STRATEGY DYNAMICS

SESSION 3

INNOVATION AND DIFFUSION OF A NEW PRODUCT

PGP 2021-23
4th February 2023
 THE CONCEPT OF FEEDBACK
Feedback is the process through which a signal travels through a chain of causal
relations to reaffect itself.

An open-loop system is a simple chain of causality:

the room temperature drops so people put on
sweaters. Notice that the act of wearing a sweater
does not at all affect the temperature in the room.

A closed-loop system, on the other hand, is a circular chain of causality that “feeds
back” to itself: the room temperature drops and activates the thermostat, which turns
on the furnace, which heats up the radiators, which raises the room temperature.
A change in room temperature automatically causes another change in room
temperature.

In the thermostat example, the effect of the two changes is balancing: a drop in room
temperature causes a rise in room temperature. If a thermostat is working correctly, the
temperature in the room should never deviate very far from the ideal setting.
 POSITIVE FEEDBACK
There are two types of feedback – positive and negative.

Positive feedback reinforces specific behavior of relevant variables.

As the population of a country increases the birth rate per year too increases as a
larger population gives rise to more babies. If the country is visualized as a system
then population is a stock variable and the birth rate is a flow which increases the
stock variable.

The causal loop diagram below provides another example of a positive feedback
mechanism. The account balance in a bank generates interest income for the
account owner, which in turn increase the account balance
resulting in higher quantum of interest.
 EXPONENTIAL GROWTH
An exponent expresses large numbers in terms of powers. In the term 64 is the
base and 4 is the exponent, and it means 6 is multiplied by itself 4 times,
i.e. 6 x 6 x 6 x 6.

A variable goes through exponential growth when its quantity increases with time.
The rate of change in quantity is proportional to the quantity itself, and therefore as
the quantity increases the rate of change too increases. The quantity undergoing
exponential growth is an exponential function of time, i.e. the exponent is the
variable representing time.

When we convert the CLD into a stock and flow diagram then we get the following:
Account
interest Balance
+
+

interest rate
 MODELING EXPONENTIAL GROWTH OF THE BANK ACCOUNT
Account Equations
interest Balance
+
+ Account Balance= INTEG (interest, 100) Units: Rs

interest rate interest = Account Balance*interest rate Units: Rs

interest rate=0.07 Units: Dmnl

 An exercise in exponential thinking

Imagine a large pond that is completely empty except for 1 lily pad.

The lily pad will grow exponentially and cover the entire pond in 3 years.

In other words, after 1 month there will 2 lily pads, after 2 months there will be 4, etc.

When do you think the pond would be half filled with lily pads?

The correct answer is 35 months.

The pond is covered in 36 months.

Right before the pond is filled, it’s half filled; because it doubles the next month.
 THE RULE OF 70

In an exponential growth the state of the system doubles in a fixed period of time
and exhibits the “Rule of 70” as per the equation below:

td = 70 / (100g)

where td is the doubling time and g is the fractional growth rate.

Therefore, an investment earning 7% per year doubles in value after10 years.

 EXPONENTIAL DECAY
The quantity undergoes exponential decay when the constant of proportionality is negative. An
exponential decay is the reverse of exponential growth and is subject to the same “Rule of 70” as
per the equation below:

Th = 70 / (100d)

where th is the time in which the value is halved and d is the fractional decay rate.

Now suppose our account balance of Rs 100 earns zero interest but is subject to an inflation rate of
7%, then the CLD below show how the relevant variables interact.
 MODELING EXPONENTIAL DECAY

Account Balance Equations

(real value)
erosion in value "Account Balance (real value)"= INTEG (-erosion in value, 100)
Units: Rs

inflation rate erosion in value= "Account Balance (real value)"*inflation rate

Units: Rs

inflation rate= 0.07 Units: Dmnl

 NEGATIVE FEEDBACK

Negative feedback exhibits goal seeking behavior and helps to balance systems
which show oscillatory or random behavior.

A classic example is an inventory control system where the actual stock of an

inventory item may trigger actions to initiate orders to suppliers if it falls below
the desired level, thereby seeking to bring the stock to the desired level.

On the other hand the system will not need to trigger any action if the actual
stock level is above the desired level, provided the delay in receiving supplies
has been considered while setting the trigger points.
 MODELING NEGATIVE FEEDBACK
Assume that in our hypothetical bank account we have a zero opening balance,
but have the target of reaching Rs 100 in 5 years.

Account Balance= INTEG (Net Inflow Rate, Opening Balance)

Units: Rs
Adjustment Time = 5 Units: Years
Gap= Target Balance - Opening Balance Units: Rs

Net Inflow Rate= IF THEN ELSE(Time<=Adjustment Time,

Gap/Adjustment Time , 0 ) Units: Units/Period
Opening Balance = 0 Units: Rs
Target Balance = 100 Units: Rs
 MODELING A PANDEMIC
A pandemic like COVID19 starts with a few infected people, who in turn infects other
people and gradually the disease spreads within the community.

The population in the community may be envisaged to comprise two components –

the susceptible population who are at risk of being infected, and the population of
infected people. If the initial population of infected people starts at one, then this
person infects others and the infected population grows.

The rate of infection which is the number of people infected over a specified time
period is dominated by two variables – the contact rate which is the number of
persons contacted per person per time period, and infectivity which is the probability
of a person getting infected after coming in contact with an infected person.
 initial infectious
total population
population
- +
+
Infected Population
Susceptible Population

infection rate
+ +
+ +

contact rate infectivity

Suppose the total population in a community is 1000, the contact rate is 2, and the infectivity rate is 0.5,
and the spread of infection starts with a single infected person, then the behavioral patterns of the
respective susceptible and infected populations over a 120 day period show the following patterns.

Since the total population is assumed to be constant, the infected population reaches a limits to growth
as the virus simply runs out of people susceptible to infection.
 Infection Rate
30

22.5

People/Day
15

7.5

0
0 12 24 36 48 60 72 84 96 108 120
Time (Day)
Infection Rate : Current

As the infected population grows the susceptible population becomes smaller, as the total
population is assumed to be constant. The population of infected people shows S-shaped growth
while the population of susceptible people shows the reverse behavior.

The model depicts two causal loops in action. The reinforcing loop initially dominates and infection
registers exponential growth. However, as the population of susceptible people becomes smaller a
negative feedback loop becomes dominant and the growth rate of infection slows down.
 INNOVATION DIFFUSION: MODELING NEW IDEAS AND NEW PRODUCTS

The diffusion and adoption of new ideas and new products often follows S
shaped growth patterns as in the case of epidemics.

A positive feedback mechanism drives the process of adoption and innovation.

An early purchaser of a new product spreads the word about the product which
influences purchase by others. As the awareness about the product spreads
among the community through contact and communication, the sale of the
product may take the path of exponential growth.

However, in the case of a market with limited number of potential consumers a

negative feedback process is set in motion as the number of potential
customers decrease and eventually the market becomes saturated.
The total market comprises two set of people – potential customers and acquired customers. As
potential customers get converted to acquired customers, the former group decrease in size with
the increase of the latter group since the total market has a limited size.

The purchase rate of the new product is a function of the contact rate and adoption fraction, where
contact rate is the rate at which people in the community come into contact with others (people per
person per day) and adoption fraction is the probability of purchase of the product by a potential
customer who has been in contact with an acquired customer.
 INNOVATION DIFFUSION:
MODELING NEW IDEAS AND NEW PRODUCTS

Potential Initial
Adopters A Adopters
Adopters P Population
B Adoption R
Market
Rate Word of
Saturation+ + Mouth
+
+ -

Contact Adoption
Rate c Fraction i

Total
Population
N
 BASS DIFFUSION MODEL
One of the flaws in the previous model is the startup problem. The model cannot
explain the genesis of the initial adopters. When growth processes begin, positive
feedback depending on the installed base are absent or weak because there are
no or only a few adopters.

Frank Bass (1969) developed a model for the diffusion of innovations that
overcomes the startup problem. Bass assumed that potential adopters become
aware of the innovation through external information sources whose magnitude
and persuasiveness are roughly constant over time.

We modify the previous model by assuming that the total adoption rate results
from word of mouth, and the effect of external sources such as advertising.

Therefore,
Adoption Rate AR = Adoption from word of mouth + Adoption from advertising
 total population N

Potential Adopters Adopters

Adoption Rate
AR

Market Saturation + Word of Mouth

+ +
Adoption from Adoption from
Advertising Word of Mouth
+ +
Market Saturation
Coefficient of Coefficient of
Innovation p Imitation q
MODEL SETTINGS
 EQUATIONS

Potential Adopters= INTEG (-Adoption Rate AR, total population N - Adopters)

Adopters= INTEG (Adoption Rate AR, 0)

Adoption Rate AR= Adoption from Advertising + Adoption from Word of Mouth

Adoption from Advertising=Coefficient of Innovation p*Potential Adopters

Adoption from Word of Mouth=Coefficient of Imitation q*Adopters/total population N

Coefficient of Innovation p=0.1

Coefficient of Imitation q=0.06

total population N=10000

The chasm represents the gulf between two distinct marketplaces for technology
products—the first, an early market dominated by early adopters and insiders who are
quick to appreciate the nature and benefits of the new development, and the second a
mainstream market representing “the rest of us,” people who want the benefits of new
technology but who do not want to “experience” it in all its gory details.
 TYPES OF CONSUMERS ATTRACTED BY NEW TECHNOLOGY

Innovators pursue new technology products aggressively. They sometimes seek them out
even before a formal marketing program has been launched. This is because technology
is a central interest in their life, regardless of what function it is performing. At root they
are intrigued with any fundamental advance and often make a technology purchase simply
for the pleasure of exploring the new device’s properties. There are not very many
innovators in any given market segment, but winning them over at the outset of a marketing
campaign is key nonetheless, because their endorsement reassures the other players in the
marketplace that the product does in fact work.

Early adopters, like innovators, buy into new product concepts very early in their life cycle,
but unlike innovators, they are not technologists. Rather they are people who find it easy
to imagine, understand, and appreciate the benefits of a new technology, and to relate these
potential benefits to their other concerns. Whenever they find a strong match, early adopters
are willing to base their buying decisions upon it. Because early adopters do not rely on well-
established references in making these buying decisions, preferring instead to rely on their
own intuition and vision, they are key to opening up any high-tech market segment.
The early majority share some of the early adopter’s ability to relate to technology, but ultimately they
are driven by a strong sense of practicality. They know that many of these newfangled inventions end
up as passing fads, so they are content to wait and see how other people are making out before they
buy in themselves. They want to see well-established references before investing substantially. Because
there are so many people in this segment—roughly one-third of the whole adoption life cycle-winning
their business is key to any substantial profits and growth.

The late majority shares all the concerns of the early majority, plus one major additional one: Whereas
people in the early majority are comfortable with their ability to handle a technology product, should they
finally decide to purchase it, members of the late majority are not. As a result, they wait until something
has become an established standard, and even then they want to see lots of support and tend to buy,
therefore, from large, well-established companies. Like the early majority, this group comprises about
one-third of the total buying population in any given segment. Courting its favor is highly profitable
indeed, for while profit margins decrease as the products mature, so do the selling costs, and virtually all
the R&D costs have been amortized.

Finally there are the laggards. These people simply don’t want anything to do with
new technology, for any of a variety of reasons, some personal and some economic.
The only time they ever buy a technological product is when it is buried so deep inside
another product—the way, say, that a microprocessor is designed into the braking
system of a new car—that they don’t even know it is there. Laggards are generally regarded as not worth
pursuing on any other basis.
 ILLUSION OF THE HIGH TECH MARKETING MODEL
The High Tech Marketing model says that the way to develop a high-tech market is
to work the curve left to right, focusing first on the innovators, growing that market,
then moving on to the early adopters, growing that market, and so on, to the early
majority, late majority, and even to the laggards. Firms must use each “captured”
group as a reference base for going on to market to the next group.
In reality, gaps may arise between any two
psychographic groups. This symbolizes the
dissociation between the two groups –
that is, the difficulty any group will have in accepting a
new product if it is presented in the same way as it was
to the group to its immediate left.

Each of these gaps represents an opportunity

for marketing to lose momentum, to miss the
transition to the next segment, thereby never
to gain the promised land of profit-margin leadership in the middle of the bell curve.
The deep and dividing chasm that separates the early adopters from the early majority. This
is by far the most formidable and unforgiving transition in the Technology Adoption Life Cycle.

What the early adopter is buying is some kind of change agent. By being the first to
implement this change in their industry, the early adopters expect to get a jump on the
competition, whether from lower product costs, faster time to market, more complete
customer service, or some other comparable business advantage. They expect a radical
discontinuity between the old ways and the new, and they are prepared to champion this
cause against entrenched resistance. Being the first, they also are prepared to bear with the
inevitable bugs and glitches that accompany any innovation just coming to market.

By contrast, the early majority want to buy a productivity improvement for existing
operations. They are looking to minimize the discontinuity with the old ways. They want
evolution, not revolution. They want technology to enhance, not overthrow, the
established ways of doing business. And above all, they do not want to debug somebody
else’s product. By the time they adopt it, they want it to work properly and to integrate
appropriately with their existing technology base. Because of these incompatibilities, early
adopters do not make good references for the early majority.
 Early Majority
coefficient of
adoption a
total population N
Adoption Rate
AR2

Potential Adopters Early Adopters

Adoption Rate
AR1
Market Saturation ++ Word of Mouth
+ +
Adoption from Adoption from
Advertising Word of Mouth
+ +
Market Saturation
Coefficient of Coefficient of
Innovation p Imitation q
THANK YOU