How Product & Service Innovation Works: Disequilibrium, Discovery and Entrepreneurship

Full Speed Ahead
"The only way to beat the competition is to stop trying to beat the competition."1 In Blue Ocean Strategy, the authors describe the insanity of traditional strategic management logic which guides managers to fight head-on battles with competitors; to fight for the same customers; and to take actions that ultimately commoditize products and services. Blue Oceans are lucrative market spaces with a relative absence of direct competition. Although traditional strategic management definitely has its place, they do offer an attractive line of thinking.

Tactical and Strategic Entrepreneurship
If you believe as I do, that the landscape of the industries never really stand still, then you might also believe as I do that businesses have continuous opportunities to discover "blue oceans". Nevertheless, in order to navigate the complexity, managers need special tools to help them detect and harness the opportunities that are out there. Clearly, the best tools for evolving the enterprise's strategies are those that detect disequilibriums, aid the discovery of alternative strategies, and uses entrepreneurial analytics to harness value. In this posting, I'd like to delve into how disequilibrium, discovery, and entrepreneurship are the essential components to innovation.

Disequilibrium
In How Markets Work 2 (the inspiration for this post), Kirzner highlights the importance of disequilibrium to entrepreneurship. Kirzner is a proponent of "Austrian economics", which dismisses the mainstream economics notion of market equilibrium:

The set of assumptions required by mainstream theory to demonstrate how a smoothly operating market might work are far too demanding in terms of the economics systems we know. the empirical unrealism of that theory's assumptions suggests that it conclusively demonstrates that real-world markets should not be able to spontaneously co-ordinate. Thus the obvious co-ordinating properties of real-world markets turn out to be counter-intuitive phenomena crying out even more desperately for an explanation.

Austrian economics places a large emphasis on "entrepreneurial discovery", where decentralized decision makers take advantage of disequilibrium to improve upon that individual's future prospects. Namely, "[m]ovements in prices, production methods, choices of outputs, and resource owner incomes generated by entrepreneurial discovery tend to reveal where current allocation patterns are faulty, and to stimulate changes in the corrective direction." Therefore, when an entrepreneur perceives a disequilibrium he/she will make decisions that ultimately affect the entire market dynamic...., which generates new disequilibriums because ultimately the decisions are made based on imperfect information. Alternatively, this concept of disequilibrium brings light to the fact that opportunities may go unnoticed and therefore ungrasped. Indeed, "Boldness, impulse, and hunch are the raw materials of entrepreneurial success (and failure); they seem to render the possibility of systematic, determinate chains of events unlikely."

Discovery
The tools of discovery are both qualitative and quantitative, where the qualitative tools are akin to maps on a submarine which can be used to plot the general path and the quantitative tools are the sonar devices that help to identify and navigate obstacles along the way. An example of a qualitative tool for discovery is the business model canvas offered up by Osterwalder & Pigneur in Business Model Generation.3  Many manager talk about business models, but have a difficult time explaining their business models in a way that everyone shares the same conception. The business model canvas is a great way to represent business models in a visual way such that all the interactions and implications can be made clear. Indeed, the business model canvas was the inspiration for one of the primary tools used by the Wissmann Group, called the Enterprise Value Map. Another example of a powerful qualitative tool was offered in Blue Ocean Strategy, which is referred to a "value curve". Value curves are a graphical technique for comparing alternative business strategies, which make it clear if the business will be engaging competition directly or if they have a strategy that will guide them towards "blue oceans".

Qualitative methods are definitely useful, especially when it comes to pointing the metaphorical ship in the right direction. Nevertheless, quantitative analytics also have a role to play and with the advent of business intelligence (BI) systems there has never been a better time to integrate them into business management systems. Three examples of quantitative tools that can be used to discover disequilibriums are (1) Demand-Price Analysis, (2) the Direct Value Method, and (3) Attribute Value Curve Analysis.4 Demand-Price (DP) Analysis uses point of purchase data to yield estimate of product value (a metric to estimate the market's average willingness-to-pay for a product). Monitoring product value using this technique can make product managers aware of changes to market tastes, competitor offerings and aid in effective value based pricing. The Direct Value Method (DVM) is a survey based tool that helps identify product changes that could improve product value, which can improve profitability and market share. Attribute Value Curve Analysis examines each product attribute for its ability to impact product value. As consumer's preferences are non-linear over the range of an attribute's performance, sometimes making small improvements to an attribute can make huge impacts on overall product value. The key is to know which knob to turn! (see "Value Driven Product Planning and Systems Engineering" to learn more).

Entrepreneurship
Entrepreneurship is about allocating resources in the best way possible to take advantages of perceived disequilibriums in price and supply. Kirzner offers the following key insight to entrepreneurship as it relates to disequilibrium and discovery:

• At any given moment, businesses are likely to be suffering from unawareness of the true plans of other businesses.
• This business awareness may take the form of undue optimism leading to a disequilibrium price for a good that is too high or too low to clear the market. Disequilibrium prices generate direct disappointment of plans. Such disappointments can be expected to alert entrepreneurs to the true temper of the market. Prices that were too high will tend to be lowered; those that were too low will tend to be bid upwards.
• Unawareness may also take the form of undue pessimism. Sellers may underestimate the eagerness of buyers to buy. Buyers may underestimate the eagerness of sellers to sell. Such unawareness leads to more than one price for the same good. Such price differences constitute opportunities for pure profit and therefore attract the attention of entrepreneurs. 
• In the course of the market movements achieved through disequilibrium, not only will resources and product prices be modified, but resources will be shifted continually from less important uses to more important uses; and undiscovered sources of new resources will tend to be discovered.
• In the real world of incessant change in underlying consumer preferences, resource availabilities and technical possibilities, these corrective tendencies may be partly or wholly frustrated or interrupted. In addition, these tendencies, operating in different parts of the ever-changing market may interrupt and confuse each other. 
• The direction of the powerful forces of entrepreneurial discovery will be shaped and moulded by the above-described systematic and corrective processes of error, disappointment, discovery, and surprise.

Here is the key insight as it relates to entrepreneurship:

In order to innovate, the business must offer superior solutions, which are only made possible through superior abilities to detect new ways to harness value.













1. W.C. Kim and R. Mauborgne (2005). Blue Ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant. 
2. I.M. Kirzner (2000). How Markets Work: Disequilibrium, Entrepreneurship, and Discovery.
3. A. Osterwalder and Y. Pigneur (2010). Business Model Generation.
4. H. Cook and L. Wissmann (2007). Value Driven Product Planning and Systems Engineering.

Value Driven Six Sigma-So What's New?

Traditional Six Sigma Mantra
Six Sigma has always been about reducing variation. Traditional Six Sigma strove to reduce process variation and its success at doing so has been well documented. Traditional Design for Six Sigma (DFSS) strove to utilize quality tools in the design processes to yield products that meet customer expectations. DFSS successes have been less prevalent, which might be the case because it can be more difficult to quantify and demonstrate veritable results.

Criticisms of Traditional Six Sigma
The critics of traditional six sigma often cry: sure you've reduced process errors, but how has that influenced the customer perceptions of product/service value? Sometimes the influence on customer perceptions are direct as in the case of reductions in call center wait times or paper work cycle time (which makes the organization more responsive to customer requests), but is the customer really receiving more value when callers are routed through a complex call filtering system for the sole purpose of reducing variation of in-call handing times?

Then there's DFSS, with tools such as the Voice of the Customer (VOC), Quality Function Deployment (QFD), Analytical Hierarchical Process (AHP), etc. Well...., these tools as proposed and traditionally used are good in theory, but..., well..., they're difficult to use in practice and often collapse under their own weight, which ends up forcing managers to shoot from the hip anyway.

Value Driven Six Sigma
The mantra of Value Driven Product Management is to use product value, product cost, and pace of innovation to guide variation reduction decision making. Value Driven Six Sigma and Value Driven DFSS looks at variation reduction through a new lens: reduce process and product variation so long as the result is positive net-value creation. The net-value of any product management decision is the change in product value minus the change in product cost. The third fundamental metric of product management is pace of innovation, which is a measure of how fast the product/process changes can be made.

Further Reading:
Design for Six Sigma as Strategic Experimentation

Quantifying Value in B2B Transactions

Value, Value, Value
Value is a word that can have many meanings based on the conversation at hand. To clarify, I offer the following graphic representation of the different types of value from the supplier's perspective that are important in B2B transactions:

The way you capture value in B2B transactions is by calculating the value the customer puts on your product (good and/or service)--calculating the product value. When we create B2B value calculators through Economic Value Analysis, we systematically quantify the value drivers for a particular customer. This is the major difference between Value Driven Management in a B2B market versus a B2C market where a product value metric is calculated and used to represent the worth an entire market gives to a particular product.

As the chart shows, if you know product value and product cost, its easier to understand what price is equitable for both the supplier and customer. Ultimately, product value and price don't change much. Price is therefore changed to give more or less incentive to the customer to go forward with a purchase. This difference between Product Value and Price is called Customer Value and in B2B transactions Customer Value usually translates directly into economic value (profit) for the customer.

What to Expect

As you work with your customers to create the value calculation, each Critical-to-Value Attribute will fall into one of the following categories (see Value Merchants below):

1. Attribute of Parity
2. Attributes of Difference
3. Attributes of Contention

An attribute of parity is an attribute that performs essentially the same as a competing alternative. An attribute of difference is an attribute that performs either better or worse than a competing alternative. Alternatively, an attribute of contention is an attribute where it is not clear whether a the competing alternative is better or worse, so more data is required.

Value Propositions from Value Calculations

Value propositions might actually vary from customer to customer due to different product use situations. Nevertheless, value propositions become clear as the value consultant and customer develop a shared mental model of how value is delivered. The attributes that perform better than the competition form the basis for the value proposition and the two or three attributes that deliver the most value become the focus. These high value earners WILL likely be what sets the supplier's products apart from the competition and ultimately become the foundation for brand building.


Additional Reading:
"Value Merchants: Demonstrating and Documenting Superior Value in Business Markets"

Book Review: "Design for Six Sigma as Strategic Experimentation: Value, Cost, Pace of Innovation" by H.E. Cook

5 Stars (out of 5)

The following is a book review of "Design for Six Sigma as Strategic Experimentation" by Harry Cook. The book was first published in 2005 by the American Society for Quality, Quality Press.

Actually, the book gets 10 out of 5 stars. Don't be fooled by the title, this book is much more than traditional DFSS. "Value Driven Strategic Experimentation: Product Performance Optimization" might have been a better title because the methods and tools described in this book address the major criticisms of traditional DFSS (too much focus on cost, value to the customer is not quantified, the tools are not integrated). Unlike traditional DFSS, VDSE uses BOTH product value and product cost to find the optimum design variable settings to maximize net-value, make tradeoff decisions between product performance attributes, and minimize performance variation. VDSE is what DFSS was intended to be, but never could be because of its reliance on "old" tools that were shoehorned together.

This book, like Cooks other book "Product Management" is the result of  an academic collaboration with industry which strove to provide tools to guide product managers through decisions that involve both technical and commercial feasibility. The book is written for the scientifically minded and mathematically inclined audience and is a seminal work for other "Value Driven Product Management" books. The specific contributions to the domain of product management include: (1) explains the role of product value in product management decisions, (2) offers analytical models for calculating product value, (3) offers analytical models for calculating the value of continuous product attributes, (4) offers analytical models for calculating the value of qualitative product attributes, (5) includes a methodology for creating experiments to find optimal settings for design variables, and (6) provides rigorous support for models based in economics, econometrics, game theory, and psychology. The book is clearly written, has an excellent bibliography, and uses real-world examples to illustrate main points.

In summary, "Design for Six Sigma" is an excellent contribution to the area of Value Driven Management and is highly recommended for quality engineers interested in being on the cutting edge.

Know Where You Are, Know Where You Are Going

“If we could first know where we are, and whither we are tending, we could then better judge what to do and how to do it.”  –Abraham Lincoln

Every day we are getting better at managing the mounds of data that our businesses produce. The size of databases tend to double every 12 to 18 months according to an InformationWeek article. Not only are the data sets getting bigger, they're becoming more real-time, where Wal-Mart is adding a billion records daily. With this explosion of data, how do we bring order to guide the business?

A Single Version of the Truth

Business Intelligence strives to deliver a single version of the truth based on trusted information to help business leaders make better decisions. To give our leaders clarity of action, we need to simplify the masses of data into manageable metrics that let us do the following:

• Know Where We Are: Understand the competitive landscape
• Know Whither We Are Tending: Identify opportunities and trends
• Know What To Do: Set targets and monitor results so we can see what works
• Know How To Do It: Create a common context and objectives for decision making across the organization

Business Intelligence for Driving Innovation

In the case of Wal-Mart, the focus is on managing a gigantic supply chain and identifying tactical moves to improve sales and minimize costs. "Supply Chain Management" is not the only area of business that can benefit from improved business intelligence. R&D and Product Managers can use sales data to obtain a single version of the truth using Voice of the Customer Exploration tools that monitor customers' willingness-to-pay for products (what I call product value) in a portfolio. A generic representation of what this would look like is shown in the figure below.

If your product is A and your competitor's is B, don't you think it's important to know when the consumers in your market become willing to pay more for your competitor's product? Total Product Value Analysis is about "Knowing Where You Are". One of the major benefits of this form of analysis is the ability to compare how you are doing against the competition (an outward looking metric). 

Product Cost is traditionally the metric that can be measured, so this is the metric that gets managed. Unfortunately, this isn't the way to make your products more valuable to your customers. However, if your Business Intelligence Systems gain the ability to measure and monitor Product Value, value driven product management becomes possible because you "Know What To Do". Ultimately, the product manager evaluating new innovative ideas by understanding how to balance the increased value to the customer with the possible increases in product cost. The only way to do this without a product value metric is to use intuition or "gut feel", which is no way to be competitive in todays ultra-competitive global economy as I discussed in a previous blog.

How It Would Work

The Business Intelligence System will be able to drill down and role up to identify trends within markets, within regions, and as a whole. Performance bands can be placed at each level so that product managers can be alerted to major changes in value that could be attributed to successful advertising campaigns or new product introductions introduced by competitors. With these alerts it becomes possible to react both tactically and strategically to drive product value back into your products via additional promotion or making tweaks to products and services.

Guidelines for a Value Driven BI System

Transforming processes into a system begins by integrating the right information and being able to summarize the data so that it is useful in supporting decisions making. Here are some guidelines:

• The system should aggregate product value and customer satisfaction data
• Managers should be able to drill down and roll up the data by product, market, segment
• The database should be able to show trends

This data should be made available to executives, general & product managers, brand managers, sales, quality, product development, R&D and customer service.