Taking a Value-Chain Perspective on Innovation

  • Kristina McElheran
  • October 25, 2016

Getting value-chain partners on board is essential for innovation and e-business success.

Market leaders have many advantages when it comes to adopting new technologies. They have the benefit of size, which can generate economies of scale. They have experience. They sometimes have dedicated technical staff to help them through implementations better and faster than others. Nonetheless, we do not always see them leading the charge to embrace new technologies. Why is that? Why do some companies adapt and flourish more quickly than others in the face of technological change?

In the 1990s, many observers thought the Internet was going to cause a great deal of disruption for leading companies. Literature around the idea of disruptive innovation, as pioneered by Clayton M. Christensen and usefully extended by Rebecca Henderson, Joshua Gans, and others, is a particularly good example of this thinking. E-commerce startups mushroomed faster than a shady backyard. Yet, today, many market leaders from the start of the dot-com boom are still standing tall. In fact, many of them were able to keep up with some big technological leaps forward.

As a researcher who studies technology use by companies, I wanted to understand what happened. Who kept up? Who fell behind? And why? I considered the fact that while leaders do enjoy economies of scale in the adoption of new technologies, they may also find that adjustment costs — tasks like tweaking processes to match the flow of new software (or vice versa), hiring employees with new skill sets, or coordinating new points of contact across the organization — may increase with scale.

Exploring the Capability Gap

A number of previous studies have fleshed out this line of thinking. Having to make costly changes to internal business processes can significantly slow down technology adoption. Basically, when technology leaps forward, the internal “capability gap” between new technology requirements and what incumbent companies can implement is often difficult to close.

But that isn’t the whole story when it comes to e-business. We need to take a wider view.

Misalignment between tech requirements and an organization’s ability to meet them can also exist outside a company’s boundaries — that is, among its partners and customers. And it turns out that these external adjustment costs matter a great deal, too.

After all, any technology that requires substantially new routines, new task knowledge, or new complementary resources also will require any organization that interacts with it to change its processes, human capital, or other resources, and know-how. ERP software, for instance, was notoriously difficult to implement, requiring significant “business process reengineering” and non-trivial interruption or duplication of key internal processes.

When we look at how digital technologies affect business-to-business interactions, we can see a similar potential to enable or disrupt key processes. This time, however, the processes cut across organizational boundaries. My research therefore focused on how links in the value chain — particularly, customers — might impact the behavior of leading companies at the onset of technological change.

I explored the logic that, if adjustment costs are significant — or if customers have enough influence to resist even small changes — high-market-share companies might steer clear of making big changes in these interactions. Remember: Big companies typically have big customers (or many smaller ones), and they cannot put the foundation of their success at risk. Smaller, entrepreneurial companies have less to lose.

My research revealed that when customer-related adjustment costs are a significant concern, the largest companies actually may resist certain technological advances, despite having a leg up in many ways. This would be surprising if we considered only what is happening inside these powerful and highly capable companies. However, a careful appreciation of value-chain realities sheds light on an often overlooked factor: External adjustment costs also feed into technology strategy.

This is not an abstract theory. I validated this argument empirically with a large and detailed U.S. Census Bureau data set on e-business activity for over 34,000 plants across 86 manufacturing industries. The correlations between market share and technology adoption were robust and striking.

For certain activities, I found no evidence of disruption. Market leaders aggressively adopted low-cost innovations. Being in the top quartile by market share, for example, was associated with a 20% greater likelihood of adopting e-buying, a brand-new but low-adjustment-cost innovation at the time of the study (even more so today).

By contrast, leaders were 36% less likely to adopt e-selling — a process where customer adjustments costs can be high. Tellingly, in settings or locations where customer capabilities were better aligned with the new technology — that is, where the external capability gap was smallest — market leaders were more eager adopters (on the order of 50%). Ultimately, it was the readiness of the value chain to adopt — and not just the readiness of a single company — that drove the appeal of this innovation for the largest companies. More generally, this pattern paints a vivid picture of how important value-chain partners are in facilitating, or slowing, technological advances.

Strategic Implications

We are continuing to deepen our understanding of how capability gaps can influence innovation. If customers’ capabilities become a determining factor for essential types of innovation, then even well-positioned organizations that are ready for technological change will be at risk. Market-leader advantages — while very real — only go so far, and they can be overturned by downstream value-chain relationships.

Taking a step back, this adds some nuance to our understanding of how business-process innovation can be a key source of competitive advantage for certain companies. New technology can be leveraged to enable performance along a chain of related companies, but only if business partners make the leap to adopt these changes as well.

The clear message for business leaders is to take a wider view of their market landscape in order to avoid flawed assumptions about the benefits and challenges of new digital technologies. And there’s a lot at stake. If the largest, most successful companies have significant exposure to customers who are technology laggards, smaller companies may seize new opportunities to leapfrog their competitors through B2B process innovation. It’s a potent reminder that all of the links in a value chain are essential to e-business success.