Paper to be presented at the DRUID 2012 on June 19 to June 21 at CBS, Copenhagen, Denmark, INNOVATING BACKWARDS: REVERSE R&D PROCESS IN SERVICE INNOVATION Ivanka Visnjic ESADE Business School Operations and Innovation management [email protected] Taija Turunen Aalto University School of Science [email protected] Andy Neely Cambridge University Department of Engeneering [email protected] Abstract Services have traditionally been perceived as less innovative than product, raising questions about why service firms are less able to apply best innovation practices than their product counterparts, and whether the process of service innovation is well understood. Based on the case-study research performed on four product-service providers, our findings reveal that conventional product-oriented thinking about the nature of the innovation process does not extend to services. While product innovation begins with research, continues with design/development, and is followed by production and use respectively, the innovation of a service starts with the initial design, while the actual research is
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Paper to be presented at the DRUID 2012
on
June 19 to June 21
at
CBS, Copenhagen, Denmark,
INNOVATING BACKWARDS: REVERSE R&D PROCESS IN SERVICE
INNOVATIONIvanka Visnjic
ESADE Business SchoolOperations and Innovation management
Taija TurunenAalto University
School of [email protected]
Andy Neely
Cambridge UniversityDepartment of Engeneering
AbstractServices have traditionally been perceived as less innovative than product, raising questions about why service firms areless able to apply best innovation practices than their product counterparts, and whether the process of serviceinnovation is well understood. Based on the case-study research performed on four product-service providers, ourfindings reveal that conventional product-oriented thinking about the nature of the innovation process does not extend toservices. While product innovation begins with research, continues with design/development, and is followed byproduction and use respectively, the innovation of a service starts with the initial design, while the actual research is
performed simultaneously to production and use of this ?first service?, as the experiential nature of service implies that asignificant part of the service is unknown in the initial design stage and that the first learning experience comes inproduction/use. The initial service delivery (production and use) tends to be less successful, which can be seen as theactual research investment that is to be recouped in the following service-delivery projects. The inverteddesign-research sequence, and simultaneity between initial service production/use and research, also results in adifferent risk profile of service innovation. Given that customers commit to pay for the ?innovative? service delivery afterthey are presented with an initial design, service innovators don?t face the market risk that the products face, butinstead face a delivery risk of that first service. This paper discusses at length the implications of the reverse innovationprocess and associated risks.
Jelcodes:M13,-
INNOVATING BACKWARDS:
REVERSE R&D PROCESS IN SERVICE INNOVATION
ABSTRACT
Services have traditionally been perceived as less innovative than product, raising questions
about why service firms are less able to apply best innovation practices than their product
counterparts, and whether the process of service innovation is well understood. Based on the
case-study research performed on four product-service providers, our findings reveal that
conventional product-oriented thinking about the nature of the innovation process does not
extend to services. While product innovation begins with research, continues with
design/development, and is followed by production and use respectively, the innovation of a
service starts with the initial design, while the actual research is performed simultaneously to
production and use of this ‘first service’, as the experiential nature of service implies that a
significant part of the service is unknown in the initial design stage and that the first learning
experience comes in production/use. The initial service delivery (production and use) tends to
be less successful, which can be seen as the actual research investment that is to be recouped
in the following service-delivery projects. The inverted design-research sequence, and
simultaneity between initial service production/use and research, also results in a different
risk profile of service innovation. Given that customers commit to pay for the ‘innovative’
service delivery after they are presented with an initial design, service innovators don’t face
the market risk that the products face, but instead face a delivery risk of that first service. This
paper discusses at length the implications of the reverse innovation process and associated
risks, as well as managerial recommendations on how to capture learning, make the right
investments and mitigate risk.
2
INTRODUCTION
Organisations respond to the changing nature of the market environment with innovation.
Innovation has traditionally been seen as an outcome of a collision between technological
opportunities and user needs that are usually embedded in new products, and represents a
critical dimension of economic value creation (Schumpeter 1934). A number of valuable
concepts at the level of a product (e.g. innovation funnel, stage-gate innovation, open
innovation), as well as firm (e.g. innovation portfolio mapping, innovation roadmaps), have
helped academics and practitioners inform their understanding of how firms innovate their
products. However, during the last decades researchers have broadened the concept of
innovation to include types of innovation other than technology driven. Amongst others these
include: design innovation (Verganti 2006; Walsh 1996), business model innovation (Amit &
Zott 2001; Zott & Amit 2010); and process innovation (Hammer 2004). Furthermore, the
interest in different innovation contexts – service environments as opposed to the well-studied
product environments – is gradually increasing (Drejer 2004).
Early interest in innovation in the service context soon faced its first challenges. Several
innovation studies have reported that innovation activities in the service sector and service
firms are less organised than those of firms in the industrial or manufacturing sectors, and that
service firms rarely have R&D (research and development) departments for innovation
activities. In a service firm, innovation tends to be conducted by different units and in relation
to different functions, such as strategic planning, training, and market development
(Fagerberg et al. 2006). Potentially due to the significant differences in the organisational
design of the innovation function (mostly centralised in product firms versus mostly dispersed
in service firms), the quantitative measures of innovation (e.g. R&D spend) have been failing
3
to capture all innovation efforts in the context of services (Gallouj 2010). At the same time,
anecdotal evidence suggests that a number of highly innovative service firms have not only
obtained competitive advantage but also succeeded in disrupting their competitors as a result
of ‘radically innovating’ the overall business model. A celebrated example of a radically new
service is low-cost air-transportation.
The presence of this, and many other examples, serves as an illustration of shortcomings that
the traditional product innovation lens may pose for the understanding of innovation in the
service context. Furthermore, given the differences in organising innovation, one may wonder
whether the underlying process of innovation is the same in product and service firms. Does
the linear funnel-based approach from research to development, followed by production and
customer use, apply to service firms as well? This question is particularly apposite when one
considers the well-established difference in the process of production and use; unlike products
where production is followed by sales and then use, services are first sold and then
simultaneously produced and consumed/used in a process that has been intuitively labelled as
co-production (Anderson et al. 1997; Grönroos 2008; Zeithaml 1981). Some more recent
research has pointed to different types of innovation that can be found in services (Gallouj
2010). Namely, service innovation can be in the form of a project, rapid application and/or
‘daily’ practice (Toivonen 2010). At the same time, much of this discussion has focused on
innovation of isolated services, without much consideration for the implications at firm level.
The purpose of this paper is to contribute to the existing literature on the process of
innovation in general, and specifically the process of service innovation, by seeking to
understand and conceptualise the process of service innovation at the level of a single service
as well as at firm level. Furthermore, our research seeks to understand the relationship
4
between service innovation and other types of innovation, such as business model
innovations, product innovation (in technology or design) and process innovation.
In order to answer these questions, we decided to concentrate on the multiple comparative
case-study analysis of companies that provided durable products and multi-year (relational)
service contracts, related to these products. Relational services, such as multi-year leasing and
maintenance contracts, are among the most complex examples of the co-production process,
which is significantly different than that of typically transactional products. In addition,
studying product-service providers allows us to contrast their process of product innovation to
that of service and also inspect their interrelationships.
The paper is structured as follows. First we introduce the well-established literature on the
process of product innovation, followed by the first contributions on the process of service
innovations. We then present our research methodology, followed by the case-study results
and discussion of conceptual framing for the process of service innovation. The paper ends
with conclusions, where we revise both the theoretical and practical implications and discuss
the challenges for further research.
THEORETICAL BACKGROUND
Product innovation: characteristics, typology and process
Innovation has already been recognised as a source of value creation in organisations in the
first part of the twentieth century (Schumpeter 1934). Nevertheless, the adoption of
innovation as a core component of firm strategies and value-creation function became
widespread during the last decades of the twentieth century, complementing and even
5
overtaking the interest in flexibility and efficiency as the core sources of value creation
(Bolwijn & Kumpe 1990). One of the most significant early contributions was an
understanding of the process of innovation and its conception as an R&D funnel
(Wheelwright 1992). What accompanied the interest in understanding the process of
innovation was interest in its success factors and productivity of the R&D process (Cooper
2008). Looking to address the major problems associated with productivity – promotion of
non-promising candidates in the later and more expensive stages of product development –
Cooper (1992) proposed a stage-gate process as a way to optimise return on the investments
in R&D. The further developments on the funnel process provide a roadmap to facilitate R&D
projects, define the project leaders’ objectives and tasks and perform stage-based evaluation
to better rank projects and focus resources (Cooper, 1990).
More recent contributions have focused on the opportunities to improve innovation success
by opening up the R&D funnel and engaging with the ecosystems and firm surroundings.
Examples include customer involvement in the early stages of R&D (von Hippel 1990) or
sourcing of innovation ideas and projects externally through licensing, partnerships or
intermediaries (Chesbrough et al. 2006), as well as the potential use of alternative business
models or routes to commercialise promising technology that doesn’t fit firm strategy
(Chesbrough et al. 2006).
Building on the milestones of these contributions, a growing number of studies further
examined the impact of ‘opening’ up the innovation process. For example, Becker and Dietz
(2004) investigated the role of R&D cooperation in the innovation process – in particular the
impact of R&D cooperation on firms’ innovation input and output, as well as the number of
cooperation partners – on the innovation behaviour of firms. Bidault et al. (1998) instead
probed the adoption of Early Supplier Involvement (ESI) in the product development process
6
at the early stages of concept development and design. Busom and Fernandez-Ribas (2008)
looked into the effects of R&D subsidies and the way they organise their innovation process.
The findings suggest that public R&D programmes trigger a behavioural change in firms’
R&D partnerships, alleviating barriers to cooperation.
Furthermore, the innovation processes in certain industries, such as low- and medium-
technology (LMT) industries, depend on non-formal R&D activities and the use of external
sources (Santamaria et al. 2009). The results strongly support the view that non-R&D
activities, such as design, the use of advanced machinery, and training, are crucial to
understanding the innovation process of any firm. The empirical evidence also revealed the
importance of external sources of innovation like consultants, hired-in personnel,
collaboration agreements, and external R&D. Howells (2006) offered a typology and
framework of the different roles and functions of the intermediation process within
innovation, and operationalised the typology within the context of the UK using the case-
study approach. Tether (2002) presented the analysis showing that the relationship between
innovation and co-operation is not straightforward. Tether’s (2002) findings suggested that
firms that engage in R&D and attempt to introduce higher-level innovations, i.e. 'new to the
market' rather than 'new to the firm', are much more likely to engage in cooperative
arrangements for innovation.
In addition to focusing on the ‘opening’ of the R&D process, literature has also looked at the
interrelationships across projects within the overall firm innovation process. Wheelwright
(1992) was amongst the first to notice that a company focus on innovation projects in
isolation may lead to suboptimal decision-making that neglects knowledge created across
related projects or at the level of ‘product platforms’. It has been argued that firms need an
‘aggregate project plan’ to optimise their R&D productivity (Wheelwright 1992). Thomke et
al. (1998) extended this conception through the description of the ongoing trial-and-error
7
problem-solving processes and strategies for experimentation used in the development of new
products and services, the rapid advances being made in problem-solving methods, and the
impact that such advances can have on the competitive position of adopting firms (Thomas et
al. 2008). More recently, the dependency and path creation in firm innovation has been
mapped out with the focus on the effect of cognitive frames and organisational processes
(Thrane et al. 2010). The results of Thrane et al.’s (2010) study illustrate how firms are
cognitively locked into an innovation path focusing on generating ever-new product versions
on different technological platforms, regardless of cannibalisation among the firm’s different
product versions.
Until recently, the main focus of innovation research has been on product innovation and the
R&D processes that lead to successful and novel products. Admittedly, certain interest in
process innovation has long been present (Hammer 2004). On the other hand, recent research
efforts have started to focus on other types of innovations, which may have value-creation
potential that meets or even exceeds the potential of product innovation. Innovation in
business models, for example, has reached considerable interest in practice as well as in
academia. Defined as content, structure and governance of transactions (Amit & Zott 2001)
and activity systems (Zott & Amit 2010), or alternatively seen as value proposition, the value-
delivery system and value-capture mechanism (Teece 2010) business model represents a
significant source of the innovation potential. Amongst the latest contributors, Doganova &
Eyquem-Renaul (2009) investigated the role performed by business models in the innovation
process. They indicate that the business model is a narrative and calculative device that allows
entrepreneurs to explore a market by playing a performing role and by contributing to the
construction of the techno-economic network of an innovation.
8
Service innovation: link to products and service innovation characteristics
Along with the interest in different types of innovation came the interest in innovation in
different contexts, such as services or the service-oriented business model of manufacturing
firms (Gallouj & Weinstein 1997; Sundbo 1997). Cooper (2011) suggests that in mature and
commoditised markets, product innovation is not sufficient for success. According to him, the
answer is radical innovation – breakthrough products, services and solutions that rely on
larger-scope and more systems-oriented solutions and service packages, such as Apple’s
iPod/iPhone with iTunes features. Cooper (2011) gives a couple of examples on how to shift
the focus to services, but the question remains about what the innovation process of services
looks like and whether it is the same as the innovation of products, particularly in light of the
production/consumption differences between products and services (Anderson et al. 1997;
Grönroos 2008; Zeithaml 1981).
This question remains difficult to answer, given that the focus of the innovation literature has
been on the innovation process and development of new products, while services have been
under-represented. Nevertheless, first contributions have started to appear. Gallouj and
Weistein (1997) laid the foundations of a theory that can be used to interpret innovation in the
service sector, drawing on the product innovation frameworks. The results illustrate various
modes of innovation in the service sectors and also stress the difference of measuring
productivity in product vs service innovations.
While first contributions mostly tried to draw parallels between the products and services,
several other authors further focused on the differences between products and services with
9
respect to innovation (Gann & Salter 2000; Hipp & Grupp 2005; Sirilli & Evangelista 1998).
Hipp and Grupp (2005) suggested that the notion of innovation established in the
manufacturing sector couldn’t simply be transposed to the service sector. Their work
criticised existing measurement concepts derived from manufacturing, and introduced a new
typology with a view to obtaining a better understanding of innovation in services. Further to
that, Castellacci (2008) compared the sectorial patterns of innovation in manufacturing and
services, stressing the increasing importance of vertical linkages and inter-sectorial
knowledge exchanges between these interrelated branches of the economy. Sirilli and
Evangelista (1998) provide empirical evidence on the characteristics of technological
innovation in the service sector, and highlight major similarities and differences with
manufacturing, emphasising the diffused and variegated nature of technological innovation
and reliance on a wide range of innovation sources, and the role of software and investments
in other service-related machinery/tools. At the same time, Amable and Palombarini (1998)
studied the pattern of technical change in the service sector using an indicator of total
technology intensity, which takes account of the R&D incorporated in purchases of
intermediates and equipment, and suggests that the service sector does not appear as
homogeneous.
Understanding the process of service innovation
After the comparison of the characteristics of product and service innovations, research has
started to focus on comparison between their innovation processes. Building on the work of
Gallouj and Weinstein (1997), de Vries (2006) made a notable contribution by distilling three
approaches to studying innovation in services: assimilation, demarcation and synthesis. The
synthesis approach attempts to arrive at a theory relevant for service and manufacturing. A
10
specific set of contributions involves the process of innovation of highly complex, project-
driven product-service systems, such as design, engineering and construction firms. Gann and
Salter (2000) found that project-based firms rely upon combining technical expertise from
other organisations in order to deliver their own technical capabilities, usually in one-off
processes. Their study also argues that these firms are only able to effectively harness and
reproduce their technological capabilities by integrating project and business processes within
the firm. Blindenbach-Driessen (2006) built on this knowledge of project-oriented firms by
focusing directly on new service-development projects in these firms. They found that some
of the success factors for functionally organised firms, as described in the literature, appear to
be more important in project-based firms, while others seem redundant; and the specific
structure and capabilities of project-based firms seem to provide an explanation for these
differences.
While innovation management literature seems to concentrate significant attention on the
innovation trajectories of product firms and new product-development processes,
understanding how service firms innovate, and what kind of processes they rely on to do so,
seems to be still in its infancy, in particular at firm level. This is surprising, given the evident
importance of services in the economy, recent technological trends that seem particularly to
be offering opportunities for service firms to innovate (e.g. advent of the Internet or
instruments, such as RFID technology and sensors), as well as a clear difference in production
processes of products and service firms. To clarify and contribute to this line of research, we
decided to conduct a case-based study that seeks to shed light on the following questions:
1. What kind of processes guides service innovations? How does it differ from the
product-innovation process?
11
2. How is service innovation related to other types of innovations, such as product
innovation, business model innovation or process innovation?
METHODS
To study the process of service innovation and its potential relationships with other types of
innovations, we opted for an inductive case study (Yin, 2009). Our intention was to map out
the fundamental innovation processes and associated phases for each of our cases and note
presence and interrelationships with any other types of innovation that took place either
before, concurrently or after the focal service innovation/s. Using this research design, we
were looking to accurately capture the characteristics of the innovation process at the level of
a service as well as at the level of a firm.
We perceived case-study design to be appropriate for a variety of other reasons as well. First,
case-study design has proved to be particularly adequate when trying to answer the ‘how’
type of questions, such as ‘how innovation processes occur in our case organizations’
(Eisenhardt 1989). In addition, we identified a research gap in the literature that led us to
assume that no theoretical frames in this area existed. Only a limited number of research
contributions addressed the question of the service innovation process. Furthermore, to our
knowledge there were no contributions that considered the firm-wide implications of the
process of service innovation, and in particular interrelationship between different service
innovation projects and other types of innovation (Eisenhardt & Graebner 2007); i.e. the level
of analysis has mostly been on individual service/product innovation processes.
12
Four comparative case studies were selected to allow for replication logic and to incite an
enriched understanding of the service innovation processes and innovation dynamics at play
(Yin 2009). The choice of the firms was both deliberate and representative (Eisenhardt 1989;
Yin 2009). First, given that our research has focused on understanding the process of service
innovation, and in particular how it might compare to the process of product innovation, we
opted for firms that provided both products and services. Our expectation was that the
respondents from these firms would be likely to contrast product and service innovation
processes. At the same time, we chose in particular manufacturers and service providers of
complex engineered equipment. Given that these products have a lifespan of ten years or
more, they provide a market opportunity for the relational services that may be of a duration
that even matches their lifespan (Neely 2008; Willkinson et al. 2009). Relational services
represent the most demanding service categories, as they imply uncertainty over long periods
of time and often also assumed risk-taking on the provider’s side (Visnjic and Neely 2011;
Willkinson et al. 2009). Finally, they are the best examples of the production/consumption or
so-called co-production between service provider and client, because they require significant
client involvement over extended periods of time (Anderson et al. 1997; Grönroos 2008;
Zeithaml 1981). It seemed appropriate to contrast the innovation process of these services
with the more transactional products that have been frequently used as an exemplar in
research of the innovation processes.
Furthermore, looking to isolate our findings from the potential sector-specific characteristics
of the innovation processes, we opted for two firms that were originally engine manufacturers
and two firms that began as train manufacturers. All of these firms operate globally, while our
primary contact was with their UK-based management. Finally, four companies anecdotally
shared different impressions with the service innovation trajectories. One train manufacturer
13
experienced minor hurdles initially, while the other had significant hurdles and losses; one
engine manufacturer exhibited no difficulties throughout the process, while the other
experienced minor hurdles.
Research has evolved in several phases, starting from data collection and description to
analysis and validation (Pentland 1999; Pettigrew 1990). As is common with case-study
research projects, we allowed for phases to overlap and intertwine (Faems, Janssens, Madhok,
& Van Looya 2008). Data collection and analysis were oriented towards organisational data,
retrievable from both archival data and semi-structured interviews (Kvale 1996). We
conducted a minimum of two interviews in all the organisation case studies, and these mainly
targeted top management, who were aware of the innovation procedures and specifics in their
organisation.
The interview protocol was built around four high-level questions: 1) What innovations have
been adopted and taken to the market over the past 20 years; 2) How would you describe
these innovations (e.g. product, service, business model, process); 3) What did the process
and sequence of these innovations look like, and were there interdependencies? 4) What were
the outcomes of each innovation project and the overall innovation process in general?
In addressing respondents with these questions, we asked additional questions to gain further
insight where appropriate. Given the focus of our research, we concentrated in particular on
the service innovations. To counter disadvantages inherited through partially retrospective
data collection, we have concentrated on concrete events, client details, timelines and project
examples (Miller & Salkind 2001). In addition to the interview data, we used company
reports, financial data and historical records to gain triangulation to deepen our understanding
14
of each case (Eisenhardt & Graebner 2007). Archival data was particularly helpful in tracking
evolutionary aspects of innovation processes.
We started the analysis process by having two individual researchers perform detailed within-
case analysis following a write-up of detailed descriptions for each case (Yin 2009). Within-
case analysis performed by two individual researchers was chosen in order to take into
account the richness of the contextual data and gain more confidence in the research findings
(Barratt et al. 2011). To avoid any bias towards the status of the informants we decided to
cross-analyse the data so that the respondent’s position in the firm remained anonymous
(Miles & Huberman 1994). The first constructs and their relationships started to emerge and
we gained initial insights into the possible characteristics of the service innovation processes
and the relationship between service and other innovations at the level of each case.
After the initial screening we conducted a cross-case analysis to recognise the patterns of
innovation processes across the cases. We selected two cases at a time and compared them to
find differences; we repeated this until all our cases were considered. With this procedure we
were able to map out the innovation processes for services and their relationships to other
innovations. To validate our findings the results were presented to the company
representatives, so that they had the opportunity to correct and provide feedback on some of
the specifics that we had possibly misunderstood. The detailed descriptions and models of
different types of innovation processes and their relation to other innovations will be
discussed next.
15
SERVICE INNOVATION IN PRACTICE: THE FOUR CASE STUDIES
Please note that the detailed descriptions of the individual case studies have been omitted to
comply with the DRUID length restriction. In Table 1 below you will find a summary of the
insights for each of the four cases.
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Insert Table 1 about here
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TOWARDS A FRAMEWORK OF THE PROCESS OF SERVICE INNOVATION
Drawing on the findings above, we isolated some of the characteristics of the innovation
process as well as the inter-relationships with other types of innovation common to all the
cases we investigated.
For all the manufacturing firms, attempting to develop innovative service offering, business
model innovation (Cooper 2011) seemed to be an important precursor to the first service
innovation. Moreover, the more ‘radical’ the service innovation seemed to be, the more the
adequacy of the business model adopted seemed to matter. For example, while Railco and
Trainco had similar service innovation ‘increments’, while Railco changed towards service
business models and acquired experienced managers ex ante, and had only minor challenges
in the process of innovation, Trainco, largely managed under a product-oriented business
model, faced severe losses. Furthermore, Logico opted for ex ante investment in a separate
16
unit that hosted the new business model, and modest, incremental service innovations, and
subsequently reported a smoother innovation process.
PROPOSITION 1: Business model innovation may be an important antecedent of service
innovation. The adopted business model needs to support the service innovation, in particular
when the innovator is a product-oriented firm.
Unlike product innovation where research and development steps roll out sequentially and are
followed by production and then consumption/use, the innovation process in services tends to
intertwine and overlap with other value-chain steps. In services, the initial service design
(development) seems to come first: service innovation begins with negotiations of what the
service will look like based on the desired service outcome of the client. Having never
delivered this relational service in the past, the service provider relies on his experience in
service delivery, back-of-the envelope calculations of service delivery costs and risks, and the
customer’s input as a user and service co-producer. As we have seen from the cases
discussed, Trainco, Railco and Airco had to sign risky service contracts due to lack of
information-sharing on the client side. On the other hand, Logico was substantially helped by
a partnering relationship with the first client, who supported them in the development of
initial service innovations.
Once the design is finalised and legalised in a multi-year contract, the provision of the initial
service starts. The customer is directly involved in the service provision and his involvement
and responsiveness, as suggested in the case of Airco, plays a crucial role for the success of
the service. Because services are only produced and, hence, visible once they are consumed,
in many instances their success depends on factors that are only visible once the service has
17
been delivered. Once the service is being consumed, both provider and customer start to learn
about the value of the service. The initial service is the first significant learning experience.
For example, Trainco had to re-engineer radically the process of service delivery, while
Railco had to learn from scratch how to deliver the service they promised.
Hence upfront research and development may be of limited applicability for the use (that
would be like testing one product and producing and selling a similar, but not the same,
product). Given that prototypes and pilots are not possible for relational services, or are at
least very costly (reproducing a five-year contract in a prototype phase would take five years),
the service provider only gets a chance to learn about service delivery once it starts providing
it. Hence, this ‘learning phase’ or research phase comes at the same time as the first service
production takes place.
The service provider makes investments in the tools and equipment needed to deliver service
(e.g. investments in IT infrastructure are a frequent follower of service innovation in our
cases) once the contract has been signed. As a service provider has a guarantee for service
revenues for a particular number of years, the role of the client in the innovation process can
be seen as changing from intellectual input, as is common in user-driven innovations (von
Hippel 1990), to a role of financier as well as co-producer.
This in turn implies that the nature of risk and the dynamics of risk-bearing differ between
products and services. Given that the customer commits to pay for the service for a number of
years after the contract has been signed and before production/use (and hence research), the
service provider faces limited market risk for its service innovation. More specifically, the
service provider does not face the risk that it will develop an expensive service only to
18
discover that there are no clients for it, as may happen in the case of products. Investments
that are made are covered by projected revenues from the customer and are usually financed
with preferential loans given clients’ contractual guarantee. This has been assumed in the case
of all the relational service cases we examined.
While the market is known ex ante, resulting in limited market risk, the service provider faces
uncertainty regarding the exact nature of the delivery process and associated risks, for
example, estimating performance levels of the service outcomes it commits to (Visnjic and
Neely 2011). As the delivery or production of the service is simultaneous with consumption,
and subject to contracted performance standards, the service provider becomes exposed to
delivery risk in the form of higher service costs that lead to penalties and losses or simply
reputational losses in the face of a dissatisfied customer. Indeed, Railco and Airco reported
decreased profitability at the beginning of their services, while Trainco faced losses.
PROPOSITION 2a: In the process of service innovation initial service development may
precede the research. The research phase may overlap with the production and delivery of the
first service.
PROPOSITION 2b: The client (user) gets involved in the process of initial service design
and development by stating his/her requirements and expected outcome. In the subsequent
phase of (initial) service research, the client figures as a co-producer and financier.
PROPOSITION 2c: The nature of the risk in service innovation changes is likely to shift the
balance from market risk towards delivery risk.
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Figure 1 illustrates the process of service innovation.
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Insert Figure 1 about here
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Given that research occurs simultaneously with delivery of the initial service, the question
that poses itself is how a manufacturer benefits from these learnings, in terms of return on the
investment. Indeed, three of our case studies demonstrate challenges with service innovation
that may even result in losses generated at the level of the initial service.
In order to benefit from the full scope of learnings and get return on the initial service
research (initial service delivery), service firms tend to focus on signing a subsequent service
contract. Design of the subsequent service with the same or another customer represents a
return on investment on learning/research from the initial service. Logico is a good example
of a service provider that manages to drive a spiral of service innovation extending from 1 to
24 services and from 1 client to more than 50.
Given the importance of learning from the initial service and the reputational factor, first-
mover advantage matters a great deal in service innovation. More specifically, firms that get a
chance to sell a service in advance of other firms entering the market have already completed
the R&D process. In the case of a sector where contracts are typically signed over five years,
this would give a five-year advantage. In addition, some of the investments made in the first
period may be cross-leveraged to the second period (IT systems). Hence, to be the first one to
enter into a promising new service market, firms are willing to decrease the price of the initial
service in order to gain the experience and reputation (piloting). In the words of Railco’s
20
service manager: ‘We had to take a hit on a price, in order to win the business development
opportunity.’ Railco, as well as the three other service providers we studied, signed service
contract extensions with the same customers as well as additional service contracts with other
customers.
PROPOSITION 3: The initial service development and research phase may be followed by a
service extension or provision of a similar service to other clients. Design/development and
delivery of a subsequent service may be seen as a point where the research insights of the first
service are leveraged.
At the same time, initial service innovation may be a springboard for other types of
innovation; Railco and Trainco reported innovating their processes directly after they had
adopted innovative service design. For example, promising a level of train availability at
Trainco rather than reactively delivering maintenance service at the client’s request meant that
the process of maintenance had to be streamlined and reconfigured. Both Trainco and Logico
further innovated their business models. Finally, coping with the initial service innovation
represented for Trainco’s management an incentive to change their business model from
product- to service-oriented. Logico’s parent company gave the green light to having their
internal supply-chain services handed over to the Logico SC unit that used to focus only on
logistics for external clients. Initial service innovation has lead to other service innovations as
well. Both Trainco and Airco developed more sophisticated monitoring services based on the
investments made into the monitoring centres they developed. In addition Trainco was
contemplating a move towards in-train service for passengers, while Railco was extending its
availability contract towards energy-efficiency performance. Logico made additional service
innovations a step-wise process for each of the subsequent services. In addition, service
21
innovation has led to innovations in product offering. Logico entered a multi-party alliance
and developed supply-chain optimisation software, while Railco reported a number of
changes in train design as a result of comprehensive involvement in service delivery.
PROPOSITION 4: Initial service innovation may be a trigger for other types of innovation,
such as process, product or subsequent service and business model innovations.
Figure 2 illustrates the interdependencies between initial service innovation and subsequent
service innovations.
---------------------------------------------
Insert Figure 2 about here
---------------------------------------------
CONCLUSION
Our results suggest that prior to opting for a service innovation, a firm needs to consider
whether its business model is adequate for hosting a particular service innovation. In
particular, product firms that are looking to develop a service offering (Cooper 2011), or
service firms that are looking to change from transactional services, which are more similar to
products than to relational services, should also strongly consider an innovation of their
business model (Chesbrough 2003). For example, IBM commenced the transition from a
product-driven business model in the 1990s and gradually shifted towards a service-oriented
business model by acquiring PWC in the early 2000s, divesting its laptop hardware business
in the mid-2000s.
22
Furthermore, our findings suggest that the process of service innovation is fundamentally
different to the process of product innovation. Service innovation starts from the initial
service design and development and, once the service starts being co-produced jointly with
the customer, the service provider starts to learn and conduct the research. Hence, not only is
the intellectual input of the client/user indispensable (von Hipel 1990) at the stage of
development, but the client also becomes an active agent in the process of co-production and
research. Moreover, having committed to the service contract after the service has been
designed, the client also indirectly finances investments in the new service by paying the
customer for the delivery. For the service provider, this fundamentally changes the nature of
the risk; while the provider has secured its customer in advance and, hence, avoided the
market risk, the provider starts to face a delivery risk of not being able to provide service with
a calculated cost base or to a certain standard, and hence faces penalties. In both cases service
innovation would generate loss.
While business model innovation might need to be kicked off before initial service innovation
begins, innovating services may in turn be a good driver for further innovation of the business
model as well as for other types of innovation such as process innovation, service innovation
and product innovation. In the IBM example, the development of extended, relational services
led to the setting-up of a new business model known as a ‘smart planet’ agenda that combines
and extends IBM’s product and service offering in an unprecedented way.
Clearly, characteristics of the service innovation process bare a number of implications for the
potential service innovator. For experienced product innovators, the product-driven process of
innovation may be a cognitive impediment to designing a service-driven approach to
innovation. Companies that, for example, host strictly technology-driven and closed-
23
innovation departments may need to consider involving the customer in the process of
product innovation before they take the more radical step of conducting R&D on ‘live’
services.
Probably the most important lesson for firms to take away would be to understand the across-
project and over-time interdependencies of the R&D process in services, and to consider the
implications of service innovation at firm level rather than as an isolated project. Firstly, this
platform-level view would ensure that all the investments were properly accounted for, as
well as all the value creation potential considered. For example, while direct service
innovation investments are indirectly borne by the paying customer, upfront investments in
the business model innovation may be the hidden cost and need to be accounted for too.
Similarly, even though the direct returns from the initial service innovation may be modest or
even absent, returns on this innovation may come during the delivery of subsequent services
as well as the knock-on effect on other types of innovations. Lack of understanding of service
innovation dynamics can discourage innovation, lead to premature abandonment of
unprofitable initial service innovations, or failure to realise the learning potential of the
research phase (initial service provision), in particular when it comes to the ‘less tangible’
experience-related factors and the customer’s role in co-production.
Besides the role it plays in adequate estimates of the project-value creation (balancing cost
and reward), as well as value-appropriation regime (the timeframe of the return on
investments), understanding the process of service innovation is crucial in decisions
concerning size of the innovation increments, and the risk and length of the innovation
process. Understanding the process of innovation of service firms and the delivery and market
risk mechanisms should help firms mitigate that risk through careful consideration of the
24
initial service design; more modest service innovations (e.g. smaller performance guarantees)
or more flexible service design (e.g. performance within the bands with gain-share
mechanisms or limitations to certain types of uncertainties, such as natural disaster) would
result in lower risk.
The risk would also depend on the length of the initial service. Admittedly, a longer service
contract would mean that the client has been locked in for a longer period of time, which
offsets the market risk of innovation. At the same time, the cumulative delivery risk on the
project would increase as the timeframe increases exponentially. Firstly, cumulative risk
proportionally increases as the contract (and hence risk) is extended for longer periods of
time. Secondly, the latter years bare more risk as the ability to foresee the future decreases
and general uncertainty increases. Hence the time of the contract would be optimal when it
balances the coverage of the market risk for baring investment while not execrating the
delivery risk. A number of other expected customers and the likelihood of the renewal would
also need to enter into this calculation: the more potential customers follow, the lower the
expected market risk and the dependence on the initial clients.
In addition to practical contributions, this paper hopes to contribute to the literature on
innovation management in general, and specifically on new product/service development. Our
paper congregates insights from a number of research contributions, ranging from open
innovation (Chesbrough 2003), to user-led innovation (von Hippel, 1990) and product
platforms, (Wheelwright 1992), and builds on this stream of literature, as well as the
upcoming literature on service innovation (Drejer 2004) by providing a perspective on the
process of service innovation and its firm-level implications in particular.
25
It goes without saying that the research reported in this paper has limitations. Relying on the
experience of four cases allowed us to obtain detailed insights, but it introduced limitations on
generalisability. In particular, we focus on the innovation process of relational services, such
as multi-year performance and maintenance contracts, and we draw on the experiences of the
product-service providers in the industrial services context. In that respect, translating the
obtained findings into larger-scale research efforts that involve quantitative testing may be
worthwhile pursuing. We hope that our findings and the research topic inspire other scholars
to engage in such efforts and develop valuable insights for both practitioners and researchers.
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2
9
Table 1. Summary of the case-study insights
Company
alias
Railco
Trainco
Airco
Logico
Core business
area
Tra
in s
olu
tions
Tra
in s
olu
tions
Engin
e and e
quip
ment m
anufa
cture
r
Engin
e an
d e
quip
ment
man
ufa
cture
r
Challenges
with the
service
innovation
Som
e oper
atio
nal ch
alle
nges
resu
lted in d
ecre
ased
pro
fita
bilit
y initia
lly.
Sig
nif
icant oper
atio
nal
chal
lenges
res
ulted
in loss
es in
the
firs
t yea
rs.
Som
e ch
alle
nges
in c
o-c
reat
ion w
ith
cust
om
er r
esulted in d
ecre
ased
pro
fita
bilit
y initia
lly.
Negli
gib
le c
hal
lenges
,
unre
mar
kable
on the
pro
fita
bil
ity
level
s.
Prior to
service
innovation:
business
model
Change
from
pro
duct
-ori
ente
d to
serv
ice-
ori
ente
d b
usi
nes
s m
odel
(fro
m s
elli
ng tra
ins
to s
elli
ng tra
in
avai
labilit
y)
foll
ow
ed b
y
inves
tment in
sta
ff.
Gro
unded
in a
pro
duct
-
ori
ente
d b
usi
nes
s m
odel
wher
e se
rvic
es u
sed to b
e
seen
as
a su
pport
funct
ion.
Antici
pat
ed s
ervic
e busi
nes
s opport
unit
y
earl
y o
n a
nd tra
nsf
orm
ed b
usi
nes
s m
odel
from
air
pla
ne
engin
e pro
duce
r to
aer
o
solu
tion p
rovid
er.
Invest
ments
in a
ded
icat
ed b
usi
nes
s
unit
wit
h a
focu
s on logis
tics
and
supply
-chai
n (
SC
) se
rvic
es f
or
exte
rnal
cli
ents
, w
ith a
n
acco
mpan
yin
g b
usi
ness
model
.
Service
innovation:
process,
customer
involvement
and risks
Lar
ge
serv
ice
innovat
ion s
tep
(9-y
ear
trai
n a
vai
labil
ity &
reliab
ilit
y p
erfo
rmance
contr
act fo
r 27 tra
ins)
. T
wo
yea
rs o
f se
rious
contr
act
negotiat
ions
wher
e cl
ient w
as
relu
ctan
t to
shar
e al
l
info
rmat
ion. Ser
vic
e del
iver
y
esti
mat
e bas
ed o
n a
num
ber
of
assu
mpti
ons
(e.g
. per
form
ance
of
secondee
s). Siz
eable
inves
tments
(new
depot)
.
Lar
ge
serv
ice
innovat
ion s
tep
(mult
i-yea
r tr
ain a
ll-i
n
per
form
ance
contr
act pri
ced b
y
km
for
>70 tra
ins)
. C
ust
om
er
takin
g s
tance
of
a hea
vy
negotiat
or
and p
ush
ing the
pri
ce
dow
n in a
bid
din
g c
onte
st.
Sever
e oper
atio
nal
iss
ues
at th
e
begin
nin
g, pen
alti
es incurr
ed o
n
a dai
ly b
asis
. M
ainte
nance
pro
cess
innovat
ion, in
vest
men
ts
in tra
in m
onit
ori
ng c
entr
e le
d to
impre
ssiv
e tu
rnar
ound to the
bes
t se
rvic
e contr
act in
UK
.
Siz
eable
ser
vic
e in
novat
ion s
tep (
'tota
l
care
’ pac
kage
of
a cu
stom
er's a
ero-
engin
e fl
eet)
. U
nce
rtai
nty
about th
e ex
act
serv
ice
deli
ver
y p
roce
ss a
t th
e tim
e of
the
(outc
om
e-bas
ed)
contr
act des
ign.
Del
iver
y h
urd
les
asso
ciat
ed w
ith c
lient
par
tici
pat
ion a
nd w
illi
ngnes
s to
collabora
te r
esulted in e
arly
iss
ues
wit
h
dec
reas
ed p
rofi
tabil
ity. A
fter
org
anis
atio
nal
innovat
ion h
as b
een
adopte
d (
join
t te
am
wit
h c
ust
om
er a
s
wel
l as
ris
k-s
har
ing m
echan
ism
) th
e
del
iver
y p
roce
ss s
tart
ed to f
unct
ion a
nd
per
form
ance
pic
ked
up.
Incr
em
enta
l se
rvic
e in
novati
on
step
s; g
raduall
y e
xpan
ded f
rom
a
war
ehousi
ng s
ervic
e to
a p
ort
foli
o
of
24 S
C s
ervic
es
wit
h p
erfo
rman
ce
level
s, e
mbed
ded in m
ulti-
yea
r
contr
acts
. C
ontr
acts
alw
ays
allo
w
for
the
tim
e to
rec
oup invest
men
ts
(usu
ally
IC
T s
yst
ems)
. C
apabil
itie
s
and c
lien
t bas
e (e
xpanded f
rom
1 to
>50)
gra
dual
ly e
xpen
ded f
rom
one
serv
ice
to a
noth
er.
After service
innovation:
additional
service sales
and
subsequent
innovations
Addit
ional
ser
vic
e in
novat
ion
(a 2
7-y
ear
contr
act on tra
in
avai
labilit
y w
ith r
etai
ned
ow
ner
ship
). A
ddit
ional
ser
vic
e
innovat
ions
conte
mpla
ted
(ener
gy-e
ffic
iency
per
form
ance
contr
act)
,
pro
duct desi
gn innovat
ions
for
bet
ter
endura
nce
and
serv
icea
bilit
y.
See
above
for
the
pro
cess
innovat
ions
and tec
hnolo
gic
al
innovat
ions.
Busi
ness
model
innovat
ion tow
ards
serv
ice-
ori
ente
d b
usi
ness
model
and
asso
ciat
ed inves
tments
in
lead
ersh
ip. Furt
her
ser
vic
e
innovat
ions
tow
ards
monit
ori
ng
and in-t
rain
ser
vic
e under
devel
opm
ent.
Org
anis
atio
nal in
novat
ion (
see
above)
and s
ubse
quen
t pro
cess
innovat
ions
(vis
ibil
ity o
f th
e sc
hed
uli
ng p
roce
ss).
Tec
hnolo
gic
al innovat
ion (
aero
-engin
e
monit
ori
ng)
and s
ervic
e in
novat
ions
(rea
l-tim
e m
onit
ori
ng s
ervic
es a
nd d
ata
anal
yti
cs, m
ulti-
par
ty p
latf
orm
avai
labil
ity c
ontr
act)
.
Ser
vic
e in
novat
ions
(see
above)
.
Busi
nes
s m
odel in
novat
ion (
inte
rnal
par
ent S
C logis
tics
per
form
ed b
y
the
dedic
ated u
nit
too).
Pro
duct
innovat
ion (
mult
i-par
ty s
oft
ware
solu
tion d
evel
opm
ent)
.
30
Figure 1. Innovation Process and Related Steps in Value Chain: Products vs Services
Figure 2. Relationship between Initial Service Innovation and Subsequent Innovations
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