Philips and the Light at the End of the Tunnel

When disruptive innovation hits an industry, usually the light at the end of the tunnel for an incumbent belongs to an oncoming train. Philips was one of the three leading players in the lighting market in the era of incandescent lighting when disruption hit the industry in the form of LED lighting. Yet this incumbent appears set to survive and flourish.

I was curious to understand how they pulled this off and was fortunate to have an opportunity to speak with someone at Philips who fleshed out the back story for me. I wrote this up as a case study to use in my innovation courses, so it's longer than most posts, but I think some readers could be fascinated by the story so I'm posting it here.

Philips Transition from Conventional to LED: Spotlight on the Response to Oncoming Disruption
With background information from Maarten Vernooij



Background
Philips, one of the three dominant manufacturers of incandescent light bulbs, is making a successful transition from incandescent to LED technology. Let's examine the industry before and after and assess Philips' strategy to deal with the disruption. [We'll compare and contrast Philips' situation and response to Kodak, the poster child of an incumbent that was destroyed by disruption.]

We'll examine the story through the lens of Philips' Lighting Division alone. Although part of a diversified company, the Lighting Division is a separate business unit accountable for its own strategy and profits.

The Philips 'conventional' lighting business consisted of two components:

• Light sources (incandescent, halogen, fluorescent, sodium and mercury bulbs): Three big players dominate light sources: Philips, GE and Osram (formerly Siemens Lighting). This business is a high margin, replacement-purchase business. The need for big factories and scale translates to a high barrier to entry and results in a small number of competitors. [Note the uncanny resemblance to disruption's poster child, Kodak, with its high margin replacement-purchase film business.]
• Light fixtures: Essentially the 'metal around the light source', the light fixtures business has a low barrier to entry, lower margins and thousands of competitors. The characteristics of this market led Philips to attempt - unsuccessfully - to sell this division in 2003-2005.

The conventional lighting business is changing. As always, it's not the new technology that is the biggest change agent; it's the new business model.  Although the target customer remained the same, just about everything else about the business model changed:

• LED bulbs have a life of 20-50 years as opposed to conventional bulbs with a life of 1-10 years.  This spells the doom of the replacement-because-the-bulb-burnt-out business model of the past. Once you've sold a bulb, you're not selling a replacement for at least 20 years! There is one saving grace here: at least the new bulb costs much more than the old bulb so there's a spike in revenue. So essentially the new model moves many years of revenue forward into the present. [Note the contrast with poor Kodak which had to compete with NO revenue for digital photography.]
• Whereas Philips manufactured conventional light source products in their own factories, the LED light sources are mostly outsourced to third-party manufacturers such as Foxcomm. Philips has been steadily closing down factories as a result. [Conversely, Kodak was still building factories as digital photography grew].
• Whereas light sources and light fixtures were purchased separately in the past, in the LED market, they are purchased as a unit. Thankfully, Philips had been unable to sell that unit in the early 2000s.
• Although the replacement-because-the-bulb-burned-out business will atrophy with the introduction of LED, there is a new replacement-because-my-bulb-feels-old-fashioned business opportunity if you can tempt customers to replace old LEDs with smarter, feature-rich new LEDs or even entire new systems of lighting. Lighting could evolve to the most ubiquitous sensor network in the Internet of Things. An example of this is the Deloitte office tower in Amsterdam, called "The Edge", which features Philips' connected lighting system with sensors that capture data about many environmental conditions and can be addressed by mobile devices. It was recognized in January 2015 as the most sustainable building in the world. This requires a totally new skill set revolving around software and systems, as opposed to expertise in large-scale manufacturing. [The 21st century opportunities in the world of photography revolve around social media. Being mostly free to consumers, this didn't offer much of a traditional consumer revenue opportunity and entering advertising sales was hard for Philips to get their heads around. Of course, some built businesses worth tens of billions of dollars around photos on the web.]

How Philips Approached Disruption

Philips understood they were about to be disrupted and that they had to undergo radical innovation and transformation to survive this disruption, and to flourish after disruption. There were several factors that enabled this.

Leadership Attitude: Philips' approach to disruption was led from the top (CEO of the lighting division). The company recognized the threat, and accepted it. This activity started under the direction of CEO Theo can Deursen, a Philips veteran with a long history in lighting, and continued when Rudy Provoost, with a history in Consumer Lighting, took over. In some ways, this is remarkable, as old hands in a business are often the most reluctant to accept that disruption is happening and to act on it.

Strategic Philosophy: Philips recognized the threat of LEDs to their business early. A strategic deep dive in 2004 cemented Philips' conviction that LEDs were the future of lighting. There were many copies of The Innovator's Dilemma floating around and management had been trained in disruption theory, so there was a clear understanding of the danger. Strategy sessions revolved not around whether there'd be a transition to LED but the speed of adoption curves. In the end, the transition happened as quickly as their most aggressive scenarios.

New Business Model was Attractive and Not Totally Alien: Incumbents usually resist moving to a new business model because of its lower profitability. In this case, the higher prices for LEDs made the new business model attractive, even though it required retooling the whole business. [Note the contrast to Kodak's situation where they were facing zero revenue for film, by far their most profitable product.]

Closing Competency Gaps Through Acquisition: Philips acquired three key companies:

• The first move came in 1999 when Philips created a joint venture with San Jose-based Agilent Technologies, called Lumileds. Agilent was home to significant expertise and intellectual property around high power LEDs and LED dies (semi-conductor components). The JV was headquartered in San Jose, with considerable autonomy and a separate management team, even when Philips acquired full ownership in 2005. By 2015, the die technology had become less critical and Philips sold 80% of Lumileds to a private equity group.
• Color Kinetics: Philips completed the acquisition of Boston-based Color Kinetics in 2007, primarily for its strong intellectual property portfolio, with important patents relating to intelligence and control technology for LED lights. This company was left quite separate.
• Genlyte: Philips acquired this lighting fixture business in 2008 for the strength of its North American sales and distribution.

Organizational Choices: There were many strategy discussions about whether the new business had to reside in a completely separate company (a recommendation in The Innovator's Dilemma) but in the end, the businesses were run as fairly distinct entities within the existing lighting business, although in separate geographies and with distinct cultures. 

In particular, it was decided not to create a separate sales force for efficiency reasons. To overcome resistance, the sales force was given specific targets and special incentives to sell the new products, and of course the fact that LEDs were more expensive made them an attractive product to sell. Incentives (and a certain amount of weeding out of those unable to make the transition) took five to eight years to transform the sales force to the new business dynamics. Five to eight years! This certainly underlines the need to start early.

Infusion of New People: Philips' employees were traditionally long tenure, and there was little history of hiring mid-career people from outside and from different industries. In order to bring in new attitudes and approaches, there was a deliberate effort to bring in new people to help in the transition.

A typical recruit was Maarten Vernooij, who joined in 2008 as a Director of Strategy and Business Development after a successful career in sales and marketing at Unilever and an MBA these entitled "Strategy in Times of Radical Innovation". 

Although there were few transfers from Color Kinetics (entrepreneurial employees in the acquired companies enriched by the Philips purchase were reluctant to transfer to the Netherlands for the completion of their lock-in periods), there were a number of Philips employees who spent time in Boston to absorb knowledge and culture.

Luck: The hike in short-term revenues made the strategic shift more palatable. Because Philips had failed to sell its Light Fixtures division, it had in place internal capacity in both light sources and light fixtures - capabilities important in the LED market. The strategic moves to address disruption originated in the Light Fixtures division, not surprising as LEDs gave this division a new lease on life.

Lessons from the Philips Experience:

We can take several lessons from Philips:

• Understanding the theory of disruption helps a company design a viable strategy. [Netflix is another company that has successfully migrated to a new business model after disruption. Before the major strategy shift, Reid Hastings had often spoken publicly about the dangers of disruptive innovation and was clearly a student of The Innovator's Dilemma.]
• It's important to start early. Philips clearly saw the risks and opportunities afforded afforded by the transition to LED. They were thinking about this as early as 1999, with a full bet from 2004 onwards, while incandescent lights were still legal in the major US market (incandescent was not banned there until 2014). [Kodak of course 'started early', at least in a technical sense as Kodak employee Steve Sasson invented the digital camera in 1975. However, the quality of early digital photographs were treated with disdain and Kodak did not act on digital photography as a business.]
• Leadership is vital: Philips' transformation was led from the top. [Kodak's leadership, on the other hand, has been widely criticized for its lack of foresight, its ossification, and just plain stupidity.]
• It's hard to effect radical innovation and transformation with the people with a vested interest and dependence on the previous business model. Philips realized it needed an infusion of people, skills, intellectual property and a new attitude toward the future. Philips made acquisitions and recruited people from outside the industry. 
• Adjusting the inventive scheme is an important way to effect change, as with Philips' special incentives for sales people. As stated above, it helped that the LEDs are more expensive. Leading a sales force out of their comfort zone is easier when they can earn more commissions selling the new product. [Kodak didn't have this luxury.]
• Philips made use of partial separation, though not the creation of a new company, to protect new acquisitions as a separate competing force. They left Agilent and Color Kinetics with separate management  in California and Boston respectively. On the other hand, they integrated the sales forces, resulting in a mixed organizational model.
• Philips had spent a tremendous amount of time on forecasting technology improvements and adoption curves. These insights created a sense of urgency and allowed proper preparation both in therms of scaling down conventional product capacity as well as building up new competencies to bring LED solutions to market.
• There was strong alignment with the company - everyone acknowledged that LED would dominate at some point in time. Debates were thus not about IF it would happen, but about WHEN and in which segments first.
• Philips jumped on early niche segments, like for example refrigerator lighting. These relatively small commercial opportunities were great learning exercises.

It's clear from this case history, and indeed others like Netflix, that the gloomy predictions of The Innovator's Dilemma have awakened some executives to understand and withstand the onslaught of disruption. Some disruptions are more insidious than others but none are easy. Clay Christensen, the author of The Innovator's Dilemma has made a huge contribution to strategic thinking. No wonder he's been twice named top Business Thinker globally and The Economist has named The Innovator's Dilemma one of the six best business books of all time.

Christensen Wins - Again!

Clayton Christensen has topped the list of best Business Thinkers, for the second time in a row.  His seminal book, The Innovator's Dilemma was published in 1997, but by 2001, he was only ranked 39th on the list.

Why did it take so long for him to be recognized? The Innovator's Dilemma proposes a number of counter-intuitive explanations of why 'great companies fail'. When I first met Clay in 1997 and heard these ideas, they hit me like an bolt of lightning "Ah that explains so much!" But I had had a somewhat unorthodox business background by then, and I was totally unschooled in and untainted by traditional business and MBA thinking. For most people it took years for these powerful ideas to percolate.

Today, Christensen's thinking has profoundly influenced management thinking, although the words 'disruptive innovation' are applied to just about any new idea or product, even when they are not in the least disruptive. In any case, it's great to see my hero recognized and I'm betting this honour will stimulate even more people to read his important books.

Note that Kim and Mauborgne, authors of Blue Ocean Strategy sit at #2. Blue Ocean Strategy is an elaboration of the theory of disruption, with the addition of a great visualization approach that enhances explainability of disruptive innovation.  Canada can be really proud to see Roger Martin and Don Tapscott in third and fourth spot.  Women hold 4 of the top 10 spots on the list, representing a significant breakthrough, and Chinese squeeze into 31st and 50th positions for the first appearance of Chinese thinkers on the list.

The Innovator's Dilemma - one of the best 6 business books of all time

This week, The Economist launched a quarterly review of business books.

For their inaugural review, they chose the best six business books of all time.  They included The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail, by Clayton Christensen.  I fervently agree with this choice, as this book was the seminal work that sparked my deep interest in innovation, and Christensen's ideas form the nucleus of my MBA courses on innovation.  My opportunities to work with Clay have been among my most stimulating intellectual experiences; amazingly he's a really nice guy besides.

There are several reasons The Innovator's Dilemma is worthy of this honour.  The first is that it presented a sound theoretical basis for the concept of disruptive innovation and why successful companies can go into a sudden tailspin when their industry is disrupted.  Many business books present anecdotal evidence of how a particular company (or a selection of companies) achieve success; then they extrapolate that behaviour as if it's a general formula for success applicable to all companies.  In contrast, Christensen identifies the industry dynamics that call for different behaviours at different times.  The Innovator's Dilemma sheds light on how a company can be disrupted; The Innovator's Solution and later works provide guidance on how to defend against disruption, or go on the offensive to disrupt an industry yourself.

The second reason the book earned a place on this very short list is because of the impact it's had on the business world.  Christensen coined the term disruption to describe a particular kind of innovation that 'disrupts' a whole industry.  Such innovations are not the ones with the most bells and whistles or the most sophisticated technology.  Rather counter-intuitively, they are just good enough on traditional attributes, but deliver a new kind of value with a revolutionary business model.  

This idea links to one of the other books on this list The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits by C. K. Pahalad. The people at the bottom of the pyramid have been considered unattractive because of their limited disposable income; but when you add up billions of these individuals, the market suddenly becomes interesting.   This market needs products that are good enough for their needs, not necessarily to the standard of the top of the pyramid - good enough is almost always better than nothing.  Yet these products that start at the bottom of the pyramid are relentlessly improved over time, and we're starting to see some very interesting products appearing in the developed world that were originally designed for those bottom-of-the-pyramid markets.  GE's portable ultrasound device is a typical example of this.  Developed in India, it will make ultrasound more convenient and cheaper for the whole world.  This is true disruption.

Christensen regrets attributing disruption to technology in his original book; he came to realize that it's the business model that does the disruption.  In fact, in his modest way, he credits Andy Groves, legendary CEO of Intel, with this insight.  In the paperback release of The Innovator's Dilemma, the new subtitle The Revolutionary Book That Will Change The Way You Do Business eliminates the word technology.

Because of The Innovator's Dilemma, the business community has an understanding of the fundamental cause of cycles in the life and death of companies, and how to deal with those cycles.  The powerhouse incumbents in an industry will no longer be taken completely by surprise by such disruptive innovations, the way Kodak was devastated by digital photography, or Western Union by the telephone, or newspapers by Internet content and advertising.

Just today, Jackie Hutter posted on Blogging Innovation how to choose a partner for a company with a radically different battery technology.  Discouraged with their first foray with a big company that didn't seem to get the potential of disruptive innovation, she hypothesized that understanding Christensen could be a filter for choosing partners.  "At a minimum, if the person on the other side of the phone has not read any of Christensen's books, we probably don't want to have a second call".

Christensen has written other books, exploring disruption in specific industries, and what DNA it takes to be a good innovator.

Clayton Christensen

For many years I've admired the groundbreaking work of Clayton Christensen on innovation.  I first met Christensen back in 1998.  I was working at the Globe and Mail and Thomson Newspapers (the owner of the Globe at the time), invited me to an all-day session in Boston where Christensen was presenting his theory of disruptive innovation.  We were given a copy of The Innovator’s Dilemma (judged by The Economist as one of the six best business books of all time), and treated - and I do mean treated -  to Christensen’s eloquent explanations.   It was an epiphany.  So much of what I had observed in the world of business suddenly clicked into a framework.  And so much of what I’ve done with my professional life since then has hinged on that original exposure to his ideas. 

The big ideas that I took away with me from that day, and subsequent exposures to his theories are:

• Technology improves faster than users’ ability to absorb, or willingness to pay, for those improvements
• Incumbent companies, seeking to maximize profits and margins and cater to their biggest and best customers, focus their attention on the possibilities at the top end of that technological curve, overshooting the majority of the market
• Disruptive innovations offer just good enough quality on traditional attributes, but provide exceptional cost effectiveness, convenience or accessibility that appeal to the least demanding consumers or non-consumers
• Technology improvements make these products good enough to take over the core markets of the incumbents (see first point above), while incumbents are loath to compete because to do so would attack their own business models

As this little summary suggests, it’s all about the business model and doing things in a radically different way – usually starting by offering less than what’s already there.

Give me 5 minutes and a cocktail napkin, and I will draw the above diagram to explain disruptive innovation to anyone who'd like to hear  - and many who would not!

Fast forward to my taking a job as Corporate Advisor to Michael Sabia, the CEO of BCE.  The  first thing I did was recommend that he should read The Innovator’s Solution, Christensen’s second book.  BCE, as Canada’s largest telephone company, was the prime victim in an industry which was being totally disrupted.  Could understanding the process of disruption help us on the path to seizing opportunities in this new world instead of being victimized?  I thought that getting the boss to read Christensen would be a good start.  I arranged a copy of the book for Michael.  He said he’d try to read it on the weekend.  On Monday, I eagerly called to see whether he'd found time in his frenetic schedule to read it.  “No”, he said.  There was a big pause while I swallowed my disappointment.  He went on to say, “I read it twice”.

And so began my fantastic journey in getting to know Christensen better and in working with him and learning from him.  We did several projects with him at BCE, involving him speaking to groups of executives, from which sprang various workshops to discuss specific implications of disruption theory for the communications business.  He would start such talks and workshops by expressing his honour to be there, learning from a great company.  (Over the years, I came to see this humility was not assumed but real).  He would then present his ideas with crystal clarity.  Questions were welcomed with remarks such as “You know, that’s a great question.  It really gets to the heart of the matter.  Thanks for asking”, after which he would deliver a succinct and lucid answer to the question.   He was always generous with praise for his students and  anyone who had contributed to his thinking.  When he invited my comments on his upcoming book, he took my modest input and criticisms seriously and, to my surprise and delight, I was mentioned in the acknowledgements.    You always walk away from a conversation with Clay impressed by his wide-ranging intellect (not to mention his 6'8" height!), but, remarkably, you also say to yourself “Gee, I never knew I was that smart”.  He just has that effect of making you feel good about yourself.

So, what prompted me to suddenly write this paean?  It was Clay’s recent address to the Ontario Hospital Association.    Clay was invited to speak because of his recent book The Innovator’s Prescription.  He’s been tussling with the ideas of disruption and how they apply to healthcare for several years now.  So he was a logical speaker for the OHA’s annual conference.   

However there was a little glitch in the plan.  After fighting off cancer last year, a heart attack before that, and diabetes since he was 30, he suffered a stroke in July which left him with expressive aphasia, the loss of the ability to produce language (spoken or written).   Wow, what a crime to have this happen to this most eloquent of men. 

As you might expect from what you’ve read so far, Christensen did not cancel the engagement, but pushed himself to deliver the talk.  He started by expressing his gratitude to the organizers for their patience with him.  Then he explained that for his whole life, he’d been learning words by writing them on little file cards and storing them away in a file cabinet in his brain.  They all had bar codes on them and a little gatekeeper in his head would pull out the words as he needed them.  However, since his stroke, the gatekeeper had been on holiday.  Would we the audience please excuse him if he sometimes used the wrong word, and shout it out if we could see him struggling to access a particular word without his gatekeeper helper.

Despite the caveats, Christensen delivered to the audience of 2,500 a clearly organized, highly relevant, spectacularly cogent and highly fluent account of disruptive innovation and what it could mean to healthcare.  Indeed, there were a handful of instances when he searched for a word.  You could almost sense the audience leaning forward to help him.  It was a masterful presentation – for someone who hadn’t had a stroke.  It was a stunning triumph for someone who had.  It met with a heartfelt standing ovation and thunderous applause that just didn’t stop.   How well deserved.

In a future post, I'll tell you what he actually said.