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4.1.3 Reaction Patterns

Political, social and economic systems react to innovations with varying adjustment speeds (Fig. 4.3).

Technology is the trigger of change. Purely technological further development requires “only” intellectual development input. No human-emotional hurdles must be overcome, as is the case subsequent to the spread of innovation. Younger people are generally more open to technology than older generations, so that the adjustment of the social systems takes place with a time delay. At the aggregated level of economic and political systems, there tends to be even more of a time lag in adjustment because in democratic societies the process of opinion-making at an individual level follows acceptance of new developments at the political level (as in democratic societies, the acceptance of new developments at the political level is

Fig. 4.3 Adjustment speeds of different systems in the digital age (Source Koye 2005, p. 116)

preceded by the opinion-making process at a personal level). That takes some time, because economic systems are oriented towards the predominant customer needs.

This transformation leads to the gradual erosion of existing positions of success, as informed customers increasingly begin to question the margins and added value of purely brokering services, and become gradually more open to new business models without brokerage fees. Price/performance configurations come under pressure as a result, making structural changes necessary. Only networked organisational forms in which individual members complete their partial processes independently and make them available to the network, can face these developments with continued competitive price/performance configurations, for if every provider were to continue providing partial processes alone, he or she cannot offer a competitive price/performance configuration on the market. Banks must direct their attention to this feature, for the question of the gradual change in customer needs among different age groups is key to the successful reorientation of banks' business models.

Schumpeter observed innovations from the process perspective: for him, the “process of creative destruction” (Schumpeter 1942) was the switch between static and dynamic phases. He regarded economic evolution as a disruption of a static state of equilibrium, which could, through destruction—i.e., innovation—cause a reaction towards a new state of equilibrium (Schumpeter 1911). He expanded on Kondratieff's research and saw innovation as the cause of longer economic cycles (Schumpeter 1961)—and called them Kondratieff cycles.

Nefiodow calls innovations that trigger a new Kondratieff cycle, thus assuming the function of a locomotive for the entire economy for many decades, revolutionary basic innovations.

• They are deemed revolutionary because entail a network of technological and economic innovations and change in the long term the business foundations of entire sectors.

• They are regarded as basic innovations because they are based on a fundamen-

tally new technological development. Established companies can survive only if they introduce the necessary transformation processes at the right time.

Building on the findings of Kondratieff and Schumpeter, Nefiodow summarised three conditions for revolutionary basic innovations (Nefiodow 1999):

• At the technological level, the direction and speed of the innovation process are determined by innovation.

• At the economic level, the entire economic growth during an upturn phase is borne considerably by innovation.

• At the social level, wide-ranging reorganisation is triggered.

The digital age quite clearly has this character—we only need to think of the emergence of e-mail, mobile phones, the iPhone or the establishment of business models such as Google. The challenge is that there are actually three different groups of customers whose behaviour influences the balance between the old and the new business model—the traditional consumer, the digital convert and the digital native. The intersections of the three curves are important elements for changing the current business models of banks. Accordingly, from 2020 the majority of customers of bank services will be composed of digital natives (Fig. 4.4).

Industrial development therefore occurred in thrusts of innovation. Phases of substantial new developments with “disruptive technologies” alternated in the long term with phases of the improved efficiency of the existing standards (sustaining technologies) of basic innovations, which could slowly be perfected while maintaining current business models. A distinction is made, therefore, between sustaining and disruptive technological developments. Sustaining developments refer to the operative further development of existing applications. Disruptive technological developments redefine the status quo of all market participants and create new applications (Christensen 1997). The response profiles of established companies can exhibit both sustaining and disruptive technological developments.

Fig. 4.4 Customer groups in the digital age (Source PWC 2013)

The following phases are distinguished:

• In the development phase, new applications are created on the basis of revolutionary technological developments, which lead to further new product innovations.

• In the transitional phase, progressive standardisation allows increased concentration on product improvements. The product innovation rate sinks with a growing process innovation rate. Product variety declines. Dominant product types evolve.[1]

• In the specialisation phase the innovation rates of both products and processes decline. Management focus is placed on cost reduction, productivity improvement and capacity utilisation.

According to the evolutionary theory of institutional survival, the most efficient company in each phase will prevail on the market during that respective phase; the less efficient companies will be pushed successively out of the market. Efficiency in the economic system can be explained by technological advances, as being a result of dismantling behavioural constraints (e.g., deregulation) or by increasing competitive pressure. Specifically this means the elimination of too high margins and profits, from an efficiency perspective, due to the intermediation systems— customers are optimally informed, can compare services, and thus pay the economically justifiable price for the effective provision of the service, without additional premiums due to a lack of information (North 1990; Bisignano 1998).

If we view innovation processes from a product perspective, it becomes clear that in the case of increasing revenues it is not the best technology that wins through on the market, but rather a quickly developed solution that creates path dependency.[2]

Solutions that are technologically perfect but have been developed later can no longer prevail. The speed of innovation development and the implementation of the innovation in concrete products are key to the successful evolution of technological developments and institutions (Arthur 1990).

In the process, the substantial new developments are often devised by market entrants who have no existing product or process infrastructure. Frequently the fundamental significance of a disrupting technological development—one speaks of a “killer application” (Downes and Mui 1998, p. 4)[3]—is not apparent to established market participants at the time of development,[4] as is the case today in banking.

The main reason for the disappearance of companies is that they cling to their strategy of gradually improving existing products or processes. Such an improvement to the efficiency and quality of existing products to maintain attractiveness and extend life cycles is known as a “burst of improvement”. The motivation for this behaviour has been identified as the economic and emotional bond (Utterback 1994) that arises from investments that have already been made in the existing production plants and processes.

In addition, there can be resistance from employees who regard the withdrawal of resources from previously successful activities or areas as unnecessary. Change potential is also often blighted by the fact that management objectives tend to concentrate on maintaining the existing success position (Christensen 1997). Culturally, the foundation of a new, separate unit is often seen as the best possible organisational option (Foster 1986). But even then conflicts can arise between organisational units, with the withholding of important information or the refusal of support or the sharing of experiences. Frequently, change processes are not addressed, or much too late (Utterback 1994). Yet the new applications are superior to the services based on the old technology, at least in the medium term. Established companies therefore have two main obstacles to managing these revolutionary changes (Koye 2005):

• Awareness of the threat to the company's existence posed by the revolutionary applications and awareness of the company's vulnerability due to its own reactive behavioural pattern.

• Willingness to implement operatively the necessary organisational adjustments to the new application.

Information-based business models experience a permanent process of evolution: the introduction to market is the beginning of a process of continuous adaptation to further technological developments. “Thinking in versions” has become established: the first version of a business model addresses only the early adapter customer group. A wider customer group is attracted later by further developments. The learning process of the provider is accompanied by a parallel learning process on the part of the customer (Brynjolfsson and Hitt 1998). Providers with a firstmover strategy are not automatically successful (Arthur 1994). In early innovation phases, competitors develop different product types before a dominant product type emerges (Utterback and Abernathy 1978). Once a critical number of users has been reached, a self-reinforcing process begins. Only then do economic rewards emerge as a result of the positive feedback and the so-called superstar effect—according to which the three most dominant business models in the digital age attain a disproportionately large share of the turnover pie (Shapiro and Varian 1999).

Due to self-reinforcing network effects, economies of scale experienced by providers due to mass customisation, the ever better informed customer—who is less willing to pay for mere intermediation but instead expects truly needs-oriented advice at very competitive prices—and the sinking costs for customers of switching, oligopolistic sector structures are likely to occur in the network economy, in which only a few information-based products, business models and providers will manage to establish themselves.

  • [1] Utterback speaks of “dominant design”, meaning “the design that wins the allegiance of the marketplace, the one that competitors and innovators must adhere to if they hope to command significant market following”. Utterback (1994, p. 24)
  • [2] An example of path dependency is the IT equipment of large companies. If the entire company uses Microsoft products, a change of system to Apple involves much time, effort, and expense, even if the quality of the Apple products is often better that that of Microsoft. The initial fundamental decision to install the Microsoft Windows system led to the path dependency of the company in later years.
  • [3] At first, the PC was underestimated by all makers of mainframes. They did not believe that existing customers would be interested in these devices. That was true, but a much larger market emerged with new customer segments, which was occupied by new manufacturers.
  • [4] When the PC was invented, not many market participants realised just how revolutionary the changes to the working environment would be. The mainframe computer industry, which dominated at the time, was completely obliterated. Only IBM managed to adapt to the PC age (Downes and Mui 1998).
 
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