R&D Implications of Microsoft’s Takeover of Skype

Summary: For Microsoft to benefit from the Skype acquisition, they will have to integrate Skype and its R&D into Windows Phone OS. Microsoft has a history of successfully integrating acquisitions (e.g PowerPoint). However there have also been some missteps (such as Danger). One of the reasons for the failure of Microsoft Kin (a derivative of the Danger Sidekick) was failure to manage R&D. This is a highly competitive market place and Microsoft will have to be very vigilant to ensure success.

Microsoft recently bought Skype for $8.5B for Skype. A lot has been said about how the price paid and the strategic fit such as (See ArsTechnica):

When the Wall Street Journal reported last night that Microsoft was going to buy Skype, the response was puzzlement. Though Skype has some value, the estimated $7 billion-8 billion valuation was unfathomable. Microsoft has now confirmed the purchase and held a press conference to announce the takeover. The morning after the night before, is it making any more sense?”

There has been some speculation that the pressure to purchase Skype came from Bill Gates (see DailyTech):

Well it turns out a lot of the pressure to buy Skype originated from Microsoft founder and tech icon Bill Gates. We were the first to note Mr. Gate’s ties to Silver Lake Partners, one of the principle groups that profited from the Skype acquisition.

Knowledge@Wharton has a different perspective on this acquisition now that it is complete (What’s Behind Microsoft’s US$8.5 Billion Takeover of Skype?): First a bit of the background. Microsoft can hope to leverage Skype’s technology to get an edge in the smart phone market:

This one makes profound sense for Microsoft. Of the three major players in cell phones, they are the third. They were the first in, and some people would say they’re now the third, after Apple and Google. If they’re going to succeed, they need to have something that offers some unique value.

Skype’s technology can provide an edge, if Microsoft can execute:

This [acquisition] may do this. If they can effortlessly merge Skype with the phone, then they have the best videoconferencing phone in the business. If they can effortlessly merge [Skype’s] tech services with their own instant messaging service, then they have the best instant messaging system in the business.

However, as eBay can point out, integrating Skype is not easy. Skype is peer-to-peer communications, but most large corporations (eBay and Microsoft) have a centralized infrastructure. This change is not going to be easy:

Skype is a peer-to-peer instant messaging system. Peer-to-peer allows a buyer and a seller to completely bypass eBay. If eBay wanted Skype as a commercial infrastructure system, it would have had to be modified. If they acquired it without the appropriate intellectual property development team, it was of no use to them whatsoever. Again, I can’t back this up. If it’s true, I’m sure there are people who can back this up.

As the article rightly pointed out, integration of acquisitions is risky:

Acquiring high-tech companies, especially when there’s a great difference in culture or technology, can be a very risky play.

Although Microsoft has stepped up its M&A activity, the results have been mixed – especially with large acquisitions such as aQuantive ($6.3B) where integration is likely to be more difficult. Furthermore, Skype is not a profitable company despite having more than 100M subscribers. So, integration Skype to generate previously untapped value is going to be key to success. What can R&D management can do to extract value from this acquisition?

Define a clear R&D vision and strategy for merged group. Unless different cultures are forced to collaborate to achieve difficult goals, they will have trouble working together. As Steve Jobs and Apple have pointed out, there is no substitute to a comprehensive vision.
Setup clear portfolio balancing processes that can overcome bureaucracies and distribute resources to “new” entities. One of the key problems that plagued Kin is the product portfolio management process that depended too much on executive sponsorship.
Align strategy with a clear product management across entities. As we have discussed in the past, corporate mindset has a significant impact on how products get managed and launched. It is likely that Skype’s culture is quite different from Microsoft.
Use concrete metrics and a strong project management process to ensure the project remains on track. Both will be critical to getting over the not-invented-here problem that plagues all acquisitions.

Please see the Microsoft Kin case study for more details.

Article first published as R&D Implications of Microsoft’s Takeover of Skype on Technorati.

Pfizer says 24% cut in R&D is good for the company

Most high tech companies have ferociously guarded their R&D spending even through the great recession. In fact, cuts in R&D spending have been much smaller than the reduction in revenues. Hence, the R&D as a fraction of overall expenditure has actually increased through the recession. It is known that R&D spending does not guarantee increased profits. Many observers have pointed out that companies might actually be protecting the wrong investments.

Reuters had an interesting article recently about Pfizer cutting their R&D budgets by 24% in 2011 (See Pfizer R&D chief upbeat despite smaller budget):

Mikael Dolsten, Pfizer’s president of worldwide research and development, said making choices about research priorities was a ‘sign of a healthy company culture.’ ‘Our action was more a thoughtful deliberation after looking at how the industry has performed as a whole,’ Dolsten said in an interview on the sidelines of the Bio-Windhover Pharmaceutical Strategic Outlook conference in New York. ‘We feel that the amount of investment in R&D that we are committing to is really the right number to drive the priorities we have put in place.’

May be the cut in R&D spending will actually force managers to think through the R&D pipeline and remove pet projects and dead wood. This is especially important because Pharma R&D seems to have declined in efficiency and return on R&D investments have been falling (See Big pharma’s stalled R&D machine).

However, it is also quite common for CTOs to claim that cutting R&D budgets is a good thing AFTER the R&D funding has been cut. TI’s CTO suggested that their 25% cut in R&D spending actually sharpened their focus. What can R&D managers do to actually get the positive results? Freescale’s CTO made some great points about cutting R&D budgets:

Have a clearly defined strategy that drives investment decisions
Decide on what R&D you are NOT going to do and what you are.
Decide what R&D will be done internally and what will be outsourced to strategic partners
Tie marketing into the R&D planning and align roadmaps with customers

Great advice because pet projects have a way to stick around no matter what. Also, 90% of all cost cuts are reversed in three years unless there is a purpose and drive behind them. Here are some portfolio management best practices that you could follow. There is a lot more about portfolio balancing here.

Article first published as Pfizer Says 24% Cut in R&D is Good for the Company on Technorati.

When to rely on gut feelings

We have discussed papers and empirical data that show that reliance on gut feelings often produces sub-optimal results. Now we have a great explanation on why we should be careful about depending on intuition from the behavioral economist Dan Ariely (in the McKinsey Quareterly interview Dan Ariely on irrationality in the workplace):

One way to think about it is the following: imagine you stand on a field and you have a soccer ball and you kick it. You close your eyes and you kick it and then you open your eyes and you try to predict, where did the ball fall? Imagine you do this a thousand times; after a while you know exactly the relationship between your kick and where the ball is. Those are the conditions in which intuitions are correct—when we have plenty of experience and we have unambiguous feedback.

That’s learning, right? And we’re very good at it. But imagine something else happened. Imagine you close your eyes, you kick the ball, and then somebody picked it up and moved it 50 feet to the right or to the left or any kind of other random component. Then ask yourself, how good will you be in predicting where it would land? And the answer is: terrible.

The moment I add a random component, performance goes away very quickly. And the world in which executives live in is a world with lots of random elements. Now I don’t mean random that somebody really moves the ball, but you have a random component here, which you don’t control—it’s controlled by your competitors, the weather; there’s lots of things that are outside of your consideration. And it turns out, in those worlds, people are really bad.

So what is the solution? We should experiment more and test our gut feelings before we go all out and implement a pervasive solution.

This actually, I think, brings us to the most important underutilized tools for management, which [are] experiments. You say, I can use my intuition, I can use data that tells me something about what might happen, but not for sure, or I can implement something and do an experiment. I am baffled by why companies don’t do more experiments.

I think the reason why many R&D executives I know do not experiment more is the lack of information – both about factors driving the decision and potential impacts of the decision. For example, executives are normally forced to rely on gut feelings to decide future R&D investments. It is difficult to experiment because R&D projects are interlinked. It is difficult to see the impact of changing one program on all the other linked programs. Funding decisions also need to satisfy a multitude of often conflicting requirements. There are no tools to quickly understand the impact of investments of staffing or on competitive position. Even when information is available, it is normally at the wrong level of detail to actually make a difference. We need tools to help executives experiment effectively in R&D management.

Nokia R&D spending – a lesson in Portfolio Balancing

In a previous post, I discussed how bureaucracy stifled innovation at Nokia. I ventured a guess that a formalized R&D portfolio balancing process might have helped counteract the effects of bureaucracy. An engadget post finally led me to an article with some concrete data and useful learnings for R&D managers.

First observation is that Nokia’s R&D budget was almost five times that of Apple in 2007. Furthermore, Nokia is focused only on mobile communications, as opposed to Apple, which has significant markets outside of iPhone. Hence, clearly, Nokia’s problems with innovation did not come from lack of R&D budget.

Now lets look at the breakdown of R&D investments across the development portfolio:

It can be seen that Nokia invested as much in hardware development as on Symbian. Each of these were as large as Apple’s TOTAL R&D budget. So there are three fundamental problems here:

R&D budget is disproportionately large compared to competitors
Spending on software and OS is much larger than competitors
R&D investment is clearly NOT delivering the kind of performance competitors are able to get

The question Nokia should be asking when distributing R&D budgets are:

What is the right amount of R&D budget. A bottoms up analysis is one way to get to an answer. The other would be to compute affordability as a fraction of sales. A competitive positioning graph such as the one above could provide some much needed perspective.
What should Nokia expect in return for the R&D investment? It is absolutely critical to have CLEAR top level objectives and metrics. These objectives can help focus R&D community and drive innovation. A benchmarking study can help decide if the objectives are reasonable. For example, if Apple can develop a hardware / software ecosystem for $300M / year, should it not be possible for Nokia to achieve at least as much (may be much more because of economies of scale).
How should the R&D budget bet distributed across different requirements – Hardware vs. software vs long-term research? Again, a bottoms-up estimate can be a good starting point, but it has to be balanced by a external perspective. If none of the Nokia competitors are spending $1.2B in software development, what is the business case for doing so at Nokia? As we get into details, competitive information will be hard to find. The answer is to set up some objectives / metrics and then track performance. Many R&D managers do not track results because it might take a year or two to understand the consequences. However, not tracking means there is no way to change the direction or even to gage if the investments are performing. More on this later….

In summary, R&D investments in this changing and highly competitive environment need to be guided by 1) clear objectives, 2) precise metrics for objectives (both qualitative and quantitative), 3) competitive benchmarking, and 4) longer-term metrics tracking.

At Apple, the Platform Is the Engine of Growth – NYTimes.com

The article At Apple, the Platform Is the Engine of Growth: has some good lessons about platform-based R&D management:

Apple has hit that magical combination of gradually shifting from a product to a platform strategy,” says Michael A. Cusumano, a professor at the Sloan School of Management at M.I.T. and author of “Staying Power: Six Enduring Principles for Managing Strategy and Innovation in an Uncertain World” (Oxford University Press, 2010).

We have discussed Steve Job’s uncanny ability to find duds in Apple’s R&D portfolio. I think platform-based portfolio management is even more important than eliminating poor projects. It is not just about selling a single product – like a great phone. But about developing an ecosystem of related products and services that provide a much better value to the customers.

Apple provides the underlying technology and marketplace: iTunes software and the iTunes Store for managing, downloading and buying music and media; iPhone and iPad software for creating applications; and the App Store for sampling and buying them.

R&D managers need to look at this carefully. If we can make portfolios of related projects, each connected based on underlying platforms, we can do a much better job of funding R&D and ensuring all the different pieces are available simultaneously. This is clearly not easy. Even Apple has had trouble:
Things look different for Apple in the market for mobile devices. There is some debate whether

Apple has become a platform strategist by design or by default: When it introduced the iPhone in 2007, Apple did not have software tools for outside developers to make applications. That came in 2008.
“The iPhone was such a great product that lots of people wanted to write applications for it,” says Marco Iansiti, a professor at the Harvard Business School. “This was a case of the hit leading to the platform, and not necessarily voluntarily for Apple.”

But then they have Jobs… He will take fix the problems in the portfolio, right?

Apple’s R&D portfolio strategy – “Get Rid of the Crappy Stuff”

Some interesting R&D portfolio management advice in the Fast Company article Steve Jobs’s Strategy? “Get Rid of the Crappy Stuff”

“Do you have any advice?” Parker asked Jobs.
“Well, just one thing,” said Jobs. “Nike makes some of the best products in the world. Products that you lust after. Absolutely beautiful, stunning products. But you also make a lot of crap. Just get rid of the crappy stuff and focus on the good stuff.”

There are two fundamental problems in executing this advice:

How do you decide what is crap? Sales to date, forecasts, executive opinion?
Why did the crap get into the portfolio to start with? Should it not have been eliminated before development was concluded?

Clearly an executive like Steve Jobs can answer these questions. As the article points out:

It takes courage to reduce the number of products a company offers from 350 to 10, as Jobs did in 1998. It takes courage to remove a keyboard from the face of a smartphone and replace those buttons with a giant screen, as Jobs did with the iPhone. It takes courage to eliminate code from an operating system to make it more stable and reliable, as Apple did with Snow Leopard.

In most companies, answers to two questions are much more difficult. There are pet projects for executives that can not be touched. A R&D portfolio manager I know went through an elaborate exercise to evaluate the portfolio and find duds. He found many projects that had gone on for years and were no closer to delivering results. He brought the list up to the senior executive’s attention. The answer from the CEO was immediate and clear – you can not touch these. No explanation was given nor any improvements suggested to the portfolio management process to ensure it did not bring up the same projects again.

Another problem is interdependencies between different projects in the R&D portfolio. Killing one project means others get impacted. Companies need to really invest in maturing and enhancing their portfolio balancing processes.

Nokia’s Bureaucracy Stifled Innovation

This New York Times article on Nokia’s Bureaucracy Stifled Innovation has several interesting lessons for R&D managers. It appears that Nokia had a smart phone before others, but cancelled it:

A few years before Apple introduced the iPhone in early 2007, the prototype of an Internet-ready, touch-screen handset with a large display made the rounds among upper management at Nokia. The prototype developed by Nokia’s research centers in Finland was seen as a potential breakthrough by its engineers that would have given the world’s biggest maker of mobile phones a powerful advantage in the fast-growing smartphone market.

I am not sure that having a prototype in 2004 and choosing not to bring it to market was such a bad decision. Apple itself had a prototype for a smart phone working with a large consumer electronics company in 2004. They too chose not to bring it to market. I do not think technology existed to actually build successful smart phones in 2004 – that included fast enough processors, low power LED backlit screens and abundant DRAM/FLASH. R&D Managers need to make touch choices at times and they can all not be the right choices. This one example does not directly prove that all decisions made at Nokia were bad – or that even this decision was a bad one.

On the other hand, the article mentions a couple of times that Nokia got complacent because of its own success:

… former employees depicted an organization so swollen by its early success that it grew complacent, slow and removed from consumer desires. As a result, they said, Nokia lost the lead in several crucial areas by failing to fast-track its designs for touch screens, software applications and 3-D interfaces.

“Nokia in a sense is a victim of its own success,” said Jyrki Ali-Yrkko, an economist at the private Research Institute of the Finnish Economy. “It stayed with its playbook too long and didn’t change with the times. Now it’s time to make changes.”

This is clearly a problem. How do R&D mangers keep from falling into this trap? I guess one has a better more formal portfolio balancing process that allows decisions to be based on qualitative and quantitative criteria that can be discussed rationally. This was NOT the case at Nokia:

Juhani Risku, a manager who worked on user interface designs for Symbian from 2001 to 2009, said his team had offered 500 proposals to improve Symbian but could not get even one through.

“It was management by committee,” Mr. Risku said, comparing the company’s design approval processes to a “Soviet-style” bureaucracy. Ideas fell victim to fighting among managers with competing agendas, he said, or were rejected as too costly, risky or insignificant for a global market leader. Mr. Risku said he had left in frustration at its culture; he now designs environmentally sound buildings.

The key phrase in portfolio balancing is BOTH qualitative and quantitative criteria. A strict focus on ROI will kill high-risk high-return innovative projects. Fundamental technology development is also a difficult area to measure ROI because technology has impact on multiple products and ROI is impossible to compute (Symbian could be seen as a fundamental technology with impact on multiple product platforms):

Proposals were often rejected because their payoffs were seen as too small, he said. But “successful innovations often begin small and become very big.”

In fact, R&D managers should set a portion of their budgets for innovation (10-20%). These projects should not have any ROI requirements. Another way to encourage manager risk taking is to reward failure.

China’s Drones Raise Eyebrows at Air Show – WSJ.com

Here is an interesting article in the WSJ with significant impact on long-term R&D strategy: China’s Drones Raise Eyebrows at Air Show.

Western defense officials and experts were surprised to see more than 25 different Chinese models of the unmanned aircraft, known as UAVs, on display at this week’s Zhuhai air show in this southern Chinese city. It was a record number for a country that unveiled its first concept UAVs at the same air show only four years ago, and put a handful on display at the last one in 2008.”

Amazing progress on Chinese front. During the cold war, USA and Russia kept pumping money into R&D. This long-term research provided sustainable lead to countries and was a source of significant innovations such as ASICs, Interenet, etc.
I think the difference between the cold war and now is the significant increase in the rate at which technology is changing. Slow progress over decades just won’t be sufficient against newcomers because they will be starting from a much more advanced computing platform. They will be able to model new environments/materials and manufacture with increasingly more capable machines. In fact, in many cases a long legacy is a drag on new innovations.
The answer, however, is not the complete elimination of long-range research. The answer is to develop more robust R&D plans, so that impact of changes in one technology can be propagated quickly across the entire system development. The answer also is a frequent re-balance of R&D portfolios to account for changing technology/market/geopolitical landscapes.
I guess R&D managers need even more powerful tools and processes.

Disruptive Innovation and IP

A quick article that elaborates on something that I have observed in many firms:

Though it may be difficult to convince a business to invest millions in pursuit of a speculative disruptive innovation, it is much easier for a small team to gain support in pursuing low-cost intellectual assets in the name of mitigating potential threats.

I have actually seen empirical data that the aggregate investment in these speculative patents far exceeds the net investment in innovation! The author repeats what many managers believe – patents are cheap so use them to protect markets:

A two-pronged approach is proposed that builds on the authors’ experience at Kimberly-Clark Corporation in dealing with disruptive threats and opportunities. The approach calls for generation of intellectual assets, often using small proactive teams

Specifically, the author suggests:

Protect yourself form other’s disruptive innovation by patenting first;
Use patents to create new business.

This approach though popular, is not easy to execute. It takes more than five years for a patent to issue. If one waits for patent issuance to decide which R&D projects to invest in, they will be far behind competitors and never be able to catch up. Millions of patents are issued each year.

It is pretty much impossible to keep up with issued patents, much less figure out who is infringing your patent and prevent them. So patents are a pretty weak approach to speculatively reducing competitive pressures. We sometimes see Motorola suing Apple. But Motorola has 10,000+ patents in cell phones. The cost of obtaining those patents $300M!

Even if one finds infringement, patent assertions are expensive and a pretty inefficient way to drive R&D strategy. In most cases, assertions take years to conclude. So from the time the inventor had an idea to asserting and changing market landscape will take 10-15 years at the minimum. How can one drive R&D strategy with that kind of a lag?

Finally, if the organization really knows which innovations are valuable, they could develop them in the first place. This approach of trying to do work around poor management decision making can lead to nothing but wasted effort.

Take home message from me is exactly the opposite of what the author suggests. Patent ONLY when you believe it is going to help you develop a significant product. Speculative patents should be limited to foundational technologies not individual products.

Portfolio management organization cultures

The article Using R&D portfolio management to deal with dynamic risk by Serghei Floricel.in the journal R&D Management has some interesting insights into why organizations adopt adopt specific approaches for project portfolio management. Here is what I took away:

They theorize that portfolio management is driven by the competitive environment (characterized by velocity, turbulence, growth and instability).
This competitive environment requires managers to develop approaches to address it and learn some preferred approaches (what I would call “gut feelings”).
These approaches to portfolio management can be characterized in four dimensions (structure, commitment, emergence and integration).

They then surveyed 795 firms in a variety of sectors and on four continents to find the following results:

high-velocity environments favor structured as well as integrated portfolio management approaches
high-growth environments favor approaches that are structured but commit significant resources to each project as well
Turbulent environments favor approaches that are emergent, but also, contrary to our expectations, have high resource commitment levels
Finally, firms in unstable environments have a marginal preference for emergent approaches

Pretty good stuff to keep in mind when designing or improving product portfolio management processes.