Claude Montpetit -- Montpetit.net -- en

The essay where I took the excerpt in my previous post lead me to other articles and books related to the subject of innovation and profitability. First, from Breakthrough ideas for 2004 (pdf format), idea #5 caught my attention: The law of conservation of attractive profits.

The author, Clayton M. Christensen, briefly describes this law as follow:

• Products are most profitable when they're still not "good enough" to satisfy customers. This is because to make them performance competitive, engineers must use interdependent, proprietary architectures. Use of such architectures makes product differentiation straightforward, because each company pieces parts together in a unique way.
• Once a product's performance is good enough, companies must change the way they compete. [...] To compete in this way, companies are forced to employ modular architectures for products. Modularity causes the product to become undifferentiable and commoditized.
• [Profits] move elsewhere in the value chain, often to subsystems from which the modular product is assembled. [...] Hence, the subsystems become decommoditized and attractively profitable.

[...]

Because the hypothesis suggests that the location in the value chain where attractive profits can be earned shifts in a predictable way over time, companies that outsource activities that are not today's core competencies may well miss the boat. This "law" might help managers foresee which activities in the value chain will generate the most attractive profits in the future so that they can develop or acquire competencies where the most money will be.

Looking for more details on M. Christensen's theories, I found the intro to his book The Innovator’s Solution, with a good summary of some of the ideas expressed in there:

• Competitive Battles. Many executives pick their battles according to things like a competitor’s size. In fact, this is almost irrelevant. The hard and fast rule: incumbents almost always win sustaining battles (which center around improved versions of already existing products), and entrants nearly always win disruptive ones.
• Market segmentation. Most companies segment customer markets along the lines for which data are available. The authors argue that segmenting markets by price point, product type and customer demographics does not reflect the way customers actually experience life. This is why companies often produce products or services that customers don’t want. When managers segment markets according to important jobs customers are trying to get done, they have a much higher chance of connecting with enthusiastic customers.
• Outsourcing Decisions. Most companies determine what activities to keep in-house and which to outsource according to their “core competencies.â€? Christensen and Raynor propose a different theory. When products are not yet good enough, companies should set up a proprietary, in-house architecture to capture the most profits. When products become more than good enough, commoditization sets in and activities should be outsourced.
• Management and Leadership. Often the managers picked to lead new ventures are those with proven track records in the core business. But these individuals are often the least-equipped to steer a fledgling business, because they don’t have the experience to see the job through successfully.
• The Growth Rationale. Most executives feel pressure to grow very quickly, and reason that profits will come later. Wrong. The authors say companies must be impatient for profits, but patient for growth. Demanding early profits actually helps a truly viable strategy to emerge quickly, and buys the new venture the ramp-up time it needs to grow successfully.