July 23, 2008
High-Leverage Innovation, Part Three:
Lessons from the Auto Industry
Money isn’t the key to successful innovation. In fact, many companies spend far less than their competitors on R&D to achieve far better performance. To learn why that’s the case, strategy+business and Knowledge@Wharton spoke with Kevin Dehoff, a partner at Booz & Company, and Karl Ulrich, Wharton professor of operations and information management. In this final part of a three-part series, Dehoff and Ulrich talk about innovation in the auto industry -- what constitutes it, why some manufacturers, like Toyota, are more innovative than others, and the role that customers play in innovative product development.
T R A N S C R I P T :
strategy+business: Karl, the automotive industry seems to be especially innovative. It’s constantly rolling out new product features and new processes. Why do you think this is?
Ulrich: First, let me disagree with the premise. I would not really characterize the automotive industry as highly innovative. Let me qualify that by saying the automotive industry pours tremendous resources into product improvement and product innovation, but, the vast majority of that innovation is done within a very static product architecture. We see improvements in tire technology, but it’s fundamentally a pneumatic rubber device on a steel or aluminum rim.
We see improvements in GPS navigation systems, but they’re still plugged into the same basic approach to how we’ve moved people around with automobiles really since the beginning of the 20th century. So, I honestly do not see a tremendous amount of innovation in the fundamental approach to how we move people around with automobiles. And yet I think we are likely to see some dramatic changes.
The biggest changes that are on the horizon here are first of all changes in energy sources. There are a lot of bets being placed as to whether the energy sources will be bio-fuels, whether they’ll be hydrogen—personally, I highly doubt that—or whether most of the energy for automotive transport might come from the electricity grid through plug-in hybrids. So that’s one disruption that is likely to play out and to lead to innovation the likes of which we haven’t seen for 100 years.
Before I interject all of my opinions, I’ll turn it over to Kevin. But I guess I would question the premise that the industry has been innovative in the way that I think the public is used to thinking about radical or dramatic innovation.
Dehoff: Yes, I think in the context of discontinuous innovation, I agree. There are two that come to mind; one you mentioned. I think there is the potential for some interesting dynamics around alternative power trains and how that’s all going to sort out. As Karl mentioned there are a number of different points of view and different bets being placed. And so I think we’re going to see that play out and I think that that’s going to be an innovation that has a dramatic affect on how we think about automobiles in the future.
The second area that I think will potentially also have a discontinuance effect is around safety, around all of the active and passive safety and some of the technology that ultimately gets to be applied, particularly in some of the near-premium and premium segments. I think that people are going to continue to demand safety in their vehicles and that’s going to be something that technology discontinuities will drive, the ability to satisfy those needs in some pretty interesting ways in the future.
Ulrich: The wild card on automotive I think is: First, what we think will happen to fuel prices in the future. And second, whether in the United States, at least, there will be a more aggressive regulatory environment. For my taste, I’d rather see the information communicated to the manufacturers through price signals, through higher costs of gasoline. But I think it’s likely that in the next administration we’ll see some regulation around CAFE—corporate average fuel economy—which will also put some serious pressure on the automotive industry to innovate.
Dehoff: Yes, I think how those regulations get divided up among land-based power generation versus the automotive industry, versus the aviation industry—I think how that regulatory balance plays out is actually going to drive innovation across all three of those areas and probably others as well.
Knowledge@Wharton: Kevin, you had mentioned innovation taking place in power trains and in safety, two key areas. Which companies specifically seem to be pushing the envelope in those areas?
Dehoff: The automotive company that I have been interested in and studied over the last couple of years has been Toyota. I have found them to be, over the last decade particularly, quite interesting in the context of what they have been able to accomplish, in terms of driving growth, in terms of taking market share and in terms of the market capitalization that that has translated into. I think that their market capitalization right now is in excess of the next four or five competitors combined. They’ve really been on a roll.
You hear a lot about Toyota’s production system and the efficiencies that they get from the production system. But what I’ve found is that in reality a lot of that is really enabled by the product creation process, by the product development system that they’ve put in place. And that is what has really been able to drive a lot of the performance that Toyota’s realized over the last couple of years.
Ulrich: I totally agree that Toyota is an amazing company. You basically have to recast the market capitalization industry with and without Toyota because it is so much of an outlier, in terms of its market value. And we saw that GM racked up a $35 billion loss for 2007. So Toyota is truly outstanding.
But it’s also interesting to look at the other extreme. I think there are going to be some very interesting activities by start-ups and new entrants. Let me just give you two examples: A venture-backed start-up out of Silicon Valley called Tesla Motors has kind of a show car that they’re beginning to produce. But then [it] has plans for a mainstream sedan that is very exciting. It’s going to be an electric vehicle that could be very disruptive.
The other thing that I think our listeners would be interested in looking at is the Automotive X Prize, which is a multimillion-dollar prize that is being offered for any innovator that can both deliver a vehicle that has certain environmental performance standards but also that can be reproduced in volume, at a reasonable cost. So it’s going to be a fascinating competition that is going to play out over the next two years. My prediction is that there will be hundreds of entrants into that competition and that we’ll see some fascinating innovation at the grassroots level in the industry.
Dehoff: The only thing that I would add to that is also the future growth in emerging markets, in China and in India. I mean you are seeing Tata Motors and some of those and how companies respond to the requirements of future automobiles in emerging markets.
strategy+business: One of the things that we are seeing from Tata, in particular, is innovation at the bottom of the pyramid, if you will, stripping a car to its very basics. That is cost-in-manufacturing innovation. What other sorts of innovation do you expect?
Dehoff: I think that it will largely be around that and around the ability to make the appropriate trade-offs in understanding what are the basic requirements for those markets and other markets. And how to make the appropriate trade-offs, in terms of providing something that is really tailored to the requirements of those emerging markets, recognizing that for GM, Ford and Chrysler it’s a completely different mind-set as to how they potentially would need to respond to those types of …
strategy+business: And the same markets in fact.
Dehoff: That’s right.
Ulrich: I think that the Tata vehicle is going to be fascinating to watch because I think there will be Americans who will say, “Why can’t I have a $2,000 car?” And it will force us to really confront what is the minimal requirement on personal transportation. When the vehicle starts to approach the price of a nice mountain bike, you start to say, “Maybe I don’t need a 6,000-pound vehicle with a global positioning system in it to get to the grocery store.” So I think that innovations in the developing markets will actually have some repercussions in the Western and mainstream markets.
strategy+business: Back to Toyota for a moment. Kevin, you started to talk about what sounded like the strategic advantage that Toyota had developed for itself with its innovation processes. Can you talk about that a bit more?
Dehoff: My belief is that strategic and competitive advantage for Toyota has come through what I call an economically advantaged product-creation system. And that is, when you look at Toyota relative to in particular the U.S. OEMs, they can develop new products faster and more efficiently than their competitors. The resultant products that they develop have inherent cost advantages. They have much higher quality, reliability and durability. As a result of that they command price premiums in the market. And so the fact that Toyota has built over many years this advantaged product-creation system, they look at investments in new segments, investments in new products differently than a company that has a different set of economics associated with their new product development process.
And so what that’s enabled them to do is drive a lot of the growth that I talked about earlier, by being able to enter new segments in cases where other companies may look at that segment and say, “Hey, we can’t make that investment work.” And then as a result of that—and this is where you come full cycle—is that those superior economics, those superior results, have enabled them to make investments in some of these new innovative technologies that we talked about, around alternative power trains. In their case, all of the hybrid vehicles and what they’ve done in that case, as well as the other one I mentioned, which is in some of the safety and some of the other technological innovations that they will ultimately be able to put in future vehicles as well.
strategy+business: It would be interesting to see how and if Toyota responds to Tata.
Dehoff: I think that that’s a challenge for Toyota in terms of how they take that successful product development model that I mentioned and globalize it. Right now it’s a very successful model; it’s largely a centralized model that works out of Tokyo. I believe that one of their challenges going forward is how do we replicate that model around the world.
Knowledge@Wharton: Karl, going back to your point about American consumers reacting to the [Tata] Nano. What roles do users or customers play in automotive innovation, and is the role growing?
Ulrich: Well it is interesting because users often can play many different roles. In some industries they can be innovators themselves. That’s typical of industries in which there’s a high level of technical skill applied by the user. For example, in surgical instruments, you’ll see a lot of orthopedic surgeons who are also garage tinkerers, and will develop surgical instruments that then get developed in practice. You don’t see so much of that in the auto industry. It’s not a game any more that many of the garage mechanics play effectively.
And so I think the principal role of users and customers is going to be as adopters, I mean as people who react to innovation rather than people who lead the innovation. There are some exceptions. Some firms have found certain segments that do a lot of customization and adaptation of their vehicles. The whole Toyota Scion line is one that’s really played to that market segment. But, by and large, I think in the auto industry, we’re a fairly passive set of users.
Knowledge@Wharton: Are there other industries where users or customers do play a more critical role?
Ulrich: Certainly in any technical products, professional software, surgical instruments, other medical devices, scientific instruments—you see the boundary between a user and innovator is quite blurry. And so you’ll see users doing innovation and then manufacturers adopting that innovation, and you’ll see this fairly fluid boundary between users and innovators.
strategy+business: Any thoughts on the changes in innovation processes, how they might transform over the next few years as innovation becomes more global, as a response to different new markets?
Dehoff: I guess only the one that I mentioned earlier around the value of a global network and cracking the code in terms of how we will operate in the context of those global networks. And then the role of technology in terms of opening up that front end of the innovation pipeline, in terms of access to new ideas and the transferability of information across those networks. I think that’s an area, as I said earlier, where the companies that figure out how to make that all work I think will enjoy some real advantage in doing so.
Ulrich: I have a hope for how innovation processes might change and it’s really more in how they might be applied. An observation I make is that some industries are pretty good at explicitly managing their pipelines and their funnels and their processes. They think about how many opportunities they have. They think about how many they’re processing, how they evaluate them and how they select them. But there are quite a few industries that are at a much different level of knowledge.
If you look, for example, at the entertainment industry, it’s an industry that uses almost no analytical tools to manage its innovation process. And yet motion pictures, for example, look for all the world to me like pharmaceuticals. If you look at the basic economics of the funnel, it’s extremely similar.
Take another example: In service industries, where we’ve done very little to codify the innovation process within service industries. So my hope is that some of the really great tools that have been developed in the more technical product-based industries will be applied in perhaps the softer, more service-oriented industries.
Click here to listen to PART ONE
Click here to listen to PART TWO | 
