According to the Economist, "Frugal innovation is not just about redesigning products; it involves rethinking entire production processes and business models. Companies need to squeeze costs so they can reach more customers, and accept thin profit margins to gain volume...."
Therein are the dots we can use to connect to Chen’s theory. His 80-3-2 rule also addresses the issue of how a company finds a way to develop a product and a business process to squeeze costs, gain volume and reach millions of new customers.
(Full disclosure here. The Economist article was first pointed out to me by a U.K.-based engineering executive who works for Taiwan’s chip giant MediaTek. He was explaining how MediaTek’s recent success has a lot to do with "frugal innovation." MediaTek, virtually unknown 10 years ago, is now a power house with huge market share in the Chinese smartphone and media tablet markets.)
MediaTek has fundamentally changed the playbook for the chip industry here, especially for smartphones and tablets. More chip suppliers for smartphones and tablets who are competing with MediaTek are now expected to provide similar “turnkey systems” that MediaTek delivers, rather than just reference designs.
Technology development, especially in the electronics industry, has historically been one-dimensional. It all pretty much comes down to how your engineering team makes a system operate faster, run more apps and features, while consuming less power.
Frugal, or reverse, innovation and the 80-3-2 rule both suggest that it’s time to rethink innovation in more in multi-dimensional terms.
I can think of two good examples for how ignoring reverse innovation costs companies.
Much has been written about the decline of mobile phone maker Nokia. Many blame it on Nokia's late entry to the smartphone market. I disagree. Nokia’s failure is directly related to its inability to beat its competitors in the global feature phone market, where Nokia once dominated. Mind you, Nokia had quality products and production was outsourced. Still, Nokia neglected to develop a “good enough” product, and failed to develop a more innovative and imaginative process.
The same goes for Japanese LCD TV manufacturers like Sharp, which insisted on building a mega fab to handle ultra-thin, large LCD panels. Sharp's strategy, which raised Japanese manufacturing to the highest "craftsmanship-like" level, was admirable but, ultimately, wasted effort. Sharp’s job was manufacturing TVs, not developing works of art.
Chinese companies that are repeatedly bashed for their reverse engineering practices may soon surprise the world with their reverse innovation ingenuity. If successful, they could reach the neglected 6 billion people on the earth.
Meanwhile, China's competitors, still steeped in the one-dimensional technology innovation, will be scrambling to compete in the replacement market of 1 billion consumers in developed countries.
Understanding China's approach to innovation is fundamental to figuring out the future direction of technology markets. There is another name for what Junko Yoshida describes above, a notion called "second-generation innovation," an approach that has worked very well for China. It allows Chinese companies to limit risk while serving domestic markets and generating more than enough profit to keep pressing ahead.
Yes, certainly the 80-3-2 rule makes sense, although those exact numbers might not, in every instance. I don't think we need to limit this "rule" just between Eastern and Western products, though.
Most companies offer multiple similar products at different price points. True for cars, true for clock radios, true for TV sets, refrigerators, and anything else you can name. GM USA can sell a whole lot more volume if they offer Chevy Cruzes AND Cadillac XTSs.
The problem I see is mostly that the trade media has come to assume that the way Apple operates is the way Western industry operates, and all the rest happens in the East. This is all part of the media hype surrounding Apple products.
I understand that Apple is an abberation. No company survives with just one model -- iPhone -- for every country.
But the point of this particular story is not about that. It is about how tech companies figure out a "good enough" product, and create a more imaginative business process, to create products in volume at a lower cost for many more people in the developing countries.
I too was immediately reminded of Muntzing as I was reading this story.
But "reverse innovation" can also be described simply as re-writing the technical specs and including lower cost as a fundamental spec that takes priority over performance or design margins.
Muntz figured out that a TV set could still function without things like "extra" capacitors, which allowed him to make the TV set cheaper, but also less reliable.
Another example would be restricting the number of unique parts in a product's bill of materials, to reduce inventory handling costs and to maximize volume discounts -- as when an engineer specifies a single 3.3 uF cap somewhere on his board, while using a number of 2.2 & 4.7 uF caps elsewhere on the same board. The reverse-innovation minded boss tells him sorry, you can't use 3.3 uF -- it has to be either 2.2 or 4.7, and we will take the performance hit or design margin hit or whatever.
My 2 cents: Android may beat Apple in terms of volume by more than 2x. But what the theory ignores is that volume is not equal to profit. The bells and whistles are what gives you the premium price, which translates to larger per unit revenue. Think GM vs. BMW. Or Apple vs. Mediatech. They are simply not in the same league.
"The bells and whistles are what gives you the premium price, which translates to larger per unit revenue. Think GM vs. BMW. ... They are simply not in the same league."
But even that is overstated. Much of that, too, is merely "common wisdom" and media hype.
First of all, profit does not translate to revenues. A company can make a lot more money by going for more volume of sales and less profit. This allows the company to diversify its products better, sell to more markets or market segments, and so on. Again, Apple is the exception to this rule, not the rule.
As to the GM vs BMW comment, perhaps you should read the current issue of Car and Driver, where they review the Camaro convertible against the BMW 6 series convertible. For that matter, GM has a no-holds-barred sports car, the Corvette, that BMW does not compete against.
What this article explains as a phenomenon for developing country markets is ALSO a phenomenon within any single country. Companies that want to make big revenues are always better off serving more than just the top segments of the economy. Android sales are very good in the US too!
@Bert23306: "First of all, profit does not translate to revenues."
The question is whether revenues translate to profits. If your cost structure is out of alignment, they don't.
And while you can attempt to diversify and sell a range of products, this carries inherent risks. The benefit is that "all your eggs aren't in one basket". You have insulation if you are doing poorly in a market segment because you might be doing well elsewhere, and your consolidated results will be respectable.
The risk is that your revenues might increase, but profits as a percentage of revenues may drop. You may be making more profit overall, but will be vulnerable to criticisms that you could make a greater profit with a different product mix. A number of companies have attempted to move up the value chain, as the question they asked was "This line is profitable, but is it profitable *enough*? Can we make a better return investing corporate funds in other areas?"
Senior management are trustees of Other People's Money, with a fiduciary responsibility to place it where it will get the best returns.
Agreed on the theory, Bert. But you do have to consider the human aspect i.e: being present in all markets dilutes brand value. The average man knows GM for its Chevvy Cruze, not Corvette. And android sales, though robust in volume, is not making money.
Diversification may serve mammoth organizations or supplier organizations. But for consumer markets, where wow factor is important, it may actually hurt sales for the flagship product if diversification is towards the low end of the spectrum. For some companies, again, Apple or BMW, its not worth the risk.
I may need to dispute the "Cruze" vs. Corvette comparison. Removing GM from it, I bet more people worldwide would recognize "corvette" than "cruze".
Frugal engineering is just coming about in medical technology. Equipment manufacturers are just finding out that adding more "bells and whistles" to medical equipment is decreasing the relibility of the equipment, making it more complicated to use and endangering patient care.
This Harvard Business Review article may help articulate what Carlos Ghosn, CEO, Renault-Nissan, for example, means by "frugal innovation."
In many cases the product development starts from the marketing team who looks at the competitor and requests what they have plus a few more features.
Japanese phones are a good example of this - they have everything you might imagine plus more.
On the other hand Apple is very frugal in what hardware they put into their products for the price point of American market can bear.
However I think 80-3-2 rule stands - if you can strip 20% of most expensive features, sell it for 1/3 of price you can always find buyers who would buy this product, play with it and thru away to get better but more expensive one. They would feel they paid 1+1/3 price justified to pay for their experience and mistakes.
I'll lay out a simple matrix that clarifies the business strategies being compared:
Strategy 1 - Cost leadership: think Walmart. This is what Rockchip is modeling. Broad target, low cost leadership, adopt the 80% rule as stated
Strategy 2 - Differentiation: think Apple. Unique set of values (in their case integration of S/W and H/W) with a broad target
Strategy 3 - Focused cost leadership. Narrow target, low cost. Think Nokia as they are right now with 80% of sales coming from handsets under $50.
Strategy 4 - Focused differentiation. No one in this space comes to mind right now. But these are the guys trying to claw a niche out in this market.
Comparing Rockchip's target market with Apple's is two opposite ends of the spectrum and not comparable. When the market for tablets matures, the cost leadership strategy will gain traction and it won't be Apple that goes there at least under their current strategy.....if they try it will either mark a shift in business objective or that management has lost it's vision.
The 80-3-2 rule sounds like an encapsulation of the fact that any market is not monolithic: there are a variety of designs and price points possible. Someone like Apple may have successfully staked out the high end of the market, but there's still the middle and low end. How do you target it and make make money?
Two ways, really. You need to constantly look for ways to take costs out of your product, so you can sell at a lower price and still be profitable. And you need to attain high volume.
In a different area, supermarkets are instructive. By definition, most of what they sell are fungible commodities. A quart of milk is a quart of milk, regardless of whose name appears on the package, so competition reduces to price. Supermarkets have been steadily consolidating to gain economies of scale and lower costs, and to attain high volumes. If your margins are paper thin and you may make a penny on a dollar, your challenge is to take in a *lot* of dollars to make pennies on. (The measuring sticks for supermarkets are inventory turns and return on assets, not profit margins.)
Supermarkets have also been trying to move up the value chain. The ones around me give pride of place to frozen foods, deli counters and the like. These provide convenience by reducing the steps the shopper must take to get and serve food, because part of the labor has already been done, and carry higher price tags and better margins in consequence. Retailers look at sales/square foot of retail space, and want those sales to carry the highest margins possible.
Whether the 80-3-2 rule is sustainable will depend on how successful you are at reducing costs and building volume. You must do so faster than your competition. Size matters, and smaller competitors won't be able reduce costs enough or sell at high enough volumes to survive long term.
There is one problem with the 80-3-2 rule. Often features don't incur hard costs, only firmware development. When that is the case, removing 20% isn't going to allow 1/3 the cost.
What is significant about reverse innovation, is that it is a strategy widely employed, particularly by emerging contries. The risks assocated with taking something that is working and doing it better and cheaper are much less than the risks of creating something new. The latter requires vision and innovation as well as a variety of technical risks and then market acceptance risks. As countries build expertise and infrastructure, they can then consider more cutting edge efforts.
Consider early Japanese automobiles. If you looked under the hood of a 1970s Datsun, you saw a Ford or Chevy, with all dimensions shrunk a bit. The general size and shape of the engine and parts were the same, just smaller. Compare that to a current Japanese car. For starters, the drive train has been moved from back to front. The engine has been rotated 90 degrees. The components don't look anything like they used to. They have moved beyond value engineering a successful design to creating some of the most reliable and fuel efficient vehicles on the planet. But they didn't start there.
You are correct, the so-named 80-3-2 is nothing new. People call it different names at different times. Japan, Taiwan, Korea all took this approach in the past. I am surprised that this is considered new at all especially when history always repeats itself!
I think people can surely gain some market share if they price their product lower. However, why and how it can be lowered? The bloody Chinese manufacturers are squeezing all the workers' (in broad sense engineers and managements are all regarded as workers) energy so that cost can be much lower. Look at the life of Chinese a bit more you can see that people who work 16 hours a day can just earn just barely 1/3 of the salary of their western counterparts so they surely can win with lower cost. Besides, just because the time-to-market is so short, I don't think Chinese companies are doing real innovation with enough time to think. So, surely they can't build products that is 120% better but just can build something 80% of the competition. With less features, how can you ask for higher price? People in third country (Chinese Government also called itself as 3rd country) are just OK to live with lower profit as they basically have no choice! In most Chinese companies, the only person who really makes money is the boss. All other people are just working like slaves!
Bear in mind that it costs far less to *live* in China than it does in the West. That "1/3 of the salary of their western counterparts" may be good money, relatively speaking, and a Chinese worker might be better off in terms of what their money will buy than their western counterpart.
And the factory workers who get the press in the west tended to be peasants from rural areas. Those factory jobs offered better hours, better working conditions, and much better pay than being a farmer back home, so there was competition to *get* those jobs. China is coping with urban sprawl and inadequate infrastructure as it copes with the migration from country to city.
China's lower cost vis the West has more than one underlying cause.
Products need to map the income distrbution / buying power of customers. This is true even within Apple. Growth rate of iPad / iPhone / iPads have been order of magnitude higher than that for even Mac Air because the former group is much cheaper ( for iPhone 5 its still $ 200 w/ contract vs $ 1,200 for the cheapest Mac Air ). Wal Mart, Media Tek and other bottom feeders should not be scorned as they cater to the masses and are well versed in squeezing large profit from thin margins by going for volume ( they have the "masses" ). Soon they pile up enough billions to buy out "boutique" houses. Chinese semiconductor companies will soon have the bucks to buy out SiV design houses and smaller Fabless companies. As the technology diffuses, Apple would try to maintain its 60 % margin with innovation / stunts but find it increasingly harder. They already exerienced one such cycle with the Mac after Gates brought out inferior but workable & cheaper Windows. So the 80 - 3 - 2 rulec claimed by this Rcckchip fellow as his own goes back at least as far as 20 years - yet another case of Chinese IP piracy and trying to impress gullible reporters !
I think The 80-3-2 rule works for Chinese manufacturers trying to sell their products globally. Because of their inherent lower cost structure, they can use this strategy.
Cost of capital is way too low.
Thank you for the article and stimulating conversation. There is another imortant item that might need attention.
Nufront (about which I know next to nothing) just introduced a 3G baseband (TeLink7619)chipset (BB+XCVR+PMU) in SiP - the baseband uses CEVA DSP in 65nm.
What is interesting is that Samsung also introduced an 4G LTE baseband (backward compatible down to 2G) - also based on CEVA DSP.
So the question is who designed these basebands - CEVA or IC vendors? Does CEVA now has an 4G LTE baseband? Since SW is very different between 3G and 4G basebands.
It would be great to review CEVA - it looks like it is becoming in BB DSPs as significant as ARM cores in application processors.
Many thanks in advance.
It is the first time that I hear the name 80-3-2 but the practice described is something that has been done by many companies before. I am not fully convinced that it is applicable in all cases. If you can offer 80% of the spec at one third of the price, you can maybe double your revenue but what will your margin be? Maybe Feng Chen can let us know the fourth number in the sequence?
Smart phones and tablets are still a growth market driven by new functionality and specs. Chinese companies have been trying to get a foothold by offering the same for a lower price but I do not think that they have been successful. These comanies often do not offer the same but less for indeed a lower cost. There is rumor these days that chinese companies are looking for consolidation or possible take-overs.
The same holds to some extent for Taiwanese companies. Mediatek is still there but the big breakthrough predicted 3 years ago has not happened. They have not been successful to take significant business from Qualcomm. Not because they are not cheaper but because they have not been able to offer a good 3G solution on time. They have now merged with one of their former competitors. The other problem Mediatek has had is that the pirate phone market in China is no longer what it was.
This may all change when the smart phone and tablet market stop innovating and competition starts to focus on price rather than on functionality. I think that we are not there yet.
Just my two cents...
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David Patterson, known for his pioneering research that led to RAID, clusters and more, is part of a team at UC Berkeley that recently made its RISC-V processor architecture an open source hardware offering. We talk with Patterson and one of his colleagues behind the effort about the opportunities they see, what new kinds of designs they hope to enable and what it means for today’s commercial processor giants such as Intel, ARM and Imagination Technologies.