Shifting Cultural Gears in Technology-Driven Industries

Ongoing innovation — of products, business processes or both — is essential for the success of any company in a competitive industry. In technology-driven industries, as core technologies mature and mainstream customers proliferate, the primary source of customer value inevitably shifts from product innovation to business innovation, which focuses on processes (product development, procurement, manufacturing, sales, distribution or services) and marketing (partnering, segmenting, positioning, packaging or branding). To meet the changing needs of customers, technology-driven companies must effect a corresponding shift in their own competencies. However, attempts to accomplish that through changes in strategy, structure, processes or rewards without changing the company’s underlying cultural assumptions are almost always doomed to failure because culture strongly shapes both the competencies and rigidities of a company.

When culture is aligned with the needs of the market, it can enable very high levels of organizational performance, but when the market changes significantly, the culture may have to change as well. Many senior managers avoid addressing cultural transformation because of culture’s invisible, difficult-to-measure nature and its stubborn resistance to quick fixes. Yet it is precisely because cultural change tends to be slow and difficult that waiting for a crisis to initiate such change is often a recipe for disaster. Consider the case of Digital Equipment Corp. (DEC), which was superb at product innovation and an industry leader for many years, but stumbled and fell when hardware commodi-tized and business innovation became the driving force. Analysis of the DEC situation powerfully illustrates that product innovation and business innovation require two quite different cultural predispositions — or biases — and suggests a model that will help executives guide their companies through the challenging transition from one to the other. (See “About the Research.”)

How Culture Shapes the Company

“You can be sure our plan was perfect. It’s just our assumptions were wrong.” Ken Olsen, 1991 (founder and president of DEC for 35 years)

Just as each person’s biological DNA shapes his or her competencies, the “cultural DNA” of a company — the individual and collective assumptions, beliefs and values of its employees — shapes the competencies of the organization. When a new company is established, the founders bring with them assumptions from their previous experiences about what it takes to be successful in the marketplace.1 These are tested and perhaps modified as the company works to develop and deliver products. If success is achieved, the assumptions are validated and soon become generally accepted. Employees at all levels become so completely imprinted with these assumptions that their perceptions and judgments become unconsciously biased toward a certain world view and certain courses of action.

External Context

Every company has an external context of customers, competitors, partners, suppliers, technologies and regulations. (See “Model of the Company.”) Success depends on the ability to provide more value or lower prices to customers than competitors do. Changes in a company’s external context —changes in what customers value as a given industry matures —require the company to adapt or risk extinction.

The Outer Company

The outer company focuses on execution and results. A company’s revenue-producing activities (engineering, production, marketing, sales and service) reside in the outer organization. The results of those activities include revenue, growth, profit, market share, company valuation and customer satisfaction. Cultural assumptions in the inner company profoundly affect quality of execution and results in the outer company, but the elusive nature of culture makes it difficult for managers to diagnose the causal connection between those assumptions and results.

The Middle Company

The middle company comprises the organization’s mechanisms of motivation, coordination and control. A company articulates a vision to energize and inspire its employees at a deep emotional level. It instills drive through a variety of motivators, including money, security, achievement and mastery. It unifies and guides its efforts through the creation of infrastructure and a variety of steering mechanisms including strategy development, role definition, goal setting and resource allocation.

The Inner Company

Cultural assumptions reside in the innermost layer of the organization. They form the tacit code that shapes how the middle company and outer company operate. Understanding the sources of cultural DNA can be helpful in understanding a company’s culture and what might be needed to change it. With DEC, for example, being aware of the product-innovation cultural roots of its founders is helpful in understanding its preference for sophisticated products and customers and its disdain for commodity products and mass marketing.

Strategy problems in the middle company and execution problems in the outer company often can be traced to misalignments between strongly held cultural assumptions in the inner company and shifting external conditions. Companies have to coevolve with those conditions in much the same way that natural organisms evolve to remain competitive within an ecosystem. Naturally occurring mutations create genetic variations, and those variations with the fittest DNA survive and reproduce. In business, startups represent a kind of naturally occurring mutation that brings new types of cultural DNA into an evolving industry. But for existing companies, modifying cultural DNA in order to adapt is a major challenge.

High-Tech Industries Evolve in a Predictable Pattern

Fortunately, technology-driven industries do not develop in a totally unpredictable manner, but typically in three distinct stages. Understanding the differences in market and industry dynamics across those stages can help a technology company anticipate and prepare for the shifts that will be necessary as its industry matures.2 (See “The Path of Technological Development.”)

The Creation Stage

The creation stage begins with the introduction of a new technology and is a period of scarce product functionality and few standard approaches. Vendors have the advantage over buyers because product obsolescence can be rapid and the cost for customers to switch to competitors can be high. Market success for vendors is primarily based on product innovation stemming from proprietary technology. Because the products are typically expensive, unreliable, and difficult to install and operate, customers are predominantly sophisticated early adopters who are able to put up with such challenges in order to get leading-edge capabilities. A good example of creation-stage products are the early computers from IBM and Univac, which were very expensive, had proprietary architectures and required a tremendous amount of programming by customers.

The Transition Stage

As the technology evolves, a product emerges with characteristics that begin to win overwhelming approval in the marketplace. That initiates the transition stage, in which the successful approach becomes the dominant design.3 The dominant design may emerge slowly or rapidly, depending on the dynamics at work, including the nature of standards formation (whether they are government imposed or market selected). The emergence in the early 1980s of affordable, standardized personal computers networked to host servers marked the dawn of computing’s dominant design.

The Commoditization Stage

Once the dominant design has been broadly accepted, the commoditization stage begins. The importance of product innovation is diminished because the market has found an approach it likes and doesn’t want major changes made. That represents a revolution in customer purchasing behavior. Product functionality and reliable performance now become abundant, while vendor differentiation diminishes. Assuming there are no vendor monopolies, buyers have the upper hand, not vendors. As a result, business innovation that serves buyers becomes more important, helping to reduce cost and increase reliability, ease of use and quality. For example, the emergence and broad acceptance of the Internet, followed by the World Wide Web as a networking standard, has limited the opportunity for breakthrough product innovation because customers have invested a lot of money in that approach and don’t want to make it obsolete.

Monopolies, patents and copyrights can delay or prevent full commoditization through limiting competition, thus constraining the emergence of buyer choice and influence over vendors. For example, Microsoft still exerts tremendous power over its resellers, partners and end-users because of its monopoly in PC operating systems. An emerging candidate to break that monopoly is the open-source Linux operating system. In the pharmaceuticals industry, drug patents create monopolies that allow manufacturers to charge inflated prices and delay commoditization until their expiration. In the entertainment industry, copyrights on music and movies prevent Napster-style commoditization.

To navigate from the creation stage through to the commoditization stage successfully, established vendors must adapt to two dramatic shifts: the shift in what customers find valuable and the shift in customer bargaining power. Adapting to those shifts requires companies to change their practices and competencies —and therefore their cultural biases.

The Inevitable Challenge of Cultural Change

“The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.” F. Scott Fitzgerald

The DNA that gives rise to a cultural bias consists of a number of “genes” — or core assumptions — that drive behaviors in the middle and outer company. Consider a model of six genes, each of which is defined by the organization’s answer to a fundamental question listed here. Answers one and two determine an organization’s “genetically” predisposed assumptions about execution and results. Answers three and four color its essential views about steering and infrastructure. And answers five and six indicate core thinking about vision and drive. In a product-innovation culture, the answers to each question are quite different from those in a business-innovation culture. (See “Mapping the Two Cultural Biases.”)

1. What is the essence of a winning product? In product-innovation companies, winning products are state-of-the-art and sell themselves; in business-innovation companies, winning products are reliable, affordable and able to project a powerful brand.
2. Who should specify new products? In product-innovation companies, new products are specified by engineers; in business-innovation companies, by customers.
3. What do employees need to perform well? Product innovators encourage autonomy and debate among employees; business innovators emphasize collaboration and lean processes.
4. What characterizes good leadership? In product-innovation companies, leadership is parental, forgiving and inwardly focused; in business-innovation companies, it is disciplined, professional and outwardly focused.
5. What is the root source of success? In product-innovation companies, success is technical genius and vision; in business-innovation companies, it’s aggressive deal making.

6. What do we strive for? Companies with a product-innovation bias strive to change the world; those with a business-innovation bias strive for exceptional market share, growth, profits and valuation.

Given these seemingly contradictory sets of assumptions, it is no wonder executives find it a challenge to transition from a cultural bias of strong product innovation to one of strong business innovation.

The Cultural Bias Toward Product Innovation

The genetic predisposition of a product-innovation company, as suggested by the foregoing questions and answers, is toward an emphasis on breakthrough engineering (for execution and results), a creative-clan mentality (for steering and infrastructure) and visionary entrepreneurship (for vision and drive). It is best suited to the creation stage, as it both nurtures product innovation and exploits vendor power.

Breakthrough-engineering orientation.

In product-innovation companies, there is a strong belief that engineers should be the ones to specify new products because they know what is technically possible. These companies also hold that a winning product is one that is innovative, is state-of-the-art, commands a premium price and is able to sell itself. Thus, early in a technology’s life cycle, design engineers define new products with outside input from a few technically sophisticated early adopters, who are often engineers or scientists themselves. (At DEC, the DEC Users Society — DECUS — provided exactly that role, bringing together lead users with DEC engineers to discuss technical issues and opportunities.) Because product functionality is scarce, only technologically advanced customers are willing to pay the premium. For them, using sophisticated, bleeding-edge designs can mean a capability or cost advantage in their own activities. Marketing is not important in this stage; the sales process often involves just a vendor engineer talking directly to a customer engineer.

Creative-clan orientation.

Product-innovation companies believe that good leadership is parental, forgiving and inwardly focused and that employees need autonomy, healthy debate and personal responsibility to produce outstanding results. Because the formula for the perfect product is not understood in the creation stage, much autonomous experimentation, creativity, debate and risk taking are necessary to produce the diversity of concepts that companies hope will lead to the discovery of the dominant design. Employees need to take risks in order to get high levels of product innovation, so failures are accepted and forgiven by leaders as an unavoidable aspect of experimentation. This parental, inwardly focused, forgiving orientation can create a sense of family that makes downsizing and outsourcing in the commoditization stage difficult. At DEC, founder Ken Olsen resisted layoffs well beyond what the financial realities dictated, making it all the more challenging for his successor to transition to a lean organization.

Visionary and entrepreneurial orientation.

Visionary, entrepreneurial companies strive to change the world. They believe that technical genius and product innovation are the root source of success — that the money will follow. At the core of many high-tech startups is an idealistic, passionate founder, a technical genius with an innovative product idea that can offer a capability previously unavailable, even unimagined. If the idea is accepted by the market, early adopters will beat a path to the startup’s door and will pay high prices to get access to the capability.

The Cultural Bias Toward Business Innovation

The genetic predisposition of a business-innovation company is characterized by a commodity-marketing mentality (for execution and results), an emphasis on lean operations (for steering and infrastructure) and an aggressive business orientation (for the company’s vision and drive). It is best suited to the commoditization stage because it nurtures business innovation and embraces customer power.

Commodity-marketing orientation.

At the commoditization stage, product functionality and standards are clear. Business-innovation companies believe that customers, not engineers, are best at specifying new products. Customers have abundant product knowledge and multiple vendors to choose from, so they exert more influence over the definition of value. The market is dominated by nontechnical customers with mainstream needs, so business-innovation companies focus less on state-of-the-art capabilities than on price, ease of use, safety and reliability. Product styling, packaging and branding also become important differentiators.

Lean-operations orientation.

The creation of low-cost, high-quality products in the commoditization stage requires low inventories, tight coordination, and clear standards and measures. Business-innovation companies embrace the view that everything revolves around process infrastructure, and that extends beyond the company to suppliers and distributors as well. Thus the bias is toward professional, disciplined and outwardly focused leadership, lean processes and employee collaboration and accountability.

Aggressive-business orientation.

Business-innovation companies typically focus on process and marketing innovation as the root sources of success. At the commoditization stage, after the emergence of a dominant design, products are reasonably standardized, well understood, well liked and dependable. Customers don’t want vendors making major changes; they seek the lower prices, higher quality and better service that come with business innovation.

Clearly the two cultural biases are very different. The product-innovation culture is heady, visionary, informal, freewheeling, inventive — even arrogant. The rules are few, the market is wide open, and competitors are eating the company’s dust. The business-innovation culture, on the other hand, is more disciplined, structured, process-oriented, accountable and incremental. Infrastructure, predictability and cooperative relationships are most important. What makes a company successful before the emergence of the dominant design can make the same company unsuccessful afterward.

Also, vendor companies at this stage are almost always publicly held and have demands from investors for consistent growth and profitability. Because these goals are more difficult to achieve as a technology matures, business-innovation companies often employ aggressive deal making — including mergers and acquisitions — to gain an edge with suppliers, customers and competitors.

The Right Cultural Bias for the Situation

In technology-driven industries, the necessary mix of product and business innovation shifts over time. (See “The Innovation Mix Shifts as a Technology Matures.”) The mix includes five categories of innovation: base product, human factors, styling and packaging, marketing, and base process. To support the evolution of innovation mix, the optimal cultural-bias mix must evolve, too. The more optimized a company’s culture is for the creation stage, the more suboptimized it is for the commoditization stage. DEC was highly optimized for the creation stage and stumbled badly when the dominant design (personal computers and client-server computing) emerged. Key factors in the stumbling were DEC’s inability to move beyond creation-stage characteristics of proprietary products and high-cost (as opposed to lean) processes.

Companies that thrive almost exclusively on product innovation typically have highly selective customers and low-volume operations. Such companies include high-tech startups, research laboratories, think tanks and skilled artisans. (See “The Cultural-Bias Landscape.”) At the opposite end of the cultural spectrum are logistics- and distribution-intensive companies that thrive almost exclusively on business innovation (especially process technology), such as FedEx, Southwest Airlines and Wal-Mart.

As it takes many years for an industry to become fully commoditized, the most successful companies find ways to develop hybrid cultures to balance both product and business innovation, even though the underlying cultures have inherent conflicts. (Additionally, if a company has multiple product lines in different stages of technological maturity, both cultural biases need to coexist successfully, perhaps separated by divisional boundaries.)

Hybrid companies that are product-innovation dominant provide high-value, noncommodity products and services at a reasonable volume. Sophisticated equipment manufacturers (such as Boeing and early mainframe-computer companies) and architectural firms are examples. Hybrid companies that are business-innovation dominant are high-volume manufacturers of consumer products such as cosmetics or personal computers, mass-market automobiles and upscale retailers. Automobile and cosmetics makers do offer incremental base-product innovation but rely mostly on styling, packaging, marketing, quality and cost to establish a competitive advantage. Representative are the popular sport utility vehicles (SUVs), which are mostly a packaging innovation built on existing base-product technology, and vehicles from Toyota, whose success is based on high levels of product quality and reliability at an affordable price.

Hybrid cultures can attempt to optimize both product and business innovation by moving toward the upper right hand corner of the landscape (high product-innovation bias, high business-innovation bias), but excessive levels of conflict between the two biases may impede success. An airline-industry example of the difficulties is high-cost, high-service carriers, such as Continental Airlines, that have tried and failed to compete with Southwest Airlines in the low-cost, low-service arena. Another example of the inherent cultural conflict is seen in retail, where the industry structure has migrated to high-value boutiques and low-price discounters, with companies like Sears struggling in the middle. To develop in both cultural dimensions, strong product-innovation and business-innovation competencies must be organizationally segregated into linked subcultures. That is one of the challenges at Hewlett-Packard today, which has more product diversity than ever since its acquisition of Compaq.

Orchestrating the Cultural-Bias Shift

As an industry transitions from creation to commoditization, a vendor’s balancing of the product-innovation emphasis with the business-innovation one would ideally be smooth and painless. In reality, however, the path is almost never smooth and painless, because executives often must apply major jolts to get managers out of comfortable grooves that have become dysfunctional ruts. But if executives don’t take on the task, competitors and customers will.

Orchestrating culture formation and change requires courage and foresight on the part of leaders, but fortunately, proven techniques are at hand.4

Begin With a Hybrid Culture

Creating a pure product-innovation culture has initial advantages, but the likelihood of successfully transforming it to a business-innovation culture down the road is slim. A hybrid culture should have a strong product-innovation emphasis at first (unless the target technology is already in the transition or commoditization stage), but business-innovation genes should be present. Though entrepreneurs in startups might find that difficult to provide, experienced venture capitalists can offer the necessary mentoring and guidance. Of particular importance in the creation stage is to avoid inserting strongly polarizing negative or elitist product-innovation assumptions that devalue and create resistance to business-innovation assumptions. (Consider the belief at DEC that simple, easy-to-use, standardized, low-cost products were akin to toys.) One early computer company that began with a hybrid culture and successfully weathered a number of industry shifts is IBM. Long before the dominant design emerged, IBM had significant competences in both marketing (for example, the renowned IBM sales force) and business processes (IBM’s Federal Services Division, precursor to the company’s highly successful e-business service). For established companies offering new technologies, the challenge is the reverse — stripping off most of the business-innovation genes and letting the product-innovation genes become dominant. That is most successfully done by creating a separate division.

Change With a Jolt

Because employees unconsciously cling to certain assumptions after years of success, awakening them — and their managers — typically takes a major jolt.5 Unfortunately, such a jolt is often an externally precipitated near-death experience, with the company sliding to the brink of disaster, as happened at Porsche in the early 1990s. Preferably, the jolt is an internal one led by executives or the board and administered in anticipation of change, not in a long-delayed reaction to it.

One effective jolt toward a business-innovation bias is visiting a company that leads in lean production. Many executives don’t fully realize how inefficient their operations are until they see and experience the operations of a world-class lean competitor firsthand. At one time, that required a trip to Japan, but today such operations are everywhere. That technique was used to jolt Porsche: One of the first initiatives of CEO Wendelin Wiedeking was to send his senior executives on a tour of Japanese auto manufacturers.6

Create Linked Subcultures

Once a company has become larger than a few hundred employees, subcultures will emerge because of functional specialization and transnational operations. Subcultures also arise if a company develops multiple product lines based on technologies at different stages of maturity. Executives should acknowledge the need for subcultures and carefully examine the balance of separateness and integration that works best for the whole company. For example, IBM’s world-class research division has a vastly different culture from its sales organization, but the two are linked by metrics for creating competitive advantage, success at technology transfer and potential for future customer revenue. At DEC, one of Olsen’s key failures in the early 1980s was his refusal to divisionalize, which blocked successful development of the range of semiautonomous subcultures necessary to span DEC’s vast array of products and services.

Replace the Founders

Entrepreneurs are typically successful because they have a fanatical belief in their vision. When the market matures and assumptions need to shift, however, fanatical belief can become fanatical resistance to change. That may necessitate replacing the founder and other early culture creators with disciplined, business-innovation-oriented leaders. They may be outsiders with experience in high-volume businesses and commodity products. Alternatively, they may be internal subculture leaders who have adapted well to the evolving external context. One might be heading up a division achieving success in implementing lean processes or building commodity marketing and channels. Though founder Steve Jobs of Apple Computer appears to be somewhat of an exception to the rule, Apple’s long-term prospects without acquisition by, say, consumer-electronics giant Sony (which Jobs would almost certainly block because of his inwardly focused “creative-clan genes”) are far from rosy.

Use Technological Seduction

One technique to help change cultural bias is to introduce information systems that require a cultural shift.7 Consider the way large consulting companies implemented centralized knowledge-management systems and metrics to encourage and reward consultants who shared valuable intellectual property with colleagues. Similarly, Wal-Mart and Dell Computer drive cultural change through the implementation and enhancement of rigorous, state-of-the-art supply-chain management and reporting systems. Here, the business-innovation cultural genes are embedded in the design of the supply-chain systems and software that heavily shape how work is done and how results and employees are measured.

Preparing for the Inevitable

If early high-tech leaders are to remain successful, they must inevitably evolve their underlying cultural bias as the driving technology in their industry moves through the creation, transition and commoditization stages. Cultural change is never easy and may require managers to be jolted out of their comfortable grooves. Though premeditated change is far more likely to succeed than waiting until disaster strikes, it takes substantial courage and foresight to fix what many see as not yet broken. For a courageous leader, the theory and tools are available for proactively guiding the development of the company’s culture from one best suited for early entrepreneurship to one capable of long-lasting industry leadership.