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In Search of Best PracticeEnduring Ideas in Strategy & Innovation

International Forum on COCOMO

and Systems/Software Cost ModelingNovember 5, 2009

Based on the 2009 13th Annual Clarendon Lectures

in Management Studies, University of Oxford

Michael A. Cusumano© 2009

MIT Sloan School of Management

cusumano@mit.edu

Oxford Clarendon Lectures• Task? Write a synthesis of my career research

– Focus: Attempt to understand “best practices”– Context: Strategy, operations, & technology or

innovation management in the auto, consumer electronics, software/internet sectors

– Methodology: Reflection on 25+ years of research, mostly inductive cases, some large sample studies

– Lectures Theme: Simple but potential “enduring ideas”

• Inspiration? – Some popular books attempting the same, but mostly

Theodore White, In Search of History (1978) 2

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In Search of Best Practice

In Search of Best Practice

1985 1991 1995

1998 1998 2002

2002 2004 2010

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“Best Practice” in Management?• Lots of popular books & academic research,

though mostly case studies, small samples, or limited analysis

• Hard to generalize; what works in one firm, time period, industry or nation may not transfer

• Partially a problem of knowledge (what do we really

know) as well as context (“controls” & management issues)– Imitation (best to common to non-differentiating practices)– Industry or technology lifecycle (new, mature, disruptive)– Type of technology or innovation (product, process, service)– Industry (industry structure, business or firm differences)– Institution or environment (country, government)– Luck or population ecology (timing, survival bias?)

For Example: Japan vs. US/West• US and Europe once center of best practices

– Japan in 1950s and 1960s: cheap, low-quality goods, but fastest growing economy

• Japan later overtook the West in some areas– “Best practices” in manufacturing, quality, HR, product

development, industrial policy

• Since 1990, many Japanese “strengths” turned into “weaknesses”– Beyond company practices to government policies and social

or cultural characteristics

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Tom Peters & Robert Waterman, In Search of Excellence (1982)

• Of 62 of McKinsey’s best clients, focused on top 43• Key success factors: (1) action bias, (2) close to customer, (3)

entrepreneurship spirit, (4) people focus, (5) hands-on management, (6) focus on what firm is good at, (7) lean staffing, (8) tight centralized values with decentralization

• Hard to disagree with these qualities, but …• No statistical or historical analysis; can’t tell which factor

impacts what, or what is “enduring”• Many “excellent” firms later struggled or failed

– Atari, Data General, Delta Airlines, DEC, IBM, Kodak, NCR, Wang, Xerox

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Jim Collins, From Good to Great (2001)

• Analyzed 1500 companies to find best performers in stock market value; focused on top 11

• Key success factors: (1) Internal CEOs, (2) focus on talent, (3) focus on internal strengths, (4) fact-based performance goals, (5) disciplined commitment culture, (6) reinforcing use of technology, (7) momentum built from early successes

• Again, hard to disagree with these qualities, but…• Again, no analysis of what effects what or how other

firms with similar characteristics performed • Again, trouble, takeovers, or bankruptcy…

• Abbot, Circuit City, Fannie Mae, Gillette, Wallgreens

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General Observations• Some practices seem more enduring than others

– Though unpredictable catastrophes (“black swans”) can disrupt any market and any firm

• What is lasting “best practice” surely DEPENDS– E.g., in manufacturing Ford (Model T) “best” until

surpassed by GM (variety) and then by Toyota (JIT)– E.g., in various areas, “Japan, Inc.” in 1980s “best”

while economy growing & competition limited

• Need to state qualifying “conditions” or context– But, for managers, specific practices moderated by

formal “contingency frameworks” get complex fast

My Six “Enduring” IdeasNot original to me, but underlie my work & have

decades of empirical & theoretical research behind them

1. Capabilities, Not Just Strategy

2. Pull, Don’t Just Push

3. Scope, Not Just Scale

4. Flexibility, Not Just Efficiency

5. Platforms, Not Just Products

6. Services, Not Just Products (or Platforms)9

Capabilities and Economies of Scope

Flexibility

New Way of Thinking AboutFIRM

AGILITY

Pull Platforms Services

New Way of Thinking AboutECOSYSTEM STRATEGY

Enduring Ideas & Competitive Advantage

How anticipate emerging customer needs or market change, and lead or adapt quickly ,flexibly – and effectively

How move to new capabilities within an industry ecosystem, and influence markets & adapt to commoditization

1. Capabilities, Not Just Strategy• Focus not simply on formulating strategy or a vision of

the future (i.e., deciding what to do) but equally on building distinctive organizational capabilities and operational skills (i.e., how to do things) that rise above common practice (i.e., what most firms do).

• Distinctive capabilities center on people, processes, and accumulated knowledge. Reflect a deep understanding of the business and the technology and enable the firm to offer superior products and services as well as exploit foreseen and unforeseen opportunities for innovation.

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“Capabilities” Intellectual HistoryUnique/Distinctive “Resources” (sometimes “Capabilities”)Penrose (1959); Chandler (1962); Richardson (1972), Wernerfeldt (1984); Barney

(1991); Grant (1991); Peteraf (1993), etc.

Incremental Strategy & Domain KnowledgeBower (1970); Quinn (1980); Hayes and Abernathy (1980); Pascale (1984);

Mintzberg (1987, 1994); Hamel and C.K. Pralahad (1989, 1990); Brown and Eisenhardt (1998); Burgelman (2001), etc.

How Much Does Industry (vs. Management) Matter?Porter (1980); Schmalensee (1985); Rumelt (1991); McGahan and Porter (1997)

“Dynamic” Capabilities & Apsorptive CapacityLeonard-Barton (1992); D’Aveni (1994); Teece, Pisano & Shuen (1997); Markides

(1999); Eisenhardt & Martin (2000); Teece (2009). Cohen & Levinthal (1990) 12

My Examples• Strategy and capabilities development at Toyota

(“indirect tech transfer”) vs. Nissan (“direct”),laying foundation for Toyota’s revolutionary process innovations (M. Cusumano, The Japanese Automobile Industry, 1985)

• Strategy and capabilities development at JVC and Sony, leading to mass-production and design skills used to create the home VCR (R. Rosenbloom and M. Cusumano, “Technological Pioneering and Competitive Advantage: The Birth of the VCR Industry,” California Management Review, 1987)

• Strategy and capabilities at Microsoft unique to PC software (M. Cusumano & R. Selby, Microsoft Secrets, 1995) 13

Lessons for Managers (Idea 1)

• Essential to couple strategy with distinctive capabilities to implement and evolve that strategy as needed.

• Unique benefits to have people at hand who have the knowledge, skills, and creativity to produce the product and process innovations – planned or unplanned – that truly differentiate firms over the long run.

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2. Pull, Don’t Just Push• Emphasize a “pull-style” of management that reverses

the sequential processes & information flow common in many firms for manufacturing as well as product development, service design and delivery, and other operations and activities.

• Link each step in key processes backward from the market to respond in real-time to changes in demand, customer preferences, competitive conditions, or internal operational difficulties. Continuous feedback & adjustment also facilitate rapid learning, elimination of waste, and incremental product & process innovations.

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“Pull” Intellectual HistoryPush vs. Pull in Marketing, Scientific Invention, Supply Chain

(Dodgson, Gann, & Salter (2005); von Hippel (various)

Toyota & “Lean” Production – Early: ManagerialSugimori et al. (1977), Ono (1978), Monden (1981 and 1983), Schonberger

(1982), Hall (1983), Cusumano (1985), Krafcik (1988), Womack, Jones, and Roos (1990), Oliver & Wilkinson (1992), etc.

Toyota & “Lean” Production – Later: Theory, AnalysisLee (1989), Fujimoto (1999) , Holweg and Pil (2004), Holweg (2007), etc.

Iterative Product Development – Software & OtherBasili & Turner (1975), Boehm (1988), Aoyama (1993), Ulrich & Eppinger

(1994); MacCormack & Verganti (1999) , Kelley (2004), Thomke (2004)16

My Examples

• Toyota Just-in-Time (Kanban/Lean) production system (which uses half the workers of conventional manufacturing &minimal inventory, with higher productivity , quality and short-cycle learning dynamics) (M. Cusumano, The Japanese Automobile Industry, 1985)

• “Iterative” or prototype-driven software development such as at Microsoft, Netscape, et al., compared to plan-driven sequential or “waterfall” processes for product development (M. Cusumano and R. Selby, Microsoft Secrets, 1995; M. Cusumano and D. Yoffie, Competing on Internet Time, 1998)

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Lessons for Managers (Idea 2)• The pull concept is a fundamental philosophy of

management, emphasizing real-time information and continuous improvement. – Pull versus push in everything from strategic

decision making to planning and operations management.

• Managers can set the pace of feedback & adjustment with mechanisms that set the “heartbeat” of the processes: kanban exchange or the (daily) build cycle.

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Process Spectrum

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User FeedbackDuring Project

Uncertainty in Requirements

Early/OftenHigh

Late/Occasional Low

Number of Cycles or Releases1 Many

Traditional Waterfall, Approaches

RapidPrototyping

XP

Agile or Iterative Methods

Incremental

Source: Adapted from Bill Crandall (formerly of Hewlett-Packard)

Process Spectrum

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Synchronize-&-Stabilize Product Vision/Architecture Design Functional Specification Milestone 1 Milestone 2 Milestone 3 Iterative Design Iterative Design Iterative Design Code Code Code Usability test Usability test Usability test Test Test Test Daily builds Daily builds Daily builds Test Test Test Redesign Redesign Redesign Debug Debug Debug Integrate Integrate Integrate Stabilize Stabilize Stabilize Buffer time Buffer time Buffer time Alpha release Beta release Feature complete Beta release Visual freeze CODE COMPLETE Final test Final debug Stabilize Final release

Synch & Stabilize Process Flow

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Toyota “Lean” Production Microsoft “Agile” Development

Manual demand-pull with kanban cards Daily builds with evolving features

JIT “small lot” production Development by small-scale features

Minimal in-process inventories Short cycles and milestone intervals

Geographic concentration – production Geographic concentration -development

Production leveling Scheduling by features & milestones

Rapid setup Automated build tools & quick tests

Machine/ line rationalization Focus on small, multifunctional teams

Work standardization Design, coding, and testing standards

Foolproof automation devices Builds &continuous integration testing

Multi-skilled workers Overlapping responsibilities

Selective use of automation CA tools but no code generators

Continuous improvement Postmortems, process evolution

3. Scope, Not Just Scale• Seek efficiencies even in activities not suited to scale

economies, such as research, engineering, and product development as well as services. Usually see scope as corporate strategy: synergies across lines of business. But potentially more practical & valuable are scope economies within the same line of business.

• Require systematic ways to share product inputs, intermediate components, or other key elements of product, process, or customer knowledge across diverse groups and projects. Scope economies also eliminate redundant activities and are an important source of competitive differentiation. 23

“Scope” Intellectual HistoryEconomies of Scope Definitions & Theory Teece (1980), Panzar & R. Willig (1981), Helfat & Eisenhardt (2004)

Corporate Diversification (across lines of business)Chandler (1962), Rumelt (1974), Bettis (1981), Ravenscraft & Scherer (1987),

Ramanujan & Varadarajan (1989)

Limits vs. Benefits of Scale in ManufacturingAbernathy & Wayne (1974), Abernathy (1978), Hounschell (1985)

Scope Examples (within a line of business, across activities)Leggette & Killingsworth (1983), Matsumoto (1984), Chandler (1990), Henderson

& Cockburn (1996), Hansen, Nohria & Tierney (1999), Hallowell (1999). Hansen et al. (1999), Christensen, Grossman & Hwang (2008) 24

My Examples

• Software factories, from US to Japan to India, for building custom applications and standardized products (M. Cusumano, Japan’s Software Factories, 1991; M. Cusumano, The Business of Software (2004); M. Cusumano et al., “Software Development Worldwide: The State of the Practice,” IEEE Software, 2003)

• Multi-project management and concurrent technology transfer in product development, at Toyota et al., to balance project management with technology reuse through in-house platforms and knowledge management (M. Cusumano and K. Nobeoka, Thinking Beyond Lean, 1998)

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Lessons for Managers (3)• Economies of scope potentially as valuable to

efficiency as traditional economies of scale, and probably more important to firm-level differentiation – precisely because this is difficult to achieve!

• Managers also must be smart enough to balance or eliminate the potential tradeoffs – e.g., with efficiency & quality

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4. Flexibility, Not Just Efficiency• Place as much emphasis on flexibility as on efficiency in

manufacturing, product development, and other operations as well as in strategy and decision making. Firms need to adapt to change in market demand, competition, and technology, and exploit opportunities for innovation and new business development.

• Moreover, rather than always requiring tradeoffs, flexible systems and processes can actually reinforce or facilitate efficiency and quality, as well as encourage innovation.

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“Flexibility” Intellectual HistoryOrganizations, Environments & StrategyLawrence & Lorsch (1967); Aaker & Mascarenhas (1984), Harrigan (1984).

D’Aveni (1994); Tushman & O'Reilly (1996); Volberda (1996, 1999); Brown & Eisenhardt (1997, 1998), Gemawhat & Sol (1998), Birkinshaw & Hagstrom (2002), etc.

Manufacturing – Flexibility-Efficiency-Quality TradeoffsSkinner (1974) , Jaikumar (1986), Krafcik (1988), Garvin (1988), Sethi & Sethi

(1990), Pine (1992), Gerwin (1993), Upton (1994), Adler et. al. (1999), Pagell & Krause (2004), etc.

Product Development – Autos & Software ExamplesWomack et al. (1990), Clark & Fujimoto (1991), Sanchez (1995), MacDuffie et al.

(1996), Sobek et al. (1998), Adler (2005), etc., as well as the “iterative” literature discussed under “Pull” idea

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My Examples• Manufacturing : Printed-circuit boards study, with some

exploration of Toyota concepts (F. Suarez, M. Cusumano, and C. Fine, “An Empirical Study of Manufacturing Flexibility in Printed-Circuit Board Assembly,” Operations Research, 1996)

• Product development: Scaling up flexibility of small, “autonomous teams” for larger projects (M. Cusumano, “How Microsoft Makes Large Teams Work Like Small Teams, MIT Sloan Management Review, 1997; A. MacCormack, M. Cusumano, C. Kemerer, and B. Crandall, “Trade-offs between Productivity and Quality in Selecting Software Development Practices,” IEEE Software, 2003; M. Cusumano, The Business of Software, 2004)

• Strategy and entrepreneurship – Netscape (vs. Microsoft) (M. Cusumano and D. Yoffie, Competing on Internet Time,1998) 29

Lessons for Managers (Idea 4)

• Flexibility comes in different forms and these can be powerful strategic levers

• Rather than worrying about tradeoffs with efficiency or quality, use flexible processes and structures to enhance organizational effectiveness when dealing with change – in strategy, customer needs, manufacturing, product development, technology disruptions, and unforeseen opportunities for innovation

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5. Platforms, Not Just Products• (At least, for firms affected by digital technologies as

well as “network effects”) should move beyond conventional thinking about strategy and capabilities to compete on the basis of platforms, or complements.

• A platform strategy differs from a product strategy in that it requires an external ecosystem to generate complementary innovations and build “positive feedback” between the complements and the platform. The effect is much greater potential for growth and innovation than a single firm can generate alone.

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“Platform” Intellectual HistoryIn-House Product Platforms & Product ModularityMeyer & Utterback (1993), Ulrich (1995), Sanchez & Mahoney (1996), Meyer &

Lehnerd (1997), Baldwin & Clark (1999), etc.

Standards & Dominant Designs to Network EffectsUtterback & Abernathy (1975), David (1985), Farrel & Saloner (1986), Arthur

(1989), Katz & Shapiro (1992), Shapiro & Varian (1998), Bresnahan & Greenstein (1999), etc.

Multi-Sided Markets (Industry Platform + Complementors)Parker & Van Alstyne (2005), Eisenmann (2006), Evans, Hagiu & Schmalensee

(2006), Eisenmann, Parker &Van Alstyne (2006), Yoffie & Kwak (2006), Adner (2006), etc.

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My Examples• Platform leadership, based on Intel case study and

comparisons, especially to Microsoft (A. Gawer and M. Cusumano, Platform Leadership, 2002)

• Product vs. platform strategy (Sony and Apple vs. JVC and Microsoft) and how to turn a product into a platform (Google, Qualcomm, et al.) (M. Cusumano, Y. Mylonadis, and R. Rosenbloom, “Strategic Maneuvering and Mass-Market Dynamics: Triumph of VHS Over Beta,” Business History Review, 1992; M. Cusumano, “The Puzzle of Apple,” Communications of the ACM, 2008; A. Gawer and M. Cusumano, “How Companies Become Platform Leaders,” MIT Sloan Management Review, 2008)

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Lessons for Managers (Idea 5)

• Enormous differences between a product versus platform strategy – with equally enormous economic consequences for users and entire industry ecosystem– Four Levers: Scope of the firm, Product technology,

External relationships, Internal organization

• Even if multiple platforms persist, platform thinking useful for in-house product development as well as strategic marketing

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6. Services, Not Just Products • (Product firms, or services firms that offer standardized

services treated as products) should use service capabilities and innovations to sell, enhance, and even “de-commoditize” product offerings or standardized services as well as create new sources of revenues and profits, such as an ongoing maintenance stream.

• The goals should be to find the right revenue balance and then “servitize” products to create new value-added opportunities and “productize” services to deliver them more efficiently and flexibly, using information technology & service automation.

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“Services” Intellectual HistoryDefinitions of Services versus ProductsJudd (1964). Rathmell (1966), Bell (1973), Levitt (1972, 1976)

Theories of Service InnovationBarras (1986), Thomke (2003), Mansharamani (2007)

Services/Servitization Strategies & Economic ValueTeece (1986), Potts (1988), Bowen et al. (1991), Quinn (1992), Knecht et al. (1993),

Gadiesh and Gilbert (1998), Nambisan (2001), Oliva & Kallenberg (2003), Slack (2005), Neely (2009)

Computers and Software Industry ExampleCampbell-Kelly and Aspray (1996), Gerstner (2002), Campbell-Kelly (2004),

Cusumano (2004), Campbell-Kelly and Garcia-Schwartz (2007)36

My Examples• Rise of services among software product and

computer hardware/systems firms (M. Cusumano, The Software Business, 2004, and “The Changing Software Business: From Products to Services,” IEEE Computer, 2008; F. Suarez, M. Cusumano, and S. Kahl, “Services and the Business Models of Product Firms: An Empirical Analysis of the Software Industry,” WP 2008)

• How services and services innovation help product firms and platform leadership (M. Cusumano, F. Suarez, S. Kahl, “A Theory of Services in Product Firms,” WP 2008; F. Suarez and M. Cusumano, “The Role of Services in Platform Markets,” forthcoming in A. Gawer, ed., Platforms, Markets, and Innovation, 2009)

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Software Products Business:Extreme Example of Innovation & Commoditization?

• Massive Industry Consolidation!!– The data are clear

• Decline of Enterprise Sales (or Prices?)– Only exceptions are hits & “platform” products?

• Growth of Services & Maintenance Revenues– Freeware/open source driving prices to zero?– Customers rebel against costly products?

• Emergence of New Business & Pricing Models Software as a Service/Cloud Computing – cheaper products, bundled

support/maintenance (Salesforce, Amazon)

Free, But Not Free, Again – supported by advertising (e.g., Google) or services (Red Hat), or multi-sided market (Microsoft & Adobe, Facebook et al.)

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Public Software Product FirmsListed on US Stock Exchanges (SIC 7372)

050

10

015

020

025

030

035

040

0

(mea

n)

de

nsityall

1990 1992 1994 1996 1998 2000 2002 2004 2006fyadj

Number of Firms in the Industry - All Sample

40(SIC codes 7370, 7371, 7373 for computer services, and mgt consulting IT services 8742)

10

02

00

30

04

00

50

0N

um

be

r o

f F

irm

s

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Year

Number of Public IT Service Firms (1990 - 2006)

Public IT Services Firms

Listed on US Stock Exchanges

41

Siebel

0102030405060708090

100

% o

f T

ota

l R

even

ues

NewProd

ServMain

Siebel

0

200

400

600

800

1000

1200

$ m

illio

n

NewProd

ServMain

42

Oracle

0

10

20

30

40

50

60

70

% o

f T

ota

l R

ev

en

ue

s

NewProd

ServMain

Oracle

0

2000

40006000

8000

10000

12000

1992

1994

1996

1998

2000

2002

2004

2006

$ m

illio

n

New Prod

ServMain

4340

0%

10%

20%

30%

40%

50%

60%

70%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

% S

ale

s

Calendar Year

Service Revenue %, Select Hardware Firms

IBM

HP

Sun Microsystems

EMC

Cisco

Dell

44 7

Business or Life Cycle Models?

0102030405060708090

% o

f To

tal

Rev

enu

es

Products

Services

Source: M. Cusumano, The Business of Software (2004)

Different S-Curve Dynamics –Product Platform Disruptions Generate New

Services & New Business Models?

Performance

Time

Ferment

Takeoff

Maturity

Platform Disruption

New Services?New Business Models?

45

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New Business Model DimensionsRevenue Model

Delivery Model

Customers

Local ClientInstallation

Local ServerInstallation

RemoteWeb-based

Remoteproprietary(e.g. hostedSAP)

Up-frontlicense fee

Subscription/Software as aservice

Advertisting-based

Transaction-based

Free but notfree (bundled)

Free (revenuesfrom services

Bundled aspart of a hardware product

Mainstream consumers

Early-adopter consumers

Small businesses

Mainstream enterprise customers

Early-adopter enterprise cust.

Source: MIT student team K. Boppana, A. Göldi, B. Hein, P. Hsu, T. Jones (The Software Business, 15.358), 2006

Traditional

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Web-Based Enterprise Software Vendors

Source: Andreas Goeldi survey (MIT master’s thesis, 2007) n=108

Year of Company Formation

0

5

10

15

20

25

19

11

19

72

19

75

19

77

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

Year

Freq

uen

cy

.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

Frequency

Cumulative %

48

0

20

40

60

80

100

Frequencyn=180

Business Models

108 Web-Based Enterprise Software Vendors

Monthly Fee

Free

Upfront License Fee

Professional Services

Open Source

Advertising

Pay Per Use

89

29 30

6 2

16

Source: Andreas Goeldi survey (MIT master’s thesis, 2007)

7

Traditional

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Software Product Firms and Other Research

• M. Cusumano, F. Suarez, S. Kahl and students

• Public software “products firms” -- Identified ca. 500 (listed on US stock exchanges) under US SIC code 7372 – PrePackaged Software

• Since 2003, downloaded data from Compustat, Mergent, and directly from 10K reports

• Over 3000 yearly usable observations• Average 10+ years of detailed financial data from 1990• Also now databases on all IT Services firms and S&P 1000 with

products and services revenues

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.2.3

.4.5

.6.7

.8

1990 1992 1994 1996 1998 2000 2002 2004 2006fyadj

(mean) servpctsales (mean) prodpctsales

Service vs Product as % Sales - Average All Sample

Note: Services including maintenance (about 55% of services revenues for firms breaking this out)

Excludes video gamesSaaS counted as product revenueServices include professional + maintenance

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Includes video gamesSaaS counted as product revenueServices include professional + maintenance

52 52

Service/Maintenance vs. Product Revenuese.g. SAP

e.g. Novell

53 53

Service/Maintenance vs. Product Revenuese.g. Business Objects, Cognos

e.g. Oracle

54 54

Service/Maintenance vs. Product Revenuese.g. Microsoft

e.g. Adobe

55 7

Services Impact on Profits & Market Value: Sweet (vs. Sour) Spots

0102030405060708090

% o

f To

tal

Rev

enu

es

Products

Services

SweetSpot?

Stuckin the Middle?

Scale, Scope, Learning Economies?

20% 60%

Lessons for Managers (Idea 6)• Many if not most product companies today are

really hybrids that have to manage both a product business and a services business – two organizations in one– Servitize products = innovate around the product to

generates value-added customization, support, training, consulting, new pricing/delivery models

– Productize services = software factory-like customization, automated service delivery

• Former partners (IT services firms + product firms) now must fight for the same services pie! 56

The Search for Best PracticeShould Begin with Practice,

But Not End There!

Thank you

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