By Victor Dos Santos Paulino
Any company faced with a radical innovation in its sector of activity will hesitate between indifference and reaction, because of the impossibility of foreseeing whether the innovation is a radical breakthrough or a product that is doomed to fail. To resolve this dilemma, the solution might be to identify potentially disruptive innovations and assess their risk for established stakeholders, as illustrated by the case of the satellite industry.
The miniaturisation of satellites has affected space industry markets over the last 20 years. On the offer side, new manufacturers have emerged, marketing small satellites at a lower cost; on the demand side, there are new clients that see this innovation as an opportunity. Quite logically, the well-established manufacturers, positioned in the segment of traditional large-size satellites, are wondering whether they should consider these radically new technological choices as a threat?
Our research, conducted in the framework of the Sirius chair (http://chaire-sirius.eu), aims to answer this question, which first involves clarifying the concept of ‘disruptive innovation’. This is necessary because the expression, which is widely used and sometimes mistakenly, makes established players in the sector anxious, while fascinating and intriguing them, without it being entirely clear what exactly we are talking about.A disruptive innovation is a particular case of radical innovation which modifies the structure of an industrial sector and whose effects may lead to existing companies being replaced by new competitors. The difficulty is that it is only possible to be certain that it is a disruptive innovation in the long run, a posteriori, once it has staked out its place or even driven out the oldest technologies and the companies that marketed them. In the short term it appears rather to be a less efficient product or service, aimed at a marginal clientele, an immature technology proposed by small companies with limited resources, less know-how and less knowledge of the market.Because of these characteristics, it is very difficult to distinguish between a real disruptive innovation which has just been introduced and so requires that existing companies react, and an innovation destined to fail, that they can comfortably ignore. This creates uncertainty about what they should do, which is known as the innovator’s dilemma, since existing companies should promptly assess the danger and possibly invest in the new market while the disruptive innovation is not yet a threat, if they are to limit the consequences. If they wait too long, it might be too late.
What matters to company executives is to be able to anticipate trends and thus, if possible, to be able to use forecasting tools. Since it is not possible to affirm at an early stage that an innovation is disruptive, the solution is to try and determine in the short term whether it has the typical characteristics, in other words whether it is a potentially disruptive innovation and if so what type of threat it is likely to pose to well established stakeholders.
Not all disruptive innovations have the same consequences: some lead to complete substitution of the old technology by the new one and thus pose an extreme threat, the typical case being that of silver-based, emulsion film photography wiped out by digital photography; other innovations do not entirely replace the initial products. This is the case in air transport, for which low-cost companies have captured only some of the clientele of traditional companies, and in telephony, where landline technology continues to coexist with mobile technology. These examples are characteristic of three types of disruptive innovation for which only the first is associated with a high risk of the pre-existing market disappearing. In the two other cases, the threat appears to be lower for established companies.
What then is the situation for the space industry? Given this conceptual framework, how should well established stakeholders react to the development of small satellites? According to the parameters chosen for our theoretical model, small satellites have most of the characteristics of potentially disruptive innovation: lower technological performance with respect to the requirements of the traditional main customers; they are less complex; they either cost less or on the contrary cost much more, for instance in the case of constellations of small satellites; they offer the perspective of introducing new performance criteria such as the possibility of designing, building and launching a new satellite in a very short time or again the improvements offered by constellations in low Earth orbit.
However, an analysis of the demand for these new satellites shows that they are intended mainly for new customers, which means that we can exclude the hypothesis of a disruptive innovation affecting an existing market, which is really the main risk case for manufacturers. Those who buy them can be divided into institutional customers from emerging countries, which do not have sufficient resources to launch conventional satellites, and private top-of-the-market customers with new needs for low orbit constellations, which conventional satellites do not meet.
Thus, small satellites are indeed a potentially disruptive innovation but they only pose a slight threat to well established stakeholders. Despite the structural changes they might lead to for this industry, there is not much risk that they will entirely replace conventional satellites. This in no way determines either their ultimate success or failure.
This study was conducted by Victor dos Santos Paulino (TBS) and Gaël Le Hir (TBS) in the framework of the Sirius chair, on a topic proposed by the chair’s industrial partners. For the theoretical part, the authors reviewed the existing literature on the theory of disruptive innovation, which enabled them to draw up a table classifying the characteristics of potentially disruptive innovations. They then applied this model to the satellite industry while referring to several sources of information (information published by manufacturers, sectoral information, interviews with experts, databases). The study was published in the Journal of Innovation Economics & Management in February 2016 under the title “Industry structure and disruptive innovations: the satellite industry”.
Innovation is one of the major themes in management. The capacity to innovate is considered to be critical for businesses to succeed. However, if we look at the space industry, we can see that innovation should be bridled with caution if a strategy is to succeed.
Conventional wisdom claims that the rapid adoption of new technologies improves the performance and survival of companies. Already at the beginning of the 20th century, Joseph Schumpeter had demonstrated the link between innovation and industrial success. In the 1990s, other scholars, such as Joel Mokyr, followed suit while explaining the inertia (the slow adoption of new technology) as being due to the phobic and irrational attitudes of managers. Against this backdrop, the space industry provides an interesting, and even paradoxical, example: this highly technological sector is a symbol of innovation, yet it considers it necessary to adopt a cautious approach. This is a requirement for telecommunications satellite operators, for whom reliability is more important than novelty, a factor that entails risk.
Innovation is a complex phenomenon that does not automatically guarantee success, progress and profits. For example, it has been demonstrated that over 60% of innovations led to failures. In addition, many companies legitimately postpone the adoption of innovations in several cases: for example, when an innovation would cannibalize an existing product or make it obsolete, or when the costs turn out to be too high compared with the expected profits. Do these factors explain the inertia-based strategy observed in the space industry?
By its very nature, the use of new technology by the space industry entails a risk: ground testing of a component, even under conditions that simulate space, may not accurately predict its behaviour in flight. It may perform perfectly, or prove faulty and no-one can be sure ahead of time! The result is that satellite manufacturers tend to favour an inertia-based strategy with which technological changes are adopted in an extremely cautious manner. Only tried and tested innovations are implemented. The cost of failure makes both manufacturers and their customers behave cautiously.
Caution features strongly in the space telecommunications sector, because the reliability of satellites is a major competitive advantage. To ensure the greatest reliability, manufacturers have set up perfectly tuned organisations and processes. This is why the cycle of design, development and manufacture of satellites is broken down – and must continue to be so, into successive phases: Phase 0 > Mission analysis; Phase A > Feasibility study; Phase B > Preliminary design; Phase C > Detailed design; Phase D > Manufacturing and testing; Phase E > Exploitation; Phase F > Decommissioning. While this approach helps ensure high levels of reliability, it also brings with it considerable structural inertia.
This need for reliability and stability leads space manufacturers to adopt information and communications technologies that have the least impact on the organization. However, it also leads them to not question technological choices for space telecommunications, choices that increase reliability, but do not allow any savings in production costs. Serge Potteck, a specialist in space project management, emphasises, for example, that to transmit a signal, engineers prefer to design antennas with a diameter of 60 cm in order to guard against possible malfunctions, whereas a less costly 55 cm antenna would suffice.
This analysis, however, needs to be refined for each of the different segments that make up the space sector. They can be classified into three groups. The first consists of telecommunications satellites and rockets (launchers). In this segment, the cost of failure would be very high. It would penalize the manufacturer, who would have produced a non-functioning satellite as well as the company that operates the launchers and markets launch services, but, also, all the players involved in the business plan. A failure can cause a delay of several years in the marketing of new telecommunications services to be delivered by satellite.
The second group consists of spacecraft built for scientific or demonstration purposes, and as always, the rockets used to launch them. The governments or space agencies that commission them are not subject to the usual profitability requirements. Here, disruptive technology and its associated risks are part and parcel of a project.
The last group overlaps the space industry and other industries. It encompasses, for example, the tools to operate the geolocation capabilities of the Galileo constellation or the distribution of digital content. In this segment, stability is seen as detrimental to the development of new markets.
While the particular environment in which the space sector operates tends to dampen its ability to experiment, it does not entirely prevent innovation. Inertia-based strategies are, in fact, largely an appearance. What we refer to as “inertia” is, in fact, a genuine innovation-dynamic: any new technology will be studied carefully before being tested, or not, on a new spacecraft, and before its possible subsequent integration. Could such a strategy, therefore, ensure the survival of a market in certain cases? To consider it as a failure to be countered would be a mistake!
The space industry would probably not innovate much if its only clients were commercial satellite operators. However, space agencies are willing to finance experimental spacecraft, thus accepting the financial risk associated with possible failure. It is thanks to them that the manufacturers of commercial satellites are able to validate the technological choices available to them, since they have proven their reliability.
From my publications, ” Innovation: quand la prudence est la bonne stratégie [Innovation: when caution is the right strategy]”, published in TBSearch magazine, No. 6, July 2014, and ” Le paradoxe du retard de l’industrie spatiale dans ses formes organisationnelles et dans l’usage des TIC [The paradox of the delay of the space industry in its organizational forms and in the use of ICT],” published in Gérer et comprendre [Managing and understanding], December 2006, No. 86
The analysis of the organizational and technological paradox that characterizes the space industry is based on several types of information: the theoretical literature available (Hannan and Freeman, 1984; Jeantet, Tiger, Vinck and Tichkiewitch, 1996); the work done by engineers in the sector (Potteck, 1999); and field observations made between 2003 and 2007 at one of the leading European prime contractors manufacturing satellites and space probes.
By Stéphanie Lavigne
Quite unexpectedly, those European companies which invest the most in Research & Development (R&D) are also those whose majority shareholders are institutional investors (and particularly pension funds located in English-speaking countries) whereas we expected to find so-called ‘strategic’ investors (the State or families) that are generally believed to support a company’s growth policy and therefore also its innovation policy.
The advent of institutional investors in the 1990s led to a radical change in equity breakdown in European companies. Today, 50 to 60% of the capital of European groups listed on the stock exchange is held by pension funds and mutual funds (which manage other peoples’ money). Now, as leading shareholders, they have imposed their own governance principles and value creation strategies, demanding about 15% return on investment for the households whose savings they manage.
To achieve this level of return, companies are implementing financially-driven strategies with shorter investment periods, so that they can deliver ever-increasing dividends to their shareholders on a yearly or even a six-monthly basis. But is this short period of time compatible with a given company’s growth and with its R&D policy in particular?
In this study, we have tried to establish a relationship between the equity breakdown and innovation policies of major European companies.
A review of empirical studies undertaken so far reveals that they relate almost entirely to the North American market and yield contradictory results. Two opposing theories have emerged regarding the influence of institutional investors: one of the theories asserts that these investors believe in short-term profitability only and do not encourage high-risk innovation policies; the second theory, on the other hand, acknowledges the control exercised by these investors and their positive influence on innovation policy, which ensures the company’s long-term profitability.
Our study shows that in Europe, the more companies’ shares are held by institutional investors the more they spend on R&D whereas we were expecting to find strategic investors such as governments or families that are known to support companies with patient growth policies. It seems that the crucial factor is the investment period of these institutional investors: the longer the period, the greater the likelihood of the company committing to an innovation policy. This may seem insignificant, but the findings have never before been demonstrated in a multinational context (a sample of 324 European companies) over such an extended period of time (tests between 2002 and 2009).
One of the major conclusions of our study highlights the detrimental effect of short-term investor attitudes on the innovation strategies of companies, which actually need the support of long-term investors in order to carry out their R&D policies.
When analyzing how the investment period influences the innovation strategies of European companies, we compared companies having short-term or “impatient” investors (with an investment period of less than 18 months) as majority shareholders with companies where long-term or “patient” investors are the majority shareholders. Our findings show that R&D spending is higher when the majority shareholders are patient investors and lower when most of the company’s capital lies in the hands of impatient investors.
This article was written by Stephanie Lavigne and the article “Ownership structures and R&D in Europe: the good institutional investors, the bad, ugly and impatient shareholder”, co-authored by Olivier Brossard and Mustafa Erdem Sakinc, published in Industrial and Corporate Change (Volume 22, Number 4) – Oxford University Press, 5 July 2013.
Our study of equity breakdown and the innovation strategies of European companies shows that we should not be disparaging about institutional investors but focus on the crucial issue of how long they leave their investments in companies.With this in mind, companies must learn to identify the investment period of any new institutional investors promptly in order to build a privileged relationship with them and attempt to offset any short-term investors.
In our research, we conducted an empirical study of the relationship between the equity breakdown and innovation policies of leading European companies. We analysed a sample consisting of the 324 most innovative European companies (as listed on the EU Industrial R&D Investment Scoreboard between 2002 and 2009) and compared their R&D expenditure against financial and shareholding data obtained from the Thomson Financial data base.