Master Thesis: Copenhagen Business School
MSC. EBA in Management of Innovation & Business Development
15th of May 2019 Supervisor: Jacob Norvig Larsen Pages: 120 STU: 270,665
Kristian Kronmann 919448 Lucas Almstrup 35263 A CASE STUDY ON
INCUMBENTS´ ROLE IN DISRUPTION
´s WAY INTO THE
CLOUD
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1 Executive summary
Cloud computing is fundamentally changing the playing field of the enterprise software industry, and the change has been well underway for the past decade. Large incumbents in the enterprise software industry have dwelled in the traditional on-premise industry and have consequently been rushed to action by the mass adoption of cloud-based enterprise applications, brought by innovative cloud-only companies with origins in the early ‘00s. These applications were provided as a service hence fundamentally challenging the conventional on-premise delivery model. The German software incumbent SAP SE engaged in the market for cloud-based solutions in the end of 2011 when it acquired the cloud-based enterprise software provider SuccessFactors. SAP has since acquired several companies in the pursuit of rapidly increasing its cloud-based business to eventually become the world’s leading cloud-based enterprise software company. Through a case study on the acquisition of SuccessFactors and an analysis of the disruptive path of the cloud technology, this paper aims at aiding SAP in its quest to lead the cloud-based enterprise software market and to provide corporations in general with guidance on how to identify and respond to new disruptive technologies. The analysis of this paper finds first and foremost that SAP was unable to look beyond its industry boundaries and identify macro-economic trends that would alter the way customers preferably would access its enterprise software. In the meantime, born-in-the-cloud start-ups matured, hardware incumbents integrated forward, and tech giants entered the cloud computing industry, forming a highly competitive business environment. Subsequently, as time was scarce, the paper finds that when SAP finally realized the value of cloud technology, it appropriately reacted to the emergence of the technology by acquiring a proven cloud-based company, SuccessFactors.
Hereafter, the paper finds that the integration of SuccessFactors into the SAP organization was a success due to SAP’s ability to transfer relevant knowledge from SuccessFactors to SAP while maintaining organizational distance between the two companies. Also, the close integration of the acquired leader from SuccessFactors into the SAP top management played a crucial role in retaining and motivating key employees at SuccessFactors during the integration. Finally, the paper recommends SAP to enhance its engagement in foreseeing relevant macro-economic trends by improving its corporate venturing activities and to continue acquiring external innovations through acquisitions with an arm’s length approach to preserve the embedded capabilities of the acquired firm.
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Table of content
1 Executive summary ... 1
2 Introduction ... 5
3 Motivation and research question ... 6
3.1 Key concepts ... 7
4 Literature review ... 9
4.1 Literature on cloud computing ... 10
4.2 Disruptive technologies ... 15
4.3 External strategic thinking ... 20
4.4 PEST ... 20
4.5 Five forces ... 22
4.6 Wrapping up external strategic thinking ... 24
4.7 Internal strategic thinking ... 25
4.8 Dynamic capabilities ... 25
4.9 Absorptive capacity ... 31
4.10 Role of leaders in acquisitions ... 33
4.11 Wrapping up internal strategic thinking ... 34
4.12 Racing to be 2nd... 35
4.13 Critique of chosen literature ... 36
4.14 Conclusion ... 38
5 Methodology ... 42
5.1 Philosophy of science ... 42
5.2 Research approach... 43
5.3 Research strategy ... 44
5.4 Time horizon ... 45
5.5 Data collection ... 46
5.6 Data quality ... 51
5.7 Credibility of our research ... 51
5.8 Delimitations ... 53
6 Case description ... 54
6.1 SAP history ... 54
6.2 Cloud computing ... 56
6.3 SuccessFactors ... 59
6.4 SAP today ... 60
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6.5 Case relevance ... 62
7 Analysis I ... 63
7.1 On-premise enterprise software... 63
7.2 Emergence of cloud ... 65
7.3 Adoption of cloud ... 68
7.4 Consolidation of cloud ... 73
7.5 Wrapping up the evolution of the enterprise software industry ... 78
7.6 Sub-conclusion: Analysis I ... 80
8 Analysis II ... 83
8.1 Dynamic capabilities ... 83
8.2 Absorptive capacity ... 91
8.3 Role of acquired leaders ... 99
8.4 Sub-conclusion: Analysis II ... 101
9 Discussion ... 102
9.1 Key findings ... 103
9.2 Reflecting on the chosen theoretical framework ... 105
9.3 Integrating the findings ... 110
9.4 Recommendations for SAP ... 114
10 Conclusion... 117
10.1 Managerial implications ... 118
10.2 Limitations and further research ... 119
11 Bibliography ... 121
12 Appendices ... 128
12.1 Appendix 1: Methodological overview ... 128
12.2 Appendix 2: Interview guides ... 129
12.3 Appendix 3: Cloud growth by segment ... 132
13 Interviews ... 133
13.1 Interview 1: Jens Bager ... 133
13.2 Interview 2: Thomas Borum ... 149
13.3 Interview 3: Jesper Schleimann ... 166
13.4 Interview 4: Louis Columbus ... 182
13.5 Interview 5: Jens Bager ... 191
13.6 Interview 6: Morten Harboe ... 195
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List of figures & tables
Figure 1: Thematic areas of the literature review ... 9
Figure 2: The Disruptive Innovation Model ... 19
Figure 3: Analytical framework ... 41
Figure 4: Deployment preference 2008 and 2014 ... 57
Figure 5: Total size of public cloud computing market ... 57
Figure 6: SaaS vendors' revenue in 2015-2016 ... 59
Figure 7: SAP's acquisitions in SaaS segment (blue) & cloud revenue (yellow) ... 62
Figure 8: From single-tenant to multi-tenant. ... 67
Figure 9: World internet adoption and Salesforce revenue ... 69
Figure 10: Fixed vs mobile internet CAGR - their infant years ... 70
Figure 11: Amazon Web Services - Revenue & Income ... 77
Figure 12: The Disruption of the Enterprise Software Industry ... 82
Figure 13: The role of ERP software... 86
Table 1: Key concepts ... 7
Table 2: Interviews ... 47
Table 3: List of selected SAP acquisitions ... 61
Table 4: SaaS vendors revenue Q2 2009 YoY... 74
Table 5: On-premise vendors revenue Q2 2009 YoY ... 75
Table 6: Key factors which aided the disruption of the enterprise software industry ... 79
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2 Introduction
The global software industry has been around since the unbundling of software and hardware concerning the antitrust case against IBM in the 1970s (Kadiyala, 2017; Salmans, 1982). Since then, the enterprise software market has been dominated by large software vendors such as SAP and Oracle and the products have been influenced by proprietorship of the software and high upfront perpetual licenses with high maintenance fees (Kadiyala, 2017; Interview 4: Columbus, 14:12). Where enterprise software traditionally was delivered by installing the purchased software on servers located on the premises of the client – commonly referred to as ‘on-premise’ – a new delivery model has erupted in today’s enterprise software market. The new delivery model Software as a Service – also known as ‘SaaS’ – has introduced enterprises to a novel way of accessing software via the internet, which is a concept often referred to as ‘cloud computing’. SaaS was primarily introduced by small entrepreneurial firms and thus took many incumbents by surprises due to the novelty of the business model. Consequently, there were about 169 acquisitions in SaaS companies at an average amount of $1.3B in 2018. Topping the list is German enterprise software giant SAP SE acquiring survey software specialist Qualtrics International Inc. for a hefty $8 billion (Jaiswal, 2019).
SAP SE is a German-based technology company making enterprise software applications. Nearly 100,000 employees across 180 countries work with “the purpose to help the world run better and improve people’s lives” by “promising to innovate”, assisting over 335,000 businesses to run at their best (SAP, 2019). As of 2017 SAP’s made €23.5B in revenue with a net profit of €4B. In December 2018, the company was valued at €113B making SAP Germany’s most valuable company (SAP, 2019).
At first, SAP’s only product was an Enterprise Resource Planning (ERP) software application offered as an on-premise solution. Over the years, SAP began to offer other on-premise products supporting most of the clients’ value chain, including logistics, operations, marketing & sales, and services together with finance, human resource management, and procurement.
As SaaS-based offerings began to emerge, vendors of these services were beginning to compete with SAP in most of its product categories. Since this cloud model is fundamentally different from an R&D, delivery, and even sales perspective, SAP consequently chose the path of acquisitions to transition from being a traditional on-premise software vendor to become a SaaS vendor. SAP primarily decided
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to acquire its SaaS offering as the internal development of such offerings would have been slow and thus SAP saw the risk of being left behind (Interview 3: Schleimann, 23:40). Therefore, since 2011, SAP has acquired key competitors in each area; SuccessFactors, Hybris, Ariba, Concur. Only for the core ERP solutions, SAP chose internal development to bring this solution set to the cloud. The case of SAP’s road to the cloud provides several interesting elements for research.
The paper aims to aid SAP in its quest to dominate the cloud. It will initiate by reviewing relevant literature for analyzing the concrete business problem. Subsequently, the analysis will begin by addressing macro-economic trends relating to the emergence of cloud computing and how it has affected the enterprise software industry’s dynamics. Eventually, the analysis will transition to address the acquisition strategy of SAP by analyzing the acquisition of SuccessFactors. The literature chosen, the empirical data collected, and the findings of the analysis will all be discussed and critically reflected upon. The discussion closes by providing strategic recommendations for SAP. Finally, a conclusion on how SAP can dominate the cloud, together with managerial implications and recommendations for further research, will be presented.
3 Motivation and research question
As business students, we were drawn by the sheer size of the 8 billion USD Qualtrics acquisition and how a company such as SAP can justify acquiring what seems to be a survey tool at a price that represents 20 times Qualtrics revenue (Nicola & Koh, 2018). Our initial investigation led us to realize that the acquisition was part of an overall strategic roadmap of SAP to: “shift its enterprise software business to the cloud from traditional on-premises services, with the goal of becoming a one-stop shop for all digital offerings” (Bond, 2018). Further research unveiled that the acquisition of Qualtrics was merely one of several anteceding acquisitions of cloud-based companies – as explained further in the case description of this paper – and of which the acquisition of SuccessFactors in 2011 seemed to be the epicenter.
As a result, we were motivated to investigate the underlying reasons for SAP to enter the market for cloud-based software, why it did so in 2011, and why its strategy to enter the market has been to acquire the technology externally. We do so to finally being able to provide SAP with strategic
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guidance on how to achieve its goal of becoming the one-stop shop for all digital offerings. Ultimately, this means that SAP must become the leading cloud-based enterprise software company, which led us to elaborate the following research question:
How can SAP successfully transition to become the leading cloud-based enterprise software company?
To support the formulation of an answer to the research question, and to guide the reader of this thesis, the following sub-questions have been composed on the basis of our literature review:
1. How have changing market conditions played a role in disrupting the global enterprise software industry?
2. How did the dynamic capabilities and absorptive capacity of SAP affect the integration of SuccessFactors?
3. How can SAP overcome the identified challenges?
3.1 Key concepts
Throughout this paper, we make use of different terms, concepts, and abbreviations. For simplicity, we now present a table (table 1) to comprehend how the most frequently used terms and concepts are being applied in the analysis and discussion throughout the paper.
Table 1: Key concepts
Concept Definition
Software market Includes all software being sold and distributed
Enterprise software market The segment of the software market which includes all software being sold and distributed to organizations, rather than to individuals
On-premise software A business model where the software is installed and runs on computers on the premises of the person or organization using the software
Cloud computing A model for enabling ubiquitous, convenient, on-demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction
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(Mell & Grance, 2011). Cloud computing consists of three service models: SaaS, PaaS, IaaS.
SaaS Abbreviation for Software as a Service: A business model where applications reside on the cloud infrastructure of service
providers and are delivered to users through web interfaces and programs (Senyo, Addae, & Boateng, 2018)
PaaS Abbreviation for Platform as a Service: A business model which offers users a platform to build and run applications through a programming interface provided and supported by cloud service providers (Senyo et al., 2018)
IaaS Abbreviation for Infrastructure as a Service: A business model which supplies a range of virtual infrastructures such as virtual servers, storage and other fundamental computing resources to users which enable them deploy and run their own operating system, applications, upload or download software or files into the cloud (Senyo et al., 2018)
Cloud enterprise software
market Includes all market segments of cloud computing, including SaaS, PaaS, and IaaS. Therefore, it is a sub-segment within the segment of the software market as well as a segment within enterprise software
Enterprise SaaS market Includes all software vendors who offer enterprise software through the SaaS service model. It is therefore a sub-segment within cloud enterprise software market.
ERP Abbreviation for Enterprise Resource Planning: The
management of all the information and resources involved in a company's operations by means of an integrated computer system (Oxford, n.d.).
HCM Abbreviation for Human Capital Management: the
comprehensive set of practices for recruiting, managing, developing and optimizing the human resources of an
organization by means of an integrated computer system. HCM systems are sold either as components of ERP systems or as separate products that are typically integrated with ERP (Rouse, 2015).
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4 Literature review
In the following section, we will present an overview and review of the selected literature for this project. First, a roadmap of the selected theory will illustrate the logic of the selected concepts and frameworks. Second, the theory will be presented and described, and third, we will address the critique and gaps of the selected literature. We round up this section by presenting an analytical framework based on the literature review.
For now, we focus on introducing the theories and the frameworks needed to address our research question. For simplicity, however, below we present a graphical illustration of theories we are using (figure 1). Thereafter, we begin to examine our chosen literature.
Figure 1: Thematic areas of the literature review
•We review the literature on cloud computing to educate ourselves and the reader on this relatively new, yet fast-growing market. Likewise, we will use it to set the context in the use of general, traditional analytical frameworks.
Cloud computing literature
•The theory of disruptive technologies will guide what to look for when assessing which technologies disrupt and which does not. Additionally, it provides recomendations of how to respond to disruption as an incumbent.
Distruptive technologies
•The PEST analysis’ job is to identify the macro-level conditions that have characterized and shaped the industry as it is today, and to provide insights into the future of cloud computing.
PEST
•The five forces help us understand the competition of the global software industry today, and how SAP should tackle it. Together with PEST, the insights into the if and how cloud computing disrupted the software industry.
Five forces
•Teece’s framework will derive insights on SAP’s strategic ability to build, integrate, and reconfigure internal and external competencies to tackle rapidly changing environments.
Dynamic capabilities
•We attempt to investige SAP’s operational ability recognize new external knowledge, assimilate it, and apply to commercial ends with regards to the acquisition of SuccessFactors. Together with the theory of dynamic capabilities, they will identifySAP’sinternal strengths and weaknesses.
Absorptive capacity
•We will utilize the theory of Graebner (2004) to analyze how the actions of the acquired leader have affected the acquisition of SuccessFactors to assess the overall importance of acquired leaders.
Role of leaders
•Racing to be second will aid a discussion of SAP and other incumbents’
dominant role and how to best sustain it.
Racing to be 2
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4.1 Literature on cloud computing
Due to its reasonably young nature, industry players and researchers have not formulated a standardized definition for cloud computing (Marston, Li, Bandyopadhyay, Zhang, & Ghalsasi, 2011;
Senyo et al., 2018). However, Marston et al. (2011) and several others (Arvanitis, Kyriakou, & Loukis, 2017; Hentschel, Leyh, & Petznick, 2018) adhere to the US National Institute of Standardized Technology (NIST) definition: “Cloud computing is a model for enabling ubiquitous, convenient, on- demand network access to a shared pool of configurable computing resources (e.g., networks, servers, storage, applications, and services) that can be rapidly provisioned and released with minimal management effort or service provider interaction. This cloud model is composed of five essential characteristics, three service models, and four deployment models.” (Mell & Grance, 2011).
Notably, the characteristics and the service and deployment models are being emphasized by researchers to describe cloud computing (Gupta, Seetharaman, & Raj, 2013; Senyo et al., 2018). Mell and Grance (2011) of NIST define the five essential characteristics as on-demand self-service1, broad network access2, resource pooling3, rapid elasticity4, and measured service5. The three service models include Software-as-a-Service (SaaS), Platform-as-a-Service (PaaS), and Infrastructure-as-a- Service (Mell & Grance, 2011). The SaaS model a cloud computing model where applications reside
1 “A consumer can unilaterally provision computing capabilities, such as server time and network storage, as needed automatically without requiring human interaction with each service provider”.
2 “Capabilities are available over the network and accessed through standard mechanisms that promote use by heterogeneous thin or thick client platforms (e.g., mobile phones, tablets, laptops, and workstations).”
3 “The provider’s computing resources are pooled to serve multiple consumers using a multi-tenant model, with different physical and virtual resources dynamically assigned and reassigned according to consumer demand. There is a sense of location independence in that the customer generally has no control or knowledge over the exact location of the provided resources but may be able to specify location at a higher level of abstraction (e.g., country, state, or datacenter). Examples of resources include storage, processing, memory, and network bandwidth.”
4 “Capabilities can be elastically provisioned and released, in some cases
automatically, to scale rapidly outward and inward commensurate with demand. To the consumer, the capabilities available for provisioning often appear to be unlimited and can be appropriated in any quantity at any time.”
5 “Cloud systems automatically control and optimize resource use by leveraging a metering capability1 at some level of abstraction appropriate to the type of service (e.g., storage, processing, bandwidth, and active user accounts). Resource usage can be monitored, controlled, and reported, providing transparency for both the provider and consumer of the utilized service.”
We review the literature on cloud computing to educate ourselves and the reader on this relatively new, yet fast-growing market. Likewise, we will use it to set the context in the use of general, traditional analytical frameworks.
Cloud computing
literature
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on the cloud infrastructure of service providers and are delivered to users through web interfaces and programs (Senyo et al., 2018). The central notion behind SaaS is to eliminate the practice of applications residing locally on devices of the individual user as the computing powers of these individual devices cannot be leveraged to provide high computing efficiency and performance to users (Senyo et al., 2018). It is believed that cloud computing is built on the genesis of SaaS (Mell &
Grance, 2011). PaaS is the second layer of cloud computing in which this model offers users a platform to build and run applications through a programming interface provided and supported by the service provider (Senyo et al., 2018). Consequently, the matters of scalability, high server speed, and storage capacities are addressed under PaaS (Senyo et al., 2018). Finally, IaaS is the service model where providers supply a range of virtual infrastructures such as virtual servers, storage, and other fundamental computing resources in order for the user to deploy and run their operating systems, applications, and upload and download their software and files into the cloud (Senyo et al., 2018).
Moreover, these service models are then deployed over the choice of one of four different delivery channels which involve public cloud, private cloud, hybrid cloud, and community cloud (Gupta et al., 2013). The user will base his choice on factors such as needed control, the number of users, security, and privacy needs (Senyo et al., 2018). The most common choice is public cloud, where a third party owns all the physical resources and then provides cloud services to multiple users over the Internet (Senyo et al., 2018). It exists on the premises of the provider (Mell & Grance, 2011). The private cloud is the deployment model targeted for organizations who want full control of corporate data, security guidelines, and system performance (Senyo et al., 2018). Private cloud is provisioned for exclusive use by a single organization comprising multiple consumers (e.g., business units). It may be owned, managed, and operated by the organization, a third party, or some combination of them, and it may exist on or off premises (Mell & Grance, 2011). Thirdly, a community cloud is frequently deployed by organizations who share the same mission that include the same security requirements, policy and compliance conditions (Senyo et al., 2018). Lastly, hybrid cloud is the combination of two or more of either public, private, and community cloud that remains separate entities but are bound by standardized or proprietary technology that enables data portability between the distinct cloud infrastructures (Mell & Grance, 2011).
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The above definition is far too long for an elevator pitch, hence why other researchers have attempted with more concise and brief classifications: Kranz et al. (2016) defines that “cloud computing flexibly provides information technology (IT) resources and services to distributed users through the internet”. Additionally, cloud computing’s relatively young nature has not only resulted in researchers’ dissention of a clear definition but also show a heavy overweight on few focus areas in the academic world (Hentschel et al., 2018).
Indeed, existing literature on cloud computing primarily focuses on the intentions as to why customers opt-in on cloud services (Asadi, Nilashi, Husin, & Yadegaridehkordi, 2017; Gupta et al., 2013; Hachicha & Mezghani, 2018; Loukis, Janssen, & Mintchev, 2019; N. Wang, Liang, Ge, Xue, &
Ma, 2019), and on the inhibitors of cloud computing adoption (Benlian & Hess, 2011; Hachicha &
Mezghani, 2018; Marston et al., 2011). Specifically, Asadi et al. (2017) studied the bank sector in Malaysia who increasingly adopt cloud technologies to create a flexible and agile banking environment that enables quick response to new business needs. The researchers conclude that perceived usefulness, perceived ease of use, cost, attitudes toward cloud and trust significantly influence users’ behavioral intention to adopt cloud computing (Asadi et al., 2017). Wang et al. (2019) study the effects of two enablers, top management support and government support, and two inhibitors, organizational inertia and data security risk on cloud computing assimilation, respectively.
They find that top management support and government support have positive effects on cloud computing assimilation, while only one of the inhibitors, data security risk, has a direct negative effect (N. Wang et al., 2019). Though, organizational inertia moderates the positive effect of top management support. Additionally, data security risk moderates the positive effects of government support (N. Wang et al., 2019). Loukis et al. (2019) relate the adoption of cloud computing to benefits and impact on firm performance. They find that the adoption of cloud computing affects operational and innovational benefits positively, hence furthering firm performance. Evidently, there exists plentiful research on intentions to cloud computing adoption. Interestingly, some researchers have explored the types of organizations who cloud computing initially attracted.
As literature has primarily looked through the lenses of (potential) customers of cloud technologies, cloud computing has merely been seen as a form of outsourcing arrangement that enables firms to
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access software applications (Martins, Oliveira, Thomas, & Tomás, 2019). In this regard, Gupta et al.
(2013) found that micro, small, and medium-sized enterprises (henceforth SMEs) were the first types of organizations showing a positive inclination towards cloud computing due to operational factors including reductions in IT costs, flexibility and scalability, opportunities for online collaboration, reliable and easy-to-use applications. These selling points were a good fit for SMEs who usually cannot afford high up-front fees for on-premise licenses and subsequently annual maintenance fees (Gupta et al., 2013). However, cloud computing literature seems only to address larger enterprises when the factors being explored pertain to cyber-attacks and data security risks (Hentschel et al., 2018; N. Wang et al., 2019).
However, as the global use of computers and smartphones have increased significantly, global competition has heightened, and this has, in turn, increased the need for businesses to expand into different geographical areas in order to be sustainable (Senyo et al., 2018). Cloud computing seeks to address this need, making it relevant for larger enterprises as well (Senyo et al., 2018). Cloud computing addresses this due to the nature of the technological features that distinguish cloud computing from traditional software solutions (on-demand self-service, broad network access, resource pooling, rapid elasticity, and measured service) make data accessible to anyone, anywhere, and anytime (Senyo et al., 2018). Indeed, cloud computing is not only for SMEs.
In turn, few researchers have investigated cloud computing from the providers’ point of view (Hentschel et al., 2018; Kranz et al., 2016; Marston et al., 2011). Understanding the perceptions of the cloud services providers and their actions and measures is essential in order to achieve a holistic picture of the notion of cloud computing (Hentschel et al., 2018). Hentschel, Leyh, and Petznick (2018) study existing customer requirements and barriers to using cloud services from a provider’s viewpoint and identify the actions of and obstacles for providers in meeting the needs and constraints of the customers, as well as current and future challenges of the providers to meet those needs. They find that one of the main challenges for the cloud provider is to meet the customer appropriately, and building relationships of trust (Hentschel et al., 2018). Ironically, this causes changes in sales processes. The essential challenge in this process is characterized as an increase in complexity, while the sales process itself is being simplified (Hentschel et al., 2018). In addition, finding the right balance
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between standardization of the multi-tenant method while meeting customer-specific requirements become essential (Hentschel et al., 2018).
On a different note, Kranz’ et al. (2016) study when an incumbent’s abiding business model is threatened by start-ups’ novel business models. Through a multiple case study of six incumbent vendors of on-premise enterprise resource planning (ERP) software, Kranz, Hanelt, and Kolbe (2016) investigate the role of absorptive capacity in the processes of their business model changes to suit cloud computing. The researchers emphasize the need for balancing market- and technology-related absorptive capacity and show that in each stage of business model change, insights on both market and technology are equally important (Kranz et al., 2016). Hence, conceptualizing absorptive capacity as technological and scientific knowledge can be hazardous. Particularly, they find, among other features, that market-related absorptive capacity increases a firm’s capacity to generalize and link internal knowledge with external knowledge to respond quickly to customer needs (Kranz et al., 2016).
The phenomenon known as cloud computing has profoundly changed the way IT is developed, deployed, scaled, updated, maintained and paid for (Marston et al., 2011). According to Marston et al. (2011), computing in general presents a paradox: On one hand computers become increasingly more powerful, while the per-unit costs decrease, so much so that computing power is basically seen as the fifth commodity6. On the other hand, as computing becomes more comprehensive within organizations, the complexity of managing the infrastructure of different information architectures, software, and data has made computing more expensive than ever before to the organization. Cloud computing’s promises to deliver all the functionalities of that of traditional computing’s – and even to enable new ones – yet to do so at radically lower up-front costs (Marston et al., 2011).
Cloud technology is still relatively novel, as is the literature about it. We must, therefore, seek to the literature on other industries which have already undergone complete technological development and established new characteristic features and thus draw parallels in order to enlighten ourselves to better understand SAPs current and future way into the cloud. We have chosen to look towards
6 After water, gas, electricity and telephony (Buyya et al., 2009)
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Clayton Christensen’s theory of disruption as he coined the term based on several industries that have undergone tremendous technological change, resulting in incumbents being pushed out of the market. The following section will present this literature, and we argue its historical element will provide a solid baseline for analyzing how cloud has changed the enterprise software industry in the context of SAP and how a large incumbent as SAP must react to such change.
4.2 Disruptive technologies
In the 1995 paper by Joseph L. Bower and Clayton M. Christensen, the authors present cases of large incumbents in various industries that were late in offering breakthrough products to the market.
Here, Bower and Christensen pose the question: “Why is it that companies like these invest aggressively – and successfully – in the technologies necessary to retain their current customers but then fail to make certain other technological investments that customers of the future will demand?”
(Bower & Christensen, 1995: 43).
Many factors play a role in answer to this question; however, one reason is more fundamental to the paradox, namely that the companies are staying close to their customers. Management is constantly trying to predict the need of its current customers and how to innovate in order to yield higher margins on these customers. In their study of companies in various industries that have confronted technological change, Bower and Christensen find that many of the leading companies are doing well in terms of developing and commercializing incremental as well as radical innovations, as long as these address the future performance their customers expect. However, it is rarely these companies being the frontrunner in commercializing new technologies that do not initially meet the needs of their main customers and that appeal to small or emerging markets (Bower & Christensen, 1995).
The technological changes that damages or even erodes incumbents usually are not radical or new from a technological point of view, but they have two particular characteristics: First, they offer a new performance that existing customers do not yet value, and second, the existing technologies
The theory of disruptive technologies will guide what to look for when assessing which technologies disrupt and which does not. Additionally, it provides recommendations of how to respond to disruption as an incumbent.
Disruptive
technologies
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improve at such a high pace so that the new technologies later can enter the overserved market (Bower & Christensen, 1995). Usually, the revenue and cost structure of a proposed technology play a crucial role when being evaluated. Disruptive technologies often appear financially unattractive to incumbents as the market is usually small and it can be challenging to predict the long-term market potential. Consequently, managers cannot justify any significant investments in such technologies.
Since maintaining current market share require investments as well, managers are often left with the choice of going either down-market with the new technology where lower profit margins must be accepted, or to go upmarket by investing in sustaining innovations with higher margins. Naturally, it is attractive for all market players to go upwards in the market, only with the result to eventually being disrupted from below by others climbing upwards (Bower & Christensen, 1995).
Being disrupted as an incumbent seems inevitable. However, the threat of disruptive technologies can be overcome. Bower and Christensen propose a method to spotting and cultivating disruptive technologies as an incumbent: First step is to assess whether the technology is disruptive or sustaining. Systems are generally in place to spot sustaining innovations to serve current customer, but it is rare any formal systems are in place to spot disruptive technologies. One way to identify potentially disruptive technologies internally is to examine internal disagreements on new product development. Whom are supporting the technology and who does not? And for what reasons?
Disagreements internally is often a solid indicator of a potential disruptive technology. Next, disruptive technologies tend to be discarded in early strategic reviews due to the wrong questions being asked to the wrong people. Hence, managers must ask the right questions to the right people.
For instance, asking the largest customers who are leading in their industry what they require from future products might lead to products that provide high-performing sustaining innovation, but they would be an inadequate indicator for disruptive technology. As a fourth step, managers should locate the initial market for the disruptive technology. Because disruptive technologies do not erupt in existing known markets, managers must create information, identify who the customers will be, and what performance measures will matter to whom. Here, Bower and Christensen suggest letting start- ups related to the incumbent experiment with the technology and potential markets (Bower &
Christensen, 1995).
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The final two steps are concerned with keeping the disruptive technology distant to the core of the business. First in that process is to place responsibility for building a disruptive technology business in an independent organization. This maneuver of separating and isolating a new project is commonly known yet poorly understood. Creating a truly separated organization is necessary only when the disruptive technology has a lower profit margin than the mainstream business and serves a new group of customers. Finally, the disruptive organization must be kept independent. Often managers believe that once the disruptive technology has proven profitable and viable, then it can be absorbed into the organization. Although this might be the right strategy for sustaining innovations, it can be lethal for the disruptive technology. Once the disruptive technology is folded together with the mainstream organization due to scale and scope incentives, disputes over resources might loom.
Since disruptive technologies have the potential of cannibalizing the existing business, it is essential that managers keep the existing business separated from the disruptive technology and watch the new technology take over and become the new driver of the organization (Bower & Christensen, 1995).
As a more general framework, C.M. Christensen and M. Overdorf (2000) argue that a fundamental reason to keep new disruptive innovations away from the mainstream organization lies in the capabilities of the incumbent organization. Like individual employees, the organization itself has capabilities, which determine what the organization can and cannot do. Within the capabilities of the organization reside resources, processes, and values (C. M. Christensen & Overdorf, 2000). The processes in place in incumbents are – as we saw earlier – made for assessing the investment potential for sustaining innovations rather that spotting disruptive technologies. Moreover, incumbents generally have the resources such as money, people, and technology to develop and commercialize the disruptive technology. Nonetheless, they are rarely the companies doing so.
Finally, start-ups might not have the resources, but they have the values to pursue small markets and the cost structure to handle the low margins (C. M. Christensen & Overdorf, 2000).
If an organization wish to develop capabilities it lacks to pursue a disruptive technology, Christensen and Overdorf (2000) propose three strategies for creating a new organizational space for developing the right capabilities. First, an organization can create new capabilities internally. This could be done
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in the form of gathering the right people already within the organization to have the construct new processes needed. Second, an organization could create the capabilities through a spin-out organization. This is particularly appropriate when the values of the incumbent prevent it from allocating resources to the new innovation project. Finally, an incumbent could create capabilities through acquisitions (C. M. Christensen & Overdorf, 2000) and when doing so, the acquiring managers must likewise assess the processes, resources, and values of the firm being acquired.
Companies that successfully obtain new capabilities through acquisition are the companies that know where the relevant capabilities reside in the acquired firm and assimilate them accordingly into the acquiring organization. If capabilities being acquired are embedded in the acquired firm’s processes and values, then it is crucial not to integrate the acquired firm into the acquiring organization. It is essential to keep the acquired firm at arm’s length and to only provide the firm with resources from the acquiring organization to avoid eroding the acquired capabilities. Conversely, if the desired goal of the acquisition is the resources of the firm, then an integration might be appropriate (C. M.
Christensen & Overdorf, 2000).
The theory of disruption has been widely recognized since its conceptualization in 1995, and the success of the concept has obscured the meaning of disruption. Hence, Clayton Christensen together with M. Raynor and R. McDonald revise the concept and accentuate two conditions that must be true for an innovation to be disruptive, congruent with the arguments of the Bower and Christensen (1995). First, disruptive innovations originate in low-end or new-market footholds, and second, disruptive innovations do not catch on with mainstream customers until quality catches up to their standards. Both illustrated in the model below (figure 2) (C. M. Christensen, Raynor, & McDonald, 2015).
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Figure 2: The Disruptive Innovation Model (C. M. Christensen et al., 2015)
Why is it important to get it right whether or not an innovation is disruptive if it has already profoundly stirred and overturn a market? Christensen et. al. (2015) argue that one must distinguish a disruptive innovation from other types to realize the true value of the theory. They raise four important points of disruptive innovations that have often been overlooked: Disruption is a process and is often misperceived to be a certain point of time to look for. This relates to the afore mentioned process of when a new technology enters a low-end market and then not until later reach a performance level where it conquers the mainstream market. Second, disrupters often build business models that are often very different from those of incumbents. Third, being disruptive does not equal being a success. Some disruptive innovations do not make it and thus a common mistake is to focus on the results achieved by the innovation. Fourth and finally, the fact that a firm should either disrupt or be disrupted is prevailing. Yes, incumbents must react to disruptive innovations, nonetheless it is crucial that they do not overreact and thus eradicate their primary business. This relates to the point of Christensen and Overdorf (2000) that incumbents are often best off by separating the investment in disruptive innovations from its sustain innovation activities as it is still of paramount importance to maintain and strengthen relationships with core customers (C. M. Christensen et al., 2015).
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Conclusively, the theory of disruption is not a prescription for managers on how to handle the development of new products or technologies. Instead, it provides a theoretical lens for assessing the value of innovations and to make strategic choices on whether to take a sustaining or disruptive path (C. M. Christensen et al., 2015). Therefore, as part of answering the overall research question of this paper and to assess the strategic opportunities SAP is facing at the emergence of the cloud technology, we must address the question: How has changing market conditions played a role in disrupting the global enterprise software industry?
4.3 External strategic thinking
To ultimately answer the question presented above, we must analyze the dynamics of the enterprise software industry and its environment from before the emergence of cloud until today. To guide such analysis, we will utilize recognized frameworks of one of the most renowned and appreciated thinkers within the research field of strategic management. First, we shortly review Koumparoulis' (2013) revision of Francis J. Aguilar’s PEST framework (Aguilar, 1967), and subsequently Porter’s own revision of his five forces framework will follow (Porter, 1980, 2008).
4.4 PEST
The next section briefly introduces the PEST analysis. Later, we shall examine the four macro-level factors of PEST – political, economic, socio-cultural, and technological – as part of an analytical framework aiding us to answer the first sub-question. Naturally, we hence use the PEST analysis, together with Porter’s five forces, to identify and characterize the software industry and how changing market conditions have motivated SAP to acquire SuccessFactors. As Barney (1991) argues PEST can help a company realize opportunities and threats in the marketplace and absorb them into the organization, we believe PEST will be an essential part of our external analysis constituting the first part of our analysis.
The PEST analysis’ job is to identify the macro-level conditions that have characterized and shaped the industry as it is today, and to provide insights into the future of cloud computing.
PEST
21 4.4.1 Political
Political decisions, made by governments and other political institutions, can have a significant effect on the opportunities and threats that reside in a specific industry – indirectly or directly. Inversely, opportunities and threats of industries can affect political decisions (Koumparoulis, 2013). Assessing any industry, one must take political factors and the political situation at play into consideration.
4.4.2 Economic
In the economic dimension of the PEST analysis, we focus on the economic situation in the market and industry in which the company operates. Some general economic factors such as GDP and inflation growth rates affect any company and any industry the same. Other industrial economic factors such as customer potential will confine to specific industries. However, it is important to focus on economic factors in order to make sense of market potential, and hence opportunities and threats in one’s industry (Koumparoulis, 2013).
4.4.3 Socio-cultural
Primarily, socio-cultural factors that affect opportunities and threats within an industry include consumer demands, preferences, and trends. These socio-cultural factors and current and future demographic circumstances have large implications on an industry and its direction – and for a company that wants to stay competitive, they also have large implications (Koumparoulis, 2013).
4.4.4 Technological
Technological advancements play an important role in strategic management. In fact, it is often utilized to create competitive advantages in the marketplace (Barney, 1991; Cohen & Levinthal, 1990;
Porter & Millar, 1985; Teece, Pisano, & Shuen, 1997). The companies that develop technological advancements will be rewarded, and the companies that hesitate to follow up are punished.
4.4.5 Assessment
To sum up, it is important to mention that none of the macro-level factors mentioned above work independently (Koumparoulis, 2013). It is, therefore, our belief that only by looking at all four macro- level dimensions as well industry-level dynamics, we will be able to provide a fully integrated identification of cloud computing impact on the software industry. Hence, we will now introduce Porter’s five forces.
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4.5 Five forces
When Porter as a young man in 1980 transformed static industrial economics models from an antitrust perspective to a business strategy perspective – by asking how firms analyze existing industry structures, and either position themselves within their industry, or change industries to their benefit, e.g. via innovation or M&As – he changed how the academic world thinks of ‘strategic management’ (J. F. Christensen, 2018; Teece et al., 1997). In essence, he argued strategists think of competition too narrowly, that is, as if competition only occurs among competitors and the company at hand itself. In order to cope with this narrow strategic mindset, Porter invented a tool to assess a more extended competitive landscape in an industry. This framework is known today as the ‘five forces’. The underlying idea is, by employing Porter’s (2008) five forces framework, managers and strategists are better able to make informed and proactive decisions to attack competition.
Essentially, Porter’s (2008) framework comprises five forces that constitute the rivalry in a competitive market: The threat of new entrants; bargaining power of buyers; threat of substitute products and services; bargaining power of suppliers; and the rivalry among existing competitors.
According to Porter (2008), it is the structure of an industry which shapes its competition and profitability – not whether it is emerging or maturing, high tech or low tech, regulated or unregulated.
Although the framework initially is presented more extendedly by Porter, we will now review the most important characteristics of the five forces relative to our case of SAP.
4.5.1 The threat of new entrants
The threat of new entrants occurs when companies external to the industry bring new capacity and a desire to gain market share, which in turn pressures incumbents on factors such as price, costs, and the rate of investments. When the threat of new entrants is high, established companies must either lower prices or boost investments to keep out new entrants. Seven factors make up the intensity of the threat of new entrants, including supply- and demand-side economies of scale, customer
The five forces help us understand the competition of the global software industry today, and how SAP should tackle it. Together with PEST, the insights into the if and how cloud computing disrupted the software industry.
Five forces
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switching costs, capital requirements, incumbency advantages independent of size, unequal access to distribution channels, and restrictive government policy. However, if new entrants ‘expect retaliation’, they may be more reluctant to enter the competition. For instance, the fear of expected retaliation is enhanced if incumbents have previously responded vigorously to attempts of entry, or if incumbents are willing to cut prices at all costs to keep out new entries.
4.5.2 The power of buyers
The power of buyers entails the capacity for consumers in an industry to force down prices, demand better quality or more services, hence driving up costs. In turn, this will play industry participants off against each other. Buyer power increases if buyers are few, industry’s products are standardized, no or limited switching costs exist, or if buyers can integrate backward and produce the product being offered themselves (Porter, 2008).
4.5.3 The threat of substitute products or services
When the threat of substitute products or services is high, profitability suffers. Put differently, substitution will impose a limit on the prices an industry can charge customers. Notably, the threat of substitute products or services increases when substitutes represent an attractive price- performance trade-off to the industry’s product, or when the buyer’s cost of switching to the substitute is low. Indeed, if an industry does not manage to distinguish itself from substitution – through product performance, marketing, or other means – it will lessen its attractiveness for firms to compete in it (Porter 2008).
4.5.4 The bargaining power of suppliers
Likewise, the bargaining power of suppliers is a factor which companies must take into account.
Powerful suppliers can charge higher prices, limit the quality of products or services, or increase switching costs to those being supplied (Porter 2008). For instance, the bargaining power of suppliers increases if the supplier group is more concentrated than the industry it supplies and if there is no substitute for the products or services being supplied. Moreover, if an industry is in a position where it makes too much money relative to its supplier group, suppliers can threaten to integrate forward into the industry – provoking to enter the market.
24 4.5.5 Rivalry among existing competitors
Lastly, the rivalry among existing competitors also limits the profitability of an industry. According to Porter (2008), rivalry takes many forms including price wars, product innovation, advertising, and service improvements. Primarily, two factors influence the rivalry’s role of the industry’s profit potential: the intensity with which companies compete, and the basis on which they compete. The first sign of high intensity is if industry participants are many or roughly equal in size. Deprived of an industry leader, best practices for the industry as a whole become unenforceable. As a result, poaching businesses arise. Secondly, intensity signifies when exit barriers are high; specialized assets or a management’s devotion to a particular business may keep companies in the market, but with low, no or negative returns.
However, the vigor of rivalry reflects not only the intensity of competition but also the basis of competition (Porter 2008). In turn, the basis of competition is influenced by the dimensions on which the competition takes place, and if competition converges to the same dimensions. Especially, industry profitability is harmed if competition gravitates only on price simply because price wars transfer the profitability from company to customer. Competition on price is likely to occur if products across the industry are nearly identical, and there are limited switching costs. Similarly, if fixed costs are high and marginal costs are low.
4.6 Wrapping up external strategic thinking
All in all, the five forces mentioned above reveal the drivers of industry competition (Porter, 2008).
The point of industry analysis is to understand the keystones of its competition and profitability, not whether it is attractive or not. Here, Porter (2008) argues an important factor is to understand time horizon. Distinguishing temporary and cyclical changes from that of structural is essential. Congruent with Christensen’s theory (1995), disruptive technologies emerge not necessarily as a matter of attractiveness, but due to some firms willingness to accept a less attractive cost structure than what incumbents are willing to accept. In addition, likewise for disruption theory it is important to understand that disruption does not occur overnight, but is a process that happens over time (C. M.
Christensen & Overdorf, 2000). Hence, by smoothly identifying - with the support from Aguilar’s (1967) and Porter’s (2008) frameworks – how industry dynamics and the environment around it have changed since the emergence of cloud computing, we can analyze the disruption process in the global enterprise software industry.
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4.7 Internal strategic thinking
To address the research question of this paper, we have until now reviewed the literature on cloud technology and how it interacts with the environment in which SAP is situated. The strategic opportunities of a firm are affected by the internal capabilities of the firm just as it is affected by its external environment. Hence the focus of the literature review will now turn its focus towards the literature on firm’s internal environment.
Invariably, researchers of strategic management have tried to address how firms create and sustain competitive advantage. However, there seems to be dissension in the matter of the outlook as to how to create and sustain competitive advantage. As we have just seen how competitive advantages can be achieved through a prosperous position in the industry (Porter 2008), we shall now look to theories that take their point of departure in organizations and formulate how competitive advantages can be achieved inside of them. We do this because one must acknowledge various schools of thought, and hence we shall now review the framework known as the “dynamic capabilities” approach, a strategic firm-level approach to strategic thinking (Teece et al., 1997). Later in this section, theories on key principles at the operational firm-level concerning innovation in the form of external knowledge acquisition will be presented (Cohen & Levinthal, 1990; Graebner, 2004).
4.8 Dynamic capabilities
Teece et al. (1997) have reviewed the most prominent literature revolving the topic on competitive advantages and suggest a new approach they refer to as dynamic capabilities. Emanating from what is referred to as resource-based view (Barney, 1991), the dynamic capabilities approach, too, perceives competitive advantage as a consequence stemming from dynamics inside the firm.
Essentially, one can thus view the dynamic capabilities approach as an enrichment to Barney’s (1991) resource-based (economizing) perspective of the research in strategic management – vis-à-vis Porter’s (2008) industrial dynamics (strategizing) perspective of the same topic. In fact, Teece et al.
Teece’s framework will derive insights on SAP’s strategic ability to build, integrate, and reconfigure internal and external competencies to tackle rapidly changing environments.
Dynamic
capabilities
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(1997) suggest that “identifying new opportunities and organizing effectively and efficiently to embrace them are generally more fundamental to private wealth creation than is strategizing, if by strategizing one means engaging in business conduct that keeps competitors off balance, raises rival's costs, and excludes new entrants” (Teece et al., 1997:509).
Explicitly, the authors define dynamic capabilities as the ability to integrate, build, and reconfigure internal and external competencies to address rapidly changing environments (Teece et al., 1997:528). In other words, a firm’s level of dynamic capabilities expresses its ability to achieve novel and innovative forms of competitive advantage. According to Teece et al., winners in the global marketplace have been firms that can demonstrate timely responsiveness and rapid and flexible product innovation, coupled with the management capability to coordinate and redeploy internal and external competences effectively. This ability to achieve new forms of competitive advantage constitutes dynamic capabilities as it demonstrates how a firm can change its capabilities according to the changing business environment.
Specifically, according to Teece et al. (1997), the term ‘dynamic’ features the capacity to renew competencies to achieve congruence with the changing business environment. The term
‘capabilities’ refers to the fundamental role in strategic management in appropriately adapting, integrating, and reconfiguring internal and external skills, resources, and functional competences to match the requirements of a changing environment (Teece et al., 1997). The software enterprise application industry is, and has been, a changing business environment since its infancy in the 1970s (Cusumano, 2009).
4.8.1 Processes, Positions, and Paths
The following section will present the framework of Teece et al. (1997). As we shall see, the dynamic capabilities framework constitutes of organizational routines (processes), that are shaped by a firm’s asset structure (positions) and strategic investments (paths) it has chosen in the past.
Processes
Teece et al. provide a framework suggesting that business opportunities flow from an organization’s unique processes. These processes are classified into three concepts: coordination/integration (a
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static concept); learning (a dynamic concept); and reconfiguration (a transformational concept).
Firstly, the integration of external activities and technologies play an increasingly important role in creating and sustaining a strategic advantage. Teece et al. (1997) argue that minor technological changes can have a devastating impact on the incumbents’ market position.
Further, if the nature of innovations to be integrated and coordinated is architectural, these innovations often require new routines and processes. In accordance, if productive systems in a firm display high interdependency, changing only one level of a bigger system may be dangerous. Put differently, several organizational processes often share the same traits, and when they do, successful integration and coordination of novel external activities require systemic change throughout the whole organization in order to create value.
The second concept of organizational processes is referred to as ‘learning’, a dynamic concept, which is even more important than integration (Teece et al., 1997). According to the scholars, learning is the process in which repetition and experimentation facilitate tasks to be executed better and faster, but also leads to the identification of new production opportunities. In the context of an organization’s learning processes, two factors are to be taken into account: individual and organizational skills. For the former, learning requires that individuals share a common set of codes of communication and search procedures. That is, individual learning does not only occur through old-fashioned relationships like a professor teaching her students but also through joint contributions to understanding complex problems. For the latter, new knowledge generated by such activities (joint contributions) resides in new routines, which form a new organizational logic. As pointed out earlier, only partially integrating a new process into an organization can be dangerous. The same goes for learning; if only part of an organization learns a new set of ‘common’ set of codes of communication – then in fact – it is not so common for the organization as a whole. However, Teece et al. argue that dynamic capabilities as a coordinative management process enable the potential for inter- organizational learning. Interestingly, research has found that by using collaboration and partnerships as a means to recognize dysfunctional routines and preventing strategic blind spots, a firm as a whole can ensure organizational learning (Teece et al., 1997).
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Lastly, firms who compete in rapidly changing environments are required to reconfigure their asset structure in order to undertake the internal and external transformation. The capacity to reconfigure itself is a learned organizational skill, and firms residing in dynamic environments which do not possess this skill are likely to be impaired. Successful reconfiguration hence demands the organization to constantly be scanning the environment, evaluating markets and competitors, and to be willing to adapt to best practice. However, reconfiguration is costly. Therefore, successful reconfiguration is not just a matter of acknowledging new trajectories within and around one’s industry, it is also about setting up the right processes to learn and integrate them. Here, Teece et al., argue that decentralization and local autonomy accelerates those processes. However, a firm’s strategic posture is not only characterized by its organizational processes, but also by the assets that enable processes to unfold. Next, the paper will highlight the several assets that play an important role in a firm’s ability to stay competitive in a changing business environment.
Positions
According to the capabilities approach, assets determine a firm’s competitive advantage at any point in time. Specific assets such as specialized plant and equipment, knowledge assets that are difficult to trade, complementary assets, reputational and relational assets are examples hereof.
This section will shortly introduce some of these.
Technological and complementary assets
There is a genuine interest from firms in the market for know-how, however, often technology does not enter it (Teece et al., 1997). This is due to the fact that most firms do not wish to sell their technology or that the acquiring firm faces issues with the transaction of the know-how that is a constituent to the technology (Teece, 1980). Also, a firm’s technological assets may be subject to intellectual property protection. Hence, this suggests that technological assets are differentiators among firms. This also applies to complementary assets. New products and processes either can enhance or decrease the value of complementary assets (Teece et al., 1997). For example, the development of computers clearly enhanced the value of IBM’s sales force in office products, while online streaming services in the media industry clearly diminished the value of DVD players.
29 Financial assets
A firm’s cash position and degree of leverage have significant implications for its strategic opportunities. In the short run, the strategic investments a firm can undertake is partially a function of its balance sheet and cash holdings. However, in the longer run, the cash flow ought to be more determinative. Nonetheless, financial assets play an important role in what a firm can and cannot do strategically.
Reputational assets
Just like us humans, firms have reputations too. Reputations summarize information about firms and thus shape the interactions with customers, suppliers, and competitors. Although reputation is often confused with a company’s current assets and market positions, Teece et al. view firm reputation as an intangible asset that enables firms to achieve various goals in the market. Its main value is therefore external, as one should perceive the reputation more as a summary statistic of a firm’s assets and market position, as well as its future behavior.
Structural assets
Other important assets that help support the direction of innovation and evolve competencies and capabilities are the formal and informal structure of organizations and their external linkages (Teece et al., 1997). Distinctive governance-modes relating to the degree of hierarchy, and the level of vertical and lateral integration, support different types of innovation. For instance, integrated structured firms with multiple products, Teece et al. argue that systemic innovation is preferred.
Paths
Earlier we saw that financial assets partially determine where a firm can and cannot go. Where a firm can and cannot go are called ‘paths’. A path is a function of all the aforementioned ‘positions’. In turn, a firm’s current positions are shaped by the path it has traveled. Put differently, a firm’s prior investments – and hence its repertoire of processes – constrain its future behavior and strategic boundaries. This is due to the fact that learning tends to be local. Teece et al. (1997) argue that opportunities for learning will be ‘close in’ to previous activities, that is, previous transactions and production systems. Also, the significance of path dependencies is augmented when there are increasing returns to adoption. This phenomenon is demand-sided, meaning that technologies and products exploiting those specific technologies become more attractive, the more they are adopted.
