How and When: Responding to Innovation Shock

Article

When and how to shift gears: Dynamic trade-offs among adjustment, opportunity, and transaction costs in response to an innovation shock. Bigelow, L., Nickerson, J., & Park, W.

Journal

Strategic Management Journal, March 2019, Volume 40, 377-407

Reviewer

Dr. Allan Gray, Executive Director and Professor

Summary

In this article, the authors attempt to explain and evaluate repositioning strategies when a firm faces a disruptive innovation. The authors found that different firms in an industry react to innovation shocks differently in two important ways–first, they choose different timing for when they react, and two, they choose different organizational approaches for reacting (often as a result of their chosen reaction timing). The different choices were a result of three main factors:

• The firm’s adjustment costs – defined as the costs/reasons why a firm might be constrained from immediately and costlessly imitating the disruptor’s innovation;
• The firm’s opportunity costs – the costs of being late to respond to the innovation; and,
• The firm’s transaction costs – defined as the costs associated with buying activities from the market (outsourcing).

The findings of their research suggested that firms:

• with higher adjustment costs would delay their reaction to the new innovation but firms with high opportunity costs would react to the new innovation faster.
• that chose to react faster were likely to be willing to incur more transaction costs and choose an outsourcing or non-integrated organizational strategy to implement the firm’s response to the innovation.
• that reacted quickly with an outsourcing model were likely to switch to an insourcing model once more firms began to imitate the innovation and competition increased.

What this means for Food and Agricultural Business

An innovation shock presents managers an opportunity to both reposition and gain advantage against competitors. It also creates competitive pressure to respond. Whether we are referring to a disruptive innovation such as robotic technology in weed control, new business model innovations such as Farmer’s Business Network (FBN), or the introduction of blockchain technology in the fresh vegetable industry, food and agribusiness firms today are constantly asking themselves when and how their firm should respond to such shocks.

This paper provides some nice insights on the factors we should consider when thinking about these two questions. Let’s examine the insights for each question in turn:

First, should we respond to the disruption now, or should we wait?

The authors suggest that the answer to this question depends on the tradeoff between adjustment costs and opportunity costs. As an agricultural retailer for example, if we are considering responding to the market disruptions caused by FBN’s innovations, we must consider how costly it will be for us to hire the expertise to mimic FBN’s digital analytics capabilities, create an electronic platform, rebrand our offerings, etc. We must weigh these adjustment costs against the opportunity costs of lost market share and lost sales if we choose to delay our response.

One of the critical elements of this analysis is thinking clearly about our firm’s overall ability to be innovative. That is, the authors make a compelling case that firms that have had more practice innovating in recent history are likely to find adjustment costs to be lower because they are more accustomed to managing the costs associated with change that comes with innovation. In my experience, it depends on where the firm is in the agricultural channel as to whether it has much experience with innovation. The agricultural retailer, for example, is not likely to have a culture that is readily adaptable to change brought on by innovations. This would mean that the opportunity costs of lost market share and sales would have to be a bit stronger before we would decide to respond quickly to a business model disruptor such as FBN.

Once we have weighed the adjustment costs against the opportunity costs, if the decision is to respond quickly, we must then ask how to respond. In the context of this research, the question of “how” is really around organizational strategy of the response; that is, should we outsource or insource the activity? I see this decision following a few different avenues:

• Go it alone and create our own response to the disruption within the context of current operations (in-sourcing)
• Create a separate entity/business unit to focus on the response to the disruption outside of the current operations (hybrid)
• Partner with an outside firm to jointly develop a response to the disruption (outsourcing)

The answer to this organization strategy question is normally addressed as a make versus buy decision that seeks to minimize transaction costs of buying from the market versus the agency costs of making the activity within the firm. The authors of the research provide evidence, however, that if we choose to respond quickly to innovative disruption (because opportunity costs of being late are greater than the adjustment costs of making the change), then the best choice is likely to outsource the response, or at least pursue a hybrid strategy. This is because the critical element is speed of the response. So, while it might be more efficient to make the innovation response ourselves within our current operation (aka build our own digital platform for ecommerce to respond to FBN), this strategy is likely to be slower to develop and bring to market, thus reducing the benefits of speed. Instead, the authors suggest a fast response would dictate using a partnership structure that may be more costly at first but allows for a quicker response. Then, once the response is established, we can revisit the organization strategy based on the traditional make versus buy decision that minimizes our overall cost structure. Figure 1 provide a visual illustration of this interactive dynamic among the two central questions for a manager responding to a disruptive innovation.

As the agriculture and food industries continue to wrestle with an increasing number of innovative disruptions, managers will need to become more adept at assessing the balancing act of when and how to react to these disruptors. How is your balance these days?

 Figure 1. Depiction of the two critical questions of responding to disruptive innovations.