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


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


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).


TYPOLOGY Of ORGANIZATION DESIGN

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

s

PERFORMANCE Innovation

< p H

(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


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


(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.


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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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

Service Innovation: Aiming to Win

119

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.

120

Tony Clayton

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

Service Innovation:

Aiming

to Win

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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%

122

Tony Clayton

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

Service Innovation:

Aiming

to Win

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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


• • • •

127

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


129

(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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Tony Clayton

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.


131

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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Tony Clayton

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.


133

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.


Part II

Sector and National Studies of Innovation in Services


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

138

Frank M. Hull & Joe Tidd

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.

The Organization of New Service Development

139

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.

140


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


141

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.

142

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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

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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/


• 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.

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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.


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.

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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


Hypotheses testing (univariate)

Tabulations, ?-tests, chi-squared tests (quantitative)


Analysis of open-ended data collected

Tabulations, frequency analysis

As provided by respondents (factors contributing to project success & failure)

Model building (multivariate)

Logistic regression


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


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%

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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)


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%


Table 9.7 TMI factors. Factor

Factor Description (TMI)


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)


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

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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.


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

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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


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

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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.


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

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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).


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

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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


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%

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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


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

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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


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

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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.


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.


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

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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

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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

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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.


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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.

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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.


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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.

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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.


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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.

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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


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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.

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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


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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.

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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.


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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

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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:


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[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).

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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


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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

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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


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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.

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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.


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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.

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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


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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

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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


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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

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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.


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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.


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

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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

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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

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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,


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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.

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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


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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

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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.


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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).

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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


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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).

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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


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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

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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


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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.

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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


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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

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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


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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

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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

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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).

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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

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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


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

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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

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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

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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

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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.


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.

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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.


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

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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.


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

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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


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

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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

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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;


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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.

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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


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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

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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.


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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

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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


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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

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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.


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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).

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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


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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.

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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).


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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.

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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


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(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).

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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).


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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

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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


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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.

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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

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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

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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

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(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?

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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

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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).

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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.

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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


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.

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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,


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.

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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


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

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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.


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


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.


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.

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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.

New York Times New York Times Paine Webber TIAA-CREF

TOTALS

MBA Course

User Group

22

10

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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

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

From Knowledge Management to Strategic Competence: Measuring Technological, Market And Organisational Innovation (Series on Technology Management)

Involving Customers in New Service Development (Series on Technology Management, V. 11) (Series on Technology Management) (Series on Technology Management)

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Cases on Information Technology and Organizational Politics & Culture (Cases on Information Technology Series)

Project-based Organization in the Knowledge-based Society: Innovation by Strategic Communities (Series on Technology Management) (Series on Technology Management)

The Emergence of Entrepreneurial Economics, Volume 9 (Research on Technological Innovation, Management and Policy)

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Creative Technological Change: The Shaping of Technology and Organisations (Management of Technology and Innovation)

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OECD Studies on Environmental Innovation Environmental Policy, Technological Innovation and Patents (OECD Studies on Environmental Innovation)

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Management of Technology and Innovation in Japan

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Project-based Organization in the Knowledge-based Society: Innovation by Strategic Communities (Series on Technology Management) (Series on Technology Management)

The Emergence of Entrepreneurial Economics, Volume 9 (Research on Technological Innovation, Management and Policy)

Product Innovation, Interactive Learning and Economic Performance, Volume 8 (Research on Technological Innovation, Management and Policy) (Research on Technological Innovation, Management and Policy)

Kellogg on Technology and Innovation

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Creative Technological Change: The Shaping of Technology and Organisations (Management of Technology and Innovation)

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