factor analyses were carried out, one for each of leadership style and TMI. The analysis for leadership style generated six components (factors) with an eigenvalue above 1. Together, these explained 72.1% of the total variance in the data to be reduced, as shown in Table 9.6. Similarly, the analysis for top management involvement generated four components (factors) with an eigenvalue above 1. Together, these explained 71.1% of the total variance in the data (Table 9.7). Table 9.6 Leadership style factors. Factor Factor Description (Leadership Style) % of variance explained Factor 1 Transformational leadership 24.5% Factor 2 Unconventionality/Intuitiveness 13.7% Factor 3 "kinder-garden teacher" (a person who would typically direct less and influence more, and would also not show sufficient trust to others when it came to important matters) 10.4% Factor 4 Sharing values and beliefs with others working on the project 9.1% Factor 5 Communicating project difficulties with employees 7.7% Factor 6 The extent to which the respondent keeps up to date with relevant scientific and other necessary skills and knowledge 6.6% TOTAL 72.1% Product Development in Financial Services 253 Table 9.7 TMI factors. Factor Factor Description (TMI) % of variance explained Factor 1 Formal and authority based management 25.5% Factor 2 Willingness to delegate 19.4% Factor 3 Whether a person is "power hungry", using formality and procedures to achieve objectives 15.2% Factor 4 Hands-on style during the early stages of product development 11.0% TOTAL 71.1% Table 9.8 Project success factors. Factor Factor Description (Project Success) % of variance explained Factor 1 All aspects of a project's success 39.9% Factor 2 Project's success related to cross-selling 10.8% Factor 3 Process success 9.0% Factor 4 Sticking to the time-frame and, to a lesser extent, the ability to exploit further opportunities 7.7% TOTAL 67.4% Finally, the analysis on project success variables generated four components with an eigenvalue above 1. Together, these explained 67.4% of the total variance in the variables to be reduced (Table 9.8). Summarising, the four factor analyses performed generated seven, six, four and four useful factors, respectively. On average, these have captured about 70% of the variance in die data. By looking 254 Evangelia Chortatsiani at these factors, there are two very important observations that can be made. First, like in any factor analysis, the first factor generated accounted for most of the variance in the data. In the case of the first success factor, this explained 39.9% of the total variance, which is more than what the remaining three factors can do together. This is a very useful property; by naming factor 1 for success, this factor has already become a good candidate for being the only measure of project success. Second, this first factor in each case (except that for the control variables) measures a construct very similar to leadership style, TMI and project success, respectively. Indeed, this consistency between the two was further established using scatter plots, correlation analyses at first, and significance tests and a linear regression model subsequently. The two tailed significance of the correlation coefficients linking the qualitatively and quantitatively developed measures for leadership style, TMI and project success were 0.000, 0.050 and 0.000 respectively, indicating a relationship at the 5% significance level for all variables and very close indeed for leadership style and project success. By accepting that the first factor contains much of the information needed, further analysis is greatly simplified particularly in the case of the project success dependent variable. Hypothesis Testing The core of the analysis was then carried out, testing the four hypotheses developed. Specifically, a series of t-tests was conducted to ascertain whether the effects previously hypothesised were in fact observed in the study's sample and could be statistically expected to also apply to the population (t-tests can ascertain whether the difference in two mean scores is significant or not). Some other supporting tests were also carried out to further explore the data collected, while chi-squared tests were also undertaken where sample size allowed. Product Development in Financial Services 255 Hypothesis 1 Product development projects managed by transactional leaders will have a significantly different success than projects managed by transformational leaders (2-tailed). With regard to hypothesis 1, a t-test carried out established that projects managed by transformational leaders will have a significantly different (higher, in fact) success than projects manager by transactional leaders. Transactional leaders had a 3.158 average success score against 3.634 for transformational, with the applicable two tailed significance of the differences in the means measuring 0.046, within the 5% margin but not comfortably so. This indicates that leadership style does matter for product development project success, as anticipated. To further establish this relationship, a chi-squared test was performed on the similarity of frequencies. The data was categorised in highly and less successful projects, managed by each of transactional and transformational leaders as in Table 9.9. It was once more confirmed that, overall, transformational leaders appeared to be more successful with 26 successes and three failures compared with transactional leaders' 14 successes and 10 failures. Table 9.9 Leadership style and project success. S_MV01 Count Tot Pet 0 Transactional 1 Transformational Low 0 High 1 10 18.9 14 26.4 24 45.3 3 5.7 26 49.1 29 54.7 53 Column 13 40 Total 24.5 75.5 Row Total 100.0 256 Evangelia. Cbortatsiani Both analyses confirmed the existence of sufficient statistical support for accepting hypothesis 1. This means that leadership style (as operationalised along the transactional/transformational basis) is indeed a significant factor in determining product development project success. If the theory developed earlier held true, however, this would only be part of the picture and the relationship between leadership style and project success would be moderated by project newness. The role of newness was tested next. Hypothesis 2 New product development (NPD) projects managed by transformational leaders will be more successful than new product development (NPD) projects managed by transactional leaders (1-tailed). Tabulating the success of the 25 NPD projects against leadership style showed that transformational leaders achieved a success rate of 85% (17 out of 20) in managing NPD projects, compared to only 40% for transactional leaders and an average success score of 75.5%, measured previously (Table 9.10). Table 9.10 Leadership style and NPD success. S_MV01 Count Tot Pet Low 0 High 1 0 Transactional 3 12.0 2 8.0 5 20.0 1 Transformational 3 12.0 17 68.0 20 80.0 19 25 Column Total 6 24.0 76.0 Row Total 100.0 Product Development in Financial Services 257 To establish whether this is held true in the entire population as it did in the sample, a £-test was carried out. The mean success for transactionally and transformationally led projects was 2.6800 and 3.6000, respectively, with the applicable 1-tailed significance indicating, at just 0.020, that difference to be significant. Hypothesis 3 Transformational leaders managing old product development (OPD) projects will delegate more of their responsibilities than transactional leaders managing OPD projects (1-tailed). Tabulating TMI for transactional and transformational leaders in OPD showed that two out of three (66.7%) transformational leaders delegate substantially, while 33.3% do not (Table 9.11). The corresponding t-test also showed that the mean involvement for transformational leaders when managing OPD projects was lower than for transactional leaders (3.9 against 2.4, 5 being the loosest). Moreover, this difference was found to be significant, as the 1-tailed significance reached 0.0015. It can be concluded therefore that transformational leaders managing OPD projects will delegate significantly more of their responsibilities than transactional leaders will when managing the same projects. In other words, sufficient support has been found to accept hypothesis 3. Table 9.11 TMI for transactional and transformational leaders in OPD. S_MV01 Loose 1 Row Total Count Tot Pet Tight 0 0 Transactional 17 60.7 2 7.1 19 67.9 1 Transformational 3 10.7 6 21.4 9 32.1 Column 20 Total 71.4 8 28 28.6 100.0 258 Evangelia Chortatsiani Further Comments on Hypothesis 3 Attention then turned to whether the same can be observed with N P D projects. A tabulation of T M I for transactional and transformational leaders managing NPD projects did show the two delegating to a similar extent (in fact, both types of leader were largely tight controllers when managing these projects). The lack of any significant difference was also confirmed by performing a t-test, the two means being 2.9800 against 2.8300, respectively and that difference not having any statistical significance. To explore this further, transformational and transactional leaders were then considered separately. In the case of transformational leaders, these appeared to become somewhat tighter in NPD than in OPD, the mean involvement reaching 2.8300 against 3.2889, respectively. The difference was not found to be significant, however, as the 2-tailed significance was 0.086. This fails the 5% test, but the relationship would have been significant if tested as a one tailed hypothesis. For lack of a suitable theoretical background, however, this is not appropriate at this stage. In the case of transactional leaders, the associated t-test results are surprising. Transactional leaders seem to manage more loosely NPD projects than OPD projects, with mean scores of 2.9800 and 2.4053, respectively. However, this relationship is only significant if tested as a one tailed hypothesis (the 2-tailed significance was 0.077) and, once more, must be rejected. Finally, leadership style and TMI attitudes where then tabulated irrespective of product newness (all projects, OPD & NPD were included). This indicated that 71.7% of all leaders in the sample manage projects tightly as opposed to loosely, and also that the number of transactional programme managers in the sample that are loose controllers is very small. All of the above testing regarding the relationship of TMI with leadership style has not been numerically associated with project success. As a result, the tests can only describe characteristics of the sample or the population along these dimensions, and cannot suggest ways of adjusting TMI to improve project success. Product Development in Financial Services 259 Hypothesis 4 Old product development ( O P D ) projects managed by transactional leaders will not be more or less successful than old product development (OPD) projects managed by transformational leaders (2-tailed). Tabulating the success of OPD projects managed by transactional and transformational leaders leads to the observation that transformational leaders were also successful in the few cases where they managed an OPD project, while none of the OPD projects in the sample managed by them failed (Table 9.12). With regard to hypothesis 4, it is not immediately obvious whether this holds true, although it may seem that transformational leaders are better at avoiding to manage (or taking responsibility for) low success projects. In order to decide whether the hypothesis holds true or not in a decisive way, a £-test comparison of means is required. The mean success for OPD projects managed by transactional leaders was found to be 3.2842, while for projects managed by transformational leaders the mean score was 3.7111. Given a 2 tailed significance of 0.083, any such difference cannot be said to be significant. It can be concluded, therefore, that that the success of OPD projects managed by transactional and transformational leaders will not be significantly different. Table 9.12 Project success and leadership style in OPD. S_MV01 Row Total Count Tot Pet Low 0 High 1 0 Transactional 7 25.0 12 42.9 19 67.9 9 32.1 9 32.1 21 28 1 Transformational Column Total 7 25.0 75.0 100.0 260 Evangelia Chortatsicmi Table 9.13 Mean project success as a function of leadership style and product newness (H.2 & H.4). Product Newness NPD OPD Leadership Transactional 2.68 3.28 Style Transformational 1 3.60 3.71 Further Comments on Hypotheses 2 and 4 Table 9.13 summarises the mean success calculated in testing hypotheses 2 and 4. With the significance of the two vertical relationships having been established when testing hypotheses 2 and 4, respectively, the two horizontal relationships were explored next using, once more, means comparing t-tests. In fact, tested as 2-tailed hypotheses, both differences failed the significance test. In other words, if there is a particular leader in an organization (either transactional or transformational), then there is no point in finding an appropriate (NPD or OPD) project for that leader. Both projects will be similarly successful. It should be stressed however, that the opposite does not hold true and, as the testing of hypotheses 2 has already indicated, finding a suitable leader for a NPD project is an important and rewarding task. Analysis of the Data from the Open-ended Component of the Instrument The data collected from the open-ended component of the questionnaire, namely the factors that programme managers believed themselves to aid and jeopardise project success, respectively, were analysed next (Table 9.14). Product Development in Financial Services 261 Table 9.14 Factors contributing to project success (respondents' own views) Respondent Views (standardised/as expressed) Times Suggested Teamworking Multidisciplinary/cross-functional teams 17 Top management contribution Leadership; commitment; support; attention; awareness; corporate willingness to help; top involvement during the early stages of NPD 14 Positioning and product specification Product literature; good market research and market analysis/evaluation; price differentiation; unique sales propositions; selection of low entry point in the market; identification of a niche; strong product positioning 13 People/Staff Expertise; previous experience of proven products; staff willingness to help; co-ordinated effort; communication and co-operation; commitment 11 Speed in NPD Fast delivery to the market place; smooth delivery; being the first entrant in the marketplace Project management Project actuarially led; good management principles; project management skills; functional liaison NPD planning Well-organized planning process; clear mission; clarity of objectives; adherence to the plan-meeting interim goalposts NPD process Focus on the process; co-ordinated effort during the NPD process; emphasis on product launch; smooth implementation; process simplification Innovation Product uniqueness; technological innovation; no imitation Skills Utilisation of diverse skills; cross-functional skills; negotiating skills; marketing skills 262 Evangelia Chortatsiani Table 9.15 Factors jeopardising project success (respondents' own views). Respondent Views (standardised/as expressed) Times Suggested Competition Competition between SBUs; competition from other companies; low market share 17 Availability of Availability of people (i.e. marketing and R&D specialists); availability of financial resources; IT resources; lack of development resources; resource conflict 14 Uncertainty and risk Country risk; legislative and regulatory changes; financial risk; technological risk; the uncertainty of entering new markets; risk adverse management 13 Complexity Product; project/process; technological; IT systems; complexity greater than originally envisaged 11 Planning and objectives setting Changing priorities; inconsistent objectives; lack of clarity of objectives; misunderstandings; different objectives between corporate level and SBU; different objectives of partners; lack of marketing and sales objectives uncertain outcomes Customers Changes in customers' funding needs; changes in customers' perceptions and preferences; lack of interest from customers; sales lower than expected Product targeting, positioning and specification Wrong targeting; wrong market movement; bad pricing Product cannibalisation Product cannibalisation resources (financial, human, technological) Politics and Politics and company culture company culture Parallel NPD Interrelated projects 3 Product Development in Financial Services 263 These factors were fully consistent with the literature and did not produce an additional variable not considered when designing the instrument. The range of issues and the priorities set by those executives responsible for product development in the UK financial services industry however, is revealing of their thoughts and concerns and offers valuable insight. Multivariate Model Building Having ascertained the value and role of each individual variable, an effort was then made to combine their explanatory power in a multivariate predictive model of project success. A logistic regression was then carried out to try to predict project success on the basis a project's environment (controls), characteristics (newness) and its programme manager's style. The model was created using the "enter" method, whereby all variables that pass the tolerance test become part of the final regression equation and, as can be seen from the table below, was capable of accurately predicting the success of 49 out of the (the sample's) 53 projects (Table 9.16). The overall equation's significance was 0.0037, while all coefficients were justifiable. 9.5 Interpretation of the Findings Results from Hypothesis Testing Having reviewed the literature, generated testable hypotheses, set out a methodology to test these hypotheses and collected and Table 9.16 A logistic regression model to predict project success. Predicted Low L High H Percent Correct Low L 11 2 84.62% High H 2 38 95.00% Overall 92.45% 264 Evangelia Chortatsiani statistically analysed the data, what remains now is a discussion of the findings, to see whether these are consistent with the theory and with the findings and experience of other researchers as reported in the literature. With regard to hypothesis 1, leadership style, as operationalised along the transactional/transformational basis, has indeed been found to be a significant factor in determining product development success. Despite the fact that most researchers use their own classification variants for leadership style, making direct comparisons difficult, there is abundant support for the above conclusion (Barczak & Wilemon, 1991; Barnowe, 1975; Frischer, 1993; Hater & Bass, 1988; Gordon, 1993; Pinto & Pinto, 1990; Scott & Bruce, 1994; Takeuchi & Nonaka, 1986). This is not taken further, however, as the following hypothesis explores a slightly more involved version of the same hypothesis. With regard to hypothesis 2, it has been established that NPD projects managed by transformational leaders are significantly more successful from NPD projects managed by transactional leaders. Again, this is consistent with key studies in the area (Bass, 1981; 1998; Barczak & Wilemon, 1991; Grint, 1997; Yukl, 1981; Van de Ven, 1986). A possible explanation is that transformational leaders are better at selecting the projects that have a greater chance of success, or that they are better at negotiating which projects they will assume responsibility for (Manz, Bastien, Hostager & Shapiro, 1989). More likely, however, as hypothesised, NPD projects require skills not possessed by transactional leaders, so projects managed by the latter do suffer in performance (McDonough III, 1990). With regard to hypothesis 3, the statistical analysis concluded that transformational leaders managing old product development projects will delegate more of their responsibilities than transactional leaders managing old product development projects. This is fully consistent with the literature. Research conducted by Johne and Snelson (1989) in the manufacturing sector found that in active product developer firms, top management tends to Product Development in Financial Services 265 relinquish day-to-day control of OPD projects and delegate responsibilities to others, although it continues to check progress against results. In less active product developer firms top management either distances itself from or meddles in development projects on an ad-hoc basis. One possible explanation is that they find the tasks involved lack interest for them. Also, they may find that they can add little by getting involved in that way (Bass, 1985; 1998; Gordon, 1993; McDonough III & Barczak, 1991; Van de Ven, Angle & Poole, 1989). By avoiding to participate, transformational leaders may be preventing unnecessary and time-consuming co-ordination activities. Looser control, or delegation of the work to teams, in that case, leads to accelerated (speedier) product development (Barczak & Wilemon, 1 9 9 1 ; McDonough I I I , 1993). Another possible explanation is that intensity of competition, high risks and uncertainty force them to remain constantly engaged in major innovations, where they just been shown to make a difference, so there is less time left for OPD (Barczak & Wilemon, 1989, 1991; Dumaine, 1989; Hinings & Greenwood, 1988; McDonough III & Barczak, 1991; McDonough III & Leifer, 1986). Further testing around hypothesis 3 also identified that the same relationship between leadership style and TMI cannot be observed for NPD projects. In other words, transformational leaders managing N P D projects do not delegate significantly more of their responsibilities than transactional leaders do. This is consistent with Drucker (1988), Johne (1984), Johne and Snelson (1989), McDonough III and Leifer (1986) and Mensch and Ramanujam (1986), who have argued in favor of close contact of project leadership with project people and the sharing a vision with them as well as commitment and day-to-day intervention. Similarly, research conducted by Johne and Snelson (1989) in the manufacturing sector found that in active product developer firms, senior management becomes involved in the NPD process on a day-to-day basis, recognising the extra leverage required to push along risky developments and envisioning, energising and enabling the innovation process (leading the process). Furthermore, as NPD projects usually 266 Evangelia Chortatsiani only pay off in the medium to long run, the ongoing support of senior management is required (Barclay, Benson & Lunt, 1990; McDonough III, 1990; Tidd, Bessant & Pavitt, 1997). Yet more testing around hypothesis 3 reveals that (i) transformational leaders are somewhat (but not significantly) looser when managing OPD than when managing NPD (Bart, 1991; 1993) and (ii) that transactional leaders are somewhat (but not significantly) looser when managing NPD than when managing OPD, while transformational leaders become a little (but not significantly) tighter controllers when managing NPD than when managing OPD projects. This latter observation might be explained by the fact that transactional leaders have perhaps never had the chance to learn how to cope with uncertainty, change and risk. As a result, they may not prefer to actively take initiative and responsibility for NPD projects, the failure of which could jeopardise their careers (Bass, 1998; Grint, 1997). In the case of transformational leaders found to be tighter when managing NPD than when managing OPD, this might be the case because, with major, risky and complex or advanced innovations (NPD), it is often difficult for buyers to understand the product, its complexity or how it can be used and key negotiators must be well aware of the necessary detail (Barczak & Wilemon, 1991). Finally, with regard to hypothesis 4, it was concluded that the success of OPD projects managed by transactional and transformational leaders is not significantly different. In fact, OPD projects managed by either type of leader were both found to be reasonably successful. Transactional leaders can be more effective when they have to work and operate in a more stable organizational environment or when they have to deal with low risk activities rather than with major innovations that entail high risks. As a result, they can do a better job with OPD projects, which possess these exact characteristics (Barczak & Wilemon, 1989; Johne & Snelson, 1989; McDonough III, 1990; McDonough III & Leifer, 1986). There might also be cases where transformational leaders may decide not to delegate because there are no other major or important Product Development in Financial Services 267 NPD projects to get involved with, or due to the particular significance of a specific OPD project. A company, for example, may have a very important product accounting for e.g. a sizeable part of its revenues, which it decides to improve. It can then be expected to make sure tJiat even the smallest modification receives full attention. If a transformational leader remains actively in charge of an OPD project, therefore, he/she might well revert to a more transactional style (Bass, 1985; 1998; Barczak & Wilemon, 1989; Bass, Waldman, Avolio & Bebb, 1987; Burns, 1978; Gordon, 1993; Grint, 1997; 1971; Yukl, 1989). To conclude, both kinds of leader can be expected to do well, and there is no reason to expect that OPD projects managed by transformational leaders will be more successful, or indeed less successful, than those managed by transactional leaders. An indirect implication of testing hypotheses 2 and 4 is that, although finding a suitable leader to manage an NPD project is a rewarding task, taking time to assign appropriate projects given a particular leader is less of a worthwhile activity. This may appear curious, and given the fact that the latter findings have been derived when asking different questions (hypotheses), they cannot be relied upon as yet; further research is needed. With the cost of hiring top management running into several months' remuneration, however, it is certainly an important question to answer. Results from the Open-ended Component of the Research Research participants were given the opportunity to name their own factors contributing to both product development project success and failure. Combining standardising their responses, some very interesting conclusions can be reached, fully consistent with the literature. Indeed, 17 respondents supported that teamworking is the most important contributor to product success (de Brentani, 1989a; Gupta & Wilemon, 1988); 14 respondents supported that senior involvement (perceived by respondents as leadership, commitment, support, attention, awareness and corporate willingness to help) is also an important contributor to product development 268 Evangelia Chortatsiani success (Booz, Allen & Hamilton, 1982; Dwyer & Mellor, 1991b; Hegarty & Hoffman, 1990; Maidique & Zirger, 1984); while 13 respondents believed that positioning in the market (Cooper, 1983; 1984a; Cooper & Kleinschmidt, 1995; Dwyer & Mellor, 1991b; Maidique & Zirger, 1984) and product specification (perceived as product literature, good research and market analysis/evaluation, price differentiation, unique sales propositions, selection of low entry point in the market, identification of a niche, and strong product positioning) are also significant (Cooper, 1979; 1988a,b; Cooper & de Brentani, 1984; 1991; Cooper & Kleinschmidt, 1995; Dwyer & Mellor, 1991b; Maidique & Zirger, 1984) were also very important. Similarly, 17 respondents thought that competition (from competitive products, from within the company/SBU, or thought low market share) was the most important factor jeopardising project success (Cooper, 1975; 1979; Hopkins, 1981; Maidique & Zirger, 1984); 14 respondents thought that the availability of resources (such as people, financial resources, IT support or resource conflict) was critical (Maidique & Zirger, 1984); while 13 respondents found that uncertainty and risk (legislative and regulatory, country, financial or technological risk, a risk adverse management, the uncertainty of entering new markets, and in general any type of risk associated with change) was also an important factor (Cooper, 1979; Maidique & Zirger, 1984). Results from Model Building The purpose of the model built with the variables that emerged as of primary importance in the previous sections was to ascertain whether the predictive power of each individual variable could be combined effectively. Indeed, such model could then be used to (i) identify the optimal candidate to oversee a particular product development project and (ii) to help people in charge of such projects adjust their management style to the one expected to maximise their effectiveness. Product Development in Financial Services 269 As developed, the model has made meaningful sense of die variables it is using, all coefficients have a sign consistent with the literature and also the findings reached by this piece of work, and it is fully consistent with the literature and the study's key findings. What would be most revealing to do next is to engage in a top management coaching exercise, helping executives adopt the style most suited to the work at hand and measuring using a control group whether this makes a difference. This could also open the way to quantifying (in this albeit narrow context) the value of executive coaching. 9.6 Conclusion It has been argued that leadership style is an important determinant of product development project success. Moreover, it has been shown that the type of project (new product development or modification) affects this relationship, with a different style being more appropriate in each case. This work has offered many suggestions about ways to enhance die performance of product development projects in financial services. This page is intentionally left blank Chapter 10 Of Barnacles and Banking: Innovation in Financial Services Paul Nightingale 10.1 Introduction In the spring of 1848 Charles Darwin became increasingly fascinated by his discovery of bisexualism in barnacles. This seemingly trivial finding was to contribute towards a revolution in scientific thought which has important implications for our understanding of innovation in general, and innovation in services in particular. Darwin's interest in how these strange creatures reproduce was important because it helped change how he and subsequently scientists understood the relationship between essence and variety (Lewontin, 2000, p. 67). Before Darwin, scientists generally understood phenomena in terms of abstract Platonic forms or essences, and regarded variety as deviations from that underlying abstract reality. This changed after Darwin. Darwin's theory showed that variety (as, for example, could be found in the reproduction of shellfish) was real, and that the abstract essences were averages constructed from the inherent variety that is intrinsic within nature. Zoologists no longer search for the Platonic "inner natures" of shellfish, but instead recognise the reality of diversity and explore its causes and consequences. Darwin's insight is only slowly trickling down to the social sciences. While some pioneers have always maintained the importance of detailed empirical examination of specific innovations, 1 more typically the methodologies used have been influenced by positivism ^ e e , for example, the work of Chris Freeman, Nathan Rosenberg, Richard Nelson and Edwin Mansfield. 271 272 Paul Nightingale and have focused on constructing statistical averages of a variety of different innovation processes in order to find their "inner nature". As a result, the features that are widely shared within the dataset become prominent, while the diversity inherent in the world has been down-played. This, in turn, has biased academic research towards a particular view of innovation that focuses on manufactured, mass-production, consumer goods. Consequently, service innovation, military technologies and capital goods are under-represented and typically regarded as special cases that deviate from the "real" essential features of innovation characterised by manufacturing. An important advance in our understanding of the diversity of innovation was made by Richard Barras (1986, cf. 1990). Barras argued that the traditional product life-cycle model used in manufacturing needs to be reversed when applied to services, because innovation in financial services is driven by processes before products (1986, 1990). Following Vernon (1966), Utterback and Abernathy (1975) had previously argued that innovation in manufacturing follows a cycle that initially concentrates on product innovation until an established design is formulated, after which time competition is based on process innovation. Barras, by contrast, argues that financial services follow a pattern whereby innovations in process allow new products to be introduced (1986). Both Utterback and Abernathy and Barras' ideas have been criticised, respectively, for lack of generalisability and for making too sharp an analytical distinction between product and process innovation in services (Pavitt & Rothwell, 1976; Uchupalanan, 2000), but they remain important theoretical developments. While Barras' model is an important step forward, it is nonetheless based on concepts taken from manufacturing. By using the categories of product and process, Barras misses the role played by infrastructure in the provision of financial services. In neglecting the importance of variety, the academic community has under-appreciated the importance of a key feature of the modern economy. Other chapters in this book have examined the processes and tools used in the development of new financial services. This chapter aims to give an outline of the nature of innovation in financial Of Barnacles and Banking 273 services, concentrating on the role of infrastructure technologies. Particular attention will be paid to the institutional and regulatory environment in which financial service firms operate and the impact of software and technical complexity on innovation. The first section provides the basic concepts needed in order to understand innovation in financial services. The next compare innovation in infrastructure and complex capital goods with innovation in mass production consumer goods, and explores the specific problems associated with innovation in embedded software. The final sections illustrates some of the arguments in the chapter by describing the problems of the Taurus system, and finally draws conclusions. 10.2 The Invisible Infrastructure of Financial Services Financial services represent about 5-10% of GDP and a similar proportion of employment in OECD countries. Some 5.4 million people are employed in the US banking sector: more than twice the combined number of employees in automobiles, computers, pharmaceuticals, steel and clothing (Frei et al., 1998, p. 1). There is, however, litde research on innovation in banking. The notion that financial services are low tech does not explain this bias. Large global banks often spend over $ l b n a year on IT (the cost of technology is second only to wages for most financial services companies) and, together with communication-based services, financial services account for close to 50% of IT capital stock (Haukes, 1999, p. 66). Between the 1970s and 1985 this capital stock increased ten-fold (ibid) suggesting that they are a vanguard sector which adopts and diffuses information technology early (Barras, 1986; 1990). Research on services more generally is similarly under-represented, and has tended to stress the intangible nature of services, their heterogeneity, and, because production and consumption are simultaneous, the importance of time constraints on service delivery. This is because services often involve a performance rather than an object which makes reliable and timely co-ordination essential. More recent academic literature has moved away from clear-cut distinctions between intangible services and tangible manufacturing 274 Paul Nightingale and now understands them as a continuum (Miles, 1996; Davies & Brady, 2000; Uchupalanan, 2000). The intangible aspect is dominant in certain areas such as teaching, and the tangible aspect in areas such as detergent production. There is also a large middle ground where they overlap, such as fast food (Uchupalanan, 2000). In this chapter, the difference between services and manufacturing is understood in terms of the tangibility of functions (along a continuum). Service firms are paid to perform a, function, while manufacturing companies produce tangible objects that are bought to provide a function (Nightingale & Poll, 2000b). Firms in the financial system perform the basic function of moving money between savers and borrowers which allows people to switch resources between current income and future spending. For example, the financial system allows people who lack resources to borrow money to buy a house, which, in turn, allows those with resources to save productively. In effect, financial products allow the interconversion of goods and labour through time and space.2 Financial institutions typically mediate this allocation of resources between savers and borrowers because they have specialised knowledge of lending risks and can pool funds, allowing the different amounts of money that borrowers and lenders have or need to be matched (Merton, 1975; 1995a; Merton & Bodie, 1995; Nightingale & Poll, 2000a). They can also take advantage of economies of scale by spreading the fixed costs of investments in process technologies and infrastructure over a large number of contracts (cf. Chandler, 1990). These scale economies help provide liquidity (the ability to 2 The development of specialised financial institutions came about through an expansion of the market for financial services following the emergence of the fiscalmilitary state in the 16 th and 17 th centuries. As early-Modern wars were fought by attrition, the ability to allocate funds (and therefore troops) through time and space effectively determined military power and enabled smaller countries like Holland and England to take on France and Spain. This "financial revolution" started when the provincial States of Holland accepted collective responsibility for war-loans by securing them on future tax returns (Dickson, 1967, p. 63). The Bank of Amsterdam was set up in 1609, with the English waiting until the cost of a war with France in 1689 forced them to form the Bank of England in 1694. Of Barnacles and Banking 275 turn assets into cash quickly and cheaply) by increasing the pool of resources available so that borrowers, who tend to want stable, long term funding can be better matched to lenders, who typically want quick access to their cash. Increased liquidity, particularly of long-term debt, tends to add value, and as this chapter will show, is one of the key drivers of innovation in financial services.3 Another key driver is changing regulation. Because financial services are so important to the wider economy, financial services have traditionally been heavily regulated (Berger et al., 1995; Merton, 1995b; Hall, 1990; Calomiris & White, 1994). Regulations typically limit the ability of financial institutions to compete in a range of product and geographic markets, which in turn influences what they do, and the structural possibilities of the technologies they use. Consequently, the development of financial technologies will almost inevitably involve national and possibly international regulators, which complicates and lengthens the design and development processes.4 Rather than being a firm-based activity, as is typical of mass production manufacturing, innovation in financial services involves a web of interactions between the various institutions and regulators involved in the sector. While there is huge diversity within the financial sector, the three main types of institution are bunks, exchanges and investment institutions that differ in how they move money between savers and borrowers. Each method used, in turn, defines the technological 3 The shift towards the securitisation of assets (whereby financial assets such as mortgages and credit card liabilities are pooled and resold as bonds) has been driven by liquidity concerns. Bonds tend to be substantially more liquid than shares because there are fewer to choose from and they are more frequently traded. The New York Stock Exchange, for example, trades about US$350 billion of bonds a day, compared to only US$28 billion a day in equities (Golding, 2001). 4 One of die most important recent changes in financial regulation was the shift towards more market based regulation. This is commonly referred to as "deregulation", but is perhaps better thought of as a process of re-regulation. Specific restrictions have been removed, but government and international regulators still play a role in the functioning of financial markets. 276 Paul Nightingale trajectories that the firms follow, and influences the kind of technologies they use. Banks are traditionally divided into two kinds, depending on how they move surplus funds from investors to borrowers. Commercial or retail banks rely on deposits drawn from individual savers that they re-lend at a profit; the savers are typically paid a nominal amount of interest. Investment banks, on the other hand, make their money through fees charged from arranging complex financial deals (Eccles & Crance, 1988). Unlike commercial banks that load the assets they hold, investment banks help allocate surplus savings by underwriting securities that are sold to other investors. Securities have the advantage of being liquid, and consequently allowing investors to make rapid changes to their portfolios. Exchanges are institutionalised markets for the trading of financial contracts. The two main types of contracts sold on exchanges are company shares (which are sold in equity markets), and government and company debt (which is sold in bond markets). 5 Markets have an advantage over institutional investment mechanisms in that they, firstly, publicise information about the price of resources, allowing financial actors to improve their resource allocation and, secondly, allow a more arms length form of exchange. Exchanges, by contrast, are normally closed institutions with their own rules and regulations, which allow well-established financial processes to be developed and used in a more "trustworthy" environment, improving the liquidity of trading. Investment institutions such as pension funds, mutual funds (called unit trusts in the UK) and life insurance companies bundle together the savings and insurance contributions of individuals to invest in a range of assets on a long-term basis. Strictly speaking, investment institutions rely on fund managers for their investment management, but in practice most investment institutions are directly involved in investing in quoted companies (Golding, 2000). They are a fairly recent development, as up until the late 19 th century 5 Equities, unlike bonds, are "real assets" that can protect the owner from inflation. Of Barnacles and Banking 277 private individuals were the main investors. In the early 20 t h century investment trusts became increasingly important, followed by unit trusts in the 1930s {ibid). In the 1960s, pension funds took off and more recendy the life insurance industry became a major force in financial investment. Each type of investment institution has different investment preferences. Pension funds have predictable longterm liabilities, while insurance funds require more liquid assets in case they should have to pay out for a disaster. Over the 1980s and 1990s investment institutions grew to control approximately US$26 trillion of funds, US$13 trillion of which are in the US (approximately three times GDP) (ibid). They hold about two-fifths of US household financial assets, and the largest five fund managers place assets larger than the combined GDPs of France and the UK. In the UK alone, institutional investors own more than £1,500 billion of assets, which is more than half the value of the quoted equity markets. These different types of financial institutions are all involved in providing, monitoring, and maintaining the processes whereby funds are pooled, matched to requirements, and allocated. They take financial contracts (funds, bonds, etc.) as their inputs, and then process them, before re-engineering them into new forms of contract that are then sold to customers. In doing so, they use sophisticated processes comprising people, knowledge and various capital goods to match borrowers to savers. Technology is used to improve these processes by complementing person-based (and often market-based) mechanisms with an organized, technology-based mechanism. This allows financial institutions to provide better services, develop new products, and exploit improved economies of scale, scope, system and speed (Nightingale & Poll, 2000b; Barras, 1986; 1990). The relationship between capital goods and performance improvement is fairly well understood in large manufacturing firms following the work of Alfred Chandler (1990). He showed that firms invest in high fixed-cost infrastructures to improve the capacity and speed of production processes in order to generate the fast, high-volume flows that turn low-cost inputs into high-value outputs. 278 Paul Nightingale In this way, the high fixed costs of capital are spread over a large volume of output to keep unit costs low and increase profits. If the volume of production falls then costs cannot be adequately spread and unit costs will rise (Chandler, 1990, p. 24). As a result, manufacturing firms organiza and co-ordinate the resources required to fully utilise the capacity of production processes and increase the average speed of "flows".6 This has been done in two ways. Firstly, firms developed sophisticated managerial techniques for controlling processes and, secondly, they exploited external and internal infrastructure technologies such as the telegraph and railway systems to ensure that production and distribution were uninterrupted. Things are slightly different within the financial services sector. Profitability is linked to the efficient contextualisation and processing of information rather than the utilisation of a fixed amount of production capacity (Nightingale & Poll, 2000a). This means that profits are far less constrained by technology than they are in manufacturing. For example, the profitability contribution of a worker on a production line is largely determined by the technology itself, and a worker would be hard pressed to increase profits substantially. By contrast, a trader in a bank, who was smarter, faster or had superior analysis could very easily make significantly more profits with very few restrictions from technology. The amount of profit made on a trade of US$100 million will be more than on a trade of US$ 1 million, even though the same telecommunications system might be used. This is called leverage. The flip side of high leverage is that while profits are almost unlimited, the same is true of losses, creating an incentive to understand and manage the extent and likelihood of these losses occurring, namely risk. As innovations in financial theory and technology have allowed more complex contracts to be produced and traded, understanding risk has become increasingly important. 6 One way to maintain capacity utilisation (and therefore lower unit costs) is to exploit unused production capacity in new product lines, thereby generating economies of scope. Of Barnacles and Banking 279 The processing and allocation of a range of financial contracts is basically an optimisation problem that must take into account the likely risks and profits that any given portfolio of transactions represents. The inputs and outputs of these optimisation problems are typically frequencies rather than flows which complicates matters because the needs and requirements of buyers and sellers change over. This can create liquidity risk — the possibility that a lack of buyers in a market, at a particular time, may lead to an asset being sold at below its market value. Liquidity risk is related to the relative size of the trade compared to the size of the overall market, which creates a link between scale economies and risk. For example, prior to the introduction of the telegraph, and the resulting increase in the scope of the market, the New York Stock Exchange only managed to sell 31 shares over a single day in March 1830 (DuBoff, 1983, p. 261). Anyone attempting to sell shares in a hurry when the volume of transactions is this low runs the risk that they will have to off-load them far below their potential market value. This problem has become increasingly acute as financial institutions have increased in scale. The growth in the size of the capital funds controlled by financial institutions highlighted earlier has compromised the ability of fund managers to cheaply adjust their portfolios. For example, a fund of US$500 million will not be able to make significant changes to its performance without trading units of about US$10 million (Golding, 2000, p. 67). Buying (or selling) such a large volume of shares in a firm that trades only US$250,000 of shares a day is going to be both time-consuming and expensive, and is likely to alert other players in the market, pushing the price up (or down). The interplay between economies of scale, liquidity, risk and the constrained optimisation problems inherent in allocating resources from savers to borrowers can be used to map out a technological trajectory for financial services.7 As a first approximation, the problem 7 The inherent heterogeneity of financial services means that this will be just one of many possible technological trajectories. 280 Paul Nightingale of liquidity risk can be reduced (given constant scale, i.e. trading volumes) by increasing the diversity and number of potential buyers and sellers. This increases likelihood of finding a party or parties prepared to undertake transactions at a given price which reduces price volatility (and liquidity risk), which in turn makes tradable assets more valuable. If the size and diversity of the market can be increased, the informational efficiency of the market increases and the frequency of trading can be approximated to a flow. There are costs associated with this expansion. These fall into three main headings. Firstly, there are search costs. Finding the first improved offer may be easy, but finding the best one may be disproportionately expensive as the marginal search costs for combinatorial optimisation problems typically increase in an exponential way. Financial institutions overcome this problem by making public the highest buying and lowest selling prices and the spread between them. Secondly, there are costs associated with the time it takes to co-ordinate transactions. Markets can move and information can become out of date which means that portfolio adjustments can be sub-optimal. Thirdly, there are co-ordination costs. These costs are the reason that financial services involving complex and conceptually intricate deals (that therefore need to be worked on face-to-face) are concentrated in large cities with large populations of service professionals, such as New York and London. Innovation in the technologies that underpin modern financial services is structured by economic considerations that improve the profitability of financial institutions. This encourages innovations that reduce costs and improve the accuracy, speed, scope and reliability of the co-ordination of resources between buyers and sellers. • Accuracy: Because of the huge complexities involved in understanding and modelling the implications of any transactions, simplified rules of thumb and control models are used to measure risk and allocate resources. These simplications can have economic Of Barnacles and Banking 281 effects if they deviate from the behavior of the real world. Innovations that improve the accuracy of the mapping between inputs and outputs of any optimisation problem — such as most profitably matching supplier inputs to customer requirements — have the potential to improve economic performance. • Speed: As already noted, financial markets change and these changes can lead to sub-optimal allocations of resources and inefficient information exchange if decisions are made on out of date information. These inefficiencies provide the opportunity for arbitrage profits, and firms that can use technology to reduce them (relative to others in the market) can extract rents for their efforts. • Scope: Expanding the scope of the market by increasing the number and diversity of customers and suppliers potentially allows more optimal performance. It increases the liquidity of contracts, reduces liquidity risk and therefore allows firms to exploit larger economies of scale. With internal risk management, calculated risk exposures will come closer to real risk exposures if the scope of risk analysis is extended to include more of the transactions that the bank is party to. For example, if the bank's offices in London, New York and Tokyo are all exposed to the same position, each office may be within its local risk limits but the bank as a whole may be over-exposed. This exposure can be reduced if more trades are included in the analysis. • Reliability: At one extreme, improvements in the reliability of technologies and organizational processes simply reduce downtime and increase economies of speed. However, as technologies allow improved performance within the financial service sector they have increasingly become "bundled-in" with the provision of services making their reliable operation business-critical. As a consequence, the latest Basel proposals for managing financial risk in the global banking industry explicidy take into consideration operational risk in the use of large scale risk management and co-ordination technologies. 282 Paul Nightingale 10.3 External Infrastructure: Technology, Speed and Market Scope The importance of speed and expanding market scope means that technologies of communication and transportation are particularly important for financial services. As Duboff notes: The expected savings from a given market search will be higher the greater the dispersion of prices, the greater the number of production stages, and the greater the expenditure on the resources or service. For example, the only way to know all the prices which various buyers and sellers are quoting at a given moment would be to bring about a complete centralisation of the market, only then will costs of canvassing, or search, be at a minimum. Conversely, with infinite decentralisation these costs will reach a maximum. To lower them it pays to centralise — to reduce spatial dispersion and the number of independent decision makers (1983, p. 266). The centralisation of markets and the improvements in pricing and liquidity that it brings are made possible by infrastructure technologies that increase the scope and speed of market searches. These technologies reduce the delays in communication that lead to price volatility and opportunities for arbitrage. This can be seen in the history of exchanges. When, for example, communication between London and Amsterdam was dependent on sailing boats it took three days for information to travel between the markets. This inefficiency in the communication of market information created opportunities for arbitrage. Similarly, when communication within Britain and the USA was undeveloped and irregular local exchanges flourished. With the advent of regular mail coaches in 1784, leaving from Lombard Street in the City of London, there was a pull towards the larger, more efficient national market in London (Michie, 1997, p. 306). The development of the telegraph infrastructure produced a significant improvement in the speed and scope of markets. This created improved liquidity and greater price stability, as large amounts Of Barnacles and Banking 283 of commodities were not being dumped in the illiquid markets of commercial centres. Starting in the United States in 1844, by 1860 there were 5 million messages being transmitted annually along 56,000 miles of wire and 32,000 miles of telegraph poles (DuBoff, 1983, p. 255). In 1851 a link was introduced between London and Paris which transcended the previous 12 hour communication times and allowed real time price communication. In 1866 the first link between London and New York was set up, by 1872 the telegraph had linked London and Melbourne and by 1898 there were 15 undersea cables (only nine were working) under the Atlantic (Michie, 1997, p. 310). By 1890, information could travel the 400 miles from Glasgow to London in 2xh minutes (ibid). A major step change in the technology occurred in 1867 when the invention of the stock telegraph increased the rate of transmission from about 15 words per minute up to 500 words per minute (DuBoff, 1983, p. 263). Together with improved infrastructure of railroads and storage, the telegraph allowed contracts to be linked to the point of production. As a consequence, "to arrive" contracts started to replace advanced payment based on "certified" samples, further stabilising prices and reducing uncertainty (Duboff, 1983). Middlemen could be cut out of transactions, buyers and sellers did not need to travel, and time lags and risks were reduced. The temporal and geographic reach of buyers and sellers was further improved by the introduction of the telephone. The geographic scope was increased again when the first transatlantic telephone cable was laid in 1956. The previous radio-based telephone infrastructure could only deal with 20 people, but by 1994 submarine cables could handle some 600,000 calls at a time (Michie, 1997, p. 318). While much of the early innovation in infrastructure involved financial services firms "piggybacking" on established technologies like the telegraph, by the late 1980s firms were investing heavily in their own communications networks that could link local branches together. In doing so they relied heavily on external suppliers such as telecommunications companies and specialised financial information suppliers like Reuters, Dow Jones/Telerate, Knight Bidder and Bloomberg. 284 Paul Nightingale 10.4 Internal Infrastructure: Technology and Internal Co-ordination Once telecommunications systems had increased the reach of markets and railroads had made improved national transportation of goods possible, market liquidity and the scale of n !u. ;tions improved, creating new innovation challenges. Firms making large numbers of transactions needed to work out how to best optimise the allocation of resources between different customers. Until recendy, this had been done using largely subjective assessments of risk, and a "my word is my bond" trust-based attitude towards risk control. Since the 1980s, the development of sophisticated theoretical tools in financial engineering has allowed products to be better priced and controlled (Berstein, 1996; Marshall & Bansal, 1992). The initial developments came in 1952 when Harry Markovitz developed die fundamentals of portfolio theory (Markovitz, 1952). William Sharpe helped develop the Capital Asset Pricing Model (CAPM) in the 1960s and in the 1970s Merton, Scholes and Black developed their option-pricing model (Black & Scholes, 1973). These theoretical developments have co-evolved with developments in internal IT infrastructure technologies that can integrate data and perform complex pricing and risk calculations (Nightingale & Poll, 2000a). The ability to value options has transformed finance because it has allowed risk to be approximated mathematically (Berstein, 1996). This allows risk management metrics to be more accurately related to the real risk exposures that financial institutions face, allowing improved product pricing and die development of a range of new products and services (Nightingale & Poll, 2000a). However, tiiese improvements in the speed and accuracy of resource allocation were dependent on an architectural transformation in internal risk management technologies. Previously, the back office function in financial institutions had been automated to reduce costs. Risk exposures were typically computed on large mainframe technologies that would provide analysis of positions at the end of the day. This meant tliat any problems that were discovered could only be managed a day after they appeared. Of Barnacles and Banking 285 With the development of sophisticated workstations and analytical software packages on traders' desks, many back-office functions were brought to the front office where they could be carried out closer to the customer. Traders have a more up-to-date analysis of their risk positions, which can be more easily managed and passed to other markets when the local markets close overnight. Risk analysis can be aggregated and performed at various organizational levels allowing "star traders" to be effectively compensated and loss-making positions recognised. However, these technologies impose a large cost on organizations and the rents that they can extract can be rapidly competed away (Brady & Target, 1996). Overall, these technologies improve the scope of data that is analysed, the accuracy of the models used, the speed of calculation and the reliability of the processes (Nightingale & Poll, 2000a). The technological trajectories of these internal process technologies and the infrastructure technologies that link them are driven towards increasing power, speed, scope and reliability. As they have increased in size and complexity new managerial problems have emerged. Table 10.1 shows a series of quantitative changes in internal risk management technologies, highlighting how increases in complexity change the nature of innovation and make incremental innovation and maintenance an increasingly complicated process. Table 10.1 Qualitative changes in risk management infrastructure. Feature # of servers Maintenance Architecture Key factor Problems Importance Risk analysis Craft 1-100 craft based decentralised automation few limited limited Mass standardisation 100-1000 standardised centralised change function Predictable Business cost end of day Adapted from Nightingale and Poll (2000a). Complex 1000+ very complex centralised risk & reliability 1-in-a-million business critical quicker and wider 286 Paul Nightingale 10.5. Innovation in Software-Intensive Capital Goods and Infrastructure While one of the main points of this chapter is to stress the diversity of different innovation processes, it should be noted that there are a number of important empirical findings about technical change that have a high degree of generalisability. Innovation is generally characterised by sector-specificity and high levels of technical and market uncertainty so that that attempts to develop and use innovations often run into difficulties (Freeman, 1982; Dosi, 1988; Pavitt, 1984; 1990). These uncertainties can be managed (Tidd et al, 2001) and a series of empirical studies have found that understanding user needs, maintaining high levels of internal knowledge co-ordination and strong internal technical capabilities in order to incorporate external sources of knowledge, contribute towards innovative success (SPRU, 1972; Rothwell et al, 1974; Rothwell, 1977; Cooper, 1983; Bacon et al, 1994; Clark et al, 1989; Shenar et al, 2002). However, the sectoral diversity of technical change means that these success factors will be important to varying degrees depending on the nature of the innovation (Freeman & Soete, 1998). Pavitt (1984) has produced a taxonomy of sectoral patterns of innovation that divides innovations into supplier-dominated, production-intensive and science-based. More recently the taxonomy was updated to include information-intensive software and services (Pavitt, 1990; cf. 1996). While the original paper is highly cited, many people miss the fact that it added an additional "fourth category... to cover purchases by governments and utilities of expensive capital goods, related to defence, energy, communications and transport" (1984, p. 276). The notion that innovation in complex capital goods is different from innovation in consumer goods was developed by Walker et al (1988) who formulated a hierarchy of military technologies that extends from very low cost materials and components (such as nuts and bolts), to high cost components (such as jet fighter engines), and on to entire military systems costing billions of dollars (such as missile defence systems). They noted that: Of Barnacles and Banking 287 [A]s the hierarchical chain is climbed products become more complex, few in number, large in scale, and systemic in character. In parallel, design and production techniques tend to move from those associated with mass-production through seriesand batch-production to unit production. Towards the top of the hierarchy, production involves the integration of disparate technologies, usually entailing large-scale project management and extensive national and international co-operation between enterprises. Thus, the pyramid is also one of increasing organizational and managerial complexity (Walker et al., 1998, pp. 19-20). During the 1980s and 1990s a growing body of research analysed these highly engineered, bespoke capital goods. The research found that in contrast to consumer goods they are characterised by their business-to-business nature, their batch production processes, high cost, and inherent uncertainties. As a result, the processes of design and production overlap far more so than in traditional consumer goods. They tend to be produced in highly regulated, bureaucratically negotiated markets by temporary networks of suppliers based around project-based systems integration firms and their suppliers (Hobday, 1998; 2000; Miller et al, 1995; Prencipe et al, 2002; Gann & Salter, 1998; Lemley, 1992; Marquis & Straight, 1965; Morgan et al, 1995; Morris, 1990; Burton, 1993; Walker et al, 1988; Sapolski, 1972). Research on the management of their development has stressed the importance of good project management, good risk management, and effective control over the various suppliers involved in project development (Dvir et al, 1998; Hobday, 1998; Miller et al., 1995; Morris, 1990; 1994; Lindkvist et al., 1998; Pinto et al., 1993; 1989). Insightful work has also revealed the particular problems associated with large-scale software development (Brooks, 1995; Boehm, 1991; Parnas, 1985). The combination of high technological complexity and uncertainty, complicated user needs, long development times, high costs and high risk makes infrastructure development extremely difficult and it suffers from a range of innovation problems and frequent project failures (Hobday, 1998; Morris, 1990; Nightingale, 2000; Flowers, 1996). 288 Paul Nightingale One way of dealing with the uncertainty and high risk is to reverse the traditional method of ex post selection of consumer products in markets. Consumer goods innovation typically starts with R&D, moves into development, then production, then marketing and finally product launch and the selection of products by market mechanisms (see, for example, Utterback & Abernathy, 1975; cf. Barras, 1990). By contrast, in complex infrastructure technologies the high risks and costs involved mean that customers, suppliers, regulators and government bodies negotiate contracts, product designs and production methods before development is begun (Hobday, 1998). This is intended to reduce risk and ensure that the end product matches the various stakeholders' requirements. As a consequence, infrastructure innovation processes will typically start with marketing and sales, and only after an outline design and production process is specified will the contracts be signed and development started. Not only are infrastructure projects and capital goods different from consumer goods but, in this instance, they go through their processes of development in nearly the opposite order. 10.6 Project Definition and Buy-in This initial stage of infrastructure development involves understanding user requirements, dealing with technical uncertainties, finding solutions that are acceptable to the various customers and users and then obtaining commitment from a whole network of stakeholders to an uncertain and potentially very risky venture. Simply getting the various users and customers, as well as national and international regulators, to define the infrastructure's function in any detail can be extremely difficult. Infrastructure technologies' initial cost estimates and overarching function are generally vague enough to interest a range of parties, but once one moves to the more specific architectural layout of the technology, the engineering trade-offs become increasingly politicised as the implications for established practices within institutions become apparent. The "Big Bang" in the City of London, which moved the City towards electronic trading, for Of Barnacles and Banking 289 example, required a large push from the UK government and met resistance form established groups within the City. Those who are negatively effected by technical change may have very rational reasons to be against the project. The very late shift towards electronic trading in the New York Stock Exchange, for example, is indicative of the power of entrenched interests. Even with a largely positive group of users, it is not necessarily the case that they will have the same requirements or demands, and substantial negotiation is needed to define acceptable solutions (cf. Moynihan, 2002). These negotiations will necessarily involve trade-offs and the final proposals may not necessarily match anyone's specific requirements, a feature that applies as much within organizations as it does between them (Barki & Harwick, 2001). The problems involved in specifying the functions of a major infrastructure technology are complicated because many firms and institutions lack the technology capabilities to be "intelligent customers". Infrastructure technologies, after all, are not produced by banks everyday. As a consequence, financial institutions are susceptible to being misled by consultants and contractors into producing overly complex technologies tiiat do not match their needs (Collins, 1997). Despite the substantial in-house capabilities that financial institutions have for developing and using information technology, many still lack the expertise needed to fully comprehend the complexities and potential difficulties they face in developing and implementing new infrastructure. Software firms are generally reluctant to be open about these potential problems, as they have an incentive to down-play them in order to secure contracts (Flowers, 1996). Even using external consultants to assess the bids may not overcome this problem, as tlieir independence from the software industry is often questionable (Flowers, 1996; Collins, 1997). The costs, complexities and risks involved mean that development projects require commitment from a range of actors. This typically comes in the form of written legally enforceable contracts, organizational commitment, and political endorsement. Unfortunately, these can easily lock counter-parties into a particular direction of technical change tliat may involve using inferior technologies and 290 Paul Nightingale architectures (Walker, 2000; Collingridge, 1983). Similar problems emerge within organizations and make changes to heavily committed decisions difficult to undertake (Flowers, 1996). The process of securing commitment to a technology can make "pulling the plug" on failing projects very difficult; this is a common problem in IT intensive infrastructure. Keil, Man and Rai (2000; cf. Keil, Tan & Wei, 2000; Keil & Montegalgre, 2000) found that between 30 and 40% of all the information systems in their sample exhibited some degree of "escalation of commitment to failing courses of action", where the projects in question spiralled out of control (cf. Smith et al., 2001; Keil, 1995). Once the initial specifications are defined and the customers are committed, the process moves to the next stage where engineers and technologists propose, test and modify solutions in increasing detail. The inherent uncertainties involved mean that initial solutions will rarely work correctly (Petroski, 1986) and an iterative process of trial and error design is needed. This is complicated for technologies where sub-components are systemically related. As Nelson points out: A particular problem in R&D on multi-component systems arises if the appropriate design of one component is sensitive to the other components. Such interdependencies mitigate against trying to redesign a number of components at once, unless there is strong knowledge that enables viable design for each of these to be well predicted ex ante or that there exist reliable tests of cheap models of the new system (1982, p. 463). This systemic complexity means that the effects of incorrect design are magnified as design modifications spread to other systemically related subsystems. Each design iteration will cause the innovation process to feed buck to earlier stages adding to its cost and schedule (Nightingale, 2000c). With simple technologies this process is rarely problematic, but with complex infrastructure technologies there are a larger number of possible feedback loops and potential failures within and between components. If the process of updating design Of Barnacles and Banking 291 specifications takes time, the design changes are extensive, or the components are related to a large number of "sensitive" components, the amount of redesign work can be very large. There is consequently a danger of "redesign chain reactions" that spread through the different systems with disastrous effects (Nightingale, 2000c). 10.7 The Importance of Embedded Software Redesign problems are exacerbated by the increasing importance of embedded software which adds to the complexity and uncertainty of development and turns what were previously straightforward engineering tasks into high-risk development projects by making sub-components of systems more systemically interdependent (Brooks, 1986; Hobday, 1998; Nightingale, 2000, p. 5; Parnas, 1985). Software is more vulnerable to design errors than other technologies because the abstract construction of interlocking concepts, data sets, relationships, algorithms and function invocations that make up a piece of software must all work perfectly if the software is to function properly (Brooks, 1995; Parnas, 1985). Unfortunately, debugging embedded software is extremely time-consuming and can introduce new errors and, as a result, systems are often launched without being properly tested (Parnas, 1985). Even if all the bugs can be found, software typically scales in non-linear ways so that changes in its function and increases in scale can cause it to fail. The problems associated with producing large software systems are well recognised in the literature (Flowers, 1996; Fortune & Peters, 1995; Collins, 1997). This literature is mainly drawn from large projects that developed software from scratch, but financial service infrastructure often involves building on older legacy systems. Such systems may have inappropriate architectures and data structures that were designed for an older generation of infrastructure. Similarly, the code may be written in a language that is no longer in common use, and the system experts may no longer be with the organization, or, if they are still within the organization, they may be committed to the older system and highly resistant to change. 292 Paul Nightingale The intangible nature of software further complicates development as it is often extremely difficult to evaluate how much more work needs to be done. Software engineers have a saying that software is "90% finished 90% of the time". This difficulty in evaluating the extent of further work creates extra uncertainties that can prevent the cancellation of a failing project well beyond the point at which it would have been stopped had the full extent of the required work been known (Flowers, 1996; Block, 1983; Staw & Ross, 1987). The problems involved in developing software-intensive infrastructure can be gauged by Gibbs' (1994, p. 72) point that "for every six new systems that are put into operation, two others are cancelled. The average software development project overshoots its schedule by half; larger projects generally do worse and some three quarters of all large scale systems are 'operating failures' that either do not function as intended or are not used at all". Similarly, the General Accounting Office has reviewed large US government IT projects and noted: "During the last six years, agencies have obligated over $145 billion building up and maintaining their information technology infrastructure. The benefits of this vast expenditure, however, have frequently been disappointing. GAO reports and congressional hearings have chronicled numerous system development efforts that suffered from multi-million dollar cost overruns, schedule slippages measured in years, and dismal mission-related results" (GAO, 1997, p. 6). Since financial services are significant users of IT infrastructure, they are particularly vulnerable to these large-scale IT failures. There have been a number of failed projects within the sector, ranging from the high profile TAURUS system in the London Stock Exchange to a whole host of lower profile failures within other institutions. There are also numerous operational failures that produce significant losses for the institutions involved where a software glitch or design error may cause a financial institution to miss-sell a series of trades. Whedier these operational failures are due to the technology, training and operations, or auditing and management, may be impossible to tell. Whatever their cause, there are numerous cases of financial institutions losing hundreds of millions of dollars. Of Barnacles and Banking 293 The implementation of financial infrastructure projects can also cause a successful design project to ultimately be an operational failure. To a large extent, successful implementation is dependent on effective project management (Pinto & Slevin, 1997; cf. Pinto & Covin, 1989; Slevin & Pinto, 1987; Currie, 1994). This includes, first and foremost, realistic planning in terms of both resources and time (ibid) and recognising the importance of "soft" human resource issues (Levasseur, 1993; Corbato, 1992). Within the UK financial services sector, contractors work on a rule of thumb that implementation will be twice as expensive and take twice as long as the best initial estimates. One particular area of risk involves data conversion and migration from old to new systems. In some instances this may be so difficult that it is judged quicker and easier to re-key all the data. This problem is gradually receding as more and more products are built on similar database platforms and are released with Other DataBase Connectivity (ODBC) drivers. This highlights the point that effective design involves considering implementation issues at an early stage, in particular customers' end-to-end business systems and requirements. The risks and uncertainties involved in system implementation mean that it is common to run parallel systems, often for months, in order to iron out last minute design problems. These systems are also used for staff training before implementation. Typically, within the City of London at least, and where it is technically feasible, the new systems will be run in a minimum of three environments; a live system, a QA (or quality assurance) system, and a test system. The test system often contains scrambled data (allowing wider access than confidential customer information would permit) and is used for training and experimental late stage design. The QA system is used for more sophisticated and rigorous testing of design changes, before components are implemented into the live system. There are limitations to the use of parallel runs, particularly in larger, more complicated, real-time, environments and where systems are being installed that are fundamentally different from the earlier technology. 294 Paul Nightingale The problems associated with the design and implementation of financial service infrastructure, highlighted in this chapter, mean that project failures are extremely common. No reliable figures are available, but anecdotal evidence suggests that at least a third of such projects are terminated or are operationally compromised. A classic, and well documented, example of financial infrastructure failure was the City of London's TAURUS system (cf. Flowers, 1996). 10.8 The TAURUS System The TAURUS (Transfer and Automated Registration of Uncertified Stock) system was an infrastructure project within the City of London that was intended to create a paper-less share trading environment. Legal requirements in the UK meant that registers of all share trades had to be held by all publicly listed companies. Consequently, even small trades involved a very inefficient process whereby at least three pieces of paper were physically moved around the City. Unsurprisingly, an international report had criticised the settlements system and it was clear that the system would be unable to cope with the mass share ownership that would follow the privatisation of UK public utilises. By August 1987, for example, a backlog of nearly 650,000 unsettled deals had built up (Flowers, 1996, p. 101). Moving to a computerised system would, it was hoped, reduce time and cut costs by removing the need to physically transfer paper during trading, as well as the middlemen who controlled the process. The London Stock Exchange (LSE) had previously installed a less ambitious Talisman system in 1979 as part of a computerised share settling system, and its success led to the proposal in 1981 to automate the entire market and end paper trading. Consequently, work started on the system that was to become TAURUS in 1983, and the LSE as an institution committed itself very publicly to developing a world-class system that would ensure its dominance over other European exchanges. The original architecture of the project involved replacing the registrars (who recorded information on trading) with a single large database administered by the LSE. Unfortunately, the project had Of Barnacles and Banking 295 many stakeholders who had vested interests in maintaining their positions. Instead of re-engineering from scratch, and then automating, the project recreated the highly inefficient organization of the exchange. The initial design was pushed forward before the various parties had reached agreement about what it should do, before legislation and regulations had been changed, and before the processes had been simplified. The registrars quickly saw that the technology would deprive them of their lucrative (but inefficient) livelihoods and became an entrenched group of actors hostile to the new technology (Drummond, 1996a; 1996b). The LSE carried on with the project from 1983 until 1988, but the share registrars' opposition produced an independent technical review. This showed that the proposed project would be extremely costly (£60 million) and very technically complex, requiring two IBM 3090 mainframes and 560 disk drives to cover the transactions in the trillion or so shares in issue by the LSE (Flowers, 1996, p. 102). Taurus 1 was consequently cancelled, and the Bank of England (the UK financial regulator at the time) became involved and set up the Security Industry Steering Committee on Taurus (SISCOT Committee). In the spring of 1989, the SISCOT Committee suggested the far cheaper and less risky option of extending the Talisman system from the original 32 Market Makers to around 1000 other financial institutions (ibid). Shares would be held in accounts on behalf of clients by TACs (Taurus Account Controllers) who would maintain the records. However, TACs could pass the maintenance of records on to registrars, which had the unfortunate effect of replicating the previous paper based system in parallel with the electronic TACs. This design however, made it extremely difficult for companies to know who owned their shares, and consequently, if they were being prepared for a hostile take-over. Together with stockbrokers, who were concerned about costs, the large firms forced through a series of design changes. In March 1990 a detailed outline of the project was published, and in October 1990 the technical specifications were published. These showed that, rather than build a system from scratch, the 296 Paul Nightingale project would involve buying and modifying a US-based system. The development work was, however, based on split locations, with 25 out of a team of 40, based at Vista Concepts' New York office (Drummond, 1996a; 1996b; Flowers, 1996). By December 1991, as costs escalated and schedules slipped, the new legal framework for the operation of TAURUS was produced. By this time the press were becoming hostile as rumours emerged about software development problems. By February 1993, a technology review predicted it would take another three years to build the system and that its costs would double. By March the project was cancelled at a cost of about £75 million. Total costs to the City were probably in the order of £400m. The Taurus project illustrates the wide range of problems associated with the production of financial infrastructure. In particular, it shows the importance of the "soft" issues needed to co-ordinate the wide range of stakeholders with divergent needs and concerns. One of the main problems with the project was the failure of the various agents involved to re-engineer the previous inefficient internal processes before technical development was started. This meant that the project re-created and maintained vested interests which were hostile to change. The slow-moving regulation process, the decision to undertake substantial redesign of a packaged system, and confusion about ultimate control over the project further complicated matters. The complexities inherent in the design of such a substantial system were made worse by constant design changes. The softwareintensive nature of the project meant that it was very difficult to know the extent of further redesign work. The lack of organizational co-ordination within the development process, and in particular the use of two main development sites on different sides of the Atlantic, further complicated the process. The story does however, have a happy ending. After the Taurus fiasco, the Bank of England project managed the development of the CREST system which appeared on schedule and to budget in the mid 1990s. The failure of Taurus partly explains the strange organizational structure of the CREST project. It is owned by a private company CRESTCo, yet was built by the Bank of England. CREST was Of Barnacles and Banking 297 a voluntary rather than compulsory system and was funded by its shareholders who represented some 80% of the initial business that the system was dude to handle. This commercial buy-in, the fact that the system was independent of the Stock Exchange and its voluntary nature meant the development process was not compromised by groups seeking to maintain their vested interest. Moreover, the overall design of the system and the changes in regulations that accompanied its introduction were put in place before development started in earnest, reducing the feedback loops in the design process that had caused so many delays to the Taurus system. 10.9 Conclusion This chapter has given a brief overview of innovation in financial services, concentrating on the role of infrastructure in expanding the scope of external markets and managing the co-ordination of internal resource allocation. It has hopefully shown how diverse financial service innovation is from mass-production manufacturing, and highlighted the institutional heterogeneity of the sector. Financial services can be extremely high-tech and the traditional view of services as un-innovative support functions for manufacturing clearly needs to be revised. While there are encouraging signs that this is taking place, our understanding of innovation in services, and financial services in particular, is a long way behind our understanding of manufacturing innovation. Financial services differ from manufacturing because they involve firms performing functions for customers rather than providing goods that provide functions. These functions are typically consumed as they are produced, making their provision time-dependent in a way that manufactured products (which can be stored) are not. Firms rely on a range of technologies and processes for this temporal control of their internal and external processes. Financial services are also different in that the economies of scale that they can exploit depend heavily on the volatility and liquidity of markets. This liquidity can be improved by using external 298 Paul Nightingale infrastructure technologies to bring together larger numbers of diverse buyers and sellers. As they are based on the contextualisation and processing of information, rather than physical materials, financial services have the potential to leverage technology to produce more profits than is possible in manufacturing. Unfortunately, the ability to generate large profits goes hand in hand with the ability to suffer substantial losses. This, in turn, creates a much larger incentive for managing risk than is common in manufacturing. This chapter divided infrastructure technologies into internal and external. Infrastructure that is external to financial institutions can be used to improve liquidity, make trading more efficient and increase the value of financial assets. This infrastructure is often provided by third parties and increases the reach of markets in time and space. Typically, these technologies will involve communications and control systems that have ranged from the earliest telegraph systems to today's high-powered settlement systems and global networks. Internal infrastructure technologies, on the other hand, are used within firms to allocate resources to customers. They involve technologies such as customer-focused information systems, ATM machines and their shared networks, and internal risk management systems. In both cases, there is a tendency for the infrastructures to increase in size and complexity as this improves the liquidity of markets and increases market coverage. Improvements in computing power, speed, and reliability similarly improve banks' ability to profitably control transactions. The tendency towards increasing the complexity of infrastructure technologies has consequences for innovation as development and operation become more uncertain and risky. This increased uncertainty comes from unpredictable emergent phenomena caused by components interacting in new ways, from technical changes to sub-systems as the time taken for projects increases, changes in regulations, and changes in business practice. All of these factors make defining system requirements and freezing them extremely difficult. The complexity has become even more problematic in the last two decades with the introduction of embedded software, and the need to work with legacy systems. Of Barnacles and Banking 299 The complexity and uncertainty of innovation mean that when problems emerge the design process has to feed-back to earlier stages in the innovation process. This adds to the cost and schedule of the project. Within software, the problem is exacerbated as repeated redesign can lead to an increasingly unreliable and fragile product. However, the major issue in financial infrastructure innovation is rarely technical. The big problems often concern "soft" issues about dealing with multiple users, dealing with regulators and coping with the politics of the organizational and institutional changes that the introduction of new technology brings. Despite the constant stream of problematic development projects, and in particular IT-based failures, the financial services industry does manage to produce infrastructure that is reliable and performs its task well. Failure may be common, but successes abound. Given the complexities of the innovative tasks involved, this success in both development and operation is a major achievement. All these features show that innovation in financial services is different, and should be recognised as different, from manufacturing innovation. Methodologies that attempt to find the inner essence of innovation by constructing statistical averages over a range of diverse processes are not identifying some Platonic reality that applies everywhere. They are mistakenly downplaying diversity and unsurprisingly running into difficulties in explaining the sources and consequences of that diversity. Methodological worries about the generalisability of the analysis of specific institutions are valid concerns, but one should remember that one generalises from arguments and not from data. It could, therefore, be argued that these worries point towards the need to do more, rather than less, research on diversity. Darwin, after all, managed to produce a theory that was rather successful, based on case studies of the reproduction of barnacles and the shapes of finches' beaks in the Galapagos Islands. Given the importance of infrastructure to the modern financial system, and by extension its impact on the global economy, understanding the nature of financial innovation is worthy of further research. This page is intentionally left blank Chapter 11 Innovation in Design, Engineering and Project Management Services David M. Gann and Ammon J. Salter 11.1 Introduction This chapter explores innovation in the delivery of design, engineering and project management services in the production of the built environment. The markets for such services are diverse, ranging from the construction, refurbishment and maintenance of housing to the production of large, complex, one-off facilities such as silicon chip fabrication plants, airports, hospitals, sports stadia and opera houses. The supply-side is equally diverse, involving many specialisms ranging from architecture and planning, design and consulting engineering services to project management, materials and component production and supply, contracting and cost consultancy. Industrial activity is largely project-based with teams from different firms coming together in temporary coalitions to perform specific tasks. The production process involves loosely coupled networks of experts and practitioners among which there are changing patterns of competition and collaboration. The construction sector is sometimes associated with low rates of technological innovation, although parts of the sector are highly innovative, particularly in developing new processes and design, engineering and management services. Three factors have been important in stimulating the growth of new services. First, the rise in demand for new types of buildings, often linked to new forms of use and changing patterns of ownership and occupation. Second, the development of new capabilities — often linked with the use of information and communication technologies. In some cases this 301 302 David M. Gann & Ammon J. Salter has facilitated opportunities for businesses to expand their markets by offering new services. Third, the changing structure of governance including privatisation and the introduction of new building and planning regulations — in particular, those relating to environmental impact. These factors have resulted in the development of new "upstream services" associated with early stages of project development and financing. They have also resulted in new "downstream services" in facilities operation and management and a growing awareness of whole-life operating costs. The chapter begins by describing the salient features concerning design, engineering and project management in the production of the built environment. These characteristics create the conditions within which innovation takes place. A general model of innovation in the built environment is presented, in which the roles of different actors in the development of new services are analysed. This is followed by a description of new forms of service provision and how and why these have emerged. The chapter concludes by arguing that evidence from the construction sector suggests that the distinction between delivery of physical products and the services associated with developing and using them is becoming increasingly blurred. In some cases the integration of design, build, own and operate functions is desirable because it enables supply firms to gain better knowledge about the total process, and offer new value-adding services to their clients. New approaches to the provision of support services may have lessons for innovation in services in other sectors. However, there is not enough empirical evidence to test the advantages and disadvantages claimed for the provision of bundled products and services and the chapter presents a set of questions for further research. 11.2 Characteristics of Design, Engineering and Project Management in the Built Environment The production and use of the built environment is an old and important economic activity. Buildings provide shelter from the external environment and facilities to support daily life at home, in the work place and for education, health, travel and leisure. Two Innovation in Design, Engineering and ... 303 elements are needed to provide these facilities: passive components, derived from the architecture and engineering of structures, envelopes and fabric of buildings; and active elements including mechanical, electrical and electronic systems which are fitted inside them. These provide the means for managing the interface between indoor and external environments and for conditioning and controlling internal environments. They also provide the infrastructure for moving people, goods and services. Other constructed products such as transport and utilities infrastructures can also be defined in terms of their passive or structural elements and active, servicing systems. In recent years, the value of active servicing elements has risen as a proportion of building costs. For example, mechanical, electrical and electronic equipment installed within buildings grew as a proportion of the total value of construction from around 7% in the mid-1970s, to more than 20% by 2000. The main actors in the production system are designers, consultant engineers and other associated services who produce specifications, drawings, layouts cost schedules and blue prints. They play an important role as technological gatekeepers for new ideas in the industry. Their work has traditionally been carried out on a fee for service basis, although this is changing. Manufacturers of materials and components play a leading part in the development of new product technologies for the sector. Contractors act as project managers and co-ordinate the assembly of components, materials and services. The project-based nature of production results in organizational complexity and discontinuities in which transaction costs can be high. Adversarial relations often result from attempts by different participants to pass on risk to others and blaming each other when problems arise. The nature and content of design activities in the built environment began to change quite fundamentally in the late 1960s and early 1970s. These changes were associated with the emergence of the information economy and new types of demands placed upon designers to produce buildings and structures to accommodate information intensive activities (Castells, 1989; Duffy, 1997; Graham & Marvin, 1996; Gann, 2000). By the 1980s it was evident that 304 David M. Gann & Ammon J. Salter information and communication technologies (ICTs) were playing a part in reshaping the ways in which people lived and worked. New systems were being installed in many types of buildings from high-tech offices to retail outlets, doctor's surgeries and homes (Gann, Barlow et al., 1999). The layout and use of space in many types of buildings was changing in order to accommodate new ways of working. For example, flexible, lightweight, multi-purpose space was increasingly required and there was growing demand for complex buildings such as bio-technology laboratories, digital control centres, dealer rooms and leisure centres. Changes in design and construction processes accompanied changes in the market place and requirements to implement new technologies. Historically, production and use of buildings and structures was a local and regional activity in which local materials and labour have been brought together to meet particular market needs. The local nature of production also reflected particular geological and climatic conditions. But international competition in the supply of design, engineering and project management services has grown, particularly on larger projects (Baark, 2001). Significant changes in design and construction processes were promoted by leading firms, partly in recognition that the traditional separation of design from production did not serve clients and building users well. The traditional approach often meant a poor understanding of user requirements and weak organization and co-ordination of design skills, resulting in high costs, delays, wasteful processes and the delivery of buildings which did not perform to specification (Higgin & Jessop, 1965; Latham, 1994). Moreover, it was difficult for designers to learn from one project to the next and mistakes and poor practices were therefore often repeated across many types of buildings. New forms of project finance emerged, such as the use of private finance to fund what were formerly public buildings. Under these conditions, designers had to consider issues concerning the longterm operation and use of buildings. Requirements were changing from initial provision of physical buildings to the design of integrated systems in which products and services were bundled together to operate over time within different environments. By the 1990s, Innovation in Design, Engineering and ... 305 designers had to work within a new regulatory framework aimed at reducing the environmental impact of buildings. Issues of "sustainability" and the use of brownfield sites came to the fore and many projects were concerned with work to existing buildings in which designers needed skills and knowledge for refurbishment, modernisation and additions to buildings. The need to upgrade and change the use of facilities led to new types of work to existing buildings. The operation of facilities often involved their management as part of larger and older technical systems and infrastructures. Thus individual projects needed to be designed and built within constraints defined by existing systems and the legacies of the technologies they embody. Design, engineering and project management knowledge needed to encompass several vintages of technology and at the same time consider the integration of new systems. The range of technical solutions expanded and new professional disciplines emerged focusing on specialist design and engineering tasks such as fire engineering, vertical transportation, acoustics, lighting, building controls and facilities management systems. Managing design processes in which many different types of specialist knowledge had to be integrated was becoming more difficult. The use of ICTs were increasingly being used to assist in the automation of some design tasks and to provide new knowledge about likely performance of design, through the use of simulation and virtual prototyping (Whyte, 2002). However, when used within the context of traditional design practices, these new electronic design tools were as likely to add to the complexity of co-ordinating design tasks as they were to relieve it. In summary, the breadth and depth of skill requirements for built environment designers expanded considerably in the thirty years between 1970 and 2000. New specialisms emerged, but general skills were also needed for co-ordination, balancing divergent interests and systems integration (see Table 11.1). Many designers, engineers and project managers needed a comprehensive knowledge of previous vintages of technology, systems, structures and buildings constructed in the past. 306 David M. Gann & Ammon J. Salter Table 11.1 Examples of new specialist and general skills. New specialist skills New general and integrative competencies Brief development and definition Design management Production planning, assembly and installation management Specialist project finance Specialist legal advice Risk assessment and management Safety management Supply-chain management Procurement and logistics Instrumentation and control systems Non-destructive testing Facilities management Energy management Water management Building physics Materials science Contaminated land engineering Geotechnical engineering Structural engineering Facade engineering and design Mechanical and electrical engineering Heating, ventilation and air-conditioning Manufacturing engineering Wind, seismic and vibration engineering Fire engineering Lighting design Acoustical engineering Simulation and modelling Computational fluid dynamics IT systems and data management Documentation control Machinery operation and maintenance Environmental planning Transport planning Space planning and changing working patterns Business analysis Dynamics and complex systems analysis Building economics and life cycle analysis Team building, co-locating, concurrent engineering Partnering and supply-chain management Interdisciplinary skills to integrate engineering and social science expertise Understanding users and regulatory frameworks Delivery of integrated products and Source: Gann, 2000, p. 226 Innovation in Design, Engineering and ... 307 11.3 The Model of Innovation in the Built Environment The need to innovate is driven by pressures on the demand and supply sides. For example, demographic, social and economic changes such as migration patterns, an ageing population in OECD countries, competition for scarce resources and issues of development in the poorest regions are reshaping construction markets. Demand has increased for flexible, lightweight, multi-function spaces that can be reconfigured for different uses quickly and cheaply. Owneroperators of large facilities are exerting pressures to improve the ways in which complex engineering and construction projects can be delivered on time, within budget and to specified quality. They also wish to improve lifecycle performance characteristics and enhance flexibility to meet unforeseen changes in demand. Environmental factors and more stringent regulations governing environmental performance are resulting in pressures on professionals to design buildings that have a lower impact on the environment and that can withstand the possible longer-term consequences of changing weather patterns. Management of innovation is complicated by the discontinuous nature of project-based production processes in which there are often broken learning and feedback loops. The choice of technology takes place under conditions where it is not usually feasible to test fullscale prototypes. Simulation and modelling is therefore of great importance in front-end decision-making, planning and execution. Product definition, development, simulation, testing and production usually involves the transfer of knowledge within complex networks of suppliers and includes a large number of interactions between many different specialists. This includes the need to deal with technical decisions in which the interdependency between components and subsystems creates the need for an exchange of technical knowhow across a range of professional and engineering disciplines. Design and engineering processes often occur concurrendy and these are increasingly affected by events which had previously been considered to be exogenous to engineering decision-making processes. For example, the role of project finance and new financial institutions 308 David M. Gann & Ammon J. Salter is becoming an important stimulant of change. The structure and timing of project finance introduces new institutional decision-makers in project planning and this may have implications for the procurement of technologies. Demands concerning environmental protection, made by what were once considered to be "external" pressure groups, are also shaping the conditions within which technical decisions are made. Design, engineering and construction firms compete in dynamic environments in which they need to manage technological innovation and uncertainty across organizational boundaries, within networks of interdependent suppliers, customers and regulatory bodies. Knowledge is differentiated and distributed throughout these supply networks. In these conditions, the management of technical knowhow has become a significant strategic consideration for suppliers and operators. In these environments there is a need for integrity of information between suppliers, designers, systems integrators, engineers, constructors, clients and end-users. Yet firms tend to manage risk by retaining information crucial to systems integration within their own sphere of control, rather than by transferring know-how between the temporary coalitions of firms with whom they collaborate. Supply firms in project-based industries trade on their reputation, based on their performance track-record from previous projects. Project-based firms are often as recognised as major product brands through their domination of specialist markets niches. It also has a direct impact on profitability and therefore on the ability to invest in new generations of technology and business process changes. The extent to which technical competences are specialised and located in different places within and between organizations affects how they can be deployed, ultimately affecting project performance, the ability to deliver value to clients, and firms' profitability. At the level of the firm, technology policy and the strategic management of resources involve issues of how firms develop their core technical competences within project-based environments. In the production and use of complex products and systems, this relates directly to issues of integration in planning, design, systems integration, assembly and construction. Innovation in Design, Engineering and ... 309 Regulatory and Institutional Framework Activities: technical, economic, environmental and social regulation Acton: government, local authorities, firms, industry associations, pressure groups,financialand insurance interests etc Project-based Firms Supply Network Activities: materials, components, equipment manufacture Actors: process, mass- and batchproduction manufacturing firms Activities: planning, design, engineering, procuring, integration services, assembly/construction Actors: consultant designers/engineers, project managers, constructors, specialist contractors, lawyers, financiers Projects Activities: commissioning and using constructed products Actors: clients/owners/users Technical Support Infrastructure Activities: long-term technical development and support Actors: government, education and R&D institutes, industry and professional associations, libraries, databases = Knowledge flows Fig. 11.1 Knowledge, information flows and actors in project-based processes.1 Figure 11.1 illustrates the types of actors, activities and knowledge flows found in project-based, service-enhanced production. This model has six main analytical dimensions: (i) (ii) (iii) (iv) (v) (vi) knowledge flows; project-based firms; project supply networks; projects (clients, owners, users); technology support infrastructures; and regulatory and institutional frameworks. In project-based productive networks, linkages between firms and other institutions differ from those found in traditional manufacturing approaches which focus on individual firms with clear boundaries and transactions between them and their operations, working in iThis approach was partially developed in our previous study of the construction R&D system which encompassed design, engineering, component manufacture, supply, assembly, construction operation and use (Gann et al., 1992). 310 David M. Gann & Amnion J. Salter a purely buy-sell relationship with one another. For example, attention may be focused on co-ordination mechanisms between firms, including non-market mechanisms such as indirect ownership, coengineering practices and partnering arrangements. Often, project-based firms' inputs into a project may be tied to a particular stage of the project's development. For example, schematic designs of fire and smoke systems are prepared in the initial stages of building design. Only after some months of construction do such designs get applied. In the meantime, changes in design resulting from the pressures of the construction process may alter the original schematic design for the fire and smoke system. The makers of the fire and smoke systems, far removed from the construction process, have to alter their designs to account for the new circumstances. Knowledge flows therefore need to be managed in the context of short-term, discrete networks of firms. Innovation in the type of activities described above, requires particular skills and resources which differ from those found in more stable production networks in which standard mass-produced products and services are delivered. Concurrent engineering is practised in many projects and this requires capabilities in co-ordination across organizations — sometimes involving co-location of staff. The consequences of failing to manage co-engineering between independent organizations may result in problems which are difficult to rectify because of the interdependent, systemic nature of technologies in complex products and systems. Success often depends upon the knowledge that people at every level of the organization bring to bear in new semiautonomous and often temporary, cross-functional teams. The knowledge base usually includes competence in specialised technical areas, particularly where component or systems technologies are developing rapidly. At the same time, interdisciplinary design and integration knowledge is required to enable the co-ordination of the many specialists and skills from different industrial activities. "Integrative competences" are becoming increasingly important. Rapid team-building skills are described by firms as core capabilities for personnel at all levels of the project-based enterprise. People need Innovation in Design, Engineering and ... 311 to be able to form teams quickly to tackle new projects or respond to events in existing projects. Professionals, managers and shopfloor operatives need to be able to respond to unforeseen events and deploy a high level of problem-solving expertise. Technological capabilities take several forms and are located within different functions in the firm. Requirements to integrate diverse arrays of existing technologies and also to develop new ones create the need for a broad span of knowledge. These capabilities may be tangible, codified, transferable assets, or intangible, tacit, uncodified competences embedded within the resources of the firm (Bell & Pavitt, 1995). The development of these capabilities needs to be linked to strategies for managing inter-firm project-processes where design and production activities are located. Innovation involves developing communications channels for knowledge generation and the diffusion of economically useful information. Understanding the pattern of knowledge flows and linkages within and between institutions is extremely important if innovation is to be managed effectively. This is more the case in complex processes such as those found in project-based industries. The capacity of project-based firms to absorb and work with new knowledge generated in different parts of the supply-network, limits the rate of innovation in subsystems and in the complex product as a whole. Project-based methods of production create a need to understand knowledge flows in client and supplier links which extend beyond the traditional economic notion of "an industry". This has implications for the form of cross-sectoral learning, development and knowledge flows including feedback, learning-by-doing and learning-by-using. Whilst such learning is generally cumulative, the discontinuous and temporary nature of project-based modes of production creates problems for rapid assimilation of new knowledge throughout a project-based organization. Modern forms of apprenticeship and peer group and team-based learning appear to offer important mechanisms for overcoming such discontinuities. Moreover, simulation of practice and observation and a recognition that professional practitioners also have to perform the role of problem-solving researchers is also useful (Groak, 1992). 312 David M. Gann & Amnion J. Salter The notion of decision-making and nature of decisions themselves are changing due to the implementation of new project and business management tools. For example, successful implementation of IT-based decision support systems in leading construction organizations demonstrates that emerging processes are quite different in character from conventional approaches. The use of IT systems is resulting in fundamental changes to the timing, sequencing and hierarchy of decision-making. The most important aspects of change are: (i) the speed and concurrence of decision-making; (ii) the ability to make information readily available when and where it is required; (iii) increased visibility of decision-making processes, including access to other people's decisions. Project-based firms also need to develop business processes to integrate capabilities acquired at the project level into their internal knowledge base. Many such firms are increasingly seeking to use IT-based project management tools, such as Baan's Dynamic Quantitative Modeler. These tools allow the firm to track the financial position of the project. But rarely do these tools assist in measuring or understanding the development of technology in the firm. Technical services within the firms are often charged to a single project. Yet the benefits of such investments may be received by all projects within the firm. Moreover, technological developments are notoriously difficult to cost. Benefits to investments in technology are often subtle, indirect and varied (Tidd et a-L, 2001). Few project-based firms have techniques for understanding their total portfolio of projects. Often the financial manager of the firm will monitor cost and time estimates on the project portfolio of the firm. Monthly or quarterly meetings of project managers may act as a device for ensuring that the status of different projects is understood, but they rarely provide a strategic direction for the firm. In a project-based environment, the articulation of an innovation strategy often depends on patchy knowledge on the current state of the firm's portfolio of projects. In part, this situation is created Innovation in Design, Engineering and ... 313 by the organization structure of project-based firms. With limited central functions, project-based firms need to find mechanisms to interpret project-based activities. They often rely on informal channels of communication among project groups to develop an understanding of the firm's project-based activities. Job rotation, monthly and informal meetings are often used to facilitate communication. In order to improve communication, many project-based firms have set aside central funding for project support groups. These project support groups act as repositories of knowledge and information about firm-wide processes. They are responsible for knowledge management within the firm, to ensure a flow of information and knowledge about current and past projects is maintained by the organization. 11.4 New Forms of Service Delivery The drivers for innovation in the built environment are leading to the emergence of new forms of production which centre on the provision of new types of services. One rationale for design, engineering and project management firms becoming interested in these has been their need to develop secure revenue streams, moving away from the traditional project boom/bust cycle. Traditional core project activities, for which work has to be tendered anew each time, have become less attractive with the breakdown of the professional fee system and growth in competition. In consequence, the move into new upstream and downstream services can be observed. For example, new upstream services include financial deal structuring, planning and design, strategic and project partnering (Barlow, Jashapara et 0/., 1998), customer support and training, supply-chain co-ordination, production and risk management, including services for legal, environmental and regulatory governance authorities. New downstream services include the management of coalitions of interests concerned with project operation, use and facilities management. Some firms have adopted an approach to sharing project information aimed specifically at extending the market for their 314 David M. Gann & Ammon J. Salter services. For example, in the US during the 1990s, the engineering firm R M Parsons created opportunities to provide clients with new value-added services, extending their market for engineering, procurement and construction, into early project decision-making and downstream facilities management (Gann, Hansen et »/., 1996). To achieve this they developed new Computer-Integrated-Project systems. These are supported by a variety of technologies such as Geographical Information Systems which are used in early development and planning processes. The adoption of this approach has resulted in the need for internal business process changes and new relationships with clients, design organizations, contractors and suppliers, government agencies and financiers and political groups. Re-positioning the organization in the market has been important in enabling the sale of services earlier in the project lifecycle. The recognition that the "bundling" of products, services and systems has the potential to offer customers enhanced performance and increased value lies at the heart of these new approaches. The growth in number and workload of systems integrators supplying turnkey solutions is an indicator of the growth in provision of bundled services. For example, Davies (1997, p. 252) argues that Ericsson and Nokia are market-leaders in the provision of telecommunications systems in part because they offer financial assistance, technical support and consultancy services to help their clients open new markets. Moreover, Tidd et al. (2001, p. 178) argue that value added at the systems level is greater than the sum of the value-added by the components — except where a component or subsystem is significantly superior to competing offerings. In the aero-engine industry, the prime engine manufacturers earn profits largely in the maintenance and service contracts associated with purchases. For some engine makers, it takes up to seven years after the original sale for the firm to begin to turn a profit (Prencipe, 1997). In all of these industries, firm competences in adding services to the original, physical project are the major enticement for the production of the artefact itself. The new manufacturing approach is in large part driven by the changing nature of demand. For example, in the UK, the privatisation Innovation in Design, Engineering and ... 315 of utilities and infrastructures has brought with it changes in the structure of markets for project-based, service-enhanced firms. The Private Finance Initiative has also changed the role of many traditional project suppliers, involving them in work earlier in project lifecycles, requiring new knowledge about financing and regulatory issues. Customers such as electricity generators which once may have engineered and commissioned new facilities now out-source far more work, including services to project-based firms. Evidence of these shifts can be found in the public statements of supplier firms. For example, the section on "Intelligent Building Systems" in ABB's 1997 Annual Report states that: Our building systems customers are increasingly asking for total solutions that cover all of their needs, from lighting and ventilation systems to monitoring and control systems that ensure the most efficient use of electricity through an entire building. ABB has the product and system know-how and design and project management capabilities to meet this growing demand, (p. 23) Adtranz, an ABB/Daimler Benz joint-venture, now the world's largest producer of trains, places particular emphasis on what it sees as the trend towards total system supply with operators letting maintenance and service contracts. 2 New debates about the convergence of manufacturing and service provision focus on clusters, chains and complexes of industrial activities (Marceau, 1994; Marceau, Manley et al., 1997). This analytical approach is helpful in understanding the ways in which knowledge flows between and within firms particularly when applied to activities of project-based firms. Marceau identifies chains of inter-linked production running from the suppliers of raw materials and primary products through manufacturing to project-based firms which themselves are very different from those that supply them. These chains of production cut across the boundaries of primary, secondary 2 We are grateful to Andrew Davies for references to ABB and Adtranz. 316 David M. Gann & Amnion J. Salter and tertiary activities. Traditional industrial boundaries become obsolete as technologies and working practices are combined in processes involving participants from many different industries. The notion of clusters is used in the Porterian sense to explain how firms with complementary assets may themselves grow by clustering together. There has been much debate in the literature about the importance of clusters of firms and of leading-edge customers as drivers of innovation and as sources of information and ideas (Porter, 1990; Riggs & von Hippel, 1994; Marceau, 1998). Clients are central to the development of the approach discussed here. Porter (1990) identifies the conditions necessary for successful industrial clusters, including skills and knowledge resources and appropriate institutional and strategic frameworks, together with strong demand and the presence of related supporting industries and infrastructures. This type of clustering may be more difficult for project-based organizations because they often have to produce products and services at the location of their final point of consumption, making it difficult to maintain continuity of relationships within an industrial district. Nevertheless, project-based firms do cluster around clients who repeatedly procure projects and services. For example, British Airports Authority, McDonalds, Marks and Spencer and a number of other leading UK clients use a variety of strategic framework agreements with their core suppliers, generating project activities in on-going, standardised processes. Construction of complex facilities such as silicon chip fabrication plants, sports stadia and concert halls have led to clustering in particular product markets. The concept of complexes is used by Marceau et a-l. to augment the chains and clusters approaches. This concept includes the regulatory, governance and institutional structures, which help to create the frameworks and infrastructures within which project-based firms perform — shown as "regulatory and institutional framework" and "technical support infrastructure" in Fig. 11.1. This discussion on the relationship between firms and their customers in supply-networks, clusters and complexes indicates the need to study both intra-organizational business processes — the Innovation in Design, Engineering and ... 317 ways in which project-based firms organiza their internal processes; and inter-organizational project-processes — the ways in which firms and institutions relate to one another in delivering projects, in order to identify the key contributors to success in the new manufacturing approach. There is a strong pattern of geographical localisation in clusters operating in project-based industries. Although many project-based activities are increasingly organizad using IT systems, there is still a need for personal contact. Tacit knowledge of individuals is essential to problem-solving in projects. Individuals often need to be physically located on sites in order to participate in the day-to-day activities of the project. Participation is continuous and contiguous. It involves the individuals from different specialisms responding together to problems generated by uncertainty in the life of the project. Projectbased firms have developed many strategies for dealing with this need to "be there" (Rimmer, 1998). For example, Balfour Beatty, a large UK-based construction firm, uses two forms of engineering support for its project activities: a central and a site-based unit. The company maintains a central engineering support function to solve problems presented by the day-to-day operations of the site. The central engineering unit is responsible for developing methodologies to improve particular technical problems. On-site engineers deal with day-to-day engineering problems related to the project. These on-site engineers have extensive links to the central support function and act as a technological gatekeeper for the development of engineering solutions by the central engineering unit (Interview, 21 July 1998). It is through physical proximity that project partners are able to solve problems in a collective manner. Services are increasingly supplied along with products across two industrial linkages: between supply-networks and project-based firms; and between project-based firms and their customers. These services are necessary to ensure that sophisticated component systems can be designed, integrated and operated as final complex products. In many cases, detailed design activities are migrating upstream into the supply network. But knowledge about operational characteristics is required to perform such design services and this knowledge must 318 David M. Gann & Ammon J. Salter flow up as well as down the supply network. Attempts to standardise procedures and to use modular approaches to design and component development are important methods for ensuring interchangeability of parts so that systems can eventually be integrated. Such an approach offers the possibility of meeting differentiated, customised requirements whilst benefiting from economies of scale derived from using standardised, pre-assembled components. Successful design and engineering firms recognise that they need management, marketing customer and user support skills, financial management skills, as well as risk assessment and co-ordination skills. Based on these, they have been able to sell project services for: (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x) planning and economic feasibility studies; technical support and transfer; environmental analysis; design and engineering; systems integration; whole-life economic assessments; procurement advice; legal advice; teaching and training; and facilities management and operations support. 11.5 Conclusions The traditional boundary between manufacturing and services is fast becoming obsolete as new forms of production emerge to supply physical products packaged together with intangible services, although much of the research on knowledge intensive business services has tended to treat all business service activities as similar. Yet design, engineering and project management services in the built environment differ from those provided in many other sectors because of the strong technical basis of knowledge required and the specific nature of the project-based organizations providing services in this sector. These are professional organizations typically with a strong project focus, and specialised technical capability, but with weak strategic Innovation in Design, Engineering and ... 319 goals. The chapter has identified a range of new upstream and downstream services and explained the reasons for their emergence, together with a deepening of technical specialisms in existing markets. However, these services have emerged in a sporadic and often ad hoc manner, because of the nature of the businesses concerned and the organization and nature of production. There has been little research on the economics of these changes and conceptual models about the provision of new services in the built environment remain weak. For these reasons it is not possible to evaluate outcomes, strengths and weaknesses. However, the emergence of some new services raises questions about whether die firms have appropriate skills to deliver — particularly in the wholesale move into support services and PFI/PPP management. Do firms with a traditional design and engineering background really have the capabilities to manage and operate schools or hospitals? If so, how have they developed these new skills and put them into practice? What do these developments mean for technological innovation and the development of traditional technical expertise associated with delivery of core services? Has there been a hollowing out of traditional technical capability in favour of developing new up- and downstream services? What mechanisms are effective in binding the agglomeration of services together within the new multi-service organizations and what are the economies of scale and scope in service delivery? Whilst a wide range of different practices can be observed, detailed empirical investigation will be required to answer these questions. We contend that project-based, service-enhanced firms represent a new area of research in management and innovation studies. Traditional treatments of firm behaviour, e.g. project management, do not have methodological equipment to explore the particular dynamics of innovation in these firms because they fail to draw a link between project and business processes. To realise the advantages of new types of service delivery within the built environment sector, it will be necessary to encourage the erosion of rigidities between professions and craft trades which now span a wide range of specialist interests from planning and development to design, engineering and management. Practices have 320 David M. Gtmn & Ammon J. Salter ossified within increasingly irrelevant discipline-based value systems that hinder the development and transfer of new knowledge. The future for the new forms of service delivery described in this paper is far from stable. Firms will need to perform in an increasingly dynamic environment. Deregulation and internationalisation are expanding and changing business opportunities. Rapid innovation in components, sub-assemblies and systems is likely to underpin competitiveness from a technological viewpoint. Winning firms will be those which are capable of making deep-rooted cultural changes whilst maintaining engineering and technical strengths. Firms are not able to achieve all of these changes alone. These emerging forms of service-enhanced, project-based activities require new and different systems of innovation support at national and international levels. Government and institutional research and development policies will need to change from not only the production of physical technologies but also to encompass organizational issues and the need to take account of and deal with knowledge about service operations needed to support those products. Governments need to be involved in setting governance and regulatory structures to enable firms to develop better practices in the delivery of these new services. Acknowledgements This chapter draws upon work carried out by the IMI/RAEng Chair in Innovative Manufacturing, SPRU, University of Sussex, and the ESRC Complex Product Systems (CoPS) Innovation Centre, SPRU/ CENTRIM (University of Brighton). We are grateful to the EPSRC and ESRC for their sponsorship. Chapter 12 Are Firms Moving "Downstream" into High-Value Services? Andrew Da-vies 12.1 Introduction Does manufacturing have a future in the twenty-first century or are we becoming a service economy? Academics and policy makers have been debating the merits of "manufacturing" and "services" since the 1960s and 1970s when Peter Drucker, Daniel Bell and others drew attention to a transition from a society based on manufacturing to one based on knowledge and services. The view that modern economies are shifting from making and moving physical products to managing knowledge and providing services continues to dominate discussions of the future of the firm (Quinn, 1992; Reich, 1992; Drucker, 1993). The debate falls into two main camps. Some argue that industrialised countries need to have a base in manufacturing (Cohen & Zysman, 1987), whereas others believe that it is sufficient to focus on service activities such as design, marketing, and brand image (Quinn, 1992). In recent versions of this debate, the literature has drawn attention to the importance of outsourcing manufacturing activities and "going downstream" into provision of highly profitable services — such as product design, marketing, branding and finance (Wise & Baumgartner, 1999). In this view, competitive advantage is not simply about the provision of services, but how services are combined with products to provide high-value solutions that address a customer's particular business or operational requirements (Slywotsky, 1996; Slywotsky & Morrison, 1997; Wise & Baumgartner, 1999; Sharma & Molloy, 1999; Hax & Wilde, 1999; Cornett et al., 2000; Bennet 321 322 Andrew Davies et al., 2001; Foote et al., 2001). For example, IBM has built its reputation as a provider of IT solutions for large business and government customers. It offers to design and install IT hardware and software and provide services and support during the life cycle of the product. This chapter examines the evidence for a shift to high-value services and solutions, focusing on firms that supply complex products and systems (CoPS). A sub-set of capital goods, CoPS represent a diverse range of software and engineering-intensive capital goods, such as flight simulators, aero-engines, airframes, telecom equipment, managed network services, high-speed trains, railway networks, and airport infrastructure. These products are designed, produced and integrated on a project basis in small batches or as one-offs to the meet the particular needs of business, government and institutional customers (Miller et at., 1995; Hobday, 1998). The chapter argues that there is evidence for a shift to highvalue added services and integrated solutions in CoPS. But the movement is not simply in one direction, away from manufacturing and towards services. In order to provide such service-based solutions, firms have to develop their systems integration capabilities. This can involve a movement upstream if a firm is already a provider of services, such as managed network services, design and technical consultancy. The literature emphasising the need to capture value that is migrating downstream fails to understand the critical role of systems integration in the provision of high-value services and solutions. Systems integrators ensure that components and subsystems are produced either in-house or by external manufacturers to meet an overall design. They have a detailed knowledge of their customer's needs as well as the product they have designed. Because of this they are in a strong position to provide the knowledge, experience, products, services and long-term solutions that their customers demand. The chapter is divided into two parts. The first part summarises some of the recent literature discussing the shift from manufacturing to services. The second part considers the evidence for such a shift in CoPS since 1995. The argument is illustrated by examples of Are Firms Moving "Downstream" into High-Value Services'? 323 five international suppliers of CoPS operating across different industries: • • • • • Alstom in railways; Ericsson in mobile phone networks; Thales in flight simulation; WS Atkins in the built environment and infrastructure; and, Cable & Wireless in managed network services. These case study examples represent some of the findings of a three year collaborative research project.1 12.2 High-Value Services: Literature Review This section reviews the literature on the subject of services and integrated solutions. Services have been defined at a general level as activities whose output does not consist of a raw material, product or construct, is usually consumed the moment it is produced, and provides intangible benefits and added value for the customer (Quinn, 1992, pp. 5-6). Manufacturing firms make products and service firms use products, human labor and intellect to deliver services. Manufacturing involves managing activities to transform raw materials and components into a physical object that performs a tangible function for the customer. Services involve managing knowledgebased activities whose output adds value in forms that are essentially intangible to the customer. Moving Downstream The manufacturing-services distinction is used to identify the main focus of a firm's activities within a chain of industrial activities — making products or providing services. Informed by this perspective, iThe chapter reports on the findings of a large three year collaborative research project — "Mastering service capabilities in complex product systems: a key systems integration challenge" — funded by the UK's Engineering and Physical Sciences Research Council (EPSRC) Systems Integration Initiative (Grant no. GR/59403). 324 Andrew Davies Wise and Baumgartner (1999) argue that the world's most successful manufacturing firms like General Electric, Coca Cola, Nokia and Honeywell are moving downstream into the provision of services to maintain, operate, upgrade and finance a product during its life cycle (Wise & Baumgartner, 1999). Firms are being driven downstream because making products has become less profitable and the provision services offers new, highmargin sources of revenue. By the late 1990s, many firms recognised that services represented a growing proportion of their overall revenues. According to one estimate at this time services represented ten to 30 times the annual volume of underlying product sales (Wise & Baumgartner, 1999, p. 134). In other words, the purchase of the product only represents a fraction of the total cost of operating and maintaining it over its life cycle. For example, railway firms spend $28 billion a year maintaining and operating their locomotives and fixed infrastructure, but buy less than $1.4 billion of new locomotives (Wise & Baumgartner, 1999, p. 134). Services provided through the product life cycle have the benefit of offering continuous revenue streams and require fewer assets than manufacturing. By expanding the product scope to include downstream services, firms can capture life cycle profits associated with the product. The promise of smooth, counter-cyclical growth is attractive to manufacturers that have been dependent on erratic, or lumpy, sources of revenue associated with one-off product sales. In addition to the attraction of more profitable activities, our research has identified two important market and institutional changes driving firms to provide an increasing range of services previously performed as in-house functions by their customers (Davies et al., 2001). First, suppliers are attracted into die provision of high-value services by strong demand from their customers. Buyers of CoPS are outsourcing non-core activities and focusing on the provision of services to the final consumer. To meet this demand, suppliers of CoPS are carrying out service activities previously handled in-house by the customer, such as design, systems integration and project management. Are Firms Moving "Downstream" into High-Value Services? 325 Second, the processes of privatisation, de-regulation and liberalisation have brought about new competitive market structures and new sets of incentives, rewards and contractual obligations in former state-owned sectors such as railways, telecoms and airports. The demand for suppliers to provide services has taken hold particularly strongly in the UK as a result of government policies to adopt new forms of private finance — private finance initiative (PFI) and public private partnerships (PPP). These contracts require that suppliers take responsibility for an increasing range of industrial activities, such as design, build and operations. For example, under its Ministry of Defence contracts, Thales Training and Simulation undertakes all the activities involved in designing and building flight simulators as well as training pilots and taking responsibility for the ownership of the buildings and trainer aircraft. Towards Integrated Solutions For Wise and Baumgartner (1999), the provision of integrated solutions is one of several downstream moves into services. But it should not be understood as simply the bundling of some extra services with existing products (Cornet et al., 2000). Bundling has been a successful strategy in consumer goods industries, where customers are provided with the same package of standardised products and services at a single price, irrespective of their differences in needs (Porter, 1985, p. 425). For example, IBM in the 1980s competed by selling personal computers as a bundle of hardware, software and after-care services. Integrated solutions, by contrast, represent new ways of creating value for the customer by offering products and services in innovative combinations to provide a tailored and precise response to a customer's pressing business need (Slywotsky, 1996, pp. 229-245; Slywotsky & Morrison, 1997, pp. 7 3 - 9 0 ; Wise & Baumgartner, 1999). For example, Ericsson — the world's leading supplier of mobile networks — has succeeded by moving beyond its traditional product focus and addressing all the equipment and service requirements of its customers — the mobile phone operators. Ericsson was among 326 Andrew Davies the first suppliers to recognise that its traditional customers faced two new challenges: first, to meet the upsurge in demand for mobile telephone by building their networks more quickly than their competitors; and second to make the transition from analogue to more complex second generation digital technology where they had little expertise (Davies & Brady, 2000, p. 942). Ericsson also had to meet the needs of newly-licensed operators that required more support widi the design, construction and operation of their networks than more experienced incumbent operators. Ericsson responded to these challenges by offering a range of network products — such as radio base stations, base station controllers and mobile switches — that could be easily installed and deployed by mobile operators. Together with these products, Ericsson offers services to help operators design, integrate and maintain their networks, acquire and build sites for transmission sites, and even to manage the technical operation of networks on behalf of their customers. Slywotsky and Morrison (1997) maintain that firms moving into this new activity have to learn that providing solutions is different to selling products or services (Slywotsky & Morrison, 1997, pp. 20-21). In a traditional value chain, the firm begins with its capabilities and assets and finds ways of turning those assets into product or services that are potentially important to a customer. In the provision of integrated solutions, by contrast, the value chain's traditional "product forward" orientation is reversed (Cornet et al., 2000, p. 2). The customer is the first link in the chain. The supplier begins by understanding a customer's needs and priorities and then identifies the right combination of products and services to provide a solution to these needs and priorities. The whole process is driven by a requirement from the customer — usually stated in the form of a question. Take for example Alstom Transport which has until recently concentrated on manufacturing trains and railway signalling systems. Instead of purely making and selling its product, Alstom is now providing its UK customers — train operating firms — with solutions for "train availability" during the life cycle of the product. Alstom's Are Firms Moving "Downstream" into High-Value Services? 327 first move into the provision of transport solutions began with its contract to renew the train fleet for the London Underground's Northern Line. Rather than specify the size and technical details of the trains, Alstom's customer only required that 96 trains be made available for service each day, for the duration of a 20-year contract. To achieve the London Underground's targets, Alstom has built 106 trains and set up a service organization to maintain them. 12.3 Moving From a Base in Systems Integration The literature on services and integrated solutions assumes that firms in diverse consumer and capital goods industries are moving in one direction only: downstream away from manufacturing. This section examines the evidence for a shift to high-value services and solutions in CoPS, taking examples from our five case study firms from 1995 to the present. This category of industrial goods is interesting to examine because large buyers of CoPS have been particularly demanding in their requirements for services and longer-term solutions (Davies et al., 2001). Moving Towards Systems Integration — The New Centre of Gravity Our research suggests that suppliers of CoPS are moving into the provision of high-value services and solutions. The direction that firms are moving can be understood by breaking down a typical CoPS industry into a number of value-adding stages in the life cycle of a product (Davies, 2003). For suppliers of CoPS with a traditional base in manufacturing, such as railway, aerospace and telecom equipment, the movement into services is downstream. As their traditional role in the value chain — making physical products — becomes less profitable, large CoPS firms such as Ericsson, Alstom and Thales are selling off their manufacturing assets, strengthening their positions as systems 328 Andrew Davies Manufacturing-services interface UPSTREAM (products) DOWNSTREAM (services) "•• Flow Earlier stages M SI OS SP | Final \ I consumer/ Manufacture (M). The First stage is responsible for taking raw materials and sub-assemblies and transforming them into components and subsystems that are manufactured to meet an overall system design. Systems integration (SI). The second stage adds value through the design and integration of these components and subsystems. Systems integrators are responsible for winning bids, managing projects, building and handing over fullyfunctioning products and systems - such as flight simulators, trains, and baggage handling systems - that meet the varying needs of business, government and other large institutional customers. Operational services (OS). The next stage is the operator who runs and maintains a system to provide services, such as baggage handling, flight simulation training, and train services. Service provision (SP). In some industries services are provided to the final consumer through intermediary organizations - called service providers. These firms buy in the system capacity they require from external operators and concentrate on brand, marketing, distribution and customer care activities. Fig. 12.1 The value-adding stages in a CoPS Industry. integrators, and outsourcing a growing proportion of their manufacturing activities to contract manufacturers. Alstom outsources 90% of the components in trains, but continues to design critical components such as traction systems in-house. Similarly Ericsson has outsourced the manufacture of mobile handsets and radio base stations to Flextronics, but continues to design and manufacture more complex subsystems, such as mobile switching centres. Thales Training and Simulation no longer manufactures the components in the flight simulators that it designs, installs, operates and maintains for its airline and military customers. It is tempting to think that the shift to services and solutions can be characterised by a move downstream, but other firms moving into this activity have traditionally been based in services. As a manager of global telecom networks for multinational corporate customers, Cable & Wireless Global Markets has recently had to strengthen its upstream role as an integrator of not just telecom but also IT equipment in order to provide complete solutions to its customers needs. WS Atkins is expanding from a specialised provider of design Are Firms Moving "Downstream" into High-Value Services? 329 Table 12.1 The shift to integrated solutions. Alstom Transport Railways Integrated Solutions (2000) Traditional product or service focus (1995) Firm Products: • subsystems (e.g. propulsion, traction, drive, electronic information systems) • rolling stock • signalling and train control systems Transport solutions (e.g. "train availability"): • Systems integrator — turnkey solutions for project management, fixed infrastructure, and finance • Services for maintenance, renovation, parts replacement & service products — "Total TrainLife Management"© Ericsson Products: Mobile Communications • mobile handsets, Systems • mobile system • subsystem products: radio base stations, base station controllers, mobile switches, operating systems, and customer databases Turnkey solutions (i.e. design, build and operate mobile phone networks): • Mobile systems — complete supplier, systems integrator and partner • Global Services — services and business consulting to support a customer's network operations Thales Training & Simulation Flight Simulation Products — standalone flight simulators for commercial and military aircraft Training solutions (e.g. "pay as you train"): • Systems integration • Training services: networked training; independent training centres for training services; and, synthetic training environments WS Atkins Infrastructure and the Built Environment Engineering consultancy, project management and technical services for infrastructure projects Integrated solutions for the built environment; • the design, build, finance and operation of infrastructure across industrial sectors • Total Solutions for Industry (TS4i) provides one-stop-shop for design, construction, maintenance and finance Cable & Wireless Global Markets Provides "managed network services" for multinational corporations • Network design • Supply telecom infrastructure and applications Global outsourcing solutions for a multinational corporation's entire telecom and IT needs on a global basis: • Network design • Supplies telecom infrastructure and applications • Network management • Ownership of the network • Network operation • Business process applications Global Business Telecom Networks • Network management • Service Level Agreements 330 Andrew Davies and technical consultancy services into a systems integrator, using components sourced from leading equipment manufacturers, and moving downstream into service such as the provision of finance, maintenance and operations. These firms are moving in two directions: they are taking on downstream service activities previously performed by their customers and strengthening their upstream capabilities in design and systems integration. From their different starting positions in manufacturing, design engineering and network operators, the firms in our research are moving in a similar direction towards being systems integrators. The rise of systems integrator organizations was first identified in the early 1990s (Rothwell, 1992). Rather than perform all large number of productive activities internally, these firms rely on a network of subcontractors and manufacturers for components and subsystems. Firms are occupying this new "centre of gravity" (Galbraith, 1983) between manufacturing and services in order to design, integrate and provide the complete solutions for products and services that their customers demand. The movement can be downstream, upstream, or both, depending on where in an industry the firm began its activities. Table 12.1 illustrates this shift in the focus of the firms' activities between 1995 and 2000. The Expanding Role of Systems Integration Increasingly buyers of CoPS want to deal with a single firm — the systems integrator — that designs and manages the integration of the system and provides services. The systems integrator ensures that individual components — manufactured in-house or by contractors — are conceived at the start of a project to meet the requirements of an overall system design. Some important activities performed by systems integrators are: • Preparing conceptual designs for the performance of each component and subsystem; • Ensuring that specifications for each component, subsystem and interface in the system are compatible; and Are Firms Moving "Downstream" into High-Value Services'? 331 • Modifying specifications for all components and subsystems if specifications change during the project. To ensure tiiat components and subsystems work together in the desired outcome, systems integrators perform a number of other activities such as technology development, project management, assembly or integration, maintaining relationships with customers, and managing internal or external component suppliers. For most of the twentieth century, these activities have been performed in-house by large vertically-integrated companies. In some cases the systems integration function was undertaken by manufacturers, such as Ericsson, Alstom and Thales, that provided their customers with single-vendor systems that were designed, produced and integrated in-house. However, many large customers, such as public utilties, railway and telecom operators, often had sufficient engineering and technical capabilities to design, integrate and even manufacture the systems that they operated. In such cases, suppliers assumed the role of a traditional manufacturer, responding passively to detailed technical specifications — so-called "build to print" — set by their customers. In response to an invitation to tender, the supplier delivered a product and "handed it over the wall" to the customer. Sometimes the supply of the product included a limited service component, such as maintenance, repair and spare parts for trains. Since the mid-1990s, a number of CoPS customers began to demand that their suppliers not only to design and integrate systems, but to maintain and operate them as well. In this changed environment, customers no longer require their suppliers to meet detailed technical specifications. They expect them to provide conceptual solutions that address their business needs — so-called "bid to concept" — offering products and services as that can be assembled directly from a supplier's portfolio. Efforts to standardise product and service offerings allows customers to choose the solution they desire from a supplier's portfolio. Depending upon their specific requirements and depth of capabilities, customers can mix and match different modules — such as train engines with or without spare 332 Andrew Denies parts — or select the entire set of modular products and services as a bundled solution. Ericsson, for example, now offers a portfolio of the above services in combination with its mobile network products. These modular services — called "Seven Service Solutions" — address the varying needs of its customers, from the initial business idea and planning, through systems integration and service start-up to technical operation. Whereas experienced operators, like Vodafone, may only require individual services, new operators — with limited technical knowledge and experience — can save time and expense by purchasing the entire set of products and services as a bundle. Customers also differ in the intensity of their needs for services and solutions during different stages of the product life cycle. In a shift away from formal, defined business-to-business relationships, suppliers are engaging in an active dialogue and closer collaboration with their customers. They are having to develop a deeper understanding of customer's experiences of operating a product, which will vary according to their capabilities as users (Prahalad & Ramaswamy, 2000). The lower the level of a customer's capabilities or the more they follow an outsourcing strategy, the earlier in the product life cycle they will require services from their suppliers. Customers with limited technical experience, such as newly-licensed mobile phone operators like Virgin Mobile, will require partnerships as early as the prebid phase to discuss business ideas, user requirements, and conceptual solutions, prior to specifying products and services. More experienced customers, such as British Telecom, may only request support at later stages. From Integrated Systems to Integrated Solutions The provision of integrated solutions requires that firms do more than just strengthen their capabilities as systems integrators. Because these organizations have a detailed knowledge of their customer's requirements as well as the products they have designed, they are well positioned to carry out many of the services — from maintenance Are Firms Moving "Downstream" into High-Value Services'? 333 Table 12.2 The range of services in integrated solutions. Firm Systems Integration Operational Services Business Consulting Services Financial Services Alstom Transport Design, manufacture and Maintain, upgrade build trains and signalling and operate systems, using equipment trains developed in-house or externally ConsultancyVendor financing based approach and asset to meet management customer needs Two business Considering, but consultancy not yet offering organizations to vendor meet needs of financing Ericsson and external customers Ericsson Design, manufacture and integrate mobile phone systems, using equipment developed in-house or externally Maintain, support, upgrade, and operate mobile networks Thales Training & Simulation Design and integration of flight simulations Provide services to Consultancy train pilots and organization manage simulator to meet building facilities. customer Joint venture needs with GE Capital Training External contractors for component supply WS Atikins Design and integrate external manufacturers equipment across diverse sectors, e.g. railway, baggage handling External contractors for component supply Cable & Wireless Design and integrate Global Markets networks using externally supplied equipment. Developing capability to integrate internet and IT systems External contractors for component supply Revenue sharing agreement for simulators, e.g. split between TT&S and United Airlines Create joint Maintain, operate Consultancyventure firm, and provide based approach TS4I, with services to endto meet Royal Bank users, e.g. setting customer of Scotiand up independent needs to provide service provider integrated to design, build, solutions for finance and design, operate baggage construction, handling services maintenance, and finance Design, build, operate and manage a global customer's IT and telecom needs Sometimes takes Consultancy based approach on responsibility to meet for ownership customer of networks for duration needs of contract 334 Andrew Davies and renovation, to financing and operating systems — required by their customers. As depicted in Table 12.2, the core systems integration activity is being surrounded by a number of high-value, knowledge-intensive services including: operational services, business consulting and financing. The latter two categories of services support several stages in the CoPS value stream, but are increasingly vital in the stages of systems integration and operational services (Davies, 2003). Together with the design and integration of the physical product, these services are required to provide customers with integrated solutions to their business needs. Systems integration: In-house function or external service Systems integration is one of the core capabilities in the design and production of CoPS (Hobday, 1998) and is the starting point enabling firms to move into the provision of integrated solutions. As we have seen, many large manufacturing organizations have recently begun to outsource a growing proportion of their manufacturing activities. But instead of simply focusing on providing single-vendor systems designed and developed in-house, firms like Alstom and Ericsson also offer to integrate equipment supplied by competing systems suppliers, as this is sometimes requested by their customers. This is known as a capability to provide "multi-vendor systems". One of the competitive advantages of companies like WS Atkins and Cable & Wireless is seen to be their ability to provide multi-vendor systems using equipment supplied by "best-in-class" manufacturers. For example, Alstom Transport's Systems business unit is a pure systems integrator organization, able to bring together components and subsystems sourced in-house and from external suppliers. Combining skills in project management, systems integration, fixed infrastructure engineering and finance, the Systems business is able to design and build complete multi-vendor systems for trains and signalling, using equipment supplied by its competitors, Bombardier and Siemens. Similarly Ericsson is able to integrate systems and provide services to support mobile equipment manufactured by other leading companies, such as Nokia, Nortel, and Lucent Technologies. Are Firms Moving "Downstream" into High-Value Services? 335 There are indications that the systems integration trend is becoming widespread across diverse CoPS industries (Prencipe, 1997; Brusoni & Prencipe, 2001). Many other leading suppliers — such as Boeing, BAe Systems, Lucent Technologies and Rolls Royce — are moving away from being broad based manufacturers into systems integration and service provision. Operational services Firms are building on their base in systems integration and crossing the boundary into services to maintain, renovate and operate systems. These operational capabilities require the expansion of existing activities, such as maintenance and the supply of spare parts, as well as the development of entirely new activities, such as training and operational management. Under some contracts, such as PFI and PPP, suppliers are required to design, build, operate and provide services to the final customer. Being involved in operational services opens the door for securing future orders for products, upgrades and replacement parts. Taking over the responsibility and risks for running systems therefore encourages suppliers to initiate technical improvements in the reliability of systems. Manufacturers are developing software technologies that allow maintenance services to be embedded in systems, such as telecoms, trains, elevators, intelligent buildings, and aircraft. These "embedded services" — which include software upgrades, remote control monitoring, diagnostic systems, and fault reporting — can reduce a customer's maintenance and operating costs (Wise & Baumgartner, 1999, pp. 137-138). For example, to help mobile operators reduce their network management costs, increase system reliability, and improve operational efficiency, Ericsson provides a 24-hour software-controlled networkmanagement service to monitor and provide real-time improvements in network performance. Another example is Alstom's train management system used to monitor faults on the fleet of Pendolino trains operated by Virgin Trains. Supported by this remotely controlled system, the driver and operator can solve problems in real time while the train is in operation. 336 Andrew Davies As they take on the responsibilities and risks of maintaining, upgrading and operating systems over long life cycles, suppliers are finding that there is an added incentive to design systems from the start that are reliable and easily maintainable. Being involved in services allows companies to grasp in-service problems and opportunities to improve system performance. Lessons learnt can be fed back into the design and build of current and future generations of systems. Because providers of integrated solutions are responsible for both systems integration and services, new feedback loops are being created between different parts of the same company. System designers and service providers operate in a closed loop, in which responsibility for operational performance and costs remain in the hands of a single organization. This can initiate a virtuous cycle of innovative improvements between service and system integration activities, leading to the design of more reliable and efficient systems being built in the future. For example, instead of building the rolling stock and selling it to the train operator, who then arranges maintenance, overhaul and train operations, Alstom now maintains, upgrades, converts and re-deploys rolling stock as usage patterns change, often recycling trains through the plants where they were originally built and designed. In this closed loop, the rolling stock never leaves the oversight of the designer and builder. In the case of Alstom's contract for the Northern Line extension of the London Underground, the managers responsible for maintenance and operational services were deeply involved in the front-end design of the rolling stock. As a result of their recommendations, the train designers made more than 250 modifications to create easy-to-maintain and easy-to-use trains. Business consulting Business consulting is an important component of integrated solutions provision. Firms are offering business consultancy services to advise customers on how to plan, design, build, finance, maintain and operate CoPS. Are Firms Moving "Downstream" into High-Value Services? 337 In comparison to the traditional focus of many CoPS firms on "hard" manufacturing or engineering capabilities, business consultancy requires an entirely new set of "soft", service-based consulting skills. To solve a specific business problems, suppliers have to develop a detailed understanding of their customer's operational and business needs. They have to forge closer links with their customers by demonstrating an ability to listen and to respond flexibly to a customer's requests. Business consultancy services are particularly important in the front-end pre-bid and bidding phases of the life cycle, when customers require assistance with business plans, financing arrangements and conceptual solutions. However, consulting skills are also important at later stages, to assist with specific problems such as project implementation and the management of an installed base of assets. The need to be able to undertake business consultancy is encouraging firms to expand their capabilities in three ways: • new alliances with other firms that have such capabilities; • acquisitions of other firms already operating in this field; and • the development of new in-house business consultancy organizations and capabilities. Some of our case study firms, such as Ericsson and WS Atkins, have set up specialist business consultancy organizations to perform this task. Other companies prefer to foster a consultancy-based approach within existing business units. Financing While some capital goods suppliers like General Electric and ABB have long had their own financing divisions, the provision of financial services for large business, institutional and government customers has become a more widespread and profitable activity since the mid1990s. The growing importance of financing is generally associated with PFI and PPP projects. But it has also grown in importance as an industry-led initiative to provide vendor financing and asset 338 Andrew Davies management services in capital-intensive industries, such as telecoms, railways and airports. Vendor financing is driven by the costs of constructing new systems, such as third generation (3G) mobile phone networks. Ericsson is considering the benefits of offering vendor financing to help mobile operators with limited funds to build 3G mobile phone networks on expectation of payment at a later date. For example, Mobilcom, the German operator, failed to secure bank loans and is negotiating 1.6 billion Euro of credit from Ericsson. Asset management is an important service for customers, such as train operating companies, seeking to reduce the costs of an installed base of products. WS Atkins, for example, set up a joint venture with the Royal Bank of Scotland to help the Bank's customers manage their capital assets, such as rolling stock, mobile networks and baggage handling systems. Summary: The Whole is More Than The Sum of its Parts Taken together, these services combine to offer integrated solutions to customers' business and operational problems. From different starting positions along the manufacturing-services spectrum, our case study firms are moving from a base in systems integration into the provision of high-value services and solutions. Integrated solutions offer customers the benefit of having a single point of contact for current and future products and services. If provided successfully, integrated solutions can help to maintain long-lasting relationships, build customer loyalty, and earn supplier's a steady stream of revenues on recurring upgrades, maintenance and other operational revenues. To move into integrated solutions, suppliers must not only demonstrate that they have acquired these new sets of capabilities, they must also be seen differently by their customers. Thales Training & Simulation, for example, increasingly wants to be seen as a provider of simulator-based solutions for the training of pilots rather than a manufacturer of flight simulators. Similarly, Cable & Wireless no longer wants to be seen as a general telecoms carrier but as a solutions provider serving the business market. Are Firms Moving "Downstream" into High-Value Services? 339 By providing integrated solutions, therefore, firms are selling the idea that their "system" and core capabilities add up to more than the sum of the parts. Firms seeking to become integrated solutions providers need to develop their core systems integration capability, move into operational services capabilities, and over time to develop at least three or possibly all four of these capabilities. 12.4 Conclusions The question whether manufacturing is being replaced by services asked at the beginning of this paper depends on how these categories are defined. Even if clear definitions can be found a resolution to the question is difficult because the boundaries between manufacturing and services are becoming blurred. Manufacturing firms are providing an increasing range of services and service firms are taking responsibility for the design and delivery of the physical product. Firms that started out as manufacturers — Alstom, Ericsson and Thales — have recendy begun to outsource many production activities and to focus on being systems integrators. Firms that grew up from a base in services like WS Atkins and Cable and Wireless have built up their upstream capabilities as integrators of equipment supplied by leading manufacturers. As Rothwell (1992) pointed out, these firms rely on a network of contractors and component suppliers to provide customers with integrated systems. Both types of firms have since the around the mid-1990s begun to move into the provision of high-value services and integrated solutions. Developing the capabilities to offer integrated solutions means that these firms do fit easily into traditional categories of manufacturing and services. This is not to say that integrated solutions providers do not perform manufacturing or service activities. The intention of this chapter has purely been to illustrate the other capabilities required to undertake this emerging category of industrial activity. By emphasising that firms "should" move downstream from manufacturing physical products to delivering high-value services 340 Andrew Davies and solutions, many commentators are offering misleading strategy advice. They neglect the continuing importance of performing knowledge-intensive activities concerned with the development, design and integration of physical products. Once firms have established a strong base in systems integration, they can extend their activities to provide their customers with integrated solutions for products, services, capabilities and support through the product life cycle. Part III Applying Innovation Management Good Practice to Services This page is intentionally left blank Chapter 13 A Composite Framework of Product Development and Delivery Effectiveness in Services Frank M. Hull and Joe Tidd 13.1 Introduction This chapter proposes a framework for the development and delivery of service products. This framework, which was adapted from goods industries, is posited as sufficiently generic as to also apply to services. A generic framework is potentially useful because goods and services are increasingly bundled. Many intangible service products have physical manifestations that require operations similar to those in manufacturing, such as check processing. Many industrial products include intangible services (Chase & Garvin, 1989; Chase & Hayes, 1991). The proposed framework enlarges upon a "composite model" of product development effectiveness that was proposed and tested by analyzing data on 100 industrial companies in the USA (Hull et */., 1996; Liker et al., 1999; Collins & Hull, 2002). Its applicability to services was confirmed when a parallel study of 70 service enterprises USA observed mostiy similar patterns of relationship (Hull & Tidd, 2002; Hull, 2002). These parallel results suggest that the framework is reasonably robust. The framework presumes that the basic steps in new service development are broadly similar to those in manufactured goods with only minor differences in emphasis and execution (Easingwood, 1986; Shostack, 1987; Cooper et al., 1994; Lovelock, 1996; Cooper & Edgett, 1996; Storey & Easingwood, 1999; Cooper & Edgett, 1999). From a systems perspective, inputs, throughputs, and outputs 343 344 ^ O "^ Q\ f 0 00 r-; o N -o CO CO • * O O K i^ O O T^ ,_; t o O ^ i-H CO IN * ^ r-t * * CN O 'O O (N r~i U-i r-j O ,' CN p-l rH VO CN 00 tn CN LO CN (7\ CN on CO 1/1 N. •K CO CN CO CO IN o * o * f* o ~; ^ * « * *-tf * w ^ * * * o * on o m rt 1 5 •"1 *"! * * * h- * o * * * * * i n "? ^ ^ * * * * Os * -! ** en ™ Ov CO ^h t n C\ ^ O O Q S r H O L O t N C O t X i — I N tn ^ Th O _ S is o cjs o "^ C o « W I-H CO -H ^ •—1 O LD CO IN "^ o 00 CO CO CO W | 5 ^ <£ o 'So | 2-S 3 S I § - 2. S -fi u SnEa •*f CO O C 0 K . C N C 0 C 0 C 0 0 v ^ 0 t > 1 0 ( N C N > — I __;"^-^i—(COcNCOLncococN—icN ^ O ^ O O s O t N - C N - ^ O ^vOCOLOCO-^lfiCO O ^ Frank M. Hull & Joe Tidd Q C-i I I .3 § a* 5 ^ S >. S 2 O w O« O U O < / 5 w , 5 l J p i Z ggHn»n.ui>ots A Composite Framework 345 must meet customer needs regardless of the type of product and transformation process — physical, symbol, or human (Collins et al., 1988; Lovelock, 1996). Despite similarities in the results of analysis for goods and services, some important differences remain. Therefore this chapter tailors the framework to better suit services. This chapter described the concepts in the framework and their interrelationships. Then evidence supporting the interrelationships is provided in three ways. First, a correlation matrix of measures of the concepts is shown in Table 13.1. The correlations are for a combined sample of 108 service enterprises, 70 from New York plus 38 others from a matching study in London. The dependent variables include an index of product development plus service delivery. The latter was added because delivery process is sometimes tantamount to the service product itself (Gronroos, 1990; Reichheld & Sasser, 1990; Zeithaml et al., 1990; Lovelock, 1996; Storey & Easingwood, 1999). Second, multivariate analyses are summarized from companion articles (Hull, 2001; Hull, 2002) and results reported in a separate chapter of this book (Hull & Tidd, 2002). Third, some case evidence from the USA is also provided in a separate chapter (Hull & Hirschhorn, 2002) 13.2 A Composite Framework of Concurrent Product Development The cornerstone of CE is early simultaneous influence (ESI) by all relevant functions on product decisions throughout the development cycle (Collins & Hull, 2002). Integrating input into product decisions at early stages is particularly important for achieving concurrency because many functions in serial development methods have input only after the bulk of decisions have already been made, e.g. features, the process of service delivery, customer service options, etc. To achieve early input, concurrent methods must overcome the constraints of bureaucratic structures, which is difficult in large corporations because size and complexity increases bureaucratic 346 Frank M. Hull & Joe Tidd structuring (Blau & Schoenherr, 1971; Blau et ai, 1976). Concurrent methods infuse bureaucratic structures with "organic" practices that enable richer and more frequent communication among people regardless of rank or position in the value chain (Burns & Stalker, 1961; Hull & Hage, 1982; Hull, 1988; Damanpour, 1991). Product development systems practicing concurrency have flatter hierarchies, more decentralized decision-making, relatively flexible rules, and roles that include general as well as specialized responsibilities. Cutting the Gordian knot of bureaucratic red tape, however, is an insufficient cause of concurrent practice. Guidance is needed for cross-functional product development team members because much of their work falls outside of the rules and hierarchy of their home departments. Disciplined control over the product development process increases the probability that ideas generated by teams will be commercialized as products (Hull, 1990). IDC (In-process design controls) are more flexible guides for cross-functional teams than the rigid controls of mechanistic bureaucracies. For example, crossfunctional teams may be given greater latitude for executing project plans to the extent they take partial ownership of the process and responsibility for outcomes. The fusion of relatively organic practices like ESI with relatively mechanistic ones like IDC creates hybrid forms of organization that are better suited for hyper-competitive markets because of their capacity for achieving multiple kinds of performance outcomes simultaneously, such as product innovation and low cost (Duncan, 1976; Daft, 1978; Hage, 1980; Hull & Hage, 1982; Hull, 1990; Susman & Dean, 1992; Leonard-Barton, 1992; D' Aveni, 1994; Hull et al, 1996; Manz & Stewart, 1997). Synergy between ESI and IDC is the driving force of the composite framework. For example, when cross-functional teams are involved in both the improvement and maintenance of product development processes, IDC becomes a hybrid kind of control that is partially self-imposed. IDC enables enterprises to handle novel as well as routine product development so that project success is more repeatable. Variants of these and other constructs in the framework have been used in many theories of organization design (Pugh et al., 1968; A Composite Framework 347 Hickson et al., 1969; Hage, 1980; Daft, 1995) and are congruent with most models of concurrency (Zirger et al., 1990; Susman & Dean, 1992; Zirger & Hartley, 1996). They are also consistent with the building blocks used by practitioners in programs such as the Lean Aerospace Initiative (Womack & Jones, 1996; Cusmano & Nobeoka, 1998; Henderson & Larco, 1999). Shown in Fig. 13.1 is an adaptation of the composite framework for services. Statistically significant correlations and/or regression coefficients were observed that support all paths shown. The framework is organized into subcomponents: (1) Antecedents, (2) Organic Enablers, (3) Strategy, (4) the Operating Core, including its cornerstone, (5) System Integration, (6) Task Contingencies, and (7) Context. Antecedents The transformation from serial to simultaneous methods of product development involves organizational and cultural changes that are counter to the norms of large-scale bureaucracies. In serial development, functions normally involved only at late stages of a cycle, such as customer service, are placed in reactive roles that limit their potential contributions. To drive the transformation from serial to concurrent methods, education/training is needed to change attitudes and champions are helpful for leading the adoption of new practices. Two antecedents are depicted in Fig. 13.1 as having an impact on enablers of ESI, the adoption of concurrent strategy, and the deployment of core CE practices. The first step is to change attitudes by raising awareness of concurrency and the principles behind it via training in the skill-sets required for its practice. A second step is leading employees in executing the new practices. The effects of these antecedents are presumed to be indirect via these intervening practices. They are termed: • Concurrency education & training; and • Concurrent enterprise championing. 348 Frank M. Hull & Joe Tidd G-CONTEXT: 12. Environmental Dynamism, 13. Organization of Product Development, 14. Nation —; + 1 * C-6. Rapid, Reiterative, Redesign Strateg Fig. 13.1 A composite model of concurrent product development in services. Concurrency Education & Training (CET). Education and training help employees become aware of the need for change and the rationale behind it. This is needed for implementing concurrent practices because the transformation from serial to simultaneous methods involves organizational and cultural changes that are counter to norms in large-scale bureaucracies. The differentiation that occurs with growth in size means that specialists are located in different parts of the corporation and often lack close relationships. For example, those delivering services to customers are often physically segregated from those developing the services, treated with relatively low status in many corporations, and have little input into the design of products. To overcome bureaucratic barriers, CET helps employees engage in practices that enable cross-functional integration. CET includes formal workshops and courses deployed by a firm to transmit information regarding concurrency, and to impart related skills to its participants. CET plays a vital technical and a cultural role in the institutionalization of CE practice, such as such as cross-functional A Composite Framework 349 teaming practices and new product design protocols. CET helps firms embrace organic, team-based structures that in turn, enable members to effectively adopt practices of concurrent product development. Concurrent Enterprise Championing (CEC). Champions help transform new attitudes into changed behaviors for transforming the enterprise. Champions lead in transforming the enterprise from functional to project-based operations. They cut across hierarchies to better integrate contributions to product development by diverse disciplines within and/or external to the enterprise. Champions often have responsibilities or the holistic response of the enterprise to customer requirements. To accomplish this, they often coach product development teams on new processes and reorganized responsibilities. Organic enablers of ESI (Early Simultaneous Influence) The framework includes three enablers of ESI, a cornerstone of concurrent enterprising. These are: • Cross-functional teaming; • Collocation; and • Group rewards. Cross-functional teaming. Achieving cross-functional integration is a necessary step for concurrent enterprising. It is a more a proactive implementation of organic organization design than the traditional approach of removing bureaucratic constraints to permit unstructured communications and chance encounters. Cross-functional teaming brings varied disciplines together and charters them with a common task. This means that a significant proportion of time is spent outside of functional departments. Implicit in this definition is the notion of sufficient empowerment relative to functional departments in terms of staffing and budget. Collocation (COL). Bringing project team members together in a shared space creates opportunities for rich communications via face-to-face contact (Daft & Lengel, 1986). To facilitate personal exchanges, many companies house product development teams in 350 Frank M. Hull & Joe Tidd dedicated spaces. An important aspect of common space is eye contact among team members. Group rewards (GR$). Incentives for team members to work together encourage collaboration among up and downstream functions because everyone has a shared stake in outcomes. These rewards may be financial and/or social. Examples include team bonuses and 360-degree-performance evaluation systems whereby both up and downstream functions rate each another. Concurrent Strategy Strategy Process of Rapid, Reiterative, Redesign (RRR). A concurrent approach to the process of strategy formulation/ implementation falls in between alternatives such as maintaining products with minor changes versus developing novel ones. Continuously making small-medium improvements in products often results in higher levels of cumulative innovation than more risky, radical approaches (Clark & Wheelwright, 1993). Concurrent approaches to product development deploy a cyclical process of planning, pilot testing, reassessing, and enlarging the initiative after appropriate adaptations (Deming, 1992). By reusing knowledge in rapidly repeated cycles, products often achieve both generic competitive advantages simultaneously, innovative differentiation and cost reduction (Azumi et al., 1983; Hull et al., 1985; Takechi & Nonaka, 1986; Clark & Fujimoto, 1989; Hull & Azumi, 1991; Funk, 1993). A reiterative approach to strategy process is often effective because the initial plan may be adapted by melding it with emergent opportunities. This is one reason why effective strategies are often continuous iterations that integrate planned and emergent options (Mintzberg & Quinn, 1996). Integrating emergent options with plans is especially important to the extent markets are characterized by risk and uncertainty. To execute a RRR strategy, an operating system is required that is both disciplined and flexible as well as enabled by continuously updated computer technologies. A Composite Framework 351 The Operating Core The operating core is comprised of a troika of constructs dealing with organization, process, and tools/technology. These are: • Early simultaneous influence • In-process design controls • Computer information technology Early Simultaneous Influence (ESI). The cornerstone of the composite framework is the reorganization of product development from a serial to a simultaneous process. ESI means that functions normally involved only at late stages of a cycle, such as customer service, participate in product decisions from the outset. ESI is a project-level application of tihe principles of "organic" organization design that increases the generation of ideas (Burns & Stalker, 1961). Up-front decision-making by all relevant functions sometimes takes longer at initial stages where ideas are generated, but progressively less so, thereby reducing total cycle time and the money associated with maintaining project teams (Hull et al.y 1987; Clark & Wheelwright, 1993; Gerwin, 1993). By integrating work performed by various functions, ESI helps benefit performance for at least six reasons. First, the bulk of costs are committed at early steps of a development cycle even though not expended until later (Hartley, 1992). Second, the cost of fixing faulty upstream decisions at late stages is exponentially greater than earlier ones. Collaboration at early stages saves money at the back-end because costly late stage engineering changes are reduced (Hartley, 1992). Third, the opportunity costs of being late to market are often enormous. Fourth, heterogeneous input in decision-making typically provides a better quality solution to complex, dynamic product development problems than solo individuals (Susman & Dean, 1992; Katzenbach, 1993; Gatenby et al., 1994). Fifth, non-value added activities are reduced because of rich direct communications instead of serial hand-offs (Daft & Lengel, 1986). Sixth, heterogeneous input allows for constructive ideas to indirectly improve the product in ways such as improving the processes of 352 Frank M. Hull & Joe Tidd developing and rendering them ready for customers (Takeuchi & Nonaka, 1986; DeMeyer & Hooland, 1990). Interaction of ESI with RRR. A strategy of RRR has an interaction effect with ESI. A concurrent strategy increases opportunities for diverse functions to have input throughout the development cycle because decision-making is reiterative. Therefore, a strategic process facilitates input by diverse functions early and often enhances the capability of ESI. In-Process Design Controls (IDC). Guidance is needed for crossfunctional product development team members because much of their work falls outside of the rules and hierarchy of their home departments. Disciplined control over the product development process increases the probability that ideas generated by teams will be commercialized as products (Hull, 1990). The concept of IDC includes not only methods for standardization, design documentation, and periodic product reviews, but also processes enabling continuous improvements, such as process mapping, benchmarking, market assessments, identification of customer needs, and translation of requirements into product specifications (McCabe, 1985; Melan, 1985; Griffin, 1992; Graessel et al., 1993; Garvin, 1995; Yearout, 1996). For example, process mapping may be used to eliminate unnecessary hand-offs and activities that do not add value to the product development. Continuous improvement via process mapping helps ensure that success is repeatable from one generation of products to the next consistent with ISO procedures (Lovitt, 1996). IDC represents a dynamic and flexible generation of practices that evolved from the rigid rules and procedures characteristic of mechanistic bureaucracies (Weber, 1947; Burns & Stalker, 1961; Liker et al., 1999). The "structuring of activities" by formalization, standardization, and hierarchy (Pugh et al., 1968) has been replaced in many corporations by processes that are more flexible and enabling than rigid rules in coercive, mechanistic bureaucracies (Adler & Borys, 1996). Interaction of IDC with RRR strategy. A strategy of Rapid, Reiterative, Redesign is depicted as having an interaction effect with IDC. A concurrent strategy increases the need for continuously A Composite Framework 353 tracking changes in intended and realized product development activities. Successful pursuit of a strategy of RRR fits better with flexible, dynamic processes than rigid rules. Interaction of IDC with ESI. If processes are flexibly managed in an enabling rather than rigidly serial, coercive manner, simultaneity in cross-functional product development can be achieved more effectively. ESI counterbalances the mechanistic tendencies of large organizations by infusing them with organic practices. Organic practices enable richer and more frequent communication among people regardless of rank or position in the value chain because hierarchies are flatter, decisions are decentralized, rigid rules are fewer, and roles include general as well as specialized responsibilities. This creates hybrid form of organizations that are better suited for hyper-competitive markets because of their capacity for achieving multiple kinds of performance outcomes simultaneously, such as both product innovation and low cost. ESI is presumed to benefit product development performance through several avenues. Thus, IDC provides a synergistic complement to the creativity stimulated by cross-functional interchange because the development process is framed and kept within boundaries for meeting market opportunities. Previously, organic firms had loose control systems that permitted novel creations to emerge, but seldom in a timely and cost-effective manner. Ironically, the flexible constraints of IDC provide boundaries that reduce the risk of project teams wandering around fruitlessly. IDC enables people to change product development plans in response to emergent contingencies. For example, cross-functional teams may be given greater latitude for executing project plans to the extent they take partial ownership of the process and responsibility for outcomes. When cross-functional teams are involved in both the improvement and maintenance of product development processes, IDC becomes a hybrid kind of control that is partially self-imposed. IDC enables enterprises to handle novel as well as routine product development so that project success is more repeatable. Thus, one difference between newer in-process controls and older static behavioral controls is that responsibility for the design concept and its realization is largely decentralized. Controls are partly 354 Frank M. Hull & Joe Tidd self-imposed by semi-autonomous product design teams, who are empowered, within limits, to improve product designs on their own initiative. Computer Information Technology (CIT). Services vary in the extent to which computer tools and technologies are applicable for product development and delivery. For example, some services are highly dependent on information and electronic transactions while others involve relatively more personal interchanges. Yet, service sector companies have been even greater consumers of information technologies than manufacturing industries (Roach, 1988) and are automating all kinds of transactions, from checks to program trades (Dabholkar, 1994; Rayport & Sviokla, 1995). However, the use of many kinds tools, such as CAD (computer automated design), is often limited because of the intangibility of many service products. However, the role of CIT in services appears less important relative to goods at this time. 1 System Integration RIC (Reciprocal Integration Capability). The essence of the system concept is interdependence among components so that the whole exceeds the parts. Among the modes of interdependence, concurrency is conceptually more congruent with reciprocal than either serial or pooled methods (Thompson, 1967; Leach, 1996). RIC means multiple functions along value chains work in a constant state of mutual adjustment, which contrasts with one-way or segregated flows. Systems also may be evaluated in terms of their level of maturity, which means that inter-relationships are structured in robust ways so that predictable results are obtained even in dynamic environments. 1 In goods industries, this synergy is augmented by parallel interactions of each of these concepts with tools/technologies. As these interactions were not replicated in prior analyses of these service data, they are tentatively omitted from the framework proposed herein. It may be that new generations of computer tools are more capable of enhancing service product development. A Composite Framework 355 Task Product novelty. Task is a contingency that affects optimal design. Product development tasks may vary in many complex dimensions. A way of simplifying the measurement is reduction to a single concept: newness of the product to the organization. Testing for the moderating effects of newness is necessary because this contingency may affect the extent to which the composite framework is more or less effective. For example, many studies show that the more novel and uncertain the nature of the work, the greater the benefit of organic practices (Burns & Stalker, 1961; Lawrence & Lorsch, 1967; Rochferdt & Rudelius, 1992; Olson et »/., 1995; Soulder, 1999; Swink, 2000). Context The extent to which product development and delivery practices are effective may be affected by the context of operations. Therefore, the framework includes the following three factors: • Environment; • Organization of product development; and • Nation. Environment. The composite framework was devised to suggest how enterprises might better survive in hyper-competitive markets described by Moore's law (D'Aveni, 1994). This law, based on the computer industry, suggests that performance doubles while costs are reduced by half every 1.5 years. Concurrent systems are postulated as optimal for competing in such environments because of their capabilities of achieving a balanced portfolio of performance outcomes simultaneously. Recently the environment of service enterprises has been affected by changes, including new technologies, globalization, and deregulation. Contingency theory suggests that large bureaucracies may transform themselves into hybrid forms of organization to better cope with such changes (Burns & Stalker, 1961; Lawrence & Lorsch, 1967; Damanpour, 1991; Susman & Dean, 1992; Liker etui., 1999). 356 Frank M. Hull & Joe Tidd Organization of the service product development function. How services organize for product development varies. Traditionally the same people developing service products were those who also managed them. Recently, some companies, especially in the US, have redefined their enterprise in terms of products and created dedicated jobs and departments for this activity. For example, several major firms recently consolidated formal responsibility for development in newly created positions in companies that emulated many practices common in goods industries, e.g. American Express, Chase Bank, etc. (see later chapter). Nation. Economies and cultures differ in terms of how they organize and manage enterprises. Thus, transnational applications of the framework need to control for regional effects. 13.3 Research Methods Samples The US study targeted large corporations. All but one of the 12 largest public corporations in the greater New York area was included. Only four companies had less than 500 employees (Hull, 2001). The London sample also included large corporations. But the percentage was smaller than in New York. Characteristics of firms in the sample are provided in Appendix A. Both studies relied upon a single key informant. Respondents were asked to report on a service product development project with which they were familiar. Because product development was not always by a dedicated specialist, respondents included line managers as well as those engaged in marketing, business development, quality, and business process reengineering. Measures Measures used in the services study are provided in Appendix B-2. The scales are based on factor analysis of the US data because the UK data is more variegated (Tidd & Hull, 2002). Alphas are A Composite Framework 357 provided for the combined dataset even though somewhat lower than in the US only data. Despite this, the median reliability of .80 meets the rule of thumb criteria for basic research (Nunnally, 1978). Performance Two indices are used, one of product, the other of process. Measures of time compression and cost reduction, signature indicators of CE benefit, reflect this distinction. Time compression from concept to test market is included in the product index; time to full-scale delivery included in the process index. Reduced cost of development is included in the product index, the cost of delivery in the process index. The product index also includes additional measures dealing with innovative features and quality. The process index includes additional measures of delivery quality and responsiveness to customers. Antecedents CE Training (CET). CE is not a term commonly used in services. Therefore a question was dealing with training in process improvement was used as a proxy. CE Championing (CEC). An index of championing included two questions: strengthening the role of project managers and reducing the levels in the hierarchy. Organic EnMers of ESI Cross-functional teams (CET). Four questions were added: using cross-functional teams, cross-training specialists, reorganizing jobs to reduce handoffs, and increasing the influence of downstream functions (e.g. customer service) in upstream product development decisions. 358 Frank M. Hull & Joe Tidd Collocation (COL), A question was asked about the general use of physical collocation. Group rewards (GR$). A question rated the extent to which project teams/groups were rewarded. Concurrent Strategy Rapid, reiterative redesign (RRR). Concurrent strategy was measured as a combination of two items: improving existing products and making changes to existing products in rapid cycles. These two items fell in between the extremes of alternative strategies of novel products versus minor changes. The Operating Core Early simultaneous influence (ESI). Input by ten functions was measured at three stages: product concept, final release, and after sale. Four of these, identified by factor analysis, were included in an index of ESI: marketing, process development, finance, and customer service.2 In-process design control (IDC). The intent was to capture enabling processes that guide development and aid knowledge reuse, such as design standards, documentation, and product reviews with broad-based participation. Also included are related practices such as benchmarking best-in-class companies, QFD (Quality Function Deployment), and continuous process improvement. Specifying early influence is important because several studies have found that the benefit to performance varies by stage of die development cycle (Olson et al., 1995; Rochford and Rudelius, 1992; Caird et al., 1997; Song et «/., 1999). Because of die actuarial detail required in answering this stage-based battery of questions, only 62 of 70 US enterprises provided responses. This question was added late to the UK study and is available for only 14 of 38 cases. An alternative measure summing five questions on early involvement, but without stage specificity, results in stronger correlations (except with collocation). The correlation between the two measures is .47. In analyzing die USA only data, die stage specific measure is used and provides similar results (Hull, 2002). A Composite Framework 359 Computer information technology (CIT). This measure focused on general measures of computer utilization because visualization tools, such as solid modeling, are often inapplicable. Several tools dealt with software and analytical methods. System Integration Reciprocal Integration Capability (RIC). The measure of system integration focused on the theme of holistic practices to balance and align competing interests along entire value chains unified these images. Nine questions were formulated from thirteen graphs depicting system integration. The statements attempted to cut across concurrency constructs to capture emergent capabilities at a system level of analysis. Task Product Newness. Newness was measured as the extent to which the product development strategy of the enterprise focused on new versus other kinds of development during the past five years. Alternatives included focusing on novel new products versus minor changes to maintain existing products. Context Environmental Dynamism. Questions were asked on the extent to which the market had increased or decreased in terms of six changes, e.g. technological complexity of service products, rate of service product introduction in the industry, quality, etc. These six items were dealt with in two ways. First, competitive pressure was measured as the sum of six changes likely to result in greater challenge, such as higher quality. Second, turbulence, the absolute change regardless of direction, was summed for the same six items. The concept is measured as the sum of standard scores of these two indexes, competitive pressure and turbulence. 360 Frank M. Hull & Joe Tidd Organization: Specialization of the service product development function. The organization of an explicit function for developing new service products was measured as the presence of a formal job for this activity. Nation. A dummy variable representing UK enterprises was used as a control in partial correlations. 13.4 Results First, we report the results of the partial correlation analysis controlling for nation. Second, results from prior analyses of the datasets are summarized within the context of the overall framework. The two dependent variables, product development and delivery performance, are strongly inter-correlated. Both measures are significantly correlated with all predictors. They are also significantly correlated with the contextual measures of organization and environment. However, neither varies significantly by nation. With one exception, described below, the correlations are stronger for product development than delivery process. One reason may be that the framework focused principally on product development in its original formulation. Antecedents CET and CEC are significantly correlated with all other predictors. They are significantly correlated with organization and environment context, but not nation. CET is the only predictor more strongly correlated with delivery than product performance because it measure was limited to process improvement. Organic Enablers All three enablers of ESI have significant correlations with other predictors except for the relationship of collocation with CE training. All are correlated with organization and environmental context A Composite Framework 361 (except collocation with environmental dynamism). None are correlated with nation. Concurrent Strategy RRR. Rapid, reiterative redesign has a significant correlation with all other predictors and with performance. In multiple regression analyses, RRR strategy was found to have indirect effects on performance via each of the troika of constructs at the operating core: ESI, IDC, and CIT (Hull, 2001). Operating Core Early Simultaneous Influence. ESI has significant correlations with all other predictors except CIT. In multiple regression analyses, it also has a main effect on performance as well as an indirect effect via RIC. 3 Interaction of ESI with strategy of RRR. The greater the deployment of a strategy of RRR, the greater the impact ESI has on performance (Hull, 2001). In-Process Design Controls. IDC has significant correlations with all other predictors. In multiple regression analyses, IDC was found to have significant main effects on performance and indirect effects via RIC (Hull, 2001). interestingly, simultaneous influence at the last stage, after sale to customer, also has a main effect on performance (Hull, 2002). Its impact after sale, contrasts with the results of analysis of the goods data. One may speculate that this is due to the fact that opportunities for continuous improvement of service products, unlike goods, do not necessarily end after sale. For example, some kinds of personal services entail repeated interchanges and may provide opportunities for continued development after sale. This conjecture is consistent with a significant correlation of simultaneous influence with value added by personal and transactional services, which are presumably relatively more amenable to further improvement after sale (not shown in a tables). 362 Frank M. Hull & Joe Tidd Interaction of IDC with strategy of RRR. The greater the deployment of a strategy of RRR, the greater the impact IDC has on performance (Hull, 2001). Interaction of IDC with ESI. The greater the use of IDC, the greater the impact ESI has on performance. Computer Information Technology. CIT is correlated with other predictors except ESI. In multiple regression analyses, its main effects are weakly significant only for product development performance, but not service delivery performance. CIT also had an indirect effect on performance via RIC in the services data (Hull, 2001). System Integration Reciprocal Integration Capability. RIC has significant correlations with all other predictors. In regression analyses, it also has main effects on performance (Hull, 2002). Task Product Novelty. A strategy of product novelty was significantly correlated with all other predictors and with both performance indicators. Interaction: ESI x Novelty. ESI has an interaction effect with a strategy of product novelty (Hull, 2001 ). 4 Context Environment. An index of environmental dynamism is correlated with most predictors (exceptions being CET, CEC, COL and ESI). Environmental dynamism is also correlated with specialization of the product development function. These results suggest that the Simultaneous influence at the latest stage, after sale to customers, also has some interaction effects (not shown in tables). A Composite Framework 363 adoption of many CE practices may be a response to environmental changes. Organization. Creating a dedicated function for product development appears to be a pivotal decision that results in the adoption of concurrent practices and the achievement of higher performance. Although this question is available only for a portion of the cases in each sample, available data show that the enterprises creating formal jobs for product development have higher levels of both performance indicators and many measures of concurrent practice, including: CE championing (CEC), cross-functional teaming (CFT), collocation (COL), a strategy of RRR, computer information tools (CIT), and system integration (RIC). Also, creating specialized jobs for product development is significantly correlated with environmental dynamism, which one may speculate is a potential stimulus of this possibly pivotal change Nation. UK enterprises are somewhat less likely to engage in concurrent practices. The correlations of the dummy variable representing UK cases are consistently negative, although significantly so only for CFT, CIT, RIC, and specialization of the product development function. However, if the organization of a formal product development function is controlled none of the practices are significantly different between the US and the UK. This suggests that much of the contrast between the US and UK pivots on whether enterprises created specialized functions for product development. 13.5 Summary CE Training and CE Championing were correlated with practices predicting performance. Organic practices found to enable ESI included cross-functional teaming, collocation, and group rewards. ESI is a predictor of performance, both solo and in interaction with IDC. IDC played a role in performance improvement in both datasets. It has main, interaction, and indirect effects. The interaction between ESI and IDC is particularly important. Fusing organic practices with mechanistic ones is a key to hybrid structures that are capable of multiple kinds of simultaneous 364 Frank M. Hull & Joe Tidd performance advantages. The transformation of large bureaucracies into hybrid forms is consistent with contingency theory, which suggests that high-performing enterprises shift their organization design relatively more toward the organic rather than mechanistic end of a continuum as markets become more dynamic and technologically complex. CIT played a weak role. One reason may be that many tools are less applicable in this sector because of the intangible aspects of the product. System integration was a strong predictor of performance. These results argue for further research measuring system level properties. To pursue a strategy of novelty, ESI is relatively more necessary. Environmental dynamism correlated with the adoption of concurrent practices, including the organization of a specialized PD function. The organization of a specialized function for product development appears to be a key contrast between the US and UK. Sub-sample analysis of the data available for this measure suggests that this practice is pivotal and seems to account for other differences in mean scores between the two nations. 13.6 Conclusions A product-focused approach to the conduct of service business appears to be a relatively new paradigm recently adopted from goods industries by several leading companies. Results of analysis suggest benefits to performance from this approach. Given the relative newness of a product-focused orientation to services, further research is needs on ways product development is like and unlike in the two sectors. The composite framework suggested herein seems to be robust enough to provide guidance for product and process innovations in service as well as goods industries. However, some important differences were observed despite strong parallels between the sectors. One difference is that tools and technology seems to play a much weaker role in services. Another is that the intangibility of many services means that they are relatively more amenable to continuous A Composite Framework 365 development than physical goods. Partly because of intangibility, the process of delivery is often very important in many service categories, especially those involving personal and/or transactions of a continuing nature. Thus further research is also needed on the ways services are distinctive from goods even though the thrust of this chapter has been to suggest a rather generic framework. Appendix A: Types of companies in samples. Category US UK Financial Services Retail banking Credit Card Lending Private Banking Investment Services Insurance Consulting Services Construction Distribution/logistics (*) Education/training Healthcare Diagnostic services Hospital Pharmaceutical services Manufacturing related services (**) Non-profit Publishing Retail Travel/Hotel 18 5 3 2 1 7 8 4 1 13 1 2 Telecommunications Transportation 6 1 8 4 1 2 4 3 2 3 2 5 5 TOTAL 70 2 10 2 5 0 4 2 1 1 1 1 2 3 2 3 38 *Utilities, Engineering Services, Distribution of Product, etc. ** Credit, Risk, etc. 366 Frank M. Hull & Joe Tidd Appendix B: Measures. PERFORMANCE Product development Alpha =.92 Delivery Process Alpha =.92 A To what extent have your service products changed during the past five years? 1. New features 2. Upgraded features 3. Higher quality 4. Greater amount of different components 5. Easier customer use after purchase 6. Shorter time from concept to test market of service product 7. Shorter time from test market to full-scale delivery of the service product 8. Reduced cost of service product development To what extent has the process of delivery your service product changed during the past five years? 9. Shorter response time to order for existing service products 10. Shorter time for adjustments to complaints 11. Reduced cost of service product delivery 12. Higher quality of delivery process, e.g. fewer customer complaints 13. Better after sales support services 14. Conformance with service product development process and procedures ANTECEDENTS CET — CE Training CEC — CE Championing Alpha = .62 To what extent have you emphasized the following kinds of activities during the past five years'? • Training in process improvement • Creating a job title for product development • Strengthening the role of project managers • Reducing levels in the hierarchy A Composite Framework Appendix B: Measures B COL — Collocation GP$ — Group rewards Using cross-functional teams Increasing the influence of downstream functions in upstream decisions, e.g. customer service in the development of service products Cross-training specialists Reorganizing jobs to reduce handoffs Collocating complementary functions Rewarding project teams/groups STRATEGY RRR — Rapid, Reiterative, Redesign Alpha = .72 D {Continued). ORGANIC ENABLERS CFT — Cross-functional teaming Alpha = .74 C 367 Strategy: To what extent did your strategy for the past five years focus on: • Making major changes to existing service products • Making rapid changes to existing service products OPERATING CORE ESI — Early Simultaneous Influence1 Alpha = .54 IDC — In-process Design Controls Alpha = .86 When are the following functions involved in product development? (1) Product concept, (2) Just before release for sale, (3) after sale to customers? Sum 75 of involvement at the product concept stage. • Marketing • Process development • Finance • Customer service Processes: To what extent have you engaged in the following activities during the past five years in the development of service products? Processes in developing service products (Alpha =.84) 1. Benchmarking best-in-class companies 2. Using structured processes for identifying customer needs and translating them into requirements, e.g. Quality Function Deployment 3. Setting performance criteria for development projects 368 Frank M. Hull & Joe Tidd Appendix B: Measures 4. 5. 6. 7. 8. 9. CIT — Computer Information Technology Alpha, = .75 (Continued). Setting standards for the performance of service products Institutionalizing systematic reviews of development projects Process initiatives (Alpha =.86) Mapping processes to reduce non-value added activities Improving documentation of processes Measuring conformance with processes Institutionalizing continuous improvement processes Information Technology: To what extent activities during the past five years'? 1. Company internal communications via E-mail or other computer networks 2. Updating existing Information Technology Systems 3. Management Information Systems (MIS), Expert Systems 4. Distributed databases on-line to multiple functions 5. Common software for project management 6. Common software for process mapping 7. Building on-line databases with lessons learned and best practice templates SYSTEM INTEGRATION RIC — Reciprocal Integration Capability Alpha = .87 To what extent do you systematically use the following approaches? 1. Involve customers early in the service product development process, pulling the product design in the direction of customer needs 2. Align competing product requirements by focusing on the VoC (Voice of Customer) A Composite Framework Appendix B: Measures 369 (Continued). Balance portfolio of competitive advantages for which customers are willing to pay (cost-novelty) Transfer lessons learned from previous activities to succeeding people so that they build upon an existing base to reach ever higher future targets Review projects frequently to ensure conformance with plan Open communication channels to all functions and ranks in the organization Cultivate staff to provide holistic, system-wide thinking as well as specialized knowledge View knowledge as a paramount competitive advantage to be gained from outside as well as inside the company Act as a good partner with others, such as suppliers, external service providers, alliance partners and customers, in creating and maintaining mutual win/win scenarios F PRODUCT NOVELTY NEW — Product novelty G CONTEXT Organization To what extent did your strategy for the past five years focus on: • Developing novel service products Presence of a formally defined product development function: Do you have a job title for persons who are responsible for differentiating your service products from those of competitors? 370 Frank M. Hull & Joe Tidd Appendix B: Measures (Continued). Market Change: To what extent have your markets changed in the following ways? Competitive pressure = the sum of directional change (Alpha = .63) 1. Technological complexity of service Environmental Dynamism products (market change + turbulence) 2. Rate of service product introduction Alpha =.90 3. Compatibility of service products with other products 4. Customization 5. Globalization 6. Quality Turbulence = absolute change regardless of direction (Alpha = .55) 7. Technological complexity of service products 8. Rate of service product introduction 9. Compatibility of service products with other products 10. Customization 11. Globalization 12. Quality Nation 1 US = 1, U K = 2 ; Mean =1.35 Alternative ESI measure that is not stage specific (Alpha = .84) • Increasing the influence of downstream functions in upstream decisions, e.g. customer service in the development of service products • Involving customers in decisions about service product development • Involving customers in decisions about changes in the service product delivery process • Involving externals (suppliers, partners, etc.) in decisions about service product development • Involving externals (suppliers, partners, etc.) in decisions about service product delivery process Chapter 14 Product Development in Service Enterprises: Case Studies of Good Practice Frank M. Hull 14.1 Introduction The adoption and adaptation of industrial methods of product development in services seem to have accelerated sharply during the past decade. Many leading companies have redefined their service businesses explicitly in terms of "product". Some recendy created new positions for product development transcending the domain of a single functional department, such as marketing, information technology, etc. One may speculate that this shift in methods has been stimulated by environmental dynamism, including globalization, deregulation, new technologies, etc. To chronicle these changes, in this final chapter we provide excerpts from 27 qualitative studies of service enterprises in the New York area to provide a collage of recent trends and practices in the development and delivery of service products. SPOTS (Strategy, Process, Organization, Tools, and System) provides the framework for the collage portraying service product development. 1 This framework is based on CE (Concurrent Engineering), a broad-based approach adopted during the past 10-15 years by many leading industrial concerns to develop products faster, cheaper, and better (Hardey, 1992; Liker etal., 1999). The essence of CE is the reiterative involvement of multiple functions in development cycles from the x The SPOTS framework was developed by melding the results of statistical analysis of 100 industrial companies with qualitative studies of 12 of these companies that also participated in a Concurrent Engineering user Group. 371 372 Frank M. Hull earliest stages using structured processes and enabling tools to create a systematic approach for launching new products and/or improving existing ones (Hartley, 1992; Susman & Dean, 1994). An advantage of qualitative information is that each of the constructs in the framework can be presented in greater variety and meatier detail than possible with the statistical analysis of quantitative measures reported in earlier chapters using the SPOTS framework. To better accommodate the qualitative excerpts, the SPOTS concepts are broken down into several sub-concepts to provide an expanded skeleton. The bits and pieces of the collage are tied together not only by the statistical results reported earlier, but also by reporting relatively more detail about the evolution of product development in an illustrative case, Chase consumer banking. Largely because of the success of CE in goods industries, concurrent practices were adopted by service businesses in recent years along with other well-known initiatives, such as Total Quality Management and Business Process Reengineering. Of course, adaptations had to accommodate the intangible nature of many services. However, many firms viewed the basic steps in new service development as broadly similar to those in manufactured goods even if somewhat different in their emphasis and execution (Easingwood, 1986; Shostack, 1987; Cooper et al., 1994; Lovelock, 1996; Storey & Easingwood, 1999; Cooper & Edgett, 1999). Whether the product is physical or intangible becomes somewhat irrelevant in generic systems terms as inputs, throughputs, and outputs must meet customer needs regardless of the type of product and transformation process. Based on such assumptions, the SPOTS framework was adapted for application to services during the conduct of qualitative studies that are summarized herein. 14.2 Theoretical Framework Environmental dynamism is presumed to stimulate the adoption of new methods of product development as depicted in Fig. 14.1. Contingency theory suggests that to the extent new forces such as globalization, emerging technologies, deregulation, and the Product Development in Service Enterprises 373 ENVIRONMENTAL CHANGE PERFORMANCE FORMALIZATION OF THE PRODUC DEVELOPMEN FUNCTION SPOTS Framework • • • • • Strategy of RRR Process Organization Tools System Fig. 14.1 Environmental dynamism, formal product development, & SPOTS. increased bundling of goods and services create new opportunities, large service enterprises need to redesign their systems to compete in these restructured environments (Lawrence & Lorsch, 1967). The formalization of the product development function is posited in Fig. 14.1 as a pivotal step in responding to environmental dynamism. Formally charging people with the responsibility of product development concentrates decision-making capability for importing new methods of doing business under changed circumstances. The SPOTS framework is built upon a composite model of CE effectiveness (Hull et «/., 1996). This model posits hybrid forms of product development systems as relatively more effective than large, bureaucratic forms in dynamic and technologically complex environments (Duncan, 1976; Daft, 1978; Hage, 1980; Hull & Hage, 1982; Hull, 1988; Hull, 1990; Susman & Dean, 1992; Liker et al., 1999). Hybrids are advantaged by their capacity for achieving both kinds of generic performance advantages simultaneously, innovation and cost, by melding the contradictory extremes of the mechanistic versus organic ends of the continuum proposed by Burns and Stalker (1961). The essence of the model is that its constructs resonate with one another to provide synergy (Hull et al., 1996; Hull, 2002). 374 Frank M. Hull The SPOTS framework uses constructs consistent with many theories of organization design (Pugh et al, 1968; Hickson et al, 1969; Galbraith, 1977; Hage, 1980; Daft, 1995) that are included in most models of concurrency (Zirger et al, 1990; Susman & Dean, 1992; Zirger & Hartley, 1996). However, they are conceived in ways that moderate the extremes of either end of the mechanistic versus organic continuum as shown in Fig. 14.2. Strategy is a reiterative process for sure footedly cumulating minor or major changes instead pursuing riskier fixed objectives (Dewar & Dutton, 1986; Clark & Wheelright, 1993; Tidd, 1995; Tidd & Fujimoto, 1995; Mintzberg et al., 2002). Process is defined as flexible and enabling guidance (Adler and Boyrs, 1996) instead of rigid, ironclad rules for structuring activities (Pugh et al., 1968). Organization is a proactive approach for engaging people in cross-functional teaming instead of a laissez faire approach of removing bureaucratic constraints and hoping that people make appropriate connections with one another (Takeuchi & Nonaka, 1986; Liker et al., 1999; Collins & Hull, 2002; Tidd & Bodley, 2001). Tools include programmable software instead of hard, inflexible kinds of automation (Collins et al, 1996; Mitchell & Zmud, 1999). System is a horizontally arrayed set of interdependencies that require reciprocal rather than serial forms of integration (Thompson, 1967; Liker et al, 1999). In sum, the components of the SPOTS framework are hypothesized as enabling enterprises to better compete in environments that require not only innovative changes, but demand global discipline. Shown in Fig. 14.2 are SPOTS concepts and examples that were first identified as potential best practices in goods industries and subsequently adapted for services. The translation of these best practices from goods to services appears to have been generally successful in that discrete measures of practices within each of these categories have significant correlations with performance in the data analyzed in other chapters of this book. However, the translations within the domain of tools were only partially satisfactory as many of the technologies used in goods industries are difficult to apply to intangible aspects of services. 6 0 'II hS.1 £a a a. o E •su E g r 6fl S s sg '% .2 •5 t3 s« § 6 « 8a -a - II I I i eg 60 — ^ s a r^S E (lil Y> JS -S •p s 11 8 E •a s 2| *-§ if 5 .3 -a & •s Product Development in Service Enterprises u u w .2 E rt t> M S r J5 c cd .22 OU •= f„ =!• 7 s c s KH o Q O nj w ~ s W U 0 U O S E O J 5 O ! fill 2J £ "U BUI-UI 5.S 60 B i -5 ~ I S"§ 0 £) II I i ual ;ree s .a :£ "te> a IS sis org 375 376 Frank M. Hull 14.3 Research Methods Concurrent product development in service sector businesses was studied using four methods of varying formality. First, the applicability of concurrency to the service sector was explored in discussions and conference workshops. Meetings were held monthly for a year to discuss the applicability of concurrent in services with a small group of executives from companies such as American Express, Bell Atlantic, Chase Bank, etc. Conferences with workshops on concurrency in services were held for 130 representatives from 75 companies in 1996 and 1997. Second, graduate students in two advanced MBA courses conducted 22 studies of varying quality and completeness. A primary objective of the studies was to assess the conceptual applicability of the concurrency principles to services. Each student in the first class of 14 administered a 200 pages of questions that were adapted from an inventory of best industrial practices of CE. Each study required mapping all or part of a process affecting value added of services as perceived by customers. Some of the processes mapped were at the core of the product development process, e.g. stage gates with exit and entry criteria. Others were tangential to product development per se, but could be demonstrated as having an impact on the value chain, e.g. customer order to fulfillment cycles, client intake processing, customer service, etc. A senior executive from the companies studied was identified as the principal client and evaluator for 18 of the 22 cases completed by students. Third, a user group of 10 service enterprises was formed to apply principles of concurrency. During operations from 1997-2000, each took turns hosting the others to share their product development processes and ongoing experiences in implementing concurrency. Five of these companies were new to the research program, five were continuing with it. The 27 enterprises studied in 18 corporations are listed by the focal topic studied in Appendix A. Fourth, a somewhat more detailed study was conducted of a large, multinational bank in collaboration with its Senior VP of Product Development in Service Enterprises 277 Product Development. The VP utilized two of the MBA students on location to map product development processes. The VP also participated in the user group from its inception. Subsequently the VP co-taught a course in service product development that included case materials from the bank. 14.4 Case Studies of Good Practice In this section we provide illustrations of improvement and innovation in services. We begin with an example of one of the qualitative studies to illustrate the framework. Then we contrast this with examples of good and not so good practice. The first case is Chase consumer banking. The Evolution of Service Product Development at Chase Consumer Banking Chase was among the leaders in pioneering a product-focused approach to performance improvement in its consumer banking business. Its story is reasonably illustrative of the adoption and deployment of product development practices within an enterprise of a large diversified financial corporation. After benchmarking with industrial firms, Chase decided that the people developing new products should be different from those managing them on a daily basis. A vice-president of product development was appointed to ensure that no one function dominated, such as marketing over information technology, or vice versa. Over time, the bank developed the strategic capability of introducing new products rapidly, but at the same time planning to continuously offer added options to further differentiates them from competition. This approach kept the development process reiterative and proactive. This was important, as reverse engineering in services lacking patent protection is relatively easy. 378 Frank M. Hull The process of product development was initially an implicit one. Stages of development were implicitly understood by those in the development group, but were unwritten. Subsequently, the tacit knowledge of how to execute the process of product development was formalized and documented in written form. Its templates included stage-gates with entry and exit criteria. It was made available to participants in all teams in hard copy and on-line. Initially, the product development group was comprised of a handful of people. Over time, die composition of members on product development teams became increasingly cross-functional. Once the needs of development projects were known, the VP of product development recruited loaners from the required functions to populate the teams with the appropriate representatives. The teams were a mix of full-time staff and part-timers. As operations matured, multifunctional involvement tended to occur at earlier stages. Key members were often physically collocated for important projects. The group increasingly used computers and the web for information searches. Model product development templates were made available on line. However, analytical tools for aiding decisions were under exploited. Within consumer banking, the level of system integration was moderately high. However, linkages with other parts of the corporations were often weak. For example, econometric modeling was housed in another part of the bank and not routinely used by the consumer-banking group. The product-focused strategy of the consumer group appears to have been successful. It grew in size from a handful of people to a total of over 100 in five years. The bank's market share in some segments also grew. Redefining services in product terms A fundamental change at Chase was the formation of a specialized function for product development. This also occurred at several other firms that created new Vice-Presidential positions for product development, including not only Chase, but also American Express, Product Development in Service Enterprises 379 Chubb Insurance, Merrill-Lynch, Morgan Stanley, etc. One of the principal shifts in thinking was redefined the value added by their enterprise in terms of "product". While this risked the error of misplaced concreteness, it provided a way of trying to manage a business process despite many intangibles. Incumbent in these positions adopted formal development processes, typically adopted a wide variety of methods, including CE (Concurrent Engineering), T Q M (Total Quality Management), BPR (Business Process Reengineering), etc. 2 Creating new jobs dedicated to product development function solved several problems. Managers in large, Balkanized corporations did not know who was developing what for whom. For example, one financial services corporation reported that divisions created products that competed with or cannibalized others. Another financial services company said they were unsure whether they made or lost money when complying with customer requests for new features. Prior to such changes, executives had only a loose idea of how many products were under development within their enterprise. Unless it was a prominent project, they were unaware of launch dates because metrics for measuring progression through the product development cycles were seldom in place. To increase sales from new products, executives in product development marshaled resources from across their enterprises to more rapidly and systematically launch new offerings. Many of the concurrent practices were adopted as part of this initiative, sometimes explicitly, sometimes as part of the flotsam and jetsam associated with the sea change. Although some companies created formal positions for product development, most did not. As a few had difficulty thinking of their business in product terms, more generic terms were sometimes 2 As noted in Chapters 1 and 6, the contrast in the adoption of concurrent product development practices between the USA and the UK is almost entirely explained by die formalization of the function in the former case. In the UK, relatively greater reliance was placed on alternative interventions to improve performance. 380 Frank M. Hull D. Enterprise Focused Cells C. Central PD Function Group of people with diverse subject matter expertise are cross-trained and share dedicated responsibility for enterprise specific product innovations. Type: Semiautonomous teams in organic structures producing batches of technically complex products Core staff in a product development department configures cross-functional development teams, help manage projects, and continually maintain product development processes. Type: Heavyweight teams in hybrid, professional bureaucracy continuously producinq complex products A. Ad Hoc Developers B. Centralized Review Board Liaisons with relatively more influence than authority facilitate the process of product reviews required as a corporate-wide check to ensure minimal conformance with product development processes. Type: Functional teams in mechanistic bureaucracies using mass customization Lar e Scope 9 The same people who manage products on a daily basis undertake sporadic development activities. Type: Lightweight teams in simple, traditional structures using craft-batch production Small Fig. 14.3 Typology of organization and service product development. used, such as strategic business process improvement. Therefore, a typology is provided for classifying different approaches to service product development. Typology of organization and service product development A typology was created to classify varied approaches to service product development includes four categories: (1) Ad Hoc Developers; (2) Central Review Boards; (3) Central Product Development Department; and (4) Enterprise Focused Cells. As illustrated in Fig. 14.3, each varies in terms of continuity of product development activities and scope. These categorizations roughly correspond with Clark and Wheelwrights' (1993) classification of product development teams and typologies of organization design (Burns & Stalker, 1961; Woodward, 1965; Mintzberg, 1979; Hage, 1980; Hull & Hage, 1982; Mintzberg et al, 2002; Collins & Hull, 1986; Hull & Collins, 1987; Tidd & Hull, 2001). Ad Hoc Developers. The same people managing products on a daily basis also develop them on occasion. Individuals or teams are assigned product development responsibility sporadically. This is typical for relatively small-scale enterprises with simple structures competing in traditional markets producing products in batches. For example, New York Times Custom Publishing assigned a couple of people to work on redefining their market and product offering with only Product Development in Service Enterprises 381 a small reduction in their regular duties. Similarly, one person at Jewish Charities Mental Health Service was given an additional responsibility for reexamining their client selection and product delivery processes. Centralized Review Board. Liaisons with more influence than authority maintain corporate-wide product development processes and facilitate centralized reviews across diverse divisions. Their mission is to ensure minimal conformance with product development processes, reconcile competing priorities, reduce duplication of effort, and prevent unwitting cannibalization. People either generate products as part of the routine of managing them or as members of temporary product development teams. This is typical for large-scale corporations with multiple lines of business engaged in mass customization for relatively mature markets. For example, Merrill-Lynch developed an on-line corporate-wide product development process with two stages of review that is described in somewhat more detail below. In trying to grow the product development function, a related activity initiated by Merrill-Lynch and some others was to centralize resources for new product ideas and ideation processes. A kind of think tank was created to solicit ideas and provide preliminary evaluations of them. Although the primary impetus for new product development remained within each of the businesses, centralized coordination and help was made available. However, similar ideation activities at American Express are a part of their centralized development process. Centralized PD Function. A department of core staff configures cross-functional development teams project by project. Responsibilities include maintaining product development processes, helping with project management, coaching, and facilitating reviews. This is typical for large-scale bureaucratic corporations continuously producing new products for multiple lines of business in complex, dynamic markets that require some degree of technical expertise. For example, American Express Travel Related Services adopted a product-focused approach that helped restore their competitiveness. Today they maintain well-established development 382 Frank M. Hull groups across a variety of businesses. This group at the outset included in-house as well as outside consultants to serve as champions in coaching teams on how to execute the new way of developing products. Enterprise Focused Cells. An operating group of people with diverse technical expertise have dedicated responsibility for enterprise specific product innovations. This is typical for small, organic groups of cross-trained people within large corporations or small, high-tech enterprises competing in fairly complex and/or dynamic environments by producing batches of relatively sophisticated products. For example, Citibank has solutions teams within various enterprises that focus on improving the product and delivery processes, e.g. new kinds of web-based products delivered globally. Syndicated banking teams at Chase focused on product development and continuous process improvements. SPOTS framework Whatever the approach undertaken for product development, the implementation of concurrency was more often piecemeal than proactive and systemic. Only six cases were observed as holistically implementing all five of the constructs in the framework. More commonly, companies focused on process improvements and/or tools, often under the banner of business process reengineering. Only if process changes happened to include product development did reorganization to achieve greater cross-function integration occur. Strategy. Several service companies adopted a strategy of rapidly introducing new products in a way similar to that practiced at Chase consumer banking. Most of these launches were variations of existing products instead of radically new concepts. Because intervals were shorter, knowledge gained from one project could be more readily reused on the next, thereby speeding development time and reducing risk. Product Development in Service Enterprises 383 Strategy at American Express American Express adopted a product-based strategy. During the decade prior to 1995, the Travel Related Services Group introduced only two new products. During the next two years, they launched over eighty (Mitchell, 1996). Almost all of these new product ideas were derivations from platforms rather than radically new concepts. To accomplish this shift in strategy, a vice-president of product development was created, cross-functional teams were formed, a formal development process was established, and computer tools were deployed, such as for rapid prototyping. Sharp increases in revenue were recorded before the end of 1997. Attempts to implement a R R R strategy failed in another case. O n e bank, trying to play catch-up without first creating a product development function, rapidly launched six n e w p r o d u c t s that immediately failed for reasons such as illegality, lack of internal capacity, and insufficient differentiation Process. To implement a strategy of rapid product introduction, it is necessary to have mature, repeatable processes txiat are continually improved such as the one that evolved at Chase consumer banking. Several enterprises devised model templates for managing product development projects, such as stage-gates with entry and exit criteria. These new processes usually resulted in greater reliability consistent with research showing that financial service firms adopting defined stage-stages for p r o d u c t development have better track records ( C o o p e r et «/., 1 9 9 4 ; C o o p e r & E d g e t t , 1 9 9 6 ; 1 9 9 9 ) . Such formalization is necessary for mature, repeatable processes that are continually improved. Process at Merrill-Lynch A vice-president was made responsible for creating and maintaining a global product development processes at Merrill-Lynch. Initiatives included devising product development templates that were made available on 384 Frank M. Hull their intranet. The templates include business case analyses and stage gates with recommended entry and exit criteria. A cross-functional committee was formed to review new product development proposals for process conformance at two stages, idea and pre-launch. Although businesses were not required to submit to review, records were kept that compared those that did with those that did not. Analysis of the records argued persuasively for conformance with the review process. The intranet and the flexible software templates enabled products to be developed using common global processes. However, having processes is not the same as using them effectively. In a financial services company, manuals for product development were developed t o standardize processes and provide guidelines including stage-gates. O n e reason was because initiatives in crossfunctional teaming without processes had resulted in some degree of chaos and uneven o u t c o m e s . H o w e v e r , the teams resisted using the processes. T h e struggle to get teams to actually use process manuals continues today. This case illustrates the need of coupling process improvements with changes in organization, and vice versa. Organization. Systemic p r o d u c t d e v e l o p m e n t requires t h e integration of work performed by diverse functions along the value chain. The importance of reorganizing people on a project basis to achieve better integration is illustrated not only by Chase consumer banking, but also by a study of private banking. Functional specialists, team members in name only, spent over 4 0 percent of their time leaving messages for one another. The reason was that each specialist was responsible for a segment of the million or more dollars of a given customer's money, but had n o responsibility for the total portfolio. As a result, millionaire customers sometimes had to make as many as five or six phone calls to find about their various accounts. Changes were initiated by reorganizing private bankers as a team collectively responsible for each portfolio. Product Development in Service Enterprises 385 Organization at Morgan Stanley At Morgan Stanley's global custody business, new products were originated by a variety of players. Most of these new products required resources from the Information Technology department. The competition for these resources was sometimes intense. Therefore, the firm appointed a vicepresident for new product development whose responsibilities included convening cross-functional "user groups" to prioritize projects for resource allocations. The user group integrated product development activities and made the resource decisions more strategically focused. Organizing cross-functional product development ultimately failed in another case. A director of product development was appointed at an insurance company to integrate activities and coordinate requests for resources, especially from the Information Technology function. However, the I T function resisted complying with the priorities and schedule of the new product development group, resulting in missed market opportunities. O n e reason was because the decision process was so serial that the I T group received a request only after the product development group had made its final decisions. To change this, the product development group tried to involve I T early in their decision processes and encouraged them to write prototype programs prior to release of final specifications. Before this suggestion could be implemented, however, line managers from I T and other specialist departments rebelled at the notion of a central product development groups and had it disbanded. All responsibilities for new product development reverted back to functional departments. Reorganizing delivery processes for supporting new products is also important. For example, a financial services company was plagued by a high error rate in processing applications from customers for a new credit card product. Customers received needless repeat calls, conflicting i n f o r m a t i o n , a n d inconsistent assessments of their creditworthiness. Change was initiated by reorganizing an assembly line into cells of cross-functional team members. Instead of handoffs and fumbles, a "one t o u c h " process was developed that resulted in higher quality service delivery. 386 Frank M. Hull Successful cross-functional integration in product development was the exception rather than the rule. Solo individuals, temporary teams, or groups without an explicit product focus, such as quality departments, u n d e r t o o k most product development and process improvement initiatives observed in the studies. O n e reason is because only in a few instances were cross-functional teams n o t only chartered, but also rewarded as a team for achieving objectives. Moreover, m o s t of the o r g a n i z a t i o n structures m a i n t a i n e d relatively tall hierarchies, which may it somewhat more difficult to horizontally integrate the work of cross-functional teams. Tools. In only a few instances did product development closely coordinate its activities with the I T function. For example, American Express routinely included representatives from I T on its development teams. They introduced Lotus Notes to provide c o m m o n processes for product development and facilitate communications among crossfunctional team members, including IT. Moreover, they experimented with rapid prototyping to develop design rules for developing products that could be more quickly ramped-up to volume delivery schedules. Tools at Morgan Stanley The product development user group at Morgan Stanley's global custody business proved to be an effective organization for prioritizing projects, but the criteria for decision-making was often lacking in quantification. For example, it was often difficult to predict whether products would make any money as past practice was to give customers pretty much what they wanted. So, they developed simulation models and made them available on their intranet to help calculate cost benefit analyses over the product life cycle. This enhanced the capability of cross-functional teams to make early decisions about whether or not to develop a given product. In most cases, p r o d u c t development did n o t involve the I T f u n c t i o n early o n . O n e result was friction b e t w e e n p r o d u c t development and the I T function analogous to that between design Product Development in Service Enterprises 387 and manufacturing engineers. In most other cases, each development project went separately to the centralized IT department for the resources to introduce their new offering, which resulted in conflicting priorities and political squabbles. Competition for IT resources sometimes led to Balkanized solutions. In a major bank, dozens of its businesses found many ways around the centralized CIT function by building business specific applications. Considerable duplication of effort occurred and rework was often necessary because of incompatible systems. With a hundred million-dollar carrot of new, integrated services, the centralized IT function tried to woo its businesses back into the fold. But each business persisted with their homegrown systems that they knew and controlled directly. Technical support for product development and delivery remained fragmented and lacking system-wide alignment. In some instances, the use of tools was very sophisticated. Examples include programs for assessing alternative derivative products and processes for delivering automated financial services, e.g. Citibank's global business offerings on-line and their relatively sophisticated ATMs. Morgan Stanley Global Custody was rather advanced in its use of tools for virtual collocation. In other instances, the use of even elementary computer tools was lacking. For example, one large company promised their customers a response within 24 hours to inquire about the status of their life insurance application. As the process used hard copies instead of soft ones, 50 highly paid gofers were occupied looking for the paperwork in any of 150 underwriters in-boxes, desktops, and outboxes. The process was subsequently automated. System. As mentioned before, the adoption of concurrent product development practices was typically partial, fragmented, and lacking in system-wide integration of value chains. Functions in many service enterprises are so compartmentalized that it is difficult to rapidly integrate a product offering to meet emergent customer needs. Many large corporations house multiple enterprises that sell to the same customers with little or no inter-unit awareness. However, in a few instances, considerable integration has been achieved. For example, in some of Citibank's businesses, varied components of a total solution 388 Frank M. Hull to a customer's need are seamlessly bundled even if external companies supplied some parts of it. Several finance businesses are increasingly able to access diverse information sources and use algorithms to rapidly provide customers with an offering that take their total circumstances into account. System at Chase Syndicated Banking Chase has a strong reputation in syndicated banking. Its competitiveness was achieved not only by its economies of scale, but by building a system that supports integrated solutions. After building a highly capable delivery processes, they decided to compete with a strategy of rapidly developing numerous varieties of their basic service. Functions were reorganized into semi-autonomous project teams. These teams were responsible for product development and service delivery, from start to finish. The latest tools and technologies were used to manage development, update processes, and speed service delivery. Their value sequence was reciprocally integrated and rapidly adjustable, from opportunity to customer delivery. Building a more systemic approach to the development and delivery of services is a strategic objective for many leading service enterprises. The bewildering variety of " n e w " product offerings has left many customers more willing to purchase relatively more total solutions from single s o u r c e s . T h e s y s t e m - w i d e capabilities of mass customization and cellular operations provide windows of opportunity for achieving such objectives. 14.5 Summary and Conclusions The speeding up of just about everything is extending n o t only to computer chips, but also the drumbeat of competition in services. The number of new products, most of involve permutations of various preexisting features, has proliferated rapidly in recent years n o t only in response to competition, but also because of new opportunities afforded by revolutionary advances in computing, deregulation, and globalization. Product Development in Service Enterprises 389 The transformation in services to explicit methods of product development continues to evolve. Many advances have been made, but many opportunities for improvement remain, especially in comparison to standard practices in leading goods companies. While one should not expect service product development to merely mimic industrial methods, there does appear to be great similarity between the two. The overlap is greatest when the service involves data, repeatable actions involving the support of things, recurrent transactions, etc. The overlap is less to the extent interpersonal exchanges are involved that entail emotional affect. In any case, the systems for developing products observed to date in services seem less integrated in services. Although a growing number of enterprises have formalized some aspects of product development, this remains as yet a minority of large firms. Tools of analysis and decisions support systems are under exploited. Organizational hierarchies remain relatively tall and cross-functional teams could be more explicitly chartered and better rewarded, even if only in terms of recognition. The qualitative evidence reported herein is basically consistent with the theoretical framework and statistical analysis reported elsewhere. Basic methods of product development seem to work well in services as those that use them appear to do better, not only in terms of statistical correlations with performance indicators, but in qualitative judgments rendered informally by peers in user group engaged in benchmarking best practices. The managerial implication is that the adoption, adaptation, and continuous improvement methods of product development appears likely to improve performance in services. Customers pay money in exchange for something, whether goods or services. Enterprises making the assumption that intangible services are unmanageable risks adverse consequences from those who have found a way to impose some creativity and discipline to the process. 390 Frank M. Hull Appendix A: Qualitative studies. COMPANY Study Focus 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Cross-functional service integration Product development system New product delivery group Global documentation process Computer services Quality process Fiber optic service delivery* Vendor management process Quality process Product development in consumer banking Private banking Product development and delivery in syndicates Tax services Product development Quality process Quality process Strategic planning Mental health service delivery Logistics services Product development system Credit services Color selection services Product development in global custody Advertising services Custom publishing Product development Customer service process AIG AMEX AMEX AMEX Bankers Trust Bankers Trust Bell Atlantic Bell Atlantic Bank of NY Chase 11. Chase 12. Chase 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. Chase Chubb Citibank GE Capital Gemini Consulting Jewish Charities Mercedes-Benz Merrill Lynch Milliken Milliken Morgan Stanley 24. 25. 26. 27. 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This page is intentionally left blank Index A Accor 48 acquisition 63, 108, 114, 128 Aerospace 8, 139, 327, 347 Airlines 333 alliances 24, 27, 337 Alstom 323, 326, 327, 328, 329, 331, 333, 334, 336, 339 Amazon 59, 74, 77 American Express 57, 146, 147, 356, 376 assessment 63, 77, 238, 306, 318 AT&T 139 attitudes 84, 212, 258, 347, 349 automation 8, 26, 145, 285, 305, 374 B Banc One 49 banking see also "financial services" 30, 52, 53, 56, 9 1 , 128, 129, 148, 169, 178, 180, 184, 185, 187, 189, 190, 191, 202, 204, 207, 208, 271, 273, 281, 365, 372, 377, 378, 382, 383, 384, 388, 390 BBC 23 benchmarking 34, 79, 105, 141, 144, 150, 171, 352, 358, 367, 377, 389 best practice 3, 4, 7, 10, 12, 14, 19, 27, 28, 29, 32, 87, 103, 105, 173, 368 BGT 20 biotechnology 90 brands see also "reputation" 308 British Airways 57 British Gas 20 bureaucracy 5, 19, 20, 2 1 , 26, 140, 141, 232, 236 Burger King 47 business process 308, 314, 372, 379, 380, 382 business process reengineering 9, 26, 356 C Cable and Wireless 22, capabilities 48, 75, 8 1 , 289, 301, 310, 311, 334, 335, 337, 338, 339 82, 89, 101, 104, 111, 140, 142, 151, 211, 286, 312, 315, 319, 322, 323, 326, 330, 331, 332, 339, 340, 355, 359, 388 429 430 Index capital 238, 322, 390 capital goods 272, 273, 277, 286, 287, 288, 322, 327, 337 change 40, 49, 58, 62, 70, 75, 77, 99, 100, 106, 114, 115, 118, 119, 120, 121, 128, 132, 143, 150, 151, 152, 165, 166, 167, 168, 174, 175, 178, 192, 205, 215, 234, 239, 240, 266, 268, 2 7 1 , 279, 2 8 1 , 283, 285, 286, 289, 291, 296, 303, 305, 308, 312, 320, 331, 336, 347, 348, 353, 359, 363, 370, 378, 379, 385 Charcol 129, 130 Chase Bank 356, 376 Chubb Insurance 147, 379 Citibank 147, 382, 390 collaboration 23, 45, 76, 251, 301, 332, 350, 351, 376 communication 33, 37, 40, 4 1 , 45, 46, 9 1 , 94, 111, 115, 116, 122, 126, 142, 173, 176, 214, 216, 218, 222, 226, 228, 232, 233, 239, 251, 261, 273, 282, 283, 301, 304, 313, 346, 353, 369 Community Innovation Survey (CIS) 9 1 , 95, 113 competition 5, 28, 62, 73, 83, 97, 118, 119, 121, 122, 123, 127, 146, 232, 272, 301, 304, 307, 313, 377, 385, 387, 388 complexity 4, 6, 7, 18, 40, 42, 45, 83, 110, 117, 125, 126, 132, 138, 146, 152, 174, 232, 238, 262, 266, 273, 285, 287, 290, 291, 298, 299, 303, 305, 345, 359, 370 Computer Aided Design 90 concurrent engineering 40 configurations 3, 10, 12, 14, 15, 16, 2 1 , 25, 27, 28, 84 consumer 72, 90, 98, 100, 101, 105, 120, 127, 129, 272, 273, 286, 287, 288, 324, 325, 327, 372, 377, 378, 382, 383, 384, 390 contingency theory 3, 4, 7, 355, 364, 372 continuous improvement 31, 171, 352, 361, 368, 389 copyright 96, 97 creativity 20, 23, 89, 353, 389 CREST 296 culture 4 1 , 109, 232, 236, 262 customer lock-in 56 customer requirements 17, 281, 349 D Darwin design 128, 275, 302, 317, 2 7 1 , 299 3, 5, 6, 8, 139, 140, 287, 288, 303, 304, 318, 319, 18, 22, 23, 27, 29, 141, 142, 143, 145, 290, 291, 292, 293, 305, 306, 307, 308, 321, 322, 324, 325, 32, 52, 89, 90, 150, 168, 173, 294, 295, 296, 309, 310, 311, 326, 328, 329, 97, 213, 297, 313, 330, 100, 101, 236, 272, 299, 301, 314, 315, 331, 333, Index 431 334, 335, 336, 339, 340, 344, 346, 348, 349, 351, 352, 353, 354, 355, 358, 361, 364, 367, 368, 374, 380, 386 development 35, 36, 37, 38, 39, 40, 4 1 , 42, 43, 44, 45, 46, 47, 48, 50, 51, 52, 53, 272, 274, 275, 276, 282, 284, 285, 287, 288, 289, 291, 292, 296, 297, 298, 299, 301, 302, 303, 306, 307, 310, 311, 312, 314, 316, 317, 318, 319, 320, 331, 335, 337, 340, 343, 345, 346, 347, 348, 349, 350, 351, 352, 353, 354, 355, 356, 357, 358, 359, 360, 361, 362, 363, 364, 365, 366, 367, 368, 369, 370 differentiation 138, 140, 142, 147, 153, 261, 268, 348, 350, 383 diffusion of innovations 51, 82, 87, 94, 311 Direct Line 59, 63, 75, 76, 77, 78 diversification 7 E education 30, 4 1 , 70, 76, 89, 100, 131, 169, 178, 180, 302, 347, 348, 365 electronics 213 embedded 111, 228, 311, 335 embedded software 273, 291, 298 environment 233, 239, 240, 244, 251, 263, 266, 273, 276, 294, 301, 302, 303, 305, 307, 312, 313, 318, 319, 320, 329, 331, 355, 360, 362 Europe 48, 70, 126, 206 expenditures 217, 221 experimentation 233 F failure 42, 131, 229, 246, 248, 250, 266, 267, 293, 294, 296, 299 Fedex 72, 73, 76, 77, 79 financial services see also "banking" 30, 37, 38, 39, 40, 44, 52, 82, 87, 116, 129, 148, 169, 180, 184, 202, 231, 232, 234, 237, 247, 263, 269, 271, 272, 273, 274, 275, 278, 279, 280, 282, 283, 292, 293, 297, 298, 299, 333, 337, 365, 379, 384, 385, 387 flexibility 5, 18, 24, 7 1 , 124, 127, 143, 195, 196, 197, 201, 205, 251, 307 flexible 50, 304, 307 Ford 139 forecasting 105, 238 France 274, 277 functional structure 7 funding 212, 217, 218, 221, 229, 262, 275, 313 fusion 346 432 Index G General Electric 324, 337 Germany 175, 180 globalisation 83, 84 groups 32, 4 1 , 49, 82, 88, 115, 122, 127, 128, 129, 131, 132, 148, 172, 183, 186, 212, 221, 227, 228, 289, 297, 308, 313, 314, 358, 367, 382, 385, 386 groupware 83, 92, 93 H Health Informatics 214 Healthcare 30, 169, 211, 212, 213, 214, 215, 216, 217, 218, 219, 220, 222, 224, 226, 227, 229, 365 I IBM 295, 322, 325 ideas 272, 303, 316, 332, 346, 351, 352, 381, 383 IKEA 49, 50 Imperial College 9, 148 implementation 40, 45, 88, 90, 105, 143, 160, 225, 233, 243, 251, 261, 293, 294, 312, 337, 349, 350, 382 incremental innovation 285 individuals 215, 225, 229, 232, 276, 277, 351 information technology 4, 4 1 , 82, 351, 354, 359, 362, 368, 371, 377, 385 Information Technology (IT) 82 infrastructure 37, 7 1 , 72, 73, 75, 78, 89, 120, 122, 124, 131, 215, 218, 219, 303, 316, 322, 323, 324, 329, 334 innovation 3, 5, 6, 7, 10, 11, 12, 13, 14, 15, 16, 19, 20, 2 1 , 23, 27, 28, 29, 31, 35, 36, 37, 39, 40, 4 1 , 42, 43, 46, 47, 49, 50, 51, 52, 53, 55, 56, 57, 58, 59, 64, 74, 76, 77, 79, 80, 82, 83, 84, 85, 86, 87, 88, 89, 90, 9 1 , 95, 96, 97, 98, 102, 103, 104, 106, 110, 112, 113, 114, 115, 116, 117, 118, 119, 120, 121, 122, 123, 124, 126, 127, 128, 129, 130, 131, 132, 133, 140, 150, 153, 154, 157, 158, 159, 160, 161, 162, 163, 164, 165, 167, 170, 175, 176, 177, 178, 179, 180, 181, 182, 184, 185, 186, 187, 188, 189, 190, 191, 192, 193, 194, 195, 197, 198, 199, 200, 201, 203, 204, 205, 206, 207, 209, 210, 211, 212, 213, 214, 216, 217, 218, 219, 220, 224, 227, 228, 229, 234, 238, 239, 240, 249, 251, 261, 265, 271, 272, 273, 275, 280, 283, 284, 285, 286, 287, 288, 290, 297, 298, 299, 301, 302, 307, 308, 310, 311, 312, 313, 316, 319, 320, 344, 346, 350, 353, 373, 377 Index 433 integrated services 387 Intellectual Property Rights 83 International Health Insurance 59, 61 internet 63, 72, 75, 90, 103, 129, 215, 333 intranet 18, 384, 386 invention 283 Italy 176, 181 J joint ventures see also "alliances" and "collaboration" K KFC 47 knowledge 5, 6, 17, 18, 19, 20, 2 1 , 25, 26, 27, 59, 62, 7 1 , 74, 76, 77, 78, 81, 82, 131, 132, 178, 212, 213, 214, 215, 217, 218, 227, 228, 286, 290, 302, 305, 307, 308, 309, 310, 311, 317, 318, 320, 321, 322, 323, 332, 334, 340, 382 27 32, 40, 48, 51, 140, 142, 144, 239, 252, 274, 312, 313, 315, 350, 358, 369, 53, 55, 173, 277, 316, 378, L Leadership style 232, 233, 235, 237, 244, 248, 250, 251, 252, 254, 255, 256, 258, 259, 260, 264, 265, 269, 346, 349 learning 49, 50, 51, 52, 55, 74, 83, 84, 92, 101, 102, 103, 104, 106, 108, 109, 111, 307, 311 Legal requirements 294 licensing 51, 238 life cycles 186, 306, 336, 386 location 19, 45, 46, 48, 85, 87, 219, 310, 316, 377 London Stock Exchange (LSE) 292, 294 M managing 3, 7, 65, 73, 74, 76, 77, 90, 102, 106, 137, 143, 213, 219, 224, 243, 244, 245, 247, 256, 257, 258, 264, 265, 266, 281, 297, 298, 303, 305, 307, 311, 321, 323, 331, 377, 380, 381, 383 marketing 39, 63, 73, 88, 114, 123, 124, 127, 131, 132, 179, 238, 261, 262, 288, 318, 321, 356, 358, 267, 371, 377 markets 22, 73, 83, 85, 87, 97, 101, 102, 105, 114, 119, 120, 122, 125, 126, 128, 174, 221, 236, 239, 240, 243, 262, 268, 275, 276, 277, 280, 281, 282, 283, 284, 285, 287, 288, 297, 298, 301, 302, 307, 308, 314, 315, 316, 319, 328, 329, 333, 346, 350, 353, 355, 364, 370, 380, 381 434 Index Marks and Spencer 316 materials 37, 89, 111, 151, 286, 298, 301, 303, 304, 306, 315, 354, 377 McDonalds 186, 316 Merrill-Lynch 379, 381, 383 Milliken 390 MMR 222, 223, 224, 226, 229 models of innovation 29, 85 Morgan 238 Morgan Stanley 147, 379, 385, 386, 387, 390 N Nelson 271, 290 Netherlands 176, 181 networks 18, 22, 27, 60, 87, 97, 98, 107, 143, 283, 287, 298, 301, 307, 308, 309, 310, 316, 317, 322, 323, 325, 326, 328, 329, 333, 338, 368 new product development 3, 7, 8, 28, 43, 44, 47, 52, 53, 137, 138, 384, 385 new products 3, 4, 7, 8, 28, 37, 43, 44, 45, 46, 47, 52, 53, 55, 137, 138, 238, 240, 247, 256, 269, 278, 303, 349, 383, 384, 385, 390 NHS 218, 222, 226 Nokia 314, 324, 334 O organization 8, 13, 17, 31, 32, 33, 35, 36, 37, 38, 39, 4 1 , 46, 47, 48, 49, 50, 51, 52, 76, 80, 137, 138, 139, 140, 145, 149, 150, 153, 154, 157, 158, 159, 160, 161, 165, 172, 173, 346, 349, 351, 355, 356, 360, 363, 364, 369, 380, 384, 385, 386 organizational processes 18 outsourcing 22, 50, 82, 321, 324, 328, 329, 332 Ove Arup 18 42, 43, 44, 142, 143, 166, 167, 371, 374, P Paine Webber 147, 390 patents 95, 96 performance 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 20, 21, 22, 23, 25, 27, 28, 29, 31, 32, 4 1 , 42, 48, 49, 6 1 , 70, 78, 79, 92, 115, 117, 119, 120, 122, 133, 137, 139, 140, 141, 142, 143, 144, 145, 146, 149, 150, 151, 152, 153, 154, 157, 158, 159, 160, 161, 162, 163, 164, 165, 166, 167, 171, 175, 178, 192, 196, 199, Index 435 201, 202, 205, 206, 227, 228, 233, 234, 240, 264, 269, 273, 277, 279, 281, 305, 307, 308, 314, 330, 335, 336, 346, 350, 351, 353, 355, 357, 358, 360, 361, 362, 363, 364, 367, 368, 373, 374, 377, 379, 389 Personalisation 94 Pharmalife 6 1 , 68, 69, 70, 78 Pizza Hut 47 planning 18, 63, 7 1 , 77, 105, 216, 218, 226, 261, 262, 293, 301, 302, 306, 307, 308, 313, 314, 318, 319, 332, 350, 377, 390 process innovation 82, 177, 179, 181, 188, 189, 195, 197, 198, 199, 200, 205, 210, 272, 344 processes 4, 5, 7, 8, 17, 18, 20, 22, 23, 24, 26, 29, 31, 32, 33, 34, 35, 36, 37, 39, 40, 42, 46, 47, 49, 52, 53, 58, 78, 86, 87, 88, 90, 93, 94, 104, 105, 108, 109, 110, 111, 119, 120, 124, 132, 138, 141, 143, 145, 147, 150, 153, 157, 165, 166, 168, 171, 172, 178, 179, 200, 205, 211, 213, 214, 233, 237, 239, 240, 243, 272, 275, 276, 277, 278, 281, 285, 286, 287, 288, 295, 296, 297, 299, 301, 304, 305, 307, 309, 311, 312, 313, 314, 316, 317, 319, 325, 346, 349, 351, 352, 353, 358, 367, 368, 372, 376, 377, 379, 381, 382, 383, 384, 385, 386, 387, 388 product development 3, 7, 8, 28, 38, 40, 4 1 , 42, 4 3 , 44, 45, 47, 52, 53, 137, 138, 141, 142, 144, 145, 147, 150, 152, 157, 162, 163, 166, 168, 170, 171, 172, 173, 231, 232, 233, 234, 237, 238, 240, 241, 242, 243, 245, 246, 247, 251, 253, 255, 256, 257, 259, 263, 264, 265, 267, 268, 269, 371, 372, 373, 376, 377, 378, 379, 380, 381, 382, 383, 384, 385, 386, 387, 388, 389, 390 professional services 48, 87, 88, 89 profitability 58, 68, 7 1 , 192, 231, 238, 278, 280, 308 project management 17, 18, 32, 47, 52, 53, 151, 173, 261, 287, 293, 301, 302, 304, 305, 312, 313, 315, 318, 319, 324, 329, 331, 334, 368, 381 prototypes 37, 307 publishing 30, 55, 64, 100, 169, 180, 365, 380, 390 Quality Function Deployment 17, 26, 358, 367 Quality Management 9, 26, 145, 147, 152, 162, 174, 372, 379 R radical innovation 86 Railtrack 131 rationale 132, 221, 313, 348 436 Index reputation see also "brands" 98, 128, 308, 322, 388 research and development 83, 85, 90, 320 risk 4 1 , 70, 72, 132, 169, 223, 224, 225, 226, 227, 233, 234, 235, 236, 238, 239, 240, 243, 244, 251, 262, 266, 268, 278, 279, 280, 281, 284, 285, 287, 288, 2 9 1 , 293, 298, 303, 306, 308, 313, 318, 350, 353, 365, 382 routines 186 S segmentation 128, 129 selection 74, 130, 248, 261, 268, 288, 381, 390 service innovation 3, 47, 9 1 , 113, 124, 131, 133, 178, 180, 186, 188, 192, 194, 195, 197, 198, 199, 205, 209, 212, 213, 216, 219, 224, 227, 228, 229, 272, 297 Siemens 334 size 4, 85, 90, 9 1 , 97, 101, 120, 121, 138, 142, 147, 148, 161, 168, 176, 180, 184, 185, 186, 187, 188, 189, 190, 201, 203, 232, 247, 254, 279, 280, 285, 298, 327, 345, 348, 378 skills 18, 70, 71, 76, 78, 99, 101, 105, 109, 110, 111, 114, 131, 178, 186, 214, 217, 241, 242, 244, 245, 252, 261, 264, 261, 304, 305, 306, 310, 316, 318, 319, 334, 337, 348 small firms 85, 190 software 20, 25, 32, 38, 51, 73, 84, 86, 88, 89, 90, 9 1 , 96, 99, 101, 127, 142, 151, 173, 180, 184, 185, 187, 188, 189, 190, 191, 202, 204, 207, 208, 273, 285, 286, 287, 289, 2 9 1 , 292, 296, 298, 299, 322, 325, 335, 359, 368, 374, 384 sources of 24, 286, 316 space 2 3 , 60, 6 1 , 63, 64, 70, 7 1 , 72, 78, 80, 274, 298, 304, 306, 349, 350 SPOTS 139, 155, 157, 159, 160, 161, 162, 163, 164, 165, 166, 167, 168, 371, 372, 373, 374, 382 strategy 4, 7, 12, 23, 28, 59, 60, 6 1 , 63, 76, 79, 86, 87, 94, 110, 129, 131, 138, 139, 140, 141, 149, 150, 152, 153, 154, 157, 158, 159, 160, 161, 165, 166, 167, 168, 170, 205, 236, 312, 325, 332, 340, 344, 347, 350, 352, 353, 358, 359, 361, 362, 363, 364, 367, 369, 371, 374, 378, 382, 383, 388 structure 4, 51, 52, 85, 86, 127, 131, 132, 142, 179, 181, 236, 296, 302, 308, 313, 315 success and failure 267 suppliers 281, 283, 287, 288, 369, 370 systems integration 107, 287, 305, 308, 318, 322, 323, 324, 327, 329, 330, 331, 332, 334, 335, 336, 338, 339, 340 Index 437 T tangibility 36, 138, 274 TAURUS 273, 292, 294, 295, 296, 297 teams 8, 22, 23, 25, 27, 32, 39, 40, 4 1 , 4 3 , 45, 51, 86, 94, 141, 172, 178, 211, 234, 241, 261, 265, 301, 310, 311, 346, 349, 351, 352, 353, 354, 357, 358, 367, 378, 380, 381, 382, 383, 384, 386, 388, 389 technology 4, 5, 6, 7, 17, 18, 25, 26, 32, 33, 4 1 , 58, 60, 7 1 , 72, 77, 78, 82, 84, 86, 89, 90, 9 1 , 95, 97, 98, 103, 105, 107, 114, 118, 119, 121, 122, 138, 142, 143, 146, 151, 153, 157, 159, 160, 162, 165, 167, 172, 175, 176, 201, 211, 213, 214, 215, 216, 220, 224, 229, 273, 277, 278, 281, 282, 283, 284, 288, 289, 290, 292, 293, 295, 296, 298, 299, 304, 305, 307, 308, 309, 312, 326, 331, 351, 354, 359, 362, 364, 368, 371, 377, 385 telecommunications 22, 30, 84, 86, 89, 90, 102, 107, 131, 169, 215, 278, 283, 284, 314, 365 Tesco 58 Thales 323, 325, 327, 328, 329, 331, 333, 338, 339 time to market 118, 121, 123, 132, 231, 233 tools 8, 10, 13, 15, 17, 20, 2 1 , 24, 25, 32, 51, 69, 83, 92, 93, 95, 96, 99, 101, 138, 139, 142, 143, 151, 153, 154, 157, 158, 159, 160, 162, 165, 166, 167, 272, 284, 305, 312, 351, 354, 359, 363, 364, 372, 374, 378, 382, 383, 386, 387, 388, 389 training 251, 292, 293, 313, 318 transaction costs 303 trust 97, 98, 107, 128, 129, 147, 223, 224, 226, 252, 284, 390 U uncertainty universities V Virgin 60, 63, 69, 332, 335 W Westinghouse X Xerox 4, 5, 6, 72, 308, 317, 350 98, 147 139 139 SERVICE INNOVATION Organizational Responses to Technological Opportunities Market Imperatives In the most advanced service economies, services create up to three-quarters of the wealth and 8 5 % of employment, and yet we know relatively little about managing innovation in this sector. The critical role of services, in the broadest sense, has long been recognized, but is still not well understood. Most research and management prescriptions have been based on the experience of manufacturing and high technology sectors. There is a clear need to distinguish which, if any, of what we know about managing innovation in manufacturing is applicable to services, what must be adapted, and what is distinct and different. Such is the goal of this book. This unique collection brings together the latest academic research and management practice on innovation in services, and identifies a range of successful organizational responses to current technological opportunities and market imperatives. The contributors include leading researchers, consultants and practitioners in the field, who provide rigorous yet practical insights into managing and organizing innovation in services. Two themes help to integrate the contributions in this book: • That generic good practices exist in the management and organization of innovation in services, which the authors seek to identify, but that these must be adapted to different contexts, specifically the scale and complexity of the tasks, the degree of customization of the offerings, and the uncertainty of the environment. • That innovation in services is much more than the application of information technology (IT). In fact, the disappointing returns to IT investments in services have resulted in a widespread debate about the causes and potential solutions — the so-called "productivity paradox" in services. Instead here the authors adopt a broader notion of innovation, including technological, organizational and market change. The key is to match the configuration of organization and technology to the specific market environment. ISBN 1-86094-367-5 Imperial College Press www.icpress.co.uk 781860"943676

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