Montroll lectures

1
Creating Economic Value from Research Knowledge
Value Creation - The Value Delivery Process
Charles B. Duke Professor of Physics, University
of Rochester VP and Senior Research Fellow
retiredXerox
Montroll lectures April 10-12 2007 University of
Rochester
2
The Big Picture

• The Global Economy of the 21st Century
• What it is
• What it means for the U.S. and for physics
• Value Creation The Value Delivery Process
• The Future of Industrial Physics and Physicists

3
Impact on You

• Point of View The creation of value from new
  research findings to yield products and services
  in the hands of customers is a complex subject. A
  firm must do well many diverse activities in
  order to create a profitable new business from
  new knowledge.
• Todays Topic We explore the highlights of how
  value is created by linking research knowledge at
  the front end of the value creation process all
  the way to the products and services that emanate
  from the back end of the process.
• Value to You One way or another, this will
  define the work environment of most new physics
  Ph.Ds in the 21st century Learn for success.

4
Todays Agenda

• Why firms perform RD
• Strategic versus economic value The
  technology-market matrix
• The creation of (economic) value Options, value
  chains, business models, product development,
  technology development and technology pipelines
• Consequences of the evolving geopolitical
  environment The Open Innovation paradigm
• Implications for industrial research
• Impact on physical scientists

5
Why Do Firms Perform RD?

• To grow Through new products and services to
  new markets
• To survive The onslaught of competitive product
  performance improvements and pricing cuts in
  currently served markets
• Research and development are very different
• Research New concepts for growth
• Development Technology injection into base
  product lines for survival

6
Small R Versus Big D

• Research
• Creates future investment options
• Emphasizes discovery
• Outcomes cannot be predicted or scheduled
  reliably
• Managed for creativity
• Development
• Creates product designs and prototypes
• Emphasizes performance at cost
• Outcomes expected to be predictable and delivered
  on schedule
• Managed to minimize risk to cost and schedule
• Development 10X Research

7
One Size Does Not Fit All

• A firm must both protect its current businesses
  (evolutionary universe) and grow (one of the
  other three quadrants).

8
The Total Value Model

• Economic Value the value resulting from the
  firms ongoing businesses.
• Value by discounted cash flow
• Include development projects and plans designed
  to support existing businesses and markets
• Example Xerox plans and designs for the next
  generation of copiers
• Strategic Value the value resulting from
  strategies, plans and projects to enter new
  markets or offer fundamentally new product lines
• Value by options theory (e.g., Black-Scholes
  model)
• Include strategies, plans and RD projects
  designed to enter new markets.
• Example Xerox plans and designs for entering the
  thermal-ink-jet personal printer market and the
  office networked systems market in the mid 1980s
• Total Value Economic Value Strategic Value
• Total Value should approximately equal Market
  Value
• Reference F. Peter Boer, The Real Options
  Solution Finding Total Wealth in a High-Risk
  World (Wiley, New York, 2002).

9
How Firms Capture Value from RD

• Use it as an input to create a profitable product
  or service via a value chain describing how the
  evolution of the product or service all the way
  from concept to customer
• Sell or license resulting intellectual property
• Value capture is described by a business model
  which
• Describes how a firm will make money
• Links technical inputs to economic outputs
• Converts intellectual property into economic
  value

10
The Creation of Value

• Research creates investment options for further
  investment to develop products or services that
  enable growth.
• To create value, these options must be exercised
  all the way down a complete value chain.
• A chain is only as strong as its weakest link.
• References C. B. Duke, Creating Economic Value
  from Research Knowledge, The Industrial
  Physicist 10 29-31 (June/July 2004) Richard A.
  Brealey and Stewart C. Myers, Principles of
  Corporate Finance, (McGraw-Hill, New York, 1996),
  chapts. 20-21.

Create Define Design
Manufacture Deliver
Support Concept Product Product
Product Product
Customer
11
Managing Product Development

• In large manufacturing firms products are
  developed via a structured phase gate process
• Define product platform and demonstrate
  technology
• Define product and deliver technology
• Design product
• Demonstrate product
• New technology is delivered via a structured
  technology development sub-process in the first
  two product development phases.
• New knowledge from research meets product
  development in the initial steps of technology
  development process.

12
Managing Technology Development

• Technology also is developed via a structured
  phase gate process
• Scan for opportunities
• Explore potential technologies
• Filter and demonstrate technology
• Confirm technology platform
• Demonstrate technology capability
• Establish technology readiness for a specific
  product
• Integrate into product program
• The economic value of the technology being
  developed is established by defining technology
  investment options that grow in value as phase
  gates are passed
• Reference F. Peter Boer, The Valuation of
  Technology, (Wiley, New York 1999)

13
The Technology Pipeline

• Product and technology development are combined
  with a firms strategy and business model to
  define its technology pipeline

• As a project moves down the pipeline, the cost of
  moving it though the next phase gate
  increasesusually a lot. Thus, there are many
  more projects in the earlier phases where the
  uncertainties are the largest.

14
Its The Business Model, Stupid

• Product development is not enough. It must be
  embedded into a successful business model to
  create profits.
• The business model includes how the product is to
  be delivered to the customer. E.g., Xerox was
  successful in the 1960s because it leased rather
  sold Xerox copiers to customers.
• Knowledge is converted into potential economic
  value via intellectual property, but most
  intellectual property is worthless because it is
  not embedded in a viable business model to
  convert it into realized economic value.

15
The Environment is Changing

• Creation of a global economy International
  outsourcing and pricing
• Globally available, mobile technical manpower
• Plentiful technical knowledge
• Inexpensive, instantaneous global communications
• Accessible venture capital
• End of the cold war rise of the war on terror
• From military to economic competition Peace
  through prosperity

16
The Evolving Context of RD

• Industry structures change from vertical to
  horizontal (PCs, consumer electronics, autos,
  ....)
• intellectual property (e.g., patents) and sources
  thereof explode (universities, national labs,
  small and large firms, consultants,....)
• Manufactured products become complex systems
  (airplanes, autos, consumer electronics,) built
  from standardized components
• Manufacturing industries consolidate around
  dominant, often modular, designs and a few large
  suppliers (e.g. PCs Dell, HP, IBM which source
  components from common suppliers, often in the
  far east)

17
Is Changing The Innovation Paradigm

• From closed (vertically integrated) value
  chains in which all elements are in the same firm
• Traditional model GE, IBM(old), Bell Labs,
  Xerox, Dupont in the 1960s-1980s
• Assumes scarce knowledge, limited mobility of
  technical talent
• To open (horizontal supplier structure) value
  chains in which different firms deliver different
  elements in the value chain
• New model Intel, IBM(new)
• Assumes plentiful knowledge, mobile technical
  talent, ready availability of venture capital

• Reference Henry W. Chesbrough, Open Innovation
  The New Imperative for Creating and Profiting
  From Technology (Harvard Business School Press,
  2003)

18
Open Versus Closed Pipelines

• In a closed innovation paradigm projects flow
  down the pipeline from within the firm.
  Technology development is vertically integrated
  with product development.
• In an open innovation paradigm, knowledge,
  technology, components or subsystems can enter
  the pipeline from outside the firm. Similarly,
  these entities can exit the pipeline to be
  further developed by other firms for their
  products.

19
Implications for Industrial Research

• New product development increasingly integrates
  knowledge and intellectual property from
  different firms.
• RD in industry concentrates on conceiving and
  designing new products and/or new value chains.
  The Bell Labs era of basic research in industry
  has morphed into the Intel era of
  university-industry collaborations
• Technology is not transferred it is
  incorporated a priori into new product definition
  and design by cross functional teams using a
  staged phase gate development process.
• Bottom Line Exercisable options for new products
  not physical science knowledge are the outputs of
  industrial research at the dawn of the 21st
  century

20
Impact on Physical Scientists

• Almost all physical science jobs in industry are
  in development, not research.
• The primary role of physical scientists in
  industrial research is to serve as subject matter
  experts solving problems as members of
  cross-functional definition or design teams. The
  employers of these scientists can be firms,
  universities, or consulting houses.
• In the value creation process, the generation of
  individual items of intellectual property (e.g.,
  patents) is a less important skill than the
  ability to incorporate such items into complete
  value chains.

21
Synopsis

• Value is created from research findings via a
  multi-stage value chain each step in which must
  be executed well to achieve business success.
  Successful execution of this process is called
  innovation.
• Value is realized though a successful business
  model it can be calculated quantitatively
• Economic value via discounted cash flow
• Strategic value via options theory
• Changes in the innovation environment during the
  past fifteen years.stimulated a transformation of
  the dominant innovation paradigm from closed to
  open.
• As part of this transformation, the era of basic
  physical science research in industry is over.
  Modern industrial research creates new investment
  options, not new knowledge.
• Consequently, physical scientists working in
  manufacturing industries can expect to be subject
  matter experts working on cross functional teams
  to design new products or processes. University
  or government partners may be members of that
  team.