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Telecommunications, Media, and Technology


Innovation and product development:

Growth versus competition

Innovation and product development:

Growth versus competition
RECALL No 19 – Innovation and product development

Welcome ...
… to the 19th issue of RECALL, McKinsey’s publica- Growing convergence adds to the complexity. From
tion for leaders in telecommunications, media, and fixed to mobile, from voice to data, and from music to
high tech. The pace of change is lightning fast, driven multimedia, traditional boundaries between services
by the consumer’s endless appetite for innovation. are blurring. Combined, these phenomena make it
Anyone who has ever observed the block-wrapping increasingly critical for industry players to abandon
lines in front of an Apple store on “release day” knows their “worn” strategies and adopt multidisciplinary
that tech consumers can never get enough. What was approaches to product development.
ground-­breaking yesterday might be obsolete tomor-
row. Players who can stay a step ahead and anticipate We see a clear need for telecoms, media, and high-tech
their customers’ needs will reap staggering rewards. organizations to become more agile in their product
Meeting, exceeding, and even creating these needs calls development endeavors – investing in innovation, not
for targeted innovation and product development – merely waiting for it to happen. In this issue of RECALL,
the focus of this issue. we discuss the need to build a professional organization
around innovation that optimizes every facet of R&D.
The year 2011 turned out to be disappointing in several Successful innovation begins with a deep understanding
ways. Much of the hope engendered during the after- of consumer insights, while sidestepping the pitfalls that
math of the global economic crisis has been dashed as can lead to misinterpretation. It also means structuring
the worldwide economy stalls once again. As organi- activities in ways that lead to sustained innovation – not
zations across industries – in the public and private just one-off breakthroughs – including a more thorough
sectors alike – tighten their belts, many are making look at managing the innovation portfolio and the R&D
significant cuts to their innovation investments. These teams that deliver it. These topics and a conversation
scale-backs may be taking the steam out of the very with one industry leader about his quest to innovate in a
engine that drives growth – innovation. time of unprecedented pressure lie in the pages ahead.

Our work with telecoms, media, and high-tech organi- We hope the articles in this issue of RECALL inspire
zations highlights the complexity of development and you to think of your organization’s commitment to and
the importance of getting it right. New players are enter- execution of research and development in new and
ing the game with seemingly unbeatable price points, helpful ways. As always, we welcome your feedback on
and a dramatic rise in applications – such as Skype and these articles and ideas for topics you would like to see
Facebook’s video-calling feature – is destroying the covered in future issues. To download a PDF copy of the
value of services that were once major revenue genera- articles or the entire brochure, please register at http://
tors for many telecoms incumbents.

Jürgen Meffert Aaron Aboagye

Leader of McKinsey’s EMEA Leader of McKinsey’s TMT Product
Telecommunications, Media, and Development and Innovation Service Line
Technology Practice in the Americas

Marc de Jong Davis Lin

Leader of McKinsey’s TMT Product Leader of McKinsey’s TMT Product
Development and Innovation Service Line Development and Innovation Service Line
in EMEA in Asia
RECALL No 19 – Innovation and product development

Innovation-led growth: Eight essentials 9

02 IQ innovations: The future of smart 17

03 More for the money: Managing the innovation portfolio 23

04 Design to value: Consumer-driven cost control 29

05 Insight traps: Missteps in consumer research that can make products worse 35

06 A billion buyers: Product innovations for a new consumer class 41

07 Managing talent: How world-class R&D organizations do it 47

08 Lean and the software imperative: Step change in development productivity 53

09 A free-flowing pipeline: An interview with Marco Ferrero 59

Appendix 63
RECALL No 19 – Innovation and product development
Innovation-led growth: Eight essentials 9

01 Innovation-led growth: Eight essentials

Enterprises that want to drive growth based on a steady 1. Aspire: Innovation is fundamental to the
stream of innovations over time need much more than growth vision
great ideas. Achieving sustained “innovation at scale”
requires eight essentials. To be a top-performing innovative company or busi-
ness unit, it is essential to describe a compelling per-
Innovation is an enduring and universal objective formance vision that places innovation at the heart of
that inspires some and eludes many. Year after year, future growth. It should answer one question: How
McKinsey surveys – in telecoms and beyond – high- much innovation do we need to meet our financial
light that innovation remains critically important, yet objectives? Many corporate executives talk up innova-
­f rustratingly difficult to achieve. tion. In reality, the underlying business either has not
prioritized it or, in some cases, does not require it to
In McKinsey’s 2010 Global Innovation Survey, a full meet relatively modest growth needs. Quantifying the
90 percent of over 300 high-tech and telecoms sec- innovation-led growth gap over time is not only possi-
tor executives who responded said that innovation is ble, it is essential to improving innovation performance.
extremely or very important to their growth strategy. Companies can achieve this through the following.
Yet, only a third had well-defined strategic innovation
priorities at the corporate or business unit level. Set a clear objective for innovation-led growth. Break
down growth drivers and quantify the amount of inno-
Some would argue that this is the normal course of vation required to meet performance goals. This value
business; after all, many believe that innovation is, by gap must be substantial to incite action. If there is no
definition, not systematic. However, serendipity is not gap, it might make sense to revisit business objectives.
a satisfactory justification to shareholders for either
good or poor innovation performance. Value your current innovation pipeline. Determine if
your current innovation investments are substantial
Even though “eureka” moments do happen, systematic enough to fill the growth gap. Be sure to account for fail-
innovation involves much more than hiring armies of ure or underperformance from new innovations, which
creative people. Innovation that continuously drives many companies inadvertently overlook.
success requires creativity under discipline. Shaping
this framework are diverse sources of insight and rig- Align senior leadership to innovation criticality. Secure
orous science backed by the appropriate process and commitment from senior leaders to take action. Allocate
structure. Built on the foundation of research and targets for growth from innovation to business units;
extensive work with clients, McKinsey has identified include these targets in strategic planning and budget-
eight essentials that prove relevant to any organization ing. Set the right mix of financial and non-financial
pursuing innovation at scale. metrics and cascade these throughout the organization.

Communicate an inspirational vision. This vision Develop market intelligence. Explore market signals
should align with the strategy and the growth gap. It and separate trivial shifts from the truly disruptive
must describe a clear path, providing employees with ones. Regularly review this intelligence with senior
the opportunity to contribute. This is also a chance to management, actively discuss and debate lessons
introduce a common innovation vocabulary to foster learned, and incorporate the implications.
broad dialog and facilitate learning and sharing.
Create scenarios for key trends and possible disrup-
2. Choose: Invest in the most valuable tions. Map the ways your business will likely develop,
­innovation spaces paying close attention to factors that will change quickly
and those that will change only slowly. Understand how
The second essential is for leaders to have a sense of the different scenarios impact your business. In the sce-
where the best current and future market opportuni- narios, include the evolution of critical technologies and
ties can be found and of the right time to tackle them. the likelihood of business model disruptions.
McKinsey calls these opportunities innovation spaces,
and they should be aligned with the company’s long- Select innovation spaces. The combination of market
term strategy, since investments in these spaces will intelligence and scenario analysis will yield a selection
build the foundation for future growth. An innovation of innovation spaces. Invest in these based on R&D,
space defines boundaries within which a company will capability-building initiatives, and business develop-
search for insight to unlock new forms of value. These ment bets. Conduct disciplined, ongoing reviews of
boundaries can be technical limits, business model these choices and allocations.
parameters, or other constraints; they can be value-
based or derived from market and category definitions. 3. Discover: Actionable and differentiated
­insights fuel innovation
Uncertainty surrounding this essential may be greatest
when an industry finds itself in the throes of transi- Great innovators interpret their existing context and
tion. Telecoms, media, and high tech are such sectors. imagine future ones. They use a combination of obser-
Examples abound of companies missing major mar- vation, intuition, and inspiration to work within the
ket shifts by failing to explore innovations emerging chosen innovation space and frame the important
around their core business. Only a decade ago, no one problems to solve. It takes experience and skill to sys-
had heard of an enterprise IT manager “renting” core tematically bring together areas of knowledge and
applications from a company on the other side of the uncover truly differentiated, actionable insights in
globe, or of consumers carrying mobile devices with order to understand the specific problems that are most
almost infinite functionalities. Today, pay-as-you-go worth solving. Organizations should create systems that
cloud services are widely used IT solutions, and – as facilitate debate about market contexts – current and
can be easily observed – numerous consumers consider future – and how to best derive their implications. The
smartphones with thousands of fit-for-purpose apps to three distinct “lenses” through which to view the market
be essential electronic accessories. context are: customer, technology, and business.

Identifying and selecting valuable innovation spaces The customer lens uncovers preferences – those that
is a difficult but critical capability that requires two can be described and those that can only be discovered
elements. First, companies must have strong market through careful observation of behavior. Great insights
intelligence on evolving customer trends, investment come from deciphering why behaviors result in certain
patterns in technologies, the regulatory environment, contexts. The technology lens assesses feasibility and
and emerging business models. Second, they must hold often provides benefits that can create and sustain com-
frequent dialogs on possible future scenarios and their petitive advantage. Technology, broadly defined, is the
implications for the company’s innovation investments. enabler of almost all innovative products, services, pro-
Once innovation spaces are chosen, companies should cesses, and business models. In the telecoms, media, and
also regularly revisit their strategies to make sure their high-tech sectors, it can also be the end product, making
choices remain appropriate. Companies ready to take it all the more a critical piece of innovation. Finally, the
the investment lead as opposed to reacting to competi- business lens examines the competitive context, prevail-
tive pressure can take three key actions. ing economics, and positioning within the value chain.
RECALL No 19 – Innovation and product development
Innovation-led growth: Eight essentials 11

While each lens can provide powerful knowledge, it is innovations, business model innovation is known to
the combination of all three elements (in some cases, generate the most significant long-term value.
supplemented with other considerations, such as an
understanding of distribution) that leads to the problem Consider business models that you can use to deliver
statements on which companies can focus their resourc- value to priority groups of new customers. Do not
es to create valuable solutions. Companies with a deep get locked into a narrow conception of your business
understanding of their relative market position and the model – have the confidence to explore broader oppor-
profit flows within their industry can better make and tunities. Pilot projects and experimentation will help in
assess innovation investments. Unearthing these game- making smart decisions regarding where resources can
changing insights happens in three steps. be allocated most efficiently.

Uncover the “why” behind customer purchase and usage Selectively invest in a diversified set of initiatives to
behaviors. Tap into a range of qualitative evidence, such explore innovative business models. Establish focused,
as in-context observations, ethnographic research, and cross-functional teams charged with developing suc-
quantitative surveys, to describe what motivates con- cessful pilots into sizeable businesses. Set understand-
sumers to purchase certain products and services and to able and widely accepted metrics to measure perfor-
see how they use them. Examine existing and emerging mance and learn from market experiences.
technologies and focus on the benefits they can offer.
Consider the business dynamics in and around your cat- 5. Balance: Adjust your innovation portfolio for
egory and the market position within your category. value, time, and risk

Synthesize information into insights and describe spe- Venture capitalists know the challenges of successfully
cific problems to solve. Use teams with members from managing an investment portfolio. They also under-
different disciplines to interpret the data and develop a stand that more active management of the innovation
concise list of the activities and outcomes that custom- portfolio can increase the expected value of the pipeline
ers hope to achieve. Assess the relative importance of by up to 20 percent, with only a marginal increase in
their desires, wishes, and wants. Scan existing solu- overall risk. However, almost 60 percent of respondents
tions, no matter how simplistic they may appear. Judge to McKinsey’s 2010 Global Innovation Survey admitted
how well the current solutions address articulated and that their companies are not good at selecting the right
unarticulated customer preferences. ideas and managing a portfolio. Yet establishing an
innovation portfolio, managing it well, and combining
Propose new solutions. Any new value proposition this with commercial excellence can enable companies
should identify who the target customer is, what prob- to realize impressive performance gains.
lem is being solved, and how a company will make
money over time, given the anticipated competition. Successful innovators demonstrate a clear advantage
World-class innovators employ systematic approaches in portfolio management. McKinsey research revealed
to gain this unique depth of insight and then translate it that over 80 percent of successful innovators have a
into valuable new propositions. well-understood portfolio management process in place
to evaluate and prioritize projects.
4. Evolve: Innovation also applies to
business models These companies begin by gaining transparency
regarding what people are working on. They then rigor-
Eighty percent of global chief strategy officers recently ously assess the expected value, timing, and associated
surveyed believe their business models are at risk. risk. Every company should be able to understand its
Among their biggest concerns are new entrants wield- innovation portfolio and determine whether or not it
ing disruptive technologies and process innovations. is in line with growth requirements and risk tolerance.
In dynamic markets, product innovation alone is Companies should also consider how their portfolio
insufficient. A strong innovation portfolio goes beyond balances incremental versus breakthrough projects
products; it includes other forms of innovation, encom- and recalibrate as appropriate. Some companies are
passing new business models and distinctive business content to merely gain transparency, but in McKinsey’s
processes that can build competitive advantage. Of all experience, this does not suffice. Most of the value from

a rigorous portfolio management approach comes from of technological advancement, a globalizing economy,
getting the right people to the table – people with the and lower capital barriers have resulted in an environ-
appropriate level of experience and relevant decision ment where a university student can come up with the
making authority – to discuss the pipeline. next multibillion-dollar innovation. Companies that
extend their reach beyond their organization’s walls
The right balance can be found in portfolios of varying to find innovation partners can get greater returns on
composition. In addition to timing, value, and risk, the their investments. Technology now allows access to the
portfolio should also be assessed for its competitive knowledge, skills, and abilities of broad – even global –
dynamics, technology investment needs, and the bal- networks of external partners.
ance between core and non-core investment. A company
must take care not to allow the core businesses to swal- For many companies, collaborating with external
low the non-core business. Far too often, innovation partners reduces costs and speeds up time to market.
pipelines become overloaded with incremental projects Successful innovators discover they can get multiples
(not breakthrough innovations) because decision mak- of every dollar invested in innovation by accessing the
ers allocate resources to their own passions, unchecked skill and talent of others. Most companies already have
by any kind of group discussion or control. Balancing for strong networks in place, but they do not readily consid-
innovation entails three leadership actions. er them a source of innovation. Co-creation with busi-
ness partners and crowd sourcing with customers and
Generate transparency in the innovation pipeline. other stakeholders yield opportunities to extract more
Comb the enterprise to find out what people are doing. value from innovation investments. Taking full advan-
Then map the innovation pipeline into a portfolio tage of the creation potential outside your company can
matrix using proven metrics – the anticipated size of the be accomplished in three steps.
opportunity, the associated risk, and the probability of
success within a certain time frame. For projects close Anchor the right mindset for extending innovation net-
to the core, historic benchmarks may provide useful works. The organizational culture must be ready to wel-
guidance. For breakthrough ideas or projects beyond come ideas from beyond corporate walls, with no bias
the core, teams may need to rely on assumption-driven against innovations developed elsewhere (to counter the
“what you have to believe” scenarios to judge the risk “not invented here” syndrome). Even if external tech-
and feasibility of success. nologies or ideas may not appear useful to a business at
first glance, these should not be dismissed too quickly.
Align the portfolio. A company’s innovation projects
should be in sync with its financial objectives and busi- Actively manage connections. Sourcing external cre-
ness strategy. Ensure that the set of projects and the ativity requires tightly managed interfaces with the
investment allocated to them reflect the organization’s external innovation community, then the ability to
belief about where the most significant growth opportu- translate the creativity that is out there into something
nities lie. Management must be confident that the port- that internal development teams will not only accept
folio will deliver on financial performance targets. but also value. While developing formal and informal
partnerships, processes and resources must be devoted
Establish an assessment and debate routine. High-risk, to managing the flow of ideas from outside the company
high-return initiatives should be managed differently to ensure a steady pipeline of ideas.
than incremental, low-risk projects. Management
must have a routine in place to discuss and debate the Use strategic networks to source new ideas. In some
portfolio – and a mechanism to aggressively weed out industries, creating relationships with other types of
low-­value, low-priority projects and then reallocate networks – say, universities, think tanks, and research
resources to opportunities that generate higher value. institutes – is an effective way to bring in different
perspectives and additional insights. But don’t just ask
6. Extend: Value lies beyond company walls outside parties for new ideas. Use these sources to solve
existing problems. Be cautious about the stage of devel-
For decades, organizations relied on strong internal opment at which you seek an outside solution, and make
R&D or technology functions to deliver innovation pro- sure there is a mechanism that matches what is external
grams. Many were successful. But the increased pace with the appropriate resources inside the organization.
RECALL No 19 – Innovation and product development
Innovation-led growth: Eight essentials 13

7. Mobilize: Organize and inspire a culture the right people in the right positions and – even more
of innovation importantly – surround these people with a support-
ive culture, while employing systematic approaches to
Successful and sustainable innovation requires high deliver better innovation performance.
levels of energy and commitment. Executives play a
critical role in promoting the right culture and environ- 8. Repeat: Processes and metrics can sustain
ment to stimulate and support the sometimes long and the “rhythm” of innovation
tedious work required to make innovation successful.
In fact, committed leadership is the greatest predictor The ability to change and innovate not periodically
of innovation success. When innovation at scale has but perpetually is a company’s “renewal capability.”
proven extremely successful, 60 percent of senior exec- According to McKinsey’s Organizational Health Index,
utives said they were either fully accountable or actively companies with a top-quartile “renewal” score are twice
involved from the early stages, according to McKinsey’s as likely to outperform their peers on margins, book
2010 Global Innovation Survey. When innovation proj- value, and income growth. But is it possible to system-
ects fell short of objectives, only 35 percent of leadership atize innovation so that it creates value again and again?
was fully accountable or actively involved early on. This capability, as noted earlier, is critical to successful
innovation. One breakthrough innovation may provide
In addition to commitment from the top, organizations a short-term boost to the company, but it will not lead to
should design structures and routines to enable specific sustainable growth. Innovation requires a substantial
innovation activities. Celebrating individual success infrastructure, one that supports and fuels a constant
stories across the company is also a powerful lever in flow of new ideas and approaches.
organizational inspiration. A few activities can help
mobilize a company toward innovation. Allow the innovation objective (aspire) to propel the
annual planning process. Too often, companies estab-
Define clear roles and responsibilities to drive the inno- lish their annual budget across business units without
vation agenda. Every person in the company should including innovation as a key initiative. Wiring in the
understand his or her contribution in producing valu- innovation targets and resource needs as part of the
able innovation. While not every employee is directly annual process is critical for repeatability.
involved in creating a product or new business model,
those who are need meaningful incentives and rewards. Establish a step-by-step process to capture and combine
Management teams must ensure that key performance new insights (discover and extend). Ensure that the
indicators and targets promote the right behavior organization evaluates and refreshes its innovation pri-
among the relevant decision makers. orities. Embed approaches to capture and nurture fresh
ideas. Encourage cross-functional, collaborative team-
Build cross-functional teams to drive innovation. While work that transcends the boundaries of the company.
it may be necessary to hire a few talented experts, look
to enable optimal performance of your current talent Anchor innovation portfolio reviews (choose, evolve,
by teaming up individuals with complementary skills and balance) in the regular business review cadence.
and backgrounds. Establish separate teams and groups Establish unambiguous qualitative and quantitative
to push for innovation beyond the core business. Use a metrics to track the performance of innovation through-
combination of virtual and collocated teams for differ- out the portfolio. Be sure to include these metrics in
ent types of innovation and encourage collaboration. quarterly business reviews. Utilize these reviews to
Review team structures regularly to ensure they are adjust resource allocations based on how well innova-
aligned with the current portfolio of innovations. tion projects perform.

Do not overemphasize organizational structure. Ensure that the appropriate people are in the right posi-
Organizational changes may be necessary, but these tions backed by adequate processes (mobilize). Reward
will not make up the entire solution. The organization fresh ideas with systematic, non-financial incentives.
design should promote collaboration and the develop- Recognition, performance contracts, and the ability to
ment of insights, but these elements cannot stem solely do meaningful work can all prove to be powerful moti-
from a structure. Talent management needs to place vators for innovation talent.

  

Determining the extent to which an organization pos-

sesses these eight essentials is an important starting
point for improving innovation performance. Do not
expect (or even attempt) to perfect all eight at once;
innovation excellence must be built over time, begin-
ning with a strong foundation, then improved upon
continually. Organizations that eventually master these
eight essentials will be well positioned to consistently
outperform their peers by achieving innovation at scale.
Those that do not will find themselves playing a game of
chance with their growth agendas.

Brian Gregg
is a Principal in McKinsey’s
San Francisco office.

Gordon Orr Erik Roth

is a Director in McKinsey’s Shanghai office. is a Principal in McKinsey’s Shanghai office.
RECALL No 19 – Innovation and product development
IQ innovations: The future of smart 17

02 IQ innovations: The future of smart

Smartphones have revolutionized the way consumers First, almost as quickly as users adopted the new tech-
stay connected while on the go. Now, new technologies nology, they became the owners of multiple smart devic-
such as biometric sensors and traffic management are es, and many were frustrated by the fact that their data
making smart devices even smarter. was spread across laptop, tablet, smartphone, and PC.
They couldn’t access music downloaded on an iPhone
Cellular technology allowed users to remain in voice from their iPad, and they couldn’t view a video stored on
contact with family, friends, and colleagues, but the an iPad with their iPod. Second, regular updates keep
21st century brought the proliferation of unparalleled Apple devices relatively bug-free, but on-the-go updat-
connectivity. Mobile devices now have advanced oper- ing hadn’t been an option for users. Having to manu-
ating systems that harness the combined power of the ally connect in order to update meant that users were a
Internet, global positioning systems, gyroscopes, and step behind until they were able to physically link their
image sensors, giving users (among other things) imme- devices to a desktop or laptop. The creation of iCloud
diate access to a vast array of Internet-enabled tools services enhanced user convenience by automatically
from mobile banking and navigation to telemedicine synchronizing data across all devices and installing
and video on demand. operating system updates. An added benefit has been
that users have access to greater storage capacity –
Now, new trends in the smart device landscape are beyond the limits of their on-device gigabytes.
laying the foundation for the next generation of these
devices. Advances in technology coupled with changes A third driver behind device integration came from the
in consumer behavior are bringing radical shifts to ser- company. iCloud services would allow Apple to link user
vice and business models, while dramatically changing preferences across platforms. Beyond device synchro-
the handheld devices themselves. Innovations in smart nization, Apple is showing evidence of moving toward
devices will come from an understanding of the under- even greater cloud-based services. Some recent infra-
lying core technology and marrying this with appropri- structure investments indicate plans in two major areas.
ate business models. Their recent purchase of 12 petabytes storage from Isilon
positions Apple to offer video and audio streaming.
Service model succession Beyond this, the acquisition of Teradata servers gives
Apple unprecedented customer analytics capacity.
A major game changer in the smart devices world has
been the advent of the personal cloud. Cloud services While at the forefront of innovation, Apple is hardly the
are driving rapid innovation in a variety of service mod- sole player in the cloud game. Microsoft is developing a
els. One player in particular is leading the way. Apple cloud-based operating system model that would make
announced its iCloud in June of 2011. This development its Windows platform suite of applications even more
was the response to some very specific user pain points. pervasive. Amazon is looking to reinvent its sales model

01 Future growth in tablets will stem more from B2B in the coming years
Future growth in tablets will stem more from B2B in the coming years

US tablet market by user type


100% = USD 5 billion USD 16 billion CAGR

B2B 10
27 +50%

B2C 90
73 +20%

2010 2015
SOURCE: Strategic Analytics; IDC; Gartner; McKinsey

with the introduction of Amazon Cloud Drive, offering Enterprise mobility – or applying smart device technol-
tailored pricing. Google is also seeking to drive adver- ogy to business – fits into three broad categories:
tising revenue by establishing an even larger user base
through low-cost cloud services. „„ Mobile office represents the range of tablet-based
applications with the largest number of current
Making greater use of the cloud has widespread implica- active users. Around 81.6 million professionals used
tions, affecting everyone in every aspect of the game. on-the-go tools such as e-mail, managed Internet
Each player has much to gain but must also be mind- and intranet access, basic messaging, and dispatch
ful of several aspects. Carriers will need to determine functions in 2009, and that number is expected to
how they will secure customer control points, while increase to 129.4 million by 2013.
the concerns for device makers will be improving the
cross-device user experience and a pricing strategy if „„ Front office is the set of applications used mainly by
ad-subsidized costs become the trend. Operating sys- a business’s field workers or sales force. These appli-
tem players will need to devise a business-to-consumer cations enable remote inventory management and
cloud service strategy that can compete with Apple’s access to customer information. Around 29.5 mil-
iCloud. The challenge for content and service providers lion workers used these in 2009. By 2013, this figure
will be securing their own content delivery channels. is expected to grow to 45.4 million.

B2B breakthroughs „„ Database integration defines the set of customized,

highly specific vertical applications that offer con-
Another area of smart devices with big changes in store stant synchronization between field and office. This
is business models. The business-to-business market has been and will likely continue to be the smallest
in particular will likely see major shifts thanks to tablet share of users (15.5 million in 2009 and 21.2 million
computing. Not only is the tablet market growing by in 2013), largely due to its specialized nature.
leaps and bounds, but B2B’s share of this growth will
be staggering (Exhibit 1). In fact, the B2B tablet market A wide range of businesses is making greater use of
could be a USD 4 billion business by 2015. mobile enterprise applications in these categories.
RECALL No 19 – Innovation and product development
IQ innovations: The future of smart 19

In the insurance industry, roving, field-based claims New form factors. Today, smart devices sport the logos
adjusters are a prime example of how smart devices of many brands, but there is little variation in their
lower costs and boost efficiency. Traditional tools for physicality. From phones to tablets, smart devices are
claims adjusters include an e-mail-enabled phone, a rectangular gadgets of similar width that users hold in
laptop computer, and a camera. Combined, this can their hands. This predictability, however, could soon
cost the insurance company over USD 800 each year change. First, advanced materials (e.g., nanomaterials)
per adjuster. With smart devices, consolidation is the will make for lighter, thinner, more durable, and more
key. One device not only does the job better (e.g., with flexible devices. Second, developments in user inter-
improved photo processing, faster booting, and longer face and experience (UIX) models will lead to devices
battery life), it does so at only half the annual operating that recognize gestures, sense pressure, determine the
costs – and significantly lightens the adjuster toolkit. immediate context, and even track the user’s retina.
Next is the convergence of operating systems. The look
Another example of the role smart devices play in the and functionality of the Mac App Store and the iOS
workplace comes from the healthcare industry. In App Store are increasingly similar, and the tiled layout
medical settings, tablets – particularly iPads – are format (e.g., Metro UI) for which Windows has become
used to enhance patient care. First, many physicians known will be consistent from PC to tablet to phone.
now carry iPads as their primary device. Instant access Finally, the chasm separating chipsets in computers
to electronic patient records, test results, and charts from those in smart devices is soon to be bridged. Intel
means much more efficient care delivery. Second, the will be launching its new Medfield line of x86 proces-
tablet is a convenient “port of entry” to the hospital’s sors, targeting the smartphone market, and ARM is
Web-enabled medical resources, making for a valuable projected to capture 20 to 25 percent of the notebook
“desk reference” even when a desk is nowhere in sight. market by 2015 according to iSuppli.
Finally, tablets enhance the physician-patient relation-
ship. They are becoming a part of the conversation in Combined, these innovations will open new doors to the
ways that more actively involve the patient in his or her ways users engage with their devices. More flexible form
own care. Using electronic health records demystifies factors will enable seamless switching between all devic-
clinical matters, and patient messaging applications es. This synergy may also give rise to an entirely new
are facilitating the interaction between physician and device: a phone-tablet-PC hybrid could join the tradi-
patient, while breaking down some of the barriers that tional devices by 2015. All in all, as smart devices morph
existed in the past. in form and function and blur the boundaries between
phones, tablets, and PCs, the competitive landscape will
Ultimately, for smart devices to be successful in the evolve accordingly. Mobile device manufacturers and PC
workplace, several stakeholders will need to act. OEMs might find themselves vying for the same custom-
Carriers, for instance, will have to broaden their foot- ers as they begin producing similar hybrid devices.
print and move from their traditional roles as band-
width providers into the realm of offering end-to-end Personal data capture. With the rise of online shop-
solutions. Operating system players have the opportu- ping, social networking, and Internet search, unprec-
nity to get in the game as well. While Apple is currently edented amounts of personal data are being generated.
in the pole position, Windows 8 has the potential to Estimates show a meteoric increase in the amount of
become a viable alternative, since CIOs prefer to run PC data from 1.2 zettabytes in 2010 to 7.9 in 2015. Every
applications for mobile and remote/virtual desktops. query, Tweet, and purchase contributes to the sea of
Finally, the necessity of confidentiality on the consumer consumer data. Alone, this would not be much more
side and data protection on the business side both mean than a mass of unstructured data points. However,
that the entire smart device ecosystem will need to work major investments in analytics capabilities will create
together to tighten security. order out of the growing data chaos. Apple, Facebook,
Google, and Amazon are all investing in technologies
Smart device developments that will allow them to track and analyze everything
from user browsing activity to offline personal data.
From macro to micro, the next set of developments will
have a direct impact on the features and capabilities of The personal data explosion will not just be one of vol-
smart devices themselves: ume. The types of personal data captured will also grow

as smart devices themselves become able to sense and tures. Soft SIMs will allow users to toggle between dif-
record user information. Capturing ambient factors like ferent carriers’ networks, and software-defined radio
altitude and temperature and biological factors such will enable users to switch between bands dynamically.
as pulse will paint an even more detailed user picture.
Beyond the “what are they doing?” industry players will Network operators can pursue several new business
soon have an understanding of “who are these users?” opportunities. Increased network capacity, for example,
This increase in data type, volume, and usability has the is creating a twofold trade opportunity: auction and bro-
potential to disrupt a host of industries. kerage. Carriers can trade spectrum real time as needed
(e.g., from high-capacity to congested networks), and
Advertising is but one area that will see a dramatic third parties can act as clearing houses, buying and sell-
shift thanks to real-time, location-based promotions. ing spectrum from and to network operators.
In 2010, mobile advertising captured only a very small
piece of the pie: about 1 percent of the USD 407 billion   
in revenues. By 2015, advertising revenue is projected
to reach USD 554 billion – and as a channel, the share of While the opportunities embedded within these innova-
mobile advertising is expected to skyrocket, increasing tions are significant, it will take serious consideration on
exponentially. As is the case for other industries, media the part of all players in the smart device ecosystem to
players can provide a personalized gaming experience, fully realize the potential. All of the technology advances
healthcare providers can monitor vital signs to keep discussed here shift the balance of power, giving users
abreast of patient needs, and retailers can optimize more freedom and flexibility than they ever had before.
product location and store layout. This means that control points that operators have over
their customers will become an increasingly insufficient
Soft SIM and radio technologies. The final device-spe- monetizing strategy. Distribution, materials sourcing,
cific disruptor would release users from a set of restric- consistent customer experience, and content delivery
tions that have defined smart device usage since their are strategies that carriers, device makers, OS players,
inception. New technologies will sever the tethers that and content and service providers will need to carefully
have traditionally bound devices to specific infrastruc- consider in the new world of smart devices.

Umit Cakmak
Venkat Atluri is an Engagement Manager in McKinsey’s
is a Principal in McKinsey’s Chicago office. Chicago office.

Shekhar Varanasi
Richard Lee is an Associate Principal in McKinsey’s
is a Principal in McKinsey’s Seoul office. Chicago office.
RECALL No 19 – Innovation and product development
More for the money: Managing the innovation portfolio 23

03 More for the money: Managing

the innovation portfolio

In many industries, innovation is the decisive differen- effective communications with investors. By adopting
tiating factor that distinguishes winning players. Still, good portfolio management practices, one company
innovating consistently over time remains a challenge. cut 15 percent of its R&D spend and 40 percent of proj-
Cross-functional governance, strategic alignment, and ects without affecting its competitive position. Another
evaluation and selection can help organizations manage shifted 20 percent of its R&D spend away from low-­
their innovation portfolios, taking breakthrough devel- value, incremental innovations to higher-growth areas.
opments from the serendipitous to the sustainable.
But managing an innovation portfolio well on a consis-
Innovation is a core element on most CEO agendas. tent basis can pose a challenge – even for companies
Leaders instinctively recognize its demonstrated ability with strong track records. In a recent McKinsey survey
to deliver profitable growth. In fact, carefully managing with over 700 senior executives, 70 percent stated that
an organization’s portfolio of innovations can prove to their company lacks a strong portfolio approach.
be one of the most effective tools a CEO has to drive stra-
tegic change and generate superior company value. This Managers often misunderstand what innovation
is why Fortune 500 “growth giants” dedicate billions of portfolio management is all about, confusing it with
dollars each year to research and development. execution-focused tools such as stage gating or technol-
ogy road mapping. Instead, it involves actively shaping
Innovation portfolio management focuses on the target­ the overall allocation of innovation resources to support
ed deployment of innovation resources. As McKinsey the company’s innovation strategy. Innovation portfolio
research into the performance of over 1,500 companies management essentially connects the “what” of innova-
from 1990 to 2005 shows: players that reallocate invest- tion with the “how” of execution to capture economic
ments more actively achieve a 2.5 percent higher CAGR value, manage risk, and make sure the portfolio aligns
in total return to shareholders. In parallel, the survival with the company’s overall strategy. Operationally,
rate of these active reallocators is 13 percentage points innovation portfolio management is a question of gover-
higher than of those who reallocate less (76 percent ver- nance, strategic leadership, and decision making.
sus 63 percent over a 15-year period).
Companies struggling with portfolio management tend
Thus, the benefits of taking a structured approach to to stumble into some common pitfalls. In governance,
managing an innovation portfolio can be considerable. they might delegate portfolio-related decisions exclu-
Leaders get the most out of their innovation-focused sively to the R&D organization or fail to review projects
investments. A well-managed portfolio of innovations across business units. Strategy missteps might be
helps to support the company’s strategic objectives. The neglecting to align financial aspirations with the portfo-
company is able to assess and manage portfolio risk lio value or investing to play, but not to win. Evaluation
levels. Plus, such an approach typically facilitates more pitfalls could include “not speaking a common lan-

guage” or using overly simplistic metrics. Some might „„ The company structures innovation portfolio man-
rely too much on net present value (NPV) analysis or agement into recurring cycles with specified mile-
easily measurable return-on-investment calculations. stones, consistent and transparent methods, and a
Others might overlook important factors or fail to assign limited number of agreed selection criteria.
option values to potential breakthrough innovations.
„„ Leadership ties innovation portfolio management
The problems that can arise are considerable. The re- cycles to the organization’s normal budgeting and
sulting portfolio might be incoherent, comprising small, financial control cycles.
fragmented programs. R&D focus could be misaligned
with strategy. Innovation efforts could even fail to gain „„ The entire organization employs a cascaded
real support from the business units. approach to innovation management that is handled
separately at the corporate, business unit, and
Leaders might also find their investments out of sync product category levels. The objective is to optimize
with opportunities – underfunding high-growth areas results across business units and categories, while
and overinvesting in low-growth ones. They might even managing the details at more granular levels.
be pouring too much money into new areas without fully
understanding the associated risks and opportunities. A multinational automaker provides a compelling
The bottom line: companies reap inadequate returns on example of how good governance can jump-start a stall-
their innovation investments – and investors remain ing innovation strategy. This company’s growth aspira-
unconvinced of the company’s innovation story. tions suggested that R&D investments were needed far
beyond the budget available. Corporate leadership chal-
Although difficult, successful innovation portfolio lenged the notion that insufficient funding was available
management is within the grasp of most companies. and thoroughly examined the innovation project busi-
One CEO of an electronics giant overcame business ness plans. They then set stretch cost targets based on
unit silos, little coordination within the R&D organiza- past best practices and staffed empowered, cross-func-
tion, and a technology-driven mindset by introducing tional teams with members from engineering, finance,
new governance processes. In another case, a specialty and controlling along with product line managers. This
chemicals player reopened the floodgates on its long- new governance approach ensured that the organization
term R&D pipeline by eliminating “bad” projects and was aligned behind key strategic projects, while reduc-
identifying new candidates using a dynamic new ide- ing expected lifetime development costs by over 30 per-
ation process. Faced with trouble finding game-chang- cent on a major new product platform.
ing innovations, another large conglomerate overcame
the challenge by redirecting top management attention Strategic alignment
toward the problem and funding a number of strategic
disruptions within the organization. Each success story Companies need to take specific actions to align innova-
relied on one of three key concepts that drive successful tion spending with overall organizational strategy and
portfolio management: cross-functional governance, objectives. They should set expectations for new growth
strategic alignment, and evaluation and selection. from innovation, determine the overall innovation
spending needed to meet the growth objectives, and
Cross-functional governance then size the investments by category (e.g., game chang-
ers, new markets), geography, time horizon (e.g., short,
McKinsey has identified the five elements of effective medium, or long term), etc. Finally, successful compa-
cross-functional governance: nies set spending limits to protect priority initiatives.

„„ CEO, CTO, and business unit leaders commit the A major specialty chemical company was unable to
time needed and demonstrate their willingness to meet its five- and ten-year growth targets because its
reach tough decisions on innovation portfolio issues. long-term innovation pipeline was not producing the
right products. Company leaders decided to rebalance
„„ The organization contributes fact-based, cross-func- the organization’s R&D portfolio, examining short-,
tional input to decision making processes involving ­medium-, and long-term projects and assessing them
R&D, business units, finance, and engineering. based on project NPV, risk, strategic alignment, market
RECALL No 19 – Innovation and product development
More for the money: Managing the innovation portfolio 25

One telco selected 20 to 30 topics for top-down budget allocation

Fixed Mobile
TV Triple/quadruple play Lean supply chain Customer applications Consumer market
Lean supply chain driven

Very high speed Internet Wholesale proposition Specific propositions Business market
Fixed/mobile integration driven

IPv6 Mobile network

upgrades (for data) Network driven

Efficiency and quality

Quality Electronic billing CRM systems driven

Licenses Testing/QA Innovation-driven Compliance Continuity and regu-

­network upgrades latory driven

attractiveness, competitive positioning, and likelihood damental economics and market attractiveness. They
of success. They introduced new idea generation pro- quickly killed projects with economic issues, then used
cesses to reinvigorate the R&D portfolio. Killing short- those resources for the remaining portfolio to increase
term projects with poor prospects – accounting for 20 commercialization rates and pursue new opportunities.
percent of portfolio spending – freed up the cash and
resources needed to pursue longer-term opportunities. Another example: a telecoms company was dissatis-
As a result, the company was able to fill its long-term fied with its existing (capital) investment allocation
pipeline with strong new projects with a value exceed- process. Annual bottom-up selection of approximately
ing USD 400 million, creating new organizational 1,000 proposed projects made it very time-consuming.
structures, metrics, and capabilities in the process, Coupled with this, R&D leaders would forecast budget
while improving its overall portfolio NPV by roughly overruns on existing projects halfway through the fiscal
50 percent. year along with projects added to the scope even after
the “freeze.” This forced R&D and business leaders to
Evaluation and selection review all projects again in order to reduce spend by cut-
ting back scope, postponing projects to the next fiscal
Business leaders need effective ways to screen, rank, year, or even cancelling projects altogether. The nega-
and optimize R&D opportunities. Effective screening tive side effects: postponement costs (stop/start) and
ensures that projects fully align with corporate strategy, sinking employee morale.
while providing a way to objectively evaluate the relative
attractiveness of competing projects. Companies then The telecoms company changed its innovation selection
prioritize projects to generate the most value possible, process dramatically. It began following a top-down
and finally, optimize the portfolio by introducing a sys- approach. Parallel to the business plan cycle, the overall
tem of checks and balances that eliminate ineffective innovation budget (excluding a contingency) was first
efforts and identify blind spots. allocated to 20 to 30 strategic topics before being broken
down to a project level (see table above). This forced
One manufacturer wanted to increase the returns its both R&D and business leaders to make inevitable stra-
projects generated. To this end, company leaders devel- tegic trade-offs early in the process rather than at the
oped a systematic approach to evaluating projects by end. The company also required any budget overruns to
creating an objective risk grid to test each project’s fun- be corrected within the business topic grouping. Finally,

the organization performed checks of its company-wide

R&D portfolio using various “lenses” to correct unin-
tended imbalances of technical/commercial risk, time
to market, or scarce resources.

  

Innovation’s link to profitable growth is undeniable, but

finding success in innovation portfolio management
remains a significant challenge. Companies interested
in either creating or reviving an innovation portfolio
management system can take a number of important
actions to ensure success in terms of economic returns,
strategic alignment, risk management, and investor
communication. Establishing cross-functional gover-
nance, ensuring strategic alignment, and developing a
system of project evaluation and selection can help lead-
ers produce the innovations they need in time and on a
consistent and sustainable basis.

Vanessa Chan Marc de Jong

is a Principal in McKinsey’s is a Principal in McKinsey’s
Philadelphia office. Amsterdam office.

Hender Grievink Christopher Johnson

is an Engagement Manager in McKinsey’s is an Engagement Manager in McKinsey’s
Amsterdam office. Philadelphia office.
RECALL No 19 – Innovation and product development
Design to value: Consumer-driven cost control 29

04 Design to value: Consumer-driven

cost control

Tight control over product cost is becoming increasingly other factors. Infrastructure operators want to mini-
critical for telecoms equipment makers. Smart deci- mize their initial deployment costs, but they are equally
sions must be driven by a better understanding of what concerned about the need to maintain and upgrade their
customers really value. networks as demand evolves. Even consumers with lit-
tle money to spend on a mobile handset want to be sure
In many important telecoms markets, being able to they will be able to access the same services enjoyed by
make products at ever-lower cost is crucial. Manufac­ their more affluent friends and relatives.
turers face the challenge of minimizing complexity
while delivering powerful and multifunctional prod- In this context, the most successful companies are mov-
ucts. Base station equipment must be robust but afford- ing away from the idea of blanket cost reduction to a
able for rural use in developing economies. Handsets new approach that focuses on identifying the product
need to satisfy the demands of tech-savvy youth while attributes that customers value most, then delivering
remaining inexpensive enough for this cash-strapped these at a cost that allows for competitive pricing while
segment. The “functional but affordable” imperative is keeping margins intact. McKinsey calls this “design to
on a steep future trajectory. Some of the most significant value.” With it, telecoms equipment makers have deliv-
growth opportunities in the sector will rely on the avail- ered gross margin improvements from 10 to 15 percent
ability of products that are even cheaper than they are over a typical 18- to 24-month period. Along the way,
today. Even at the higher end of the market, the entry of they were able to exploit rapid savings, making such
new low-cost players providing everything from smart- improvement projects self-funding. At the end of the
phones to switches is intensifying price competition. process, they have stronger product development func-
This trend is forcing all equipment makers to focus on tions as well, with departments working together more
reducing the costs of manufacturing, selling, and sup- effectively and with greater momentum in the organiza-
porting their products. tion for broader product and portfolio improvements.

Opportunities to reduce costs arise across the entire Understanding what customers value
product life cycle. While sourcing, manufacturing, and
aftersales support are obvious components in a product’s Design to value begins with a deeper understand-
lifecycle costs, these phases aren’t necessarily the most ing of exactly which product features customers want
cost-intensive. Over 50 percent of a product’s lifecycle and what they are prepared to pay for them. For all
costs are determined before manufacturing even begins, but the very simplest products, purchasing decisions
during the concept and design phases (Exhibit 1). involve complex and subtle trade-offs between dif-
ferent features. Customers can rarely articulate the
The first two phases are also key for customer’s sense of value they attribute to a particular feature in isolation.
value. Price is important to customers, but so are many Fortunately, modern market research techniques can

01 The largest share of product cost is determined early in its life cycle
The largest share of product cost is determined early in its life cycle

1 2 3 4 5
Product Aftersales
Product design Sourcing and supply
concept support

6 Quality management

 Market insights  Features/specs  Vendor identi-  Manufacturing  Customer support

 Concept/indus- definition fication  Supply chain  Product improve-
trial design  Detailed design  Negotiation and management ment
 Target market agreements
 Pricing

Costs incurred (of total product lifecycle cost)

Costs impacted by
> 50 product concept/
design stages

Product concept Sourcing Manufacturing Aftersales Total

and design and supply chain support


provide a good indication of what the customer’s percep- ter segment would actually place more value on a thick-
tion of overall value comprises. er, more robust unit, even if it is cheaper to produce.

An established technique that gives companies a rich Cost-optimizing tools

understanding of consumer needs is conjoint analysis:
presenting customers with various hypothetical prod- Once they have built up a detailed, quantified under-
uct configurations and price points, then asking them to standing of customer needs, equipment makers can
choose between these. Regression techniques applied to identify opportunities to deliver on those needs at lower
their responses help isolate the effects of individual fea- cost. Leading companies that have made design to value
tures on the customer’s perceived product value. pivotal to their strategies make use of an array of tools to
identify and exploit cost reduction opportunities.
If a company understands the incremental cost of add-
ing a particular feature to a product, it can use conjoint Competitive teardowns involve dismantling competitor
analysis results to understand not only the most impor- products side by side to identify cost reduction opportu-
tant features for its customers, but also the most profit- nities. Do competing products have simpler packaging?
able ones. Certain network infrastructure features like Have part counts been reduced and assembly simplified
power management, for example, may prove valuable by replacing separate fasteners with molded snap fits?
enough to add to the initial chassis design. Teardowns are an opportunity for equipment makers to
identify competitor cost-savings approaches and adapt
Similar analysis across different customer segments them to their own needs as appropriate.
can also help companies plan their product portfolio:
Which features should be included in all products? Platforming and modularization. Companies with
Which should be used to differentiate a premium offer- complex product portfolios can frequently achieve
ing? Sometimes, distinct segments have markedly dif- significant savings in engineering, procurement, manu-
ferent value perceptions. Some customers may want facturing, and product support by reducing the number
an ultraslim handset; others might tend to avoid such of components used across their product range based
designs due to quality and durability concerns. The lat- on platforming and modularization strategies. Building
RECALL No 19 – Innovation and product development
Design to value: Consumer-driven cost control 31

multiple products for different user segments with the their actual achievements. Avoiding this requires a dis-
same basic architecture can dramatically cut costs and ciplined, cross-functional approach.
provide significant margin increases at the high end.
Some of the most successful companies establish cross-
Successful modularization programs rely as much on functional teams to ensure that their cost reduction
strong governance as they do on smart engineering. efforts withstand external forces. These teams – typi-
Companies may rigorously measure adherence to an cally comprising representatives from the equipment
agreed parts list in new product development, for exam- makers’ engineering/design, sourcing, operations, and
ple, and require product teams to justify deviations marketing functions – carry out three primary activities.
from the list on a case-by-case basis.
Target setting. Such a team sets cost targets for dif-
A key part of platforming is component standardiza- ferent commodity groups. Ideally, these targets are
tion, leading to higher purchased volumes for each established on a “clean sheet” basis by looking at the
component type. This typically yields cost reductions best practice achieved by competitors in their own and
and quality improvements for every product that uses in other industries. The team then determines the gap
the components. The approach is not risk-free, however. to the company’s current performance.
If a quality issue or supply interruption does occur in a
highly standardized environment, it may affect a large Action plan design. The cross-functional team will then
share of a company’s product offering. Knowing this, agree on action plans to achieve the required improve-
companies must ensure they identify strategically criti- ments in each commodity. Members meet regularly to
cal component groups and focus their supplier quality ensure that the organization’s cost-optimizing activities
assurance and risk management efforts on those. are aligned with the plan.

Design for sourcing. Smarter use of external component Performance monitoring. Finally, the team is charged
suppliers is another area where companies can achieve with assessing the actual improvements in cost perfor-
significant cost reductions. Could one design-specific mance and checking progress in this area against the
part be replaced with a standard one from a supplier’s targets. This assessment is carried out on a regular basis
portfolio? Could material specifications or surface and for each of the commodity groups. Since external
treatment options be altered to better match supplier factors can change and progress issues may arise, the
manufacturing capabilities? Such decisions are com- team revisits the action plan and revises it accordingly.
plex, requiring input from the purchasing, product
design and engineering, and product management McKinsey’s work with equipment makers around the
functions. They also require a detailed understanding globe has demonstrated the undeniable power of the
of supplier capabilities and cost drivers. To make these design-to-value approach for telecoms and other equip-
decisions, the best companies engage with potential ment segments, both in developed and in emerging
suppliers early on, before product specifications are markets. While many companies can navigate well in the
finalized, and they hold regular cross-functional meet- familiar territory of their local markets, many of them
ings to evaluate options. struggle in China and other low-cost countries, where
they face severe price competition with local players. The
“Clean sheet” costing. Finally, equipment makers can price difference is sometimes 40 to 50 percent between
build detailed, bottom-up should-cost models for com- products with comparable levels of functionality.
ponents and services. Using McKinsey’s proprietary tool,
companies can effectively negotiate with suppliers and   
assess cost reduction opportunities on an ongoing basis.
A true understanding of what local customers value
Making optimization happen and how to adapt technical specifications to “local stan-
dards” can deliver equipment makers with a global foot-
Many companies start off with bold ambitions to reduce print the winning hand in important growing markets.
product costs dramatically, only to find that events – On the road to achieving this, design to value is not only
from fluctuations in material and component prices a tool to control costs, but also a lever to open doors to
to last-minute requests for additional features – erode new and exciting growth opportunities.

Aaron Aboagye Abhijit Mahindroo

is a Principal in McKinsey’s is an Associate Principal in McKinsey’s
New Jersey office. Silicon Valley office.

Tobias Strålin
Dmitri Mishustin is a Principal in McKinsey’s
is a Principal in McKinsey’s Tokyo office. Stockholm office.
RECALL No 19 – Innovation and product development
Insight traps: Missteps in consumer research that can make products worse 35

05 Insight traps: Missteps in consumer

research that can make products worse

Companies already understand just how critical cus- causes that create critical disconnects in the product
tomer insight is to product success. What they often development process. These are the “insight traps” that
overlook, however, is how misguided, incomplete, or ultimately lead to commercial disappointment.
unheeded feedback can turn a technical innovation into
a commercial catastrophe. Targeting the wrong customers

Many of today’s product companies have invested heavi­ It is exactly a company’s efforts to engage their custom-
ly in the expertise, tools, and processes that allow them ers more closely that leads them into the first trap. The
to create complex, high-performing designs that are top 10 percent of “power” users are most likely to explore
easy to manufacture and which perform reliably, even the limits of existing product designs and offer improve-
under tough conditions. Usually, these achievements ment ideas and feature requests for subsequent models.
are completed remarkably quickly, as technologies Unfortunately, these users may operate equipment in
evolve ever more rapidly and product life cycles shorten. ways that bear little resemblance to the habits of most
customers. This can result in products that are cost-
Too often, however, these brilliantly designed and engi- prohibitive or too difficult to operate.
neered products have one significant flaw: they are not
what customers want. Customers find the product too Engaged but unrepresentative user groups can take
expensive or too complex, or the product itself lacks many forms. In the car industry, for example, motoring
critical features or underperforms in important ways. journalists, visitors to car shows, or track-day enthusi-
Regardless of the specifics, the result of this mismatch asts might be high-profile proponents of certain aspects
between consumer desire and product innovation is of vehicle design and styling, but their priorities could
always the same: the product fails commercially. have little in common with the vast majority of everyday
road-going users.
What is often perplexing to product companies is that
they actually invested in consumer insight research Similarly, some companies fall into the snare of design-
before bringing the product to market. So if the needs ing products to suit the needs of their one or two largest
and behaviors of customers were explored, why do these clients, rather than those of the majority of customers.
products fail? In all cases, problems arise not because The pressure to do this is understandable: beyond the
the engineers and designers lack the appropriate skills, aspect of financial importance, companies usually
but because they are basing their design decisions on an spend more time talking to their top customers. But
incomplete or erroneous picture of customer needs. altering products to suit the requests of such a small
minority can risk alienating the largest set of users and
McKinsey’s work with product development leaders also divert development resources from improvements
has led to the identification of four common underlying that might have wider appeal.

Clinical complexity: When more is less

in medical product innovation

Sometimes, companies have a mistaken impression was particularly problematic in their busy, high-
of who their real customers are. Two examples of pressure clinical environments where speed, sim-
how insight from the wrong target group can lead plicity, and reliability were much more important.
to lackluster sales come from the world of medical
equipment manufacturers. Another medical device company had focused its
design efforts on the requirements of surgeons.
One company worked closely with a small num- When it observed operations and interviewed par-
ber of research hospitals when refining its design ticipants, however, it discovered that physician’s
of an imaging machine. These users applied the assistants and scrub nurses were also essential
machines to a wide variety of difficult tasks. Given operating room team members. Plus, they needed
the scope of usage, they wanted a high degree of to use this particular device during surgery. These
control over the machine’s operation and data pro- two groups were quite influential in the hospital’s
cessing. When the company built devices to these purchasing decisions, but their input wasn’t sought
specifications, they quickly learned that the appeal during the design phase. Unfortunately, their needs
was not at all widespread. While the test group val- differed from those of surgeons in several impor-
ued control, regular clinical users found the extra tant ways. The outcome: the final product ended up
flexibility simply added unnecessary extra cost and only satisfying the requirements of one-third of the
made the machines harder to use. This complexity operating room staff.

Companies can circumvent this trap by making sure product development units inside emerging markets
that they engage with a truly representative customer and staffing them with local employees, who can bring a
sample as they build their understanding of user deep knowledge of regional tastes and market require-
requirements. Achieving this is not difficult, but it does ments. This approach has led to some radically differ-
take a relentless push by management to ensure the tar- ent product designs, often sacrificing a relatively small
get customers are correctly identified. If a survey is used amount of performance for dramatic cost reductions.
to gather product design information, for example, the
company should be certain that it surveys a group that Asking the wrong questions
represents the overall market – including the customers
of competitors, not just its current users. The second trap companies fall into as they develop
the requirements for new products is asking customers
The mistake of only targeting existing customers rather what they want, rather than what they are willing to pay
than the full range of potential customers is becoming for. When people are asked open questions about their
increasingly important. In established markets, this product requirements, they tend to ask for higher speci-
approach risks missing out on crucial aspects of product fications than they currently enjoy or focus on nice-to-
design that may stop some users from making purchas- have features that aren’t really central to their purchase
es. As markets expand, it may prevent companies from decisions or product use. Companies that build their
understanding that the requirements of some poten- specifications on the basis of such requests can end up
tially very large user groups vastly differ from those of with expensive, feature-laden products that customers
their established customer base. find interesting but don’t actually want to pay extra for.

Many Western companies have struggled to sell in high Companies can avoid this trap by making use of discrete
volumes in emerging markets like India and China, for choice modeling techniques in which customers are
example, where few customers can afford their prod- asked to compare different product configurations with
ucts. Some have overcome this issue by establishing different feature sets and to say how much they would
RECALL No 19 – Innovation and product development
Insight traps: Missteps in consumer research that can make products worse 37

be willing to pay for each. Such techniques allow compa- Failing to convert good insights into
nies to understand exactly how much value customers great products
place on specific features and compare that with the
cost of implementing them. This knowledge allows them The final trap that snags many companies is a failure
to position their products much more intelligently, find- to turn useful customer insights into real products.
ing sweet spots in the market where product margins Sometimes, this results from a failure to translate cus-
are likely to be highest. tomer requirements into clear product specifications.
But just as often, we see engineering teams working
It isn’t only customer buying habits that are likely to with lists of specifications that they simply can’t deliver.
differ from their claims in interviews. Real-world deci- Faced with the need to make trade-offs in order to man-
sions about many other aspects of product use – from ufacture a product at the required price, design teams
the foods we choose to eat to our adherence to mainte- may reach compromises that make sense to them but
nance schedules – are likely to differ markedly from turn out to be far less appealing to customers.
what we hope we would do in ideal circumstances. To
avoid the risk of designing products for customers’ ideal Companies can sidestep this trap by building a better
selves – rather than their actual selves – companies will understanding of product design capabilities into the
need to ensure that they supplement interview data with upstream concept definition phase. Some of the meth-
information from other sources. Ethnographic research ods described above can be used to accomplish this:
on the way products are used is helpful here, while data discrete choice studies, for example, can yield a better
from field service and repair operations can reveal a understanding of what features customers consider
great deal about the conditions products must endure ideal or reveal their price trade-offs. Bringing manu-
when they are used under real-world circumstances. facturing and sourcing specialists into teardowns can
help teams decide whether the company has the internal
Not acting on the available data capabilities or the external supply relationships to adopt
alternative technologies or production processes.
Even when they manage to collect rich data from appro-
priate customer targets, many companies fail to give What is also important is that development teams are
that valuable information enough importance when it transparent about the trade-offs they make during the
comes to specifying future product design. Usually, this design process. Engineers may make hundreds of such
is because tradition, personal experience, or some other choices when developing a product, and few are subject
form of bias prevents decision makers from accepting to formal review by management. To avoid bogging
the evidence that they should revise their approach. down decision making in endless discussions, compa-
nies can help their engineering teams by making their
Competitive product teardowns are good examples of requirements clearer up front by, for instance, creating a
this issue. Many companies carry out such teardowns, rank order prioritization of proposed product features.
in which they compare the specifications and engineer-
ing approaches used by rival products with their own. Manufacturing and sourcing expertise can bring tre-
Often, however, existing product design teams run mendous value during the engineering process too,
these exercises. As a result, they have a tendency to use helping design teams ensure that they are not inadver-
the differences they identify as retrospective justifica- tently adding unnecessary cost or complexity. McKinsey
tion for their own design decisions, rather than as an has observed processes in which designs are taken to a
opportunity to question them. high level of maturity before teams even review the cost
implications of their decisions. One example of this was
The first step in overcoming these forms of bias is sim- the use of expensive application-specific integrated cir-
ply recognizing that they exist and ensuring that key cuits in low-volume products, when a cheaper general-
assumptions are regularly questioned to be certain that purpose chip could have done the same job.
the available data still supports them. An important
second step is to introduce new perspectives into the All of these customer insight caveats are only useful if
discussion – by rotating design team members or bring- the product company’s culture and values support the
ing in personnel from other teams or business lines to development of products that meet consumer needs.
conduct competitive teardowns and design reviews. Companies will have to ensure that their incentive

systems aren’t fostering the wrong behaviors among

their R&D personnel. Are employees incentivized for
launching products on time and on budget, rather than
for launching successful products? Or are they more
likely to be rewarded for launching a weak product than
abandoning it? Is a product’s success measured by sales
revenue rather than profitability, encouraging teams to
make expensive, feature-rich designs? In some cases,
incentives are fragmented to such a degree that, while
every individual is rewarded for the part they play in the
product development effort, no one is truly motivated by
the product’s ultimate success.

  

Companies sometimes find that their investment in

design engineering and product innovation yields
disappointing commercial returns. Such products are
often doomed from the outset because they simply fall
short of meeting customer needs – despite the com-
pany’s commitment to consumer insights research.
Organizational commitment to getting the right type of
insights from the right consumer base and then turn-
ing these insights into action can mean the difference
between technical innovations that flop and products
that consumers clamor for.

Dave Fedewa
is a Principal in McKinsey’s Atlanta office.

Jim Williams
Asutosh Padhi is a Practice Manager in McKinsey’s
is a Director in McKinsey’s Chicago office. Seattle office.
RECALL No 19 – Innovation and product development
A billion buyers: Product innovations for a new consumer class 41

06 A billion buyers: Product innovations

for a new consumer class

Emerging markets are characterized by more than just This story, however, extends well beyond China, as
low-cost production. Economic growth is lifting mil- countries throughout Asia, Latin America, Eastern
lions out of poverty and leading to a rise in consumer- Europe, the Middle East, and Africa play their roles
ism. Will players in telecoms, media, and high tech be in global economic rebalancing. The demographics of
prepared to meet the specific demands of a growing emerging-market demand are shifting: by 2020, 40 per-
middle class around the globe? cent of the world’s population will have reached middle-
class status – compared with less than 20 percent today.
By now, most companies have heard the siren’s song of This means that real per capita income will double in
emerging market growth. Still, today’s shifting global emerging markets and unprecedented levels of new
economy may result at a scale and with implications middle-class consumer demand will arise. In pursuit
that could indeed be more dramatic than most believe. of sating the appetite for modern improvements arising
For instance, predictions that emerging markets will from these new consumers, many companies are failing
collectively add more growth to the world economy over to recognize the essential distinguishing features of the
the next decade than all mature-market countries com- demand they are attempting to satisfy.
bined suggest that such countries could be an impor-
tant component in multinational corporation (MNC) The face of a new consumer
strategy. This is the first time such significance has
been achieved since the industrial revolution, when the In emerging markets, there are a multitude of distinct
United States was itself an emerging market. Thus, hav- customer groups with very different needs. These
ing a plan to address new customers in today’s emerging customers number in the hundreds of millions, but
markets seems more like an imperative. addressable market concentrations are distributed
across many nations and scores of cultures and ethnici-
China has headlined the growth story, racing from being ties. Geographic and societal differences are reflected in
an economic afterthought twenty years ago to its cur- diverse consumer needs and wants. Emerging-market
rent position as the world’s second-largest economy. It consumers are exhibiting extremely sophisticated and
has accomplished this, not merely as a manufacturer continuously evolving purchasing behaviors. They are
of low-cost goods, but by developing its own advanced less influenced by global brands and are no longer sat-
industry base and making its way toward employing isfied with “yester-tech” and products that have been
the largest population of R&D workers in the world. discontinued in the mature markets. Consumer tastes
Companies still thinking that China only excels at man- and preferences in emerging markets will evolve just
ufacturing based on intellectual property from abroad as rapidly – if not more so – as those of consumers in
should consider firms like Huawei. It applied for more developed markets. They will demand products tailored
patents than any other company in the world in 2010 – to their needs and of the same quality as those found
no US corporation was among the top 10 in applications. in more advanced economies, but at much lower price

01 Conducting R&D locally helps to achieve better local insights and to lower
Conducting costs
R&D locally helps to achieve better local insights and to
lower development costs
Corporate objectives for R&D in emerging economies, by focus
Percent of respondents1

Global product platforms Local innovation in emerging economies

n = 211 n = 184

Lower development costs 44 26

Better access to local con-

36 39
sumer insights

Access to larger talent pool 23 22

Proximity to local manufactur-

20 24
ing and production

Access to proprietary relation-

14 15
ships and intellectual property

Government incentives 12 14

1 Respondents who answered “do not know” or “other” are not shown
SOURCE: 2011 McKinsey Global R&D Survey

points – as little as 30 percent of developed market structures are radically reengineered. Such products
prices. In this melting pot of opportunities and chal- are derived directly from a deep understanding of the
lenges, local and global innovators will have to compete particular needs and resources of projected end users.
to identify the best solutions. They span every consumer category from telecommuni-
cations and high tech to durables and household goods,
In the past few years, the primary competitors in most differing significantly from their “global” counterparts
emerging-market segments transformed into local in qualitative aspects. Local, contextual insight into
innovators. Given their understanding of local needs, specific concentrations of emerging-market demand
they were able to gain market share with tailored prod- has thus become the engine that drives leading-edge
ucts, low price points, and broad customer reach. innovation (Exhibit 1; see also text box).

By utilizing customization to meet user needs, local Unilever serves as an example of such localized inno-
companies have proven to be inventive in creating new vation success. This MNC entered emerging markets
markets. Galanz, for example, decided to design and in a competitive market space with its Wheel brand
manufacture microwave ovens tailored to the domestic laundry detergent. At first, the price points were too
market. These have six different cooking programs for high: Wheel was priced 40 percent higher than the local
rice. Individual units were priced at USD 50, and the competing product, Nirma. Unilever quickly identified
product targeted China’s newly emerging middle class – the challenge and reduced the concentration of active
at a time when only 2 percent of Chinese households ingredients in order to meet local requirements and the
owned microwave ovens. Today, Galanz has become the local price point. The company also innovated products
world’s largest microwave oven manufacturer. to meet local out-of-pocket spending behaviors with
small-sized packages. Following these initial experi-
Successful product innovation ences, Unilever significantly broadened its knowledge
base for each product category.
Hundreds of individual products – most of which are
designed and produced within and for emerging mar- In the area of medical devices, GE developed one of the
kets – are revealing a trend in which price and cost first heavily market-tailored products by collaborating
RECALL No 19 – Innovation and product development
A billion buyers: Product innovations for a new consumer class 43

Tailored telecoms: Indian insights

and innovation

Nokia looked to India as an emerging-market labo- ness of unreliable electricity in many rural areas in
ratory. As the first multinational company to enter India. This led to developing new features – includ-
the consumer electronics market, Nokia invested ing longer battery life and a one-touch flashlight
heavily, establishing R&D facilities and a design function – all delivered at a cost of not much more
studio in Bangalore and developing the first mobile than USD 10. Nokia also found out that users con-
phone with menus in Hindi in 2000. The team sider agricultural information very important to
researched the needs of the rural population. The better equip them to negotiate with agents, but are
results were eye-opening. constrained by access distance and cost. Armed
with this insight, Nokia invested in services that
While language is consistently a region-specific provided agricultural market price information and
differentiator, other segment needs are often less weather forecasts – plus cricket match results and
obvious. Nokia’s research revealed the pervasive- other local, entertainment-related information.

with small Indian hospitals and with paramedics to price they can afford – and all of this at the right time
design the MACi ECG device. Problem areas for the local and the right place. Innovations must be holistic solu-
market were the product’s dependence on electricity, its tions. Innovators need to master the overall value chain,
high price, its lack of durability, and poor usability for choose the right infrastructure, and build capabilities
non-trained paramedics. The result: a MACi device that and mindsets. In their rush to establish presence in
is battery-operated, portable, and capable of complet- emerging markets, even the best-performing global
ing 500 three-channel ECGs for every three hours of companies have not always considered what they
battery charge. At USD 500, the price is low compared needed to do to achieve sustainable success. On its many
with that of a “regular” ECG machine, typically costing journeys with global clients, McKinsey has worked with
USD 1,500. GE also innovated within the value chain, top management to transcend conventional thinking
structuring financing through national banks to offer and the static strategies responsible for early failures.
zero-interest loans. More importantly – after being suc- In these relationships, McKinsey established numerous
cessfully introduced in emerging markets – this innova- paths to emerging-market success.
tive product was successfully launched to create a new
market in developed countries. Among the few constants of the innovation approach are
granular local knowledge, substantive local input, and
Given the mismatch between price points and features relentless top management commitment. Successful
and local needs, standardized products frequently fail paths to innovation have overarching themes that can
to address the requirements of diverse emerging-mar- be summarized in four interconnected requirements.
ket populations. For mature-market leaders, the reduc-
tion of product cost structures by 50 percent (or more) Contextual insight. Clearly identify and frame the
is the key to reaching and meeting the massive new problem in context. Of particular importance is deter-
emerging-market demand. This requires breakthrough mining who the consumer population is. A typical first
innovation – experience suggests that 30 percent is the step toward fulfilling this requirement is to granularly
upper limit for “cost-out” potential in existing designs. segment customers and compile in-context insights.
McKinsey research has, for example, identified “12
Meeting market demand Indias” and “6 Chinas,” each with distinctive local cus-
tomer preferences and unmet needs. The contextual
Only groundbreaking innovation can fulfill the major- toolkit includes ethnographic studies, shop-alongs,
ity of emerging-market aspirations, providing new competition scans, and in-context interviews. Some
and savvy consumers with the solutions they want at a global companies have bypassed the granular analysis

that would reveal this differentiation and deployed supplier partnerships can be initiated and developed.
strategies focused on introducing preexisting products A go-to-market strategy requires innovative approaches
to emerging markets as fast as possible. The lessons to effectively reach fragmented distribution and remote
they have learned by taking such static approaches areas. An example of such an innovative approach is the
have proven costly, e.g., missing price points, failing to thousands of micro-entrepreneurs in India deployed so
provide local features. In contrast, low-cost solutions effectively by Coca-Cola and Unilever.
that use copycat design (known as “shanzai” in China)
have proven to be successful on many occasions. This is Organizational setup, capabilities, and mindset. Global
especially true if improved features and extensions have companies are learning through experience that success
been included. The success of shanzai mobile phones – demands considerable knowledge and investment –
with their improved texting, dual SIM cards, and other and an intense focus on emerging-market innovation.
advanced features that meet local customer needs – In China, for example, 1,000 multinational companies
demonstrates that companies should consider copycat already have operating R&D centers. Manufacturing
design solutions, despite the fact that these phones are can often involve non-standard supply chains, and
often dismissed as brand name knockoffs. delivery can require assembling complex, localized dis-
tribution networks. Some global leaders have hesitated
Holistic solutions. Use technical and commercial to make the required investments, however, and have
insights to build in profit for all stakeholders. Holistic done so for understandable, if short-sighted, reasons.
concepts address the entire local value chain with
durable and complete stakeholder-focused solutions. Experience has shown that preexisting mature-market
The overall objective of achieving extreme cost targets innovation organizations are inadequate for meeting
involves active collaboration and support in concept the challenge. When entering emerging markets, key
development from value chain partners. Product tear- talent needs to be hired or trained – often within a very
downs yield key insights, robust cost benchmarks pro- short time frame. New organizations must retain local
vide a basis for accurate cost targets, and “should-cost” top talent using a tailored model to be attractive to the
models accelerate solution development. To account for local population. In India, for example, this means fast
limited technology reach to emerging-market consum- promotion cycles and a hierarchy that works in the con-
ers, visual quantitative surveys and in-depth respondent text of the local culture. New structures must encourage
orientation can replace traditional conjoint analyses. technical and commercial functions to work together
using cross-functional task teams. To effectively mobi-
McKinsey has observed that holistic solutions can arise lize the local team, the company needs to understand
from frugal local engineering, especially in financially and adapt to local mindsets, rather than transplanting
disadvantaged emerging markets. Behind this “do-it- its own mindset to the new geography.
yourself” phenomenon is urgent consumer demand
that remains otherwise unsatisfied. Dozens of small   
companies in China, for example, are producing electric
cars at a cost of USD 2,500 to 5,000. These cars travel at A burgeoning global middle class is putting disposable
slow speeds (around 50 km/h) and have limited range income in the pockets of hundreds of millions of con-
(100 km), but they are a dramatic step up from bicycles sumers for the very first time. Their needs, however,
and they meet the needs of a large consumer base. are just as varied as the geographies in which they live.
Companies who want to take full advantage of these
End-to-end systems. Sustainable performance requires new emerging-market segments will abandon the one-
an end-to-end system that covers the supply chain, the size-fits-all mindset. The successful and sustainable
manufacturing footprint, and the go-to-market strat- approach to product innovation in these markets will
egy. Key questions regarding the manufacturing foot- consider a host of local realities such as language and
print are the extent to which manufacturing should be culture, economics and price points, and environmental
outsourced to local partners and how sustainable landscape and infrastructure.
RECALL No 19 – Innovation and product development
A billion buyers: Product innovations for a new consumer class 45

Derrick Kiker Karin Löffler

is an Associate Principal in McKinsey’s is a Practice Specialist in McKinsey’s
Chicago office. Munich office.
RECALL No 19 – Innovation and product development
Managing talent: How world-class R&D organizations do it 47

07 Managing talent: How world-class

R&D organizations do it

Strategy and portfolio management are important fac- exist among industrial labs. Yet many research institu-
tors in research and development, but nothing shows as tions don’t understand how well they are doing because
high a correlation with performance as the management the people who work there wildly overestimate their
of talent harbored within R&D teams. own performance. The same McKinsey study revealed
that 12 percent of respondents consider their own lab
Of the USD 1.2 trillion spent globally each year on R&D among the top 1 percent in R&D productivity, and
across corporations and academia, 40 percent – by far 70 percent believe their lab to be in the top 25 percent.
the largest component – pays for people. To discover Most researchers don’t know how productive great labs
what drives research productivity in labs, McKinsey are or how they become great. In fact, most labs can
recently conducted a study entitled SuccessLab to assess how well they do only by basic output measures.
interview and survey world-class researchers. The pool A halo effect further distorts perceptions: researchers
of respondents comprised 4,500 researchers in 260 who think that their lab performs well assume that its
laboratories in academia and a range of research-based talent management practices are also strong.
industries such as automotive, basic materials, high
tech, and pharmaceuticals. The outcome was that – The elements of talent management
regardless of specialty or industry – the best R&D labs
share behavioral patterns across at least six key prac- Talent management isn’t simply about hiring the best
tices: talent management, strategies and roles, collabo- people; not everyone can. It’s about managing talent
ration, problem solving, portfolio and project manage- appropriately based on selection, recruitment, develop-
ment, and business and market alignment. ment, and rewards. Just about any lab can do this, yet
many don’t. SuccessLab looked at each of these areas,
Subsequent analysis then revealed which of these fac- and while all are correlated with performance, some
tors had the greatest bearing on lab success. More than matter more than others (Exhibit 2).
anything else, talent management is what the best R&D
operations consistently get right. While all six practices Recruiting for potential. Managing talent starts with
correlate clearly with high performance, the talent fac- recruiting the right team members. In response to one
tor is the most important driver behind a lab’s produc- SuccessLab question, the head of one top-ranked aca-
tivity. The talent management practice also shows the demic lab explained that “the most important intrin-
highest opportunity for improvement, making this a sic [quality] we look for is scientific curiosity.” Great
tremendously powerful lever to boost R&D productiv- labs such as this one evaluate researcher potential by
ity, regardless of current levels (Exhibit 1). appraising their basic intellectual ability, general prob-
lem solving skills, and enthusiasm. They also test for
Top-quartile academic labs are five times more produc- cultural fit, an important factor supporting collabora-
tive than bottom-quartile ones. Similar differences tion, which in turn drives productivity. Candidates may

01 Talent management is the area where labs have the greatest potential
to improve
Talent management is the area where labs have the greatest potential
to improve
Improvement potential1
Percent of respondents

Talent man-
Effective problem agement
solving approach
Effective project and
portfolio management

Environment that Clear strate-
promotes collaboration gies and roles
0.55 0.60 0.65 0.70 0.75 0.80

Correlation of practice2 with high performance

r value (0 = no correlation, 1 = high positive correlation)

1 Defined as percentage of respondents within a lab who neither agree nor strongly agree that their lab is in line with the desired practice
2 “Alignment with the needs of the business and the market” was excluded in this analysis because of insufficient data
SOURCE: McKinsey

spend an afternoon devising answers to a specific ques- significant time with new researchers, mentoring them
tion or working in the lab together with the team. This continually. Such efforts flow into year-end reviews.
approach helps labs assess a candidate’s social skills and The most productive labs also require all researchers to
compatibility as well. Before reaching a decision, the draft annual personal development plans.
best labs also solicit the perspectives of team members
regarding each candidate. Recognizing success. Many researchers crave recogni-
tion, and labs have a number of ways to provide this:
Average labs typically place specific technical profi- acknowledgment in meetings, awards, and opportuni-
ciencies – say, the ability to use a piece of equipment ties to present at conferences or attend symposiums.
or to run certain tests – at the top of their list of hiring Even more recognition comes from offering high per-
criteria. Specific technical capabilities are sometimes formers opportunities such as larger research budgets,
required, but even when this is the recruiting focus, leadership of bigger efforts, and part-time professor-
top labs want people who can adapt to new roles as the ships. Such incentives can often motivate researchers
research evolves. Those new roles, especially in indus- more than monetary incentives, while costing far less
trial settings, should include project management and and lowering turnover significantly.
business experience – something many labs overlook.
Although recognition is important, it’s not everything.
Nurturing people. Talent management does not stop McKinsey found that researchers also want financial
once researchers are hired. During the course of rewards for superior performance. In the best labs,
SuccessLab research, another R&D executive said, such incentives are transparently linked to achieve-
“Many of our research leaders don’t have the capabilities ments – great research, publication in leading journals,
they need to succeed in senior positions in the organi- milestones, or successful patent applications. One lab
zation. We are trying to give people more experience awards small bonuses to researchers chosen by peers
across the business to round out their future leader- for being exceptionally helpful. Another offers stock
ship potential.” Unlike weaker counterparts, a top lab options for killing projects early to avoid wasting money
actively supports researchers’ development throughout on futile or low-value efforts. Many academic labs, how-
their careers. Senior team members, for example, spend ever, must rely more on non-financial motivators.
RECALL No 19 – Innovation and product development
Managing talent: How world-class R&D organizations do it 49

02 Some talent management activities are more important for high

Some talentthan others
performance than others
activities are more important for high

Correlation with high performance for R&D labs

r value (0 = no correlation, 1 = high positive correlation)

By area By activity
Recruiting for potential Talent selected to ensure cultural fit 0.74

Talent selected based on research experience 0.69

Talent selected based on intrinsic qualities 0.68

Lab members involved in decision to offer job 0.57

Nurturing people Members are supported by structured mentoring 0.69

Clear apprenticeship offered for new members 0.67

Members have personal development plan 0.58

Recognizing success Those who fail to deliver suffer consequences 0.68
Celebration of achievements is central to lab culture 0.68
Financial compensation is tied to performance 0.63

Building diversity There is turnover in the lab team 0.64

New members are from diverse professional backgrounds 0.58
SOURCE: McKinsey

Not everyone succeeds in the laboratory. Obviously, fail- agement is the one most in need of improvement. Even
ure should have consequences, but often it doesn’t. In the best labs can raise their game in this area, and their
one research unit, the weakest performers were moved research productivity can improve significantly even if
to another lab to initially address the issue. The best labs executives are already happy with current levels.
don’t tolerate poor performance for long. If foundering
researchers don’t improve, they are asked to depart. Since research is so important for many (if not most)
This entails the added advantage of being able to inject companies, these matters are clearly for the C-suite, not
the team with fresh talent and ideas. just research managers. Top executives should start by
focusing on practical, tactical actions: inquiring into
Building diversity. Another driver of high performance diversity of backgrounds, experience, and capabilities
is a diverse team of people with different backgrounds, among researchers; how the unit’s culture can foster
specialties, and forms of expertise to help solve prob- innovation; the development support researchers get;
lems. The most important aspect of building such a and alignment between incentives and performance.
team is to encourage turnover. Not only does weeding
out underperformers achieve this, but also fostering Research leaders who invest in great talent manage-
rotation to adjacent research areas, other geographies, ment will find that the related initiatives are easy to
different roles, or – for an industry lab – to the business implement and have high impact. What’s more, the
side of the company. To help researchers better under- incremental costs are far lower than those stemming
stand the needs of business and to create a greater appe- from other approaches to raise productivity such as
tite for career opportunities outside R&D, one commer- restructuring or investing in new facilities.
cial lab organizes regular presentations by former group
members who have rotated into business positions.   

High improvement potential – even at the top Six key factors drive successful research labs. Among
them, talent management shows the highest correlation
Of the six critical practices that influence a lab’s pro- with performance and has the greatest opportunity for
ductivity, researchers surveyed stated that talent man- improvement. No lab should neglect its people.

This article has been adapted from an article first pub-

lished by McKinsey Quarterly in May 2011.

Wouter Aghina
is a Principal in McKinsey’s
Amsterdam office.

Marc de Jong Daniel Simon

is a Principal in McKinsey’s is an Engagement Manager in McKinsey’s
Amsterdam office. London office.
RECALL No 19 – Innovation and product development
Lean and the software imperative: Step change in development productivity 53

08 Lean and the software imperative: Step

change in development productivity

The value of many products is increasingly dictated by this trend. In fact, McKinsey regularly encounters
the degree to which they are enhanced by software. The companies that are not constrained by their ability to
capability of vendors to produce the appropriate soft- imagine new products or by customer interest in them,
ware, however, lags behind consumer demand. but by their ability to develop the required software for
new products on time, within budget, and at appropriate
The growing importance of software in all product productivity levels. This variation in software devel-
classes is hard to overstate. Planes, medical devices, opment capacity underlies huge performance differ-
cars, printers, and weapons systems are all surprisingly ences – of up to four times – between the most and least
software-intensive and increasingly so. The automotive equipped companies (Exhibit 1).
industry is only one example of this trend. According to
the Institute of Electrical and Electronics Engineers, a Root causes of poor software development
premium car today runs around 100 million lines of code
using some 70 microprocessors. Across all industries and McKinsey is getting to the bottom of such challenges.
products, sales of embedded microprocessors outnum- Based on our work with over 50 organizations, we have
ber PC-based processors 35 to 1. This amounts to 3.5 bil- uncovered the areas that drive down performance.
lion every year. Software is no longer just for computers. Analysis results and benchmarks point to several areas
where companies struggle – and it is clear that the chal-
The rapid rise of software-enhanced products is not lenge traverses processes and people (Exhibit 2).
going unnoticed by consumers. In fact, end user per-
ception of product value is shifting toward software- Each problem area listed below is associated with sev-
dominated attributes. In mobile phones, for example, eral specific challenges that require targeted solutions.
the perceived value of a device used to be rooted in the Gaps identified include:
compact design, assembly quality, aesthetics, battery
life, and interface simplicity. Although these attributes Insufficient use of iterative and agile methods. Com-
remain important, key differentiators today are operat- panies still adhere to waterfall methods in domains
ing system capabilities and the application ecosystem where iterative and agile methods could significantly
richness. In other words, electronics used to be the point reduce lead times and improve productivity.
of differentiation; now it’s software.
Weak peer review processes. A valuable investment to
Some companies have adapted remarkably well to the catch defects early, peer review reduces quality-related
shift toward software-intensive products. Even though costs. Still, insufficient resources are allocated for this.
there are more system software engineers in the US
than mechanical, electrical, and electronics engineers Limited or non-existent testing automation. Over-
combined, many companies struggle to keep up with reliance on manual testing cycles is time-consuming

01 Companies ahead of the “embedded software curve” perform up to four

times better than
Companies strugglers
ahead of the “embedded software curve” perform up to
four times better than strugglers
Good performers

Mediocre performers


< 50

< 35


Productivity Projects within Projects on time

Development hours/ budget Percent
function point Percent

SOURCE: McKinsey

and a drain on resources. Automated test suites run fre- dard certification. McKinsey’s experience shows that
quently are an efficient way to control quality. such processes tend to be burdensome. In many cases,
process efficiency analyses reveal that as little as 15 to
Immature build processes. Some companies build code 25 percent of a developer’s available time is adding value
too infrequently, opening the source control process to in these environments. Second, organizations tend to
code conflicts and code instability. engage in piecemeal efforts, targeting only one element
at a time. This approach is blind to interdependencies
Excessive “context switching.” Engineers are interrupt- between multiple elements. Third, and perhaps most
ed multiple times each day by a combination of meet- important, process improvement gets relegated to spe-
ings, field tickets, technical issues, and other non-core cial teams without sufficient buy-in from practitioners.
activities (see text box on page 56).
To address these challenges in software development,
Weak demand management. Many companies have a McKinsey has applied an approach that has affirmed
tenuous grasp on demand, leading to unbalanced utili- its power in many other complex operations: lean. Over
zation of their resources. the past 15 years, the lean methodology has repeat-
edly proven its value in optimizing manufacturing and
How lean can help service operations by eliminating waste while reduc-
ing variability and inflexibility. Lean transformation
Companies have attempted to resolve these software is highly practical, since it invests 25 percent of the
development issues for years – in many cases with little time in analysis and 75 percent in implementation. The
success. And productivity in this area has remained rela- transformation is based on an iterative learning process
tively constant. There are many reasons why companies where new ideas are tested, feedback is gathered, and
are unable to realize sustainable improvement in soft- improvements are implemented immediately.
ware and application development, but three stand out
as major hurdles. First, companies often try to improve Contrary to other performance improvement method-
performance by setting up detailed and extensively doc- ologies, the following lean concepts can be applied to
umented processes, in many cases in the context of stan- most environments.
RECALL No 19 – Innovation and product development
Lean and the software imperative: Step change in development productivity 55

02 When asked about their company’s performance, leaders admit to

several weak spots
When asked about their company’s performance, leaders admit to
several weak spots
Average response in category

Topic Poor Mediocre Good Best-in-class

Processes and Strategic planning
tools Budgeting
Portfolio and project management
Software development life cycle
Organization Organizational structure
and governance Governance
Skills and capabilities
People and Mindsets and behaviors
performance People management
Performance management
Sourcing and Sourcing and location
suppliers Third-party management
Architecture Architecture management
Footprint Development footprint

SOURCE: McKinsey

Empowering. Practitioners (not a central team) propose Applying lean to software development typically results
and test improvements. They are trained as champions in productivity gains exceeding 20 percent (in hours per
to bring improvements to other areas. use case, story, or function point). It goes beyond this to
substantially reduce lead time (often more than 40 per-
Efficient. Lean is based on eliminating waste, increas- cent), thus enhancing overall post-release quality.
ing flexibility, and reducing rigidity. As a result, lean
transformations often lead to remarkably light and The keys to making a lean transformation work
simple processes with limited documentation overhead.
While the principles of lean are battle-tested and typi-
Flexible. Lean does not prescribe a particular software cally result in dramatic performance improvements,
development life cycle (although it often results in the organization must prepare itself in ways that lay the
approaches that incorporate many agile concepts). groundwork for success. Five organizational objectives
will help companies ensure that their transformation
Far-reaching. Lean goes beyond process improvement efforts have a fighting chance and yield the improve-
and tackles management systems, mindsets, and orga- ments they envision.
nizational friction.
First, the transformation objective should be clearly
Continuous. Lean is not a “one-off” change program. communicated from the top down. Senior management
It instills a new way of working based on continuous should support the transformation to secure backing
improvement by solving problems and removing waste. and adoption across the organizational units affected.
Successful companies design a sophisticated commu-
In recent years, lean has been successfully applied to nication plan and market the initiative in an inspiring,
software development environments, since R&D man- non-threatening way. They make it “their company’s
agers have moved beyond their initial skepticism of yet way” of achieving operational excellence.
another “process improvement methodology.” Because
this approach is based on continuous improvement, the Next, management should set ambitious targets and
benefits achieved are lasting ones. create clear value realization plans. A common set of

Focusing engineers on engineering

One global high-tech company had wedged itself lishing a common requirements inflow function for
into a corner: they faced a rapidly increasing devel- all units to ensure filtering, removing duplicates,
opment backlog coupled with increasing pressure and devising more sophisticated activities routing.
to reduce costs. After years of targeted process- The company segmented the development process
related improvements, the company conducted a by complexity of incoming work to provide for
lean diagnostic across application development and multiple tracks with varying levels of process rigor,
maintenance processes. overhead, and support requirements. Tools rang-
ing from automated build systems to requirements
Initial analysis revealed that only 20 percent of management were improved to reduce workload
available engineer time was spent on core activities and waiting times across all teams. In general, a
such as pure development. Partially overlapped standardized approach to managing performance
work flooded into teams, which also entailed was introduced across teams – including common
unclear prioritization and value. metrics and visual management boards.

In response, the company primarily became active Total potential amounted to 35 percent higher pro-
in demand management, complexity segmentation, ductivity and a 45 percent drop in lead times. By
tool automation, and performance management. applying lean principles, the company freed up sig-
Demand management improved based on estab- nificant R&D resources and reduced time to market.

metrics and clear accountability among line manag- Finally, transformation teams must be equipped with
ers will help ensure that value is consistently captured. a combination of lean skills and sufficient software
Complex and fragmented transformation organization domain knowledge. Beyond lean skills such as process
with no value realization plans reduces transparency optimization, visual management systems, and perfor-
regarding the “leanified” unit’s performance. Freed-up mance dialogs, teams need specific software develop-
time could revert back to non-value-adding tasks. ment skills to develop a lean target model. Such skills
could include being able to optimize demand man­
Building capabilities, management systems, and met- agement across maintenance and development proj-
rics to support the effort is also a part of the groundwork ects, to leverage agile development in pace teams to
an organization must do to ensure a successful lean cope with different delivery horizons, and to instill
transformation. While some have succeeded in taking standardized time estimation to support productivity
the first step toward a high-performance lean develop- point metrics.
ment organization by removing waste in processes,
generating sustainable impact requires improvements The tricky aspect in lean transformations is frequently
beyond the process dimension alone. This includes less technical than it is behavioral. One multinational
building the right skills, instilling accountability, player launched an effort to shorten the release schedule
anchoring performance dialogs and metrics, and and reduce costs – only to see the effort fizzle. Their
­establishing a culture that strives for improvement. primary focus on process reengineering meant that
the vital mindset shift among employees was missing.
Management should also be mindful of the organiza- Since top management led this effort, business manag-
tion’s objectives, its situation, and its resources to scale ers assumed little accountability for the success of the
the transformation accordingly. The process could program. By taking a step back and adhering to the full
range from a sequential “self-discovery” approach range of lean principles, they were finally able to make
across development areas to a full-blown concurrent the program a success. This included a shift to a line-led
transformation, depending on the organization’s overall rollout combined with an increased focus on changing
culture and its readiness for change. mindsets and behaviors.
RECALL No 19 – Innovation and product development
Lean and the software imperative: Step change in development productivity 57

  

Lean can be an effective approach to improving soft-

ware development performance in product companies
by addressing many of the root causes behind poor
software development. Companies need to ensure some
specific conditions to make lean successful and strike
the balance between process improvements, perfor-
mance management, and mindsets and behaviors.

Daniel Alsén Santiago Comella-Dorda

is an Associate Principal in McKinsey’s is an Associate Principal in McKinsey’s
Stockholm office. Boston office.

Javier Garabal Krish Krishnakanthan

is an alumnus of McKinsey’s is a Principal in McKinsey’s New York office.
Barcelona office.
RECALL No 19 – Innovation and product development
A free-flowing pipeline: An interview with Marco Ferrero 59

09  A free-flowing pipeline:
An interview with Marco Ferrero
Area Sales Director, Vodafone Italy

Vodafone Italy is one of the country’s largest telcos. This and businesses. As a company eager to constantly and
operator earned over USD 8.7 billion in revenues in the successfully innovate and with an obsession for quality,
2011 fiscal year, serving more than 30 million active we decided it was time to drastically review the way we
customers – in both consumer and enterprise segments develop products. That was the beginning of our “Make
with mobile and fixed business. Despite the economic it fast” initiative.
crisis and price cuts driven by the country’s regulatory
bodies, Vodafone Italy continues to invest in quality and McKINSEY: What was the objective?
innovation, working to increase broadband availability
and usage to narrow Italy’s “digital divide.” MARCO FERRERO: The aim of “Make it fast” was to
transform our product development infrastructure
Marco Ferrero joined Vodafone Italy in 2007 as head into a source of distinctiveness and competitiveness
of its wholesale unit. From 2009 to 2011, he was Head for Vodafone. The first and most important goal was to
of the Consumer Product and Services Department. obtain a significant reduction in time to market from
As part of his role, he was responsible for the opera- concept definition to market launch. We would then be
tor’s product development function from end to end. able to deploy new products faster than our competitors.
Mr. Ferrero is now Area Sales Director at Vodafone Italy. We aimed to reduce both concept and implementation
time by 50 percent.
McKinsey had the opportunity to speak with Mr. Ferrero
in 2011 about Vodafone’s quest to develop and deliver McKINSEY: How did the organization accommodate
innovations in a time of industry-wide market pressure. such a grand ambition?

McKINSEY: Why did Vodafone Italy decide to revisit MARCO FERRERO: That’s where our supporting goals
how it brings new products and services to the market? came into play. From the people perspective, we also
sought to dramatically reduce the fatigue everyone was
MARCO FERRERO: When I joined the Consumer feeling at that time. And on the fiscal side, our aspira-
Product and Services Department in 2009, there were tion was to decrease costs and optimize our budget
some early signs that our product development capabili- allocation to free up capacity for additional products.
ties were suboptimal. This stifled our innovation power. Together with the CEO and our senior executives, we
Time to market was becoming too high and almost thought that “Make it fast” was the perfect name for
unpredictable. We had the feeling that product devel- such a program.
opment costs were increasing and the organizational
effort we put into making products ready for the market McKINSEY: As the executive responsible for the initia-
was very high. And this was true across all segments tive, how did you define the scope?

MARCO FERRERO: Since the objective was to change MARCO FERRERO: As a first step, we reviewed the way
our way of developing new products end to end, we we size and allocate the product development budget.
decided that the scope had to be as broad as possible, The key here was to preallocate funds directly to the
both in terms of development types and focus areas. We business units. This amount was the net of strategic
targeted three main development types: simple prod- initiatives and a buffer for flexibility in the event of
ucts – such as new rate structures and promotions and unexpected market changes. Beyond this, we extended
maintaining existing products; new products and major our capital allocation perspective up to 18 or 24 months
innovations – like our fixed offering; and go-to-market to empower business units to spend correctly within
enablers – the CRM system or the dealer station for our the assigned budget in the medium term as well. We
shops, for example. also linked financial planning to operational planning,
building in prioritization and trade-off mechanisms.
McKINSEY: How did you decide on an implementation
methodology? McKINSEY: Was redesigning the gating process as
MARCO FERRERO: Our product development infra-
structure had been in place since 1995. That’s more than MARCO FERRERO: That also followed from the lean
enough time for organizational and industry changes diagnostic. We structurally reviewed our gating process
to render a finely tuned mechanism inefficient. We to further emphasize the required inputs, the expected
thought that lean methodology was the best way to fur- outputs, the necessary activities, and the owners
ther improve our performance. It enabled us to identify assigned to each of the four typical phases (concept,
sources of inefficiency in the current environment and design, development, and testing). We also rethought
develop sustainable solutions in a bottom-up approach the number and function of the gates, putting more
to gain full buy-in from the organization. Lean really emphasis on the “gate preparation” phases. That led us
helped us in the diagnostic phase to lend transparency to introduce mechanisms to check product development
to the real issues. At the end of the diagnostic, we count- team availability across the company before starting.
ed ten root causes – mostly cross-functional – behind The rationale here was to force a higher filtering ratio
the malfunctions in our product development systems. at the very beginning and to anticipate the commercial
decision to pursue or not to pursue a product in the earli-
McKINSEY: So how exactly did you address the issues est phases according to the 80/20 approach.
that were hindering development productivity?
McKINSEY: These are all big changes to various compo-
MARCO FERRERO: The first step was to review and nents of product development, but how did the transfor-
clean up our project pipeline, the enabler. The diagnos- mation tackle the process as a whole from end to end?
tic phase revealed that there were too many new prod-
ucts and services in our project pipeline that Marketing MARCO FERRERO: We reviewed the entire way we
and the other business units were pushing without work – from concept development to market launch.
considering the overall company throughput – in my What we found were discontinuities across teams. We
department as well as in IT and Network. We realized anchored more structured, cross-functional team-
that this was leading to an inefficient stop-and-go based approaches between Marketing, Technology, and
working attitude within product development teams. Customer Operations. We also specified end-to-end
The decision to clean it up was not easy, but there was accountabilities and reduced the number of hand­
a strong commitment from our top management to do overs. To help us stay on track, we introduced a few
this. In the end, we reduced the volume by 70 percent. simple KPIs to monitor the health of the new process.
In parallel, we focused on three key areas: the evolution Indicators measured now include time to market, killing
of our gating process and its governance, the introduc- ratio at gates, and maximum difference between budget
tion of a new cross-functional way of working, and the and actual cost per product. We also evaluate ex ante
definition of specific KPIs to measure the health of the versus ex post business cases when we set business unit
newly redesigned processes. targets and evaluate people’s performance.

McKINSEY: Can you describe the solution design from McKINSEY: Has Vodafone Italy begun to reap the ben-
the process perspective? efits of this transformation?
RECALL No 19 – Innovation and product development
A free-flowing pipeline: An interview with Marco Ferrero 61

MARCO FERRERO: We have already exceeded our

greatest expectations. Overall time to market has
declined by 53 percent, and we expect to reduce it even
further. We also cut our product development costs by
20 percent and succeeded in combating organizational
fatigue – we spend 30 percent less of our time in meet-
ings and in preparing documentation.

McKINSEY: Based on your experience, what lessons

would you share with other organizations considering
embarking on such a transformation?

MARCO FERRERO: First, ensure top-down sponsor-

ship for the transformation. The CEO has to align top
management and enlist them in the changes. Second,
follow a bottom-up approach in solution design to gain
strong buy-in from the key business units that will be
involved in the process turnaround. Finally, make sure
HR is aligned and involved to ensure people’s targets
and incentives are linked to the agreed KPIs.

Marco Ferrero was interviewed by Fabrizio Pessina, an

Engagement Manager in McKinsey’s Milan office.
RECALL No 19 – Innovation and product development
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RECALL No 19 – Innovation and product development
Appendix 65

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