The above statement posits that R&D is the only viable option for the firm, if it wants to innovate. The statement assumes that innovation is brought about through investment in R&D. This would imply that it refers to innovation where it is only concerned with product development. However, this is not always true, as innovation encompasses a wide variety of business functions and where it is concerned with product development, innovation is not necessarily down to R&D.

According to Schumpeter innovation is the process of applying explicit knowledge in different ways with an end to achieving a ‘better’ result. Innovation is vital to companies because it is a source of competitive advantage, through the creation of new products or method of production. Although, the process is often complex and costly, furthermore the innovation can easily be imitated hence eroding away any advantages gained from it. However, innovation is also a key form of distinctive capability and therefore according to Kay it cannot be copied exactly and can lead to added value.

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According to Penrose, R&D is “….the deliberate investigation of the as yet unknown properties of the materials and machines used in production (or as yet undeveloped ways of using them) for the express purpose of improving existing or creating new products and productive processes,…..” (Penrose, 1995, pg 112). R&D here is described as a way of improving products and the process of manufacturing.

Evidence from several areas of research regarding a wide range of business practices will be used to analyze the strength of the above statement. In particular other aspects of businesses will be viewed to explore how innovation can lead to improvements and influences how an organization operates. And finally I will look at some examples where product innovation has come about without extensive R&D. However, before proceeding it is important to look at why firms innovate in the first place and what incentives are there that drive them.

It is common knowledge that large companies with a strong reputation, wealth of assets and abundant financial resources often lose out to less well known companies. It is widely believed that because smaller firms are ‘leaner’ and less bureaucratic than large firms, that they are better suited to breaking away from traditional views and practices which allows them to innovate and adopt quicker to new forms of technology. Furthermore, because large established firms often have huge amounts of resources ‘sunk’ into one form of technology it would be costly for them to initiate a process of upgrading or equipping (installing and retraining) the company with the new technology. This is known as the ‘sunk cost’ effect and is most likely to be an issue with manufacturing process innovations.

Additionally an incumbent has less of an incentive to innovate, if it is already established in the market. Whereas a new entrant would look to differentiate itself from other firms in order to carve out a market share for its products. This is known as the ‘replacement effect’ and is the likely scenario that will cause smaller firm to overtake larger firms.

Finally, the ‘efficiency effect’ stipulates that in order for a company to protect its market power/position it will be driven to innovate as the company has more too lose because new competition destroys industry profitability.

Ultimately, therefore, firms innovate to increase their profitability, difference will arise over how they choose to do so. Schumpeter identifies 5 different types of innovations:

* The creation of new products

* New methods of production.

* Entry into new markets

* The introduction of new materials and resources.

* The development of new forms of organizations.

Source: Lecture Notes

From the above table it can be seen that innovation is only partially concerned with product development. According to Schumpeter innovation can occur in any one if the above business areas. Additionally innovation also concerns how a product/service is marketed and sold to the customer. Many companies look to bypass the traditional channels, i.e. sales men and sell directly to the end customer. This practice has grown with the ascendancy of the internet.

Any business that operates in a dynamic environment cannot be stagnant, it needs to evolve, and for this is needs to innovate. Therefore innovation is a continuous process and not a one off event. This is known to all companies, hence they have channeled considerable resources towards R&D and rely on their managers to come up with new and innovative solutions to improve the operational functions of the enterprise.

As with all other investments, investment in R&D is not without risk. It does not guarantee success. Motorola, a formidable company, spent billions of dollars on Iridium, a satellite communications system, which went bust in 1998. Philips, the Dutch electronics group, devoted its world-class research staff and billions of dollars on CD-i, a video machine, music system, game player and teaching tool all wrapped into one. It flopped – even though the company claimed that it would be the biggest thing since the VCR. When Monsanto backed genetically modified seeds, it cost billions of dollars, tarnished its corporate image and saw the departure of Bob Shapiro, its chief executive.

Heavy investment does not guarantee success nor a future as market. Large companies can easily be overtaken by smaller companies who can enter a market and with limited resources innovative products that can establish them within a short space of time. This is perfectly illustrated by the experiences of James Dyson. In the late 1980s he invented the ball-barrow as an alternative to the traditional wheel-barrow. The idea behind the ball-barrow was that by replacing the wheel with the ball, to create a more balanced and therefore safer piece of equipment. Furthermore, the ball-barrow was made of plastic instead of steal as it was only meant to be used for gardening. However, despite the noble idea the product never really took off and only made a modest return

After that James Dyson developed the Dyson Vacuum cleaner. An innovative product which made the contemporary vacuum cleaners useless. The Dyson vacuum cleaner had an advantage over other vacuum cleaners which need a paper bag to store all the collected dust. His invention did not need a paper bag but simply relied on a plastic container which collected the dust and was then easily emptied and replaced back into the vacuum. This minor improvement is a primary example of innovation without huge expenditure on R&D. By patenting his innovation Dyson was able to establish a strategic assets, enabling him to create a new market. His company now makes 30 Million Pounds a year and is valued at around 730 Million Pounds.

However, despite this product innovation is more likely to be the outcome of heavily investing in R&D than about minor improvements. In a highly competitive market no single firm can expect to remain profitable without heavy investment in R&D. The department is expected to come up with new and innovative products, which the company would need to continue making profits and grow. A single innovative product can be the source for a firm to transform itself from a minor company to a large multinational organization.

The manufacturing process, as listed above, is a vital area of innovation. The rational for striving to improve the process of manufacturing is basically to gain a competitive cost advantage. The principles of manufacturing processes were advanced furthest by the Japanese car-makers Toyota, who after entering a new market against American and European contestant were able to, in a space few years, gain market dominant positions. This was partially down to strategic innovations in the manufacturing process as well as minor improvement in the final product.

Among the new innovative strategies that the Japanese firms pursued was the advent of Just In Time (JIT). This process redefines the relationship between the mangers and the suppliers (external architecture). Suppliers are responsible for delivering parts for the final product that the company does not manufacture itself, for e.g. in case of cars they maybe the carpets and seat covers. Traditionally these parts were delivered and had to be stored as inventory in the warehouses, which caused overheads to increasing and costs time, such as unloading, storage in the warehouses and then uploading on the production line for manufacturing.

The new method implemented by Toyota superseded any cost advantage that incumbent car firms had. Rivals had to reorganize their production operation to implement the new innovative process or suffer from steadily declining market share.

General Motors Toyota Ratio

Assembly time per car 40.7 hours 18 hours 2.3

Defects 130 per car 45 per car 2.9

Assembly space 8.1 sq feet 4.8 sq feet 1.7

Inventories 2 weeks 2 hours 168

Source: The mature business: The Competitive Challenge by C. Fuller and J. Stopford

Best describes the process as, “The JIT communication system is in the form of actual consumption figures of the following stage, and not of orders from a planning staff anticipating future demand”. This passage describes the essence of JIT, which is that only the parts that are necessary are ordered, and are delivered just as the car for which the parts are needed is about to be assembled. This has the advantage of not requiring to store the parts and just as they are delivered they can be put on to the production line. This can be seen in the table above where Toyota only stored inventories for 2 hours and up too 2 days at GM.

The next form of innovation on the list is entry into new markets. A specialized firm in a competitive market is vulnerable to shocks, that can adversely affect the demand for its goods. “Its growth is limited by the growth of the market for its existing products or by the share of the existing market” (Penrose, 1995, pg 113). In order to avoid this, it is imperative that a firm either introduces new products or enter new markets. Even if the firm is operating in a monopolistic market environment the threat to its sustainability of market dominance can come from close substitutes.

This can be illustrated by the Microsoft. One of the defining characteristics of a computer is that it has a relatively small life cycle, as every computer manufactured is effectively made obsolete only after a few years when ‘better’ technology comes out. This allows the company to keep upgrading their software and hardware by incorporating new technology every few years. Furthermore, Microsoft have also branched out into the games console market with their version due to come out around September.

The development of new forms of organization refers to the ability to create new strategies, which alter the competitive rules of the game in the industry. This ability is perhaps best represented by Macdonald’s.

Innovation in service sector has many unique characteristics. For example:

* Rarely organized through R;D departments.

* Very frequently conducted on a project-specific basis.

* Often involves close collaboration with clients or other firms.

* Highly influenced by issues such as rules and regulations.

* New methods and ideas often immaterial in nature and therefore difficult to protect.

* Relies heavily on copyrights, trademarks and non-formal means of intellectual property protection.

An industry where all of these characteristics are common is financial and technical business services. Large investment banks do not rely at all on R;D departments, infact their knowledge is gained through experience and bounded by rules and regulations. They are also required to collaborate with other banks for specific tasks such as organizing a stock listing of a company, for example underwriting the risk, prior to an IPO requires more than one but less than 5 banks.

Case Study

Origins and Rationale

Michael Dell began in 1984 with a simple business plan. He could bypass the dealer channel through which personal computers were then being sold. Instead he could directly sell to the end customers and build products to order. This allowed Dell to eliminate the resellers markup, the costs and risks associated with carrying large inventories of finished goods. The formula became known as the ‘Direct business model’ and allowed Dell to create a $13 Billion industry.

Today Dell computers are unique in the sense the way they are manufactured and sold to the customers and all the support services that go hand in hand with the actual product. Previously companies would produce a set number of computers with similar specifications and sell them onto the customers (see diagram below). However according Michael Dell, this way of doing business creates little value for the customers. They are having to pay extra price for the mark up and software that they may not have any use for.

Diagram 1

Direct Business Model

Approach by customers Website Linked to Allow clients to order

Via website ordering, inventory and online


Provide web Sell Build computers

and phone enabled to specifications

support services

Original Business Model

Mass produce computers Sell to Customers approach dealers

with same features dealers

Provide phone enabled Sell to customer

Customer support

For Michael Dell to manufacture according to the direct business model, it required an innovative approach towards the manufacturing process and a complete reshaping of the organizational features of the company. This included building an internet enabled customer purchase and support infrastructure that would allow buyers to navigate their way around buying their first computer, without the need for a sales man and solve any after sales problem themselves.


Early in its company’s existence Michael Dell realized that for his idea to be successful, to provide tailor made computers, he would have to do so by integrating his ordering and manufacturing systems so that the company could assemble and ship computers in a matter of few days. This meant that buyers would have to order online and the details of their purchase could be fed to the inventory list that would then make the necessary purchases. This was not only efficient but also had the added advantage of keeping inventory costs zero and would make it possible to squeeze the maximum profit out of a fast changing industry, which was also very competitive.

Dell takes orders directly from its end customers and builds its computers to order. This allows a close personal relationship between the company and its customers, who range from individuals to large multinational corporations. Dell has thus eliminated retailers or other resellers that can add unnecessary time and cost or can diminish Dell’s understanding of customer expectations. This is often the case when it comes to other companies who only sell to other sales men, who then resell the computers. In Michael Dells reasoning this adds unnecessary costs to the client and time in searching for the right product and crucially it means that the manufacturers have no real understanding of the needs of the consumers.


The production process has to be integrated with the company’s order books to allow efficient management of inventory and swift completion of orders and delivery. For this purpose the company built their website and allowed buyers to choose the features they want to see in their computers. To mange the inventory and production process Dell instituted a manufacturing process similar to Toyota’s Just In Time (See diagram below).

As a computer is purchased over the internet, the company orders the necessary parts that are required for the production. The parts are then delivered by the suppliers before the production process starts the following day, hence minimizing inventory. Furthermore by getting Sony to produce all of there computer monitors they are assured of the highest quality. For Dell this means that they do not personally have to check each monitor for defects. Therefore, once the computer is complete, Dell ask UPS to collect the computer main-frame from their Texas plant and the monitor from Sony’s Mexico factory and then deliver them to the buyers address.

Diagram 2

According to Michael Dell this way of doing business also benefits the suppliers. This is because the cost of transportation of monitors has been cut and also the overheads often caused by the back-log when demand suddenly falls.

Managing inventory is a crucial advantage because of the rapidly changing technology in the PC industry means that every computer in inventory is potentially obsolete the day it is built. By not building computers until they are ordered Dell has eliminated the risk of holding outdated computers. In an interview he explained “…if I’ve got 11 days of inventory and my competitor has 80, and Intel comes out with a new 450-megahertz chip, that means I’m going to get to market 69 days sooner”. Dell has thus pioneered the ‘Direct business model’ as applied to this particular industry.

Risk, Problems and Barriers

The biggest problem the company faced, with allowing customers to choose the features they wanted in their very own personal computers and ordering online. This was solved by building an infrastructure that would allow this to function properly and link it with customer support service and all the various departments within the company. Dell is not just one homogenous company, it is divided into several largely autonomous business unit segments organized by target markets. These markets include government, education, consumers, large corporations and local government. Each unit is responsible for its own R&D and manufacturing as required by their defined markets.

In 1996 the company decided that its web activities should be coordinated within a central organization. This was to allow the company support staff to improve the standard of performance and quality. This was achieved in several stages. The whole process was launched from a small base and then gradually expanded.

Results & Competition

In the first quarter of 1998 the Dell website received an average of 1.5million customer visits each week. This translated into $6million in computer sales a week. An internal survey by the company found a high degree of customer satisfaction and that the systems ordered online generally end up with a higher configuration price than the average price of a system sold by Dell over the telephone. According to its website about 50% of the sales of it computers are web enabled, about 50% of its technical support activities and 76% of Dell’s order status transactions occur online (this is where buyers can follow the progress of their orders.)

However, competition is also catching up with Dell. Compaq computers has recently revamped its ordering and manufacturing process allowing it to sell as made to order. Gateway 2000 has been following the Direct Business Model from the very beginning of its existence.

Dell’s approach to manufacturing computers or doing business with clients are not an outcome of heavy investment in R&D. Although there are cases where it might be the case that a company invest heavily in R&D to find more cost effective ways to manufacture or build relationship with clients. For Dell the idea of supplying computers and matching it to each individuals needs was developed in stages and along the line it became clear to Dell that the normal way of manufacturing was just was not compatible with his original idea.

However, there is no denying the fact that R&D is crucial. Dell spends $300 million annually on R&D and in 1998 it filed over 200 patents. However, this does not necessarily translate into success. Brilliant innovation can come about through minor improvements that lead to something bigger.

“…what happens is that we get a series of seemingly small innovations that over time add up to a huge improvement” .Michael Dell



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1 Dorothy Leonard and Jeffrey. F. Rayport (1997) Spark innovation through emphatic design, Harvard Business Review, Nov-Dec, pg103

2 Joan Magretta (1998) The Power of virtual integration: An interview with Michael Dell, Harvard Business Review, March- April, pg 72

3 K. Sobek II, J. K. Licker and Allen Ward (1998) Another look at how Toyota integrate product development, Harvard Business Review, July-August, pg 36

4 Walter Kuemmerle (1997) Building effective R&D capabilities abroad, Harvard Business Review, March-April, pg 61

5 W. Chan Kim and Renee Mauborgne (1997) Value Innovation: The strategic logic of high growth, Harvard Business Review, Jan-Feb, pg 103







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