In 2007, Nokia’s mobile handset business was the undisputed market leader of the industry, holding a market share of about 50%. By 2013, however, the Finnish company’s market cap had fallen to $30 billion—from more than $150 billion in 2007—and it sold its mobile handset business to Microsoft for $7.18 billion. Three years later, Microsoft sold the business to a subsidiary of Foxconn for $350 million.
What happened to Nokia’s vaunted mobile handset business? The business declined for many reasons, but the main one, in our view, is that the company failed to change as the world changed. For example, new competitors, such as Google’s Pixel and Apple’s iPhone, were quick to design offers for Web 2.0’s users. Nokia’s old mobile business—which had designed products for an integrated, globalized, and (relatively speaking) stable world—could not adapt quickly enough to compete. In addition, its centralized R&D team took too long to respond when new segments emerged in local markets. For example, it took the company two-and-a-half years to come out with a product when the segment for dual SIM cards emerged. During that time, Nokia’s market share in India to fell to below 40% from close to 70% in 2007.
Why are we pointing to this story now, all these years later? Nokia transformed itself, becoming a global leader in telecom network technology. But many traditional global companies have yet to embrace the lessons of the failure of the traditional innovation process—even as they face similar and ever more urgent challenges. As the previous article in our series on fractal strategy explained, the pace of change and the fragmentation of the global market are accelerating fast, driven by three disruptive forces: the fracturing of the geopolitical consensus, the onward march of digitization, and the rise of deep-tech innovation.
For traditional global companies, the consequences are profound: the power is shifting to local consumers; the global market is becoming a multitude of small, fast-evolving, local playing fields; and the winners are the local companies—we call them fractal companies—that meet the differentiated needs of customers in each local arena with speed, responsiveness, and innovation. Dynamic, digitally connected, and yet often subscale, these fractal challengers are giving the global champions a salutary lesson: global scale and pedigree are no longer guarantees of success in this new world. These challengers have won commercial success by radically rethinking the traditional customer offer—the product—and the innovation process for creating it.
To compete with them, global rivals need to reimagine their portfolio of products—what they create and how they innovate. In particular, global companies must embrace a new way of designing products—something we call fractal innovation. That’s critical because the traditional innovation process, which reliably created winning products in the past century, may now be the biggest roadblock to success in the present one.
Traditional global companies create global products for global customers. They do this by adopting what we call a product-out approach: a centralized R&D team converts a customer need analysis into new products that are designed to satisfy the averaged needs of the global customer without breaching certain performance, quality, and, importantly, scale-driven cost and profit margin thresholds.
By contrast, fractal companies create customer solutions that are localized, customized, and even personalized—solutions that are focused not only on meeting the current needs of customers but also on anticipating their future needs. These companies do this by adopting what we call a customer-in approach: they consider the entire customer journey (which starts long before—and ends long after—the purchase of the core product), and they draw on the local customer’s unique and real-time data.
Fractal companies are using this approach to revolutionize all kinds of products—from the luxury car to the humble bar of soap. You may think that a bar of soap is a just a bar of soap. But in today’s fractal world, digitally connected customers want, and have come to expect, more than global products—even if they are the best in class. Customers want solutions. So, in the case of soap, the solutions could be more lather, a choice of perfumes, or even microservices such as personalized skin care advice that is delivered digitally and differently depending on the micromarket or the individual customer.
Similarly, a car is no longer just a car. Originally, cars were simply designed to enable customers to move from point to point. When they were built with software to improve their functionality and performance, cars were transformed into computers on wheels. Now, the most modern cars are, in effect, smartphones on wheels: complete solutions offering customers an ever-growing variety of digital microservices for personalizing their driving experience.
But if fractal companies put local customers at the heart of everything they do, they cannot abandon the need for the cost efficiency that global companies deliver through economies of scale. Indeed, it is only those solutions that are designed for cost-efficient localization, personalization, and adaptation to future needs that become the winners.
It sounds like an impossible task: combine cost-efficient global design with costly local customization. But the fractal innovation process allows companies to square the circle. To adopt this approach, traditional global companies need to make four significant changes to how they innovate.
Design Versatile Three-Tiered Solutions. The customer-in solution necessitates a new kind of design structure. To explain what we mean, consider that cars used to be designed with a fixed, integrated product structure. Now, the most advanced electric vehicles are designed with a versatile three-tiered structure: a hardware layer, an embedded software layer (sometimes called the intelligent hardware layer), and a microservices layer.
Data is the lifeblood of this design structure, and it is typically incorporated via a digital data platform that collects, stores, and processes data from internal sources (for example, from sensors embedded in the car’s hardware) and external sources (for example, from social media sites and apps that provide real-time traffic and road conditions).
Each of the three layers is designed in such a way as to allow for quick, cost-efficient, and independent manipulation (that is, without having to change the design of the other layers). Specifically, designers have modularized the hardware layer, integrated cloud technology into the embedded software layer, and used application programming interfaces (APIs) to design the microservices layer.
Using such a flexible structure, designers can make decisions about which parts should be designed for global scale and which should be fashioned for speedy customization and local adaptation. Also, by integrating cloud technology with API-based design, they can collaborate with external and local market-based designers who are close to customers and who can ensure that the functionality and applications can be updated frequently, instantaneously, and cost efficiently.
Employ Solution Architects. To create fractal solutions that have a more complex design structure requires companies to make some difficult choices. Should the solution be fixed and globalized or flexible and localized? Where should they put the processing intelligence that drives the functionalities and, ultimately, revenues? Should it be in the hardware, in the embedded software, or in the cloud?
The answers to these questions depend on several factors. One is speed (technically referred to as latency): How fast should the product or solution be able to respond to a customer action? Another factor is current and future needs: Should microchip capacity be sufficient to meet only current processing needs (and thereby make the product cost efficient)? Or should the solution include excess capacity to meet future and sometimes unknown processing needs (which would decrease the risk of early obsolescence but increase the upfront costs)?
Making the tradeoffs to get the right balance is the challenging but critical task of a new tribe of designers called solution architects. These experts have the design thinking and diplomatic skills to mediate among the often-conflicting needs of various groups: the R&D team that focuses on technology and quality, the product management team that wants to meet every need of every local customer, and the finance team that wants to minimize costs. The extent to which the solution architects can answer the big questions and better deal with the tradeoffs than the company’s competitors will determine the winning potential of the customer offer.
Embrace Open Innovation. To be able to deliver new kinds of versatile solutions, global companies need to cultivate a new corporate mindset. Many have a closed, proprietorial approach to innovation: they decide what their customers need and try to design or control everything. By contrast, fractal companies are open innovators: they create solutions in a remarkably collaborative way.
First, fractal companies team up with their customers. One way they do this is by setting up digital customer centers to cocreate solutions for new opportunities and to address the friction across the customer journey using real-time customer data. Another is by launching minimum viable products. MVPs are early-design or prototype solutions that can be perfected over time with the help of real-time user feedback that is collected digitally.
Second, fractal companies draw on an army of external innovators to design new services, functionalities, and applications. For example, SAIC Motor, the largest Chinese automaker, partnered with Alibaba, the Chinese digital leader, to develop Banma, an open infotainment digital platform. Now, Banma is the default internet solution for Chinese electric vehicles. That’s because it offers an unmatched innovation-driven customer experience that, as SAIC says, shifts the role of cars “from simple travel tools to intelligent mobility terminals.”
Third, fractal companies break down the internal barriers that distance centralized corporate design teams from real-time developments in key local markets. They do this by distributing some of their R&D specialists into key design markets to capture local customers’ needs for the next generation of solutions, to draw real-time insights from local data to adapt current solutions rapidly, and to support the rapid-cycle testing of new ideas with local customers.
To replicate the success of fractal companies, traditional global companies will need to take a similar approach to teaming with customers, partnering with other innovators, and decentralizing their design teams.
Renault is a major global company that has experimented with decentralization by building R&D teams in a few select markets. This exercise has gotten the teams to focus on developing local solutions and then scaling the solutions on a regional or global basis. In India, the local R&D team, supported by a small group of global experts, was tasked with designing a market-specific vehicle. Drawing on the team’s deep understanding of the Indian market, it came up with the Kwid, a crossover city car, which has been a striking success. Since its launch in 2015, the Kwid has been progressively adapted for other markets, and more than 5 million vehicles have been sold around the world.
Focus on the Return on Capital Employed. As well as a new design structure, new people, and a new mindset, traditional global companies need to come to terms with the new economics of fractal innovation. Most have a simple metric for any new product: Does it deliver the promised gross margin target expected by financial markets? Again, considering car manufacturers as an example, the typical central R&D team tries to hit the key financial target by maximizing economies of scale. It does this by designing a global car with 85% to 90% of the fixed cost spread over the projected number of vehicles sold around the world. The problem is that this approach makes it difficult, if not impossible, to design fractal solutions that square the circle by being localized for different markets, flexible and innovative enough to meet difficult-to-anticipate future needs, and marketable at lower price points.
So, how does the fractal approach differ? Typically, a fractal company focuses not only on gross margins but also on the return on capital employed (ROCE). So, in the case of fractal automakers, they design not for the global average but for a de-averaged set of eight to ten “local heavy” design markets. While this limits the fixed cost that can be globally scaled to about 70% or 80%, it does allow the companies to capitalize on lower localized development costs and, thereby, increase the ROCE, introduce more competitive pricing, and boost the chances of higher sales volumes.
Siemens, the global industrial powerhouse, is a good example of a company that is actively seeking to transform what it creates and how it innovates. According to Peter Körte, chief technology and chief strategy officer, the company’s focus has switched from solely developing technology to solving problems for customers.
The company now thinks in terms of customer-in solutions; develops technology that conforms to a versatile, multitiered microservices architecture; and fosters an open innovation culture. For example, its Xcelerator open digital business platform, which was launched in mid-2022, links all the key participants in a creative ecosystem—including, above all, the customers.
The sea change in the way Siemens operates is reflected in a striking statistic. Two decades ago, the company had a limited number of software developers. Today, more than half of its 42,000 R&D engineers are software specialists and solution architects. As a result, the company now ranks among the top ten industrial software companies in the world.
Customers today want solutions that fit their local, personal, and ever-changing needs—not just global products. If traditional global companies want to compete, they will have to transform what they create and how they innovate. This transformation cannot be made overnight. It will take enormous energy, resolve, determination, and patience to make the necessary changes. That is why this must be a leadership imperative—and not simply another R&D initiative. Our advice to CEOs is this: make your company’s fractal innovation transformation your personal mission. As Körte rightly observes, “Without the full buy-in and conviction from the CEO and the entire board, such a transformation is impossible.”
We would like to thank Peter Körte of Siemens for taking the time to share the industrial giant’s story and help sharpen many of the ideas presented in this article.