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.

MOOCs - A Coming Onslaught

I've been writing about, talking about, thinking about and taking MOOCs (Massive Open Online Courses) for quite a while now.   I've just read Thomas Friedman's recent New York Times article about MOOCs.  He and I are pretty much on the same page - although a lot more people read his page than mine!  Of course, Clayton Christensen has been talking about education being ripe for disruptive innovation for years and published Disrupting Class five years ago.

Friedman points to the emergence of Professor as Rock Star.  I've long made the point that, with the globalization of education, the few will rise to the top and drive out mediocrity. Friedman describes how  Harvard Humanities professor Michael Sandel, has become a rock star in Korea and China.  I first heard Sandel speak at the TED conference in 2010 and I've just signed up for his upcoming Justice course on edX, the joint MOOC platform of Harvard and MIT.  Regular readers of this blog may soon read more about that course.

Who wants to learn high school math from a crappy, or even mediocre, high school math teacher when you can learn from the incredibly popular and engaging Salman Khan at Khan Academy?  Who wants to learn history from a schmuck at a third-tier university when you can learn at the feet of Jeremy Adelman of Princeton?  (see my rave review of his Coursera course here.)

I've mused about this rock star phenomenon with my students in the Managing Innovation course I've been teaching in two different MBA programs since retirement from full time employment.  I consider myself a 'pretty good' teacher, regularly earning Teaching Excellence awards at University of Toronto's Rotman School of Management and complimentary comments from students.   But world class?  I think not.  Clayton Christensen is not teaching online yet, but if someone were to be given the chance to learn from this rock star, the pre-eminent world expert on innovation, or from Lib Gibson, they'd be crazy to choose me.

So what are the prospects for a good-but-not-world-class professor?  As lectures become available online, institutions are experimenting with flipping the classroom model: watch the lectures online in your own time at your own pace  and do homework or discussions during class.  San Jose State is flipping that classroom with MIT's introductory Circuits and Electronics course and College Preparatory School in East Palo Alto is doing the same with Salman Khan's math videos.   Perhaps there'd be scope for people like me running those discussions.  But this prospect would be rather gloomy if teaching was my chosen career.  Such outsourcing would definitely diminish my value.

Another of Friedman's points is about the coming shift from the Time Served model of education to the Stuff Learned model.  Sitting through high school, and getting a graduation certificate (of uncertain pedigree since different high schools have such different standards), will no longer be the benchmark.  Rather, your actual competence in a subject will be measured.

A good example of this is my own abortive registration for Calculus: Single Variable by Professor Ghrist of University of Pennsylvania.  I had two motives.  One was a crazy desire to refresh my memory about calculus and one was to see Professor Ghrist's teaching methodology, which looked downright exciting.  I was advised to take a self-administered test before starting the course to ensure I had the right background: if I scored less than 80%, think twice about registering.  So, I have a Masters in Math, and I've even taught first year calculus - a mere 43 years ago - although I've never used a stitch of what I learned.  The Axiomatic Foundations of Algebraic Topology (my thesis topic) doesn't exactly come up in everyday conversations.  Well, I was even rustier than expected and I didn't come near scoring 80%.  So I self-selected out of the course.  (Maybe I'll go to Khan Academy and brush up on some of that prerequisite stuff).

So how does this differ from what happens now?  I'm sure that with a credential like a Masters in Math, I'd have been accepted into that course.  In the bricks-and-mortars world, my bum in that seat would have denied a chance for another more worthy student.  In the world of 'infinite' capacity, I can decide whether to take the course or not, without impacting access for anybody else.  And there was a great online tool to help inform my decision.

Clayton Christensen on the early days of Disruption Theory

There's a short video of Clayton Christensen on the HBR Blog Network.  In his quiet way, he  describes the wide applicability of his theory of disruptive innovation, in spheres as diverse as chip manufacture and the military.  Well worth a few minutes of your time to hear about the early days of the idea of disruption exploding in the marketplace of ideas.  Click here.

Coursera and Peer Evaluation

Readers of this blog know how enthusiastic I am about taking a course on world history on Coursera.  I've loved learning the history, and the experience has provoked many thoughts about the future of education (see this post).  Education is undergoing the process of disruptive innovation, and it's about to explode.

I've just discovered a TED talk by Daphne Koller, one of the founders of Coursera from TED Global this summer.  It outlines some of the motivations of the founders of Coursera and talks more about data on the efficacy of online teaching.

She quoted Thomas Friedman's article in the New York Times:

Big breakthroughs happen when what is suddenly possible meets what is desperately necessary. 

How true that is.

MOOCs (massive online open courses) in the social sciences must figure out a way to include written work as part of the course.  For a class of more 80,000 students, like The History of the World Since 1300,  what is desperately necessary - evaluation of those essays - meets what is suddenly possible - mass technology-enabled anonymous peer evaluation.

But can peer evaluation be effective and fair?  Koller showed some fascinating data on peer evaluation (which she acknowledged was based on relatively small samples).  Here's her chart of the very high correlation between peer grades and the grade a teacher would offer.

Even more surprising was the chart showing that self-evaluation correlated even more highly with the teacher grade (given some software that prohibited perfect scores).

I'm eager to see what my peers think of my first essay handed in a few days ago.  Coursera also asks students to self-evaluate their essays.  Coursera is so cleverly designed that I'm sure this data will all be collected and form the basis of future publications on the effectiveness of peer evaluation.  It is truly a new age!

Revolution in Education

Adelman and the ivied walls of Princeton

When my daughter attended Princeton, I was filled with immense pride and a dollop of envy.  The pedagogical experience was awesome - the small classes and individual attention from world class faculty showed the wisdom of her decision to eschew Harvard in favour of Princeton.  


Now I've just registered to take A History of the World Since 1300 from Princeton professor Jeremy Adelman, starting this September.  How, you might ask, is this woman in Toronto taking a course at Princeton?  Coursera is the answer.  Coursera offers online courses from 17 of the world's top universities, free. I certainly won't get the individualized learning experience of an undergrad at Princeton, but I will learn from one of their top faculty.


And that's not all:  I also registered for Healthcare Innovation and Entrepreneurship taught by Bob Barnes and Marilyn Lombardi of Duke, and Critical Thinking in Global Challenges by Celine Caquineau and Mayank Dutia of University of Edinburgh.  The breadth of choice, even at this early stage, is amazing.  To peruse the courses on offer at Coursera is to be a kid in a candy store.

There is one downside - in Adelman's email to me confirming registration, he already handed out pre-reading.  

Thank you for your interest in global history.  This is a course I have taught for many years, and I never cease to find it a source of excitement.  We will be in touch with more details when the class starts.  But in the meantime, you should feel free to start reading the recommended textbook, Worlds Together, World Apart (3rd edition), Volume 2.

Hmm, some things are the same about online education.

This course will run for 24 lectures of 50 minutes each, with regular assignments of map tests and short essays.  The lectures are expected to take two hours, including the embedded assignments, plus two hours for writing and three hours for reading each week.  

In 1997, Clayton Christensen introduced the concept of disruptive innovation in his book The Innovator's Dilemma (named one of the six best business books of all time by The Economist) and Coursera is disruptive innovation at its finest - a product that is "not as good as" that offered at traditional institutions.  At least not by traditional standards.  You can forget the ivy-clad walls, the chance to talk to the prof in person after class, parties, football games, and most importantly, that certificate on the wall saying you're a Princeton grad.  However, it's vastly more convenient and accessible for people who would not otherwise be able to attend university, let alone storied Princeton.  Many advocates argue that, for many topics, online learning is actually better, because of the frequent progress testing, and the ability to proceed at an individualized pace.   And did I mention it's free?  That's what disruptive innovation is all about, less good on traditional attributes, but 'disrupting' an industry through the introduction of some new attribute that overturns our whole view of the industry, in this case the opportunity to take a Princeton course while staying at home in Toronto, doing it on my own time, and doing it for free. 


A typical reaction of people vested in an industry threatened by disruption is to treat the disruptor with disdain.   It's no different in education.   I've met people who sneer at a degree from University of Phoenix, a pioneer in online education and the largest university in the US, and liken it to a mail-order degree.  And an MBA from Athabaska?  Pshaw.  It doesn't hold a candle to an MBA from one of Canada's prestigious programs.  


However, disruptive innovations undergo continuous improvement over time, and ultimately challenge the leading incumbents.  Just look at the universities involved in Coursera, and it's hard to justify disdain: University of California (Berkley and San Francisco), California Institute of Technology, Duke, Ecole Polytechnique National de Lausanne, University of Edinburgh, Georgia Institute of Technology, University of Illinois, John Hopkins, University of Pennsylvania, Princeton, Rice, Stanford, University of Michigan, University of Toronto, University of Michigan, University of Washington.  Then, there's edX, started by Harvard and MIT and recently joined by University of California at Berkeley, offering mostly courses in Computer Science.  Clearly, the big names are jockeying for position in this new arena.  

The limitations of online education are sure to be diminished over time.  New generations find online social media as satisfying as real-life interactions and they may not miss university social life quite as much as the older generation expects them to.  For this history course, Princeton is not offering an official credit, but will provide, with my approval, data documenting my progress and performance.  This is definitely inferior to a course credit or degree from Princeton, for students or potential employers. 


However, it doesn't take much imagination to envision testing centres, similar to those for SAT tests, to enable those taking courses online to get official credits for the courses they take.  How will an employer respond to an applicant who has a full load of course credits, spread over 8 world-class universities, but no degree from a single one of them?  It unbundles the idea of a 'degree' as we've known it.   


Will students get very picky about where they take course and from whom?  Think of a student given the choice between taking a course from a local university, potentially from an unseasoned or just plain weak professor, or taking the same material from a renowned professor who's earned a global reputation for this course?  As a adjunct professor in a couple of MBA programs myself, I can certainly understand the threat of this competitive breeze down my neck.  Teaching faculty could be disrupted as much as the institutions themselves. 


Coursera's founders are from Stanford and they are funded by two Silicon Valley venture capitalists.  It's not been stated what the eventual business model will be - is the initial free offering to be superseded by fee-based courses once the concept is established?  Stanford Department of Engineering was a pioneer in online courses online: a graduate course in Artificial Intelligence last year attracted a remarkable 160,000 students from 190 countries.  


Of course, it's not an either/or decision.  Online courses are already popular with 'regular' college students.   As reported in the Sloan Consortium 2011 report, almost one third of students at college in the US are taking an online course.  Online education can also be a supplement to traditional education.  Perhaps the greatest success story of online education is the Kahn Academy.  Started 'accidentally' by Salman Kahn who was tutoring some cousins at a distance through online lectures - no fancy technology, just a YouTube video of Kahn with his engaging manner and the equivalent of a black board for notes.  Those first efforts have led to a site with over 3,000 videos and millions of views (see Kahn's TED talk for more information about some of the revolutionary techniques being used in K-12 curricula).  


As education costs continue to spiral upward, the cost effectiveness of online education will become even more important - consider that one Stanford prof teaching 160,000 students!  It could also lead to the unbundling of university degrees, the enhancement of the brands and success of the top universities and the erosion of second-rate institutions, the need for much fewer teaching faculty - in short a revolution in education.  It's happened in many other industries.  There's no reason education would be exempt.


Education is in for a revolution.  I'm excited to be a small part of this revolution as a student of my first online course.

Driving Disruption in Healthcare

After a rather long hiatus (for a long variety of boring reasons), I'm going to try to catch up with quite a few new posts.

To be in an industry that is being disrupted can be anything from disquieting to distressing to downright terrifying.  Most people in such an industry will respond disruption with denial.  So how do you get them past denial?  Creep up on them with a story from a different industry, so they can understand the concepts and hope they recognize the application to their own industry. 

There’s a story Christensen tells of how this happened at Intel.  Christensen described how the conventional integrated steel industry was disrupted by mini-mills making inferior steel cheaply.  The mini-mills captured the rebar market, bits of steel which are embedded within concrete, a market that needed only low quality and exhibited great price sensitivity.  Since the integrated mills considered this the least interesting segment of the market –  `nuisance´ customers who were the smallest market segment with the lowest profit margin – big steel almost welcomed loss of their rebar customers to the new mini-mills.  Moreover, they disdained these new mini-mills who could only produce steel good enough for the lowly rebar market, and assumed they could never produce steel good enough for any part of the market except rebar. 

But the mini-mills moved quickly up the technological improvement curve and peeled off one segment after another of the steel market, each one bigger and with a better profit margin than the last.  Eventually, the conventional steel mills were left defending their best customers, the car makers.  The car market represented the biggest part of the market, and the most lucrative by far, with the best profit margins.  So conventional steel looked seemed to be doing very well, as their profit margins had steadily increased with the departure of the lower-margin customers.   Until, that is, the mini-mills figured out how to make automotive steel, and conventional steel was wiped out. 

The conventional steel companies had known about the mini-mills for years; they simply didn’t consider them a threat, because of their `crummy' products.  They were complicit in mini-mills taking over the steel market, because they were happy to yield small markets, with low margins and cranky customers in order to focus on bigger markets, with higher profit margins and customers who valued their quality. 

When he heard Christensen tell this story, Andy Groves, Intel’s brilliant CEO, exclaimed, “That’s what’s happening to Intel.  We’re losing the low end of the chip market, and we’ve been complacent about it because they’re the lowest margin segment of the market.  But those low-end chip makers will keep peeling off low-end segments of the market, until they attack our core business”.  Groves acted decisively and built a new low-end chip business for Intel.

And Christensen’s message to the OHA was that the hospital industry was about to be disrupted – in fact had to be disrupted if we are ever to get healthcare costs under control.   And one way they will be disrupted is by simpler hospitals, those without the incredible sophistication of high end acute-care teaching hospitals.

To bring home his point, Christensen describe a company that made axles.  Their oldest plant was about to be closed down because they had the highest per-unit cost, due to high overhead costs.  The manager sought Christensen’s analytical help.  As she and Christensen compared this plant to all the rest, they realized that this was the only plant that offered to build any sort of axle.  The plant layout looked like this:

 When orders came in, they followed different paths through the plant.  This put a high burden of overhead costs on the plant.  Other plants had essentially laid out the different departments in a straight line, and only accepted certain orders, that fit their pre-arranged pattern.  Christensen likened the axle factory to today’s general hospital, whose main costs are due to their very general nature; patients take totally individual paths through the hospital.

Christensen compared this to the Shouldice Hospital in Toronto, which has done the equivalent of those newer axle factories.  They deliver only one treatment, hernia repair, basically in an assembly line.  Thirty patients operated on daily, a full briefing for everybody the night before, walk away from the operating table after their local anaesthetic, and home after a good night's sleep.  When you compare the cost of hernia repair at Shouldice versus a typical acute-care teaching hospital, it's hugely cheaper at Shouldice.  The direct costs are slightly less, but the overhead costs are massively less.  This also follows the pattern of medical services drifting to the simplest - and cheapest - locale possible, as described in the previous post.