The Problem with Product Proliferation28 April, 2017 / Articles
Royal Philips, the Netherlands’ most valuable brand, has long been a leader in product innovation. But in the first 10 years of the new millennium, the company’s revenue plunged 40%, profits for the decade were wiped out, and its market capitalization fell significantly. What went wrong?
The problem, it turned out, was excessive innovation. In the early 2000s, executives expanded the company’s product portfolio, through in-house development and acquisitions, to encompass an extraordinary array of new products and services. In 2003, Philips was the top patent filer in Europe and among the top 10 in the United States. Innovations included energy-efficient light bulbs, medical scanners, web-enabled cameras, chipsets for in-car entertainment systems, software offerings, and product-related services. By 2011, Philips was active in more than 60 product categories.
But because Philips had allowed business leaders in various product lines and geographies to design stand-alone systems to support their products and customers, business complexity—in supply chain, sales and marketing, product development, and administrative processes—increased significantly, leading to much higher expenses. Complexity also led, not surprisingly, to greater customer and employee difficulties. For example, health care customers buying medical scanners and related software and services had to work with multiple account managers and received multiple invoices. Employees struggled to navigate the more than 10,000 IT applications, including 60 enterprise resource planning systems, that had sprung up. With customer data spread across all of them, it was nearly impossible for frontline employees to get a view of a customer’s needs or to provide a consistent level of service.
Welcome to the dark side of innovation. Every time customers have to enter the same data twice, have inconsistent experiences when interacting with different parts of the business, or are forced to contact multiple people to get something done, it hurts the company. Every time employees can’t access important customer information or have to wait for decisions and approvals by multiple people in multiple departments, it hurts the company. It can even destroy a business, as almost happened with Royal Philips.
Customers and frontline employees are well aware of the problems that product variety can introduce. Leaders, however, tend to focus exclusively on the potential benefits. The top team at one large financial services company we studied admitted to being “addicted to innovation.” Even when executives recognize that some of their innovations generate little value and that their company has become difficult to do business with, they don’t see the connection. The desire to be first to market with a new product—or to quickly replicate a competitor’s offering—blinds companies to the potential downside of adding to the product portfolio. Most companies do assess the potential for cannibalization of other products, but few consider the costs of added complexity.
To examine this problem, we surveyed 255 senior executives and studied seven companies in depth through interviews with 72 executives. (The companies were DHL Express, IBM, ING Direct Spain, the LEGO Group, Principal Financial Group, Royal Philips, and USAA.) We found that on average, product variety is not correlated with company profitability—but it is correlated with customer and employee difficulties. The bottom line: The more potentially value-generating innovations you add to your company’s product portfolio, the more value-destroying complexity you are likely to embed in your business. We offer three guidelines for addressing this problem: Focus on product integration rather than proliferation. Make sure that product developers are in close touch with customer-facing and operational employees. And define your purpose in a way that will guide decision making.
Facing the Dark Side of Innovation
When Philips set out to address the problems that unmanaged innovation had created, it soon realized it needed to transform both its operations and its portfolio of businesses. In 2011, as part of an ongoing business transformation program, the company began building a “greenfield” platform of globally standardized systems and processes that spanned three areas: from idea to market (all processes relating to innovation), from market to order (processes related to marketing and sales), and from order to cash (those related to finance and back-office fulfillment).
The goal of the platform was to significantly reduce employee and customer difficulties, but Philips management realized that with the current portfolio of products it would take years to implement. So the company also reduced product variety—dramatically. In 2000, it was doing business in six areas: lighting, consumer electronics, domestic appliances and personal care, components, semiconductors, and medical systems. The company gradually sold off low-margin businesses until it was down to just two units: HealthTech (health care and consumer lifestyle) and Lighting. In 2016, Philips sold off its lighting business so that it could focus exclusively on its HealthTech business. To be sure, the decision to focus on only one business sector was not motivated solely by the difficulties that operational complexity presented—but that was one of the biggest factors, according to executives we spoke with.
Philips’s transformation achieved its midterm goal of increasing EBITA margins to more than 10%, and its share price has doubled since 2011. But its journey to reduce complexity—like that of many companies—has been long and painful.
You don’t have to be as diversified as Philips to experience the dark side of innovation. In the 1990s, the LEGO Group reacted to the expiration of the patent on its iconic brick—and the growing popularity of computer games—with an all-out effort to innovate. The company doubled the number of unique bricks to more than 12,000 from 1997 to 2004. It also moved into new areas, such as computer games, children’s clothing, and theme parks. As product variety grew, complexity crept into LEGO’s operational processes. Customers and employees began to struggle with a lack of transparency in its supply chain. LEGO’s popular sets began to experience out-of-stock issues, sometimes because just one brick in a set of more than 500 was not available. Retailers were frustrated by the company’s inability to respond to a shortage in one country by moving excess inventory from another country. In 2004, LEGO found itself on the brink of bankruptcy.
Like Philips, the LEGO Group addressed its value-destroying complexity by initiating a major business transformation. Starting in 2004, it sold off theme parks and standardized its global supply chain and product-life-cycle management processes. It also reduced the number of unique bricks, although it continued to innovate around the way bricks were combined into sets. These efforts have paid off in profitability and growth. And they have made LEGO easier for customers and employees to deal with.
Fixing the Problem
The prescription for managing value-destroying complexity is not to stop innovating. Innovation is essential to growth and enables companies to respond to shifts in technology and market conditions. Advances in digital technologies, in particular, offer opportunities to enhance products with information and to personalize customer interactions. Companies that fail to embrace these technologies will surely sacrifice competitiveness.
Emphasizing integration over variety can mean walking away from revenue in the short term.
But to ensure that innovations do more good than harm, companies must minimize customer and employee difficulties. We have found that successful innovators follow three principles to help them recover from—or avoid altogether—the downside of innovation.