AWSJ Article

The Perils of Ignoring Innovation – Asian Wall Street Journal, August 1999

By Brian Walker

TOKYO – The personal computer industry is stuck in a rut.  Growth is strong but profit margins are being squeezed.  Product innovation isn’t the primary means of growing profits anymore; instead firms are squeezing profits from gains in operational manufacturing efficiency.  How should firms response to this kind of difficult situation?  The contrast between Japanese and American companies reveals valuable lessons.

Compaq, IBM, Hewlett-Packard and others have tried to create value through a range of different strategies.  These include new services, product line-up integration through mergers, splitting product lines into “value” and “performance” positioning and even through software development and bundling.  However, none of these have really compensated for the lack of core product innovation.

Meanwhile, here in Japan the economic situation has inspired some Japanese PC manufacturers to “swing for the fence,” trying to hit a homerun with innovative products in the hope that profitability will return.  Sony did it with the Vaio ultra-slim notebook line.  Sharp did it with their Zaurus line of personal digital assistants.  The primary innovation in both cases was miniaturization, increased quality and revolutionary features in the area of digital convergence.  In other words, Japanese firms have reverted to their core competency of engineering and applied technology research and development. 

In the American market, however, the picture is quite different.  The products are big, bulky, energy intensive and pretty much identical.  Quality has suffered, but because of greater focus on technical support, most customers are fairly satisfied.  The products meet the customer needs, run the latest software for about two years and generally can be built to any specification required.

The problem is that all it would take is an aggressively priced hit product farther down the curve of digital convergence and miniaturization to knock the whole industry over.  It is already starting to happen with Sony’s direct sales in North America.

There are some real obstacles to this scenario, but it can’t be dismissed.  It’s true prices are so low in North America that new market entry for any firm would be a very expensive proposition.  And Japanese companies are much more cash constrained than in previous years.  But on the other hand, the Japanese are farther down the curve of technological innovation than American PC companies.  Thus, a “home run” product on the U.S. home field would put them far ahead of the Americans.

The American PC industry is relying on a combination of market development strategies from market leaders like Dell, Intel and Microsoft, that when viewed in aggregate have a nasty blind spot.  They are leading the industry into a vicious circle of lower margins, decreasing product differentiation and worsening product performance.  Like a bicycle coasting without power, once world-wide market growth slows, the whole industry is in danger of falling over.

The two words “white boxes” strike terror in the hearts of most American PC industry executives.  They can only give one good reason why someone should buy their product instead of a generic, white box PC manufactured in a garage: lower price due to bulk parts procurement and greater manufacturing efficiency.  The “commoditization” of PC products has been a nightmarish trend that the PC industry has been living with for years.

But American producers haven’t done anything about it.  The focus on manufacturing and operational efficiency has led them to sacrifice product innovation and product differentiation.  As any first year marketing student will tell you, product differentiation is the key to growing and maintaining profitability.  So why does the PC industry seem to be stuck on this path?

As a product analyst for Compaq Japan, I worked with my counterparts world-wide to develop the new line of Deskpro Commercial Desktop products for 1997.  Our primary focus had been on creating highly manageable products with the best serviceability features that we could dream up.  Like most major PC companies, we had a special technology innovation team that identified innovations solutions to customer demands and then coordinated the development and implementation of such technology.  IN 1996, Compaq’s topnotch engineering capabilities allowed us to proposed new features for future PC’s that are revolutionary even by today’s standard.

But for 1998 planning, everything changed and most of the innovations were dropped.  The change was a result of strong pressure from Dell on Compaq’s operational and distribution inefficiencies.  Product development changed radically.  The focus moved away from innovation onto parts standardization, so that the products could be manufactured more cheaply as well as giving the customer greater flexibility in choosing features.

It all seemed like a good idea at the time.  After all, Intel and Microsoft were still constantly upgrading their core technologies.  So Compaq felt that once its operational nightmares were solved, it would be able to compete on equal or better footing with Dell because of the Compaq brand, wider product lineup and service solutions.  Unbeknownst to all of us, that was when Compaq was sucked into the storm.  We all lost sight of the fact that Intel and Microsoft are just parts suppliers.

Given their status as near monopolies, it is easy to overlook this key fact.  Innovation by parts suppliers cannot substitute for innovation by the product vendor for the end user.  Intel has been using the same P6 microprocessor core since 1995, with the major improvements being processor packaging and speed increases.  They have added new command sets, but hardly anyone ever uses them.  Microsoft has just been adding on new bits and pieces to the DOS operating system for years.  This has turned Windows into a huge amalgamation of extraneous features, most of which users will never even be aware of.

Because PC makers have copied Dell’s focus on efficiency in manufacturing, operations and sales, and haven’t paid attention to product engineering, a large hole has opened up in the industry’s market development strategies.  Who knows if it will be the Japanese PC companies, Apple or some other company, but eventually somebody is going to introduce a product with strong customer “pull”, set at the right price.  Then we could see a repeat of the consumer electronics nightmare scenario of the 1970s when American producers were decimated by better engineered imports.  The twin pillars of American PC industry, Microsoft and Intel, may ensure American dominance of the PC industry in the short run, but they will undermine its strength on the long run.  If American producers don’t wake-up to the innovation gap, their success could be short-lived.

Mr. Walker spent the last five years as an engineer and marketer in the Japanese PC industry.  He is currently a graduate student of Georgetown University’s School of Foreign Service.