A Salami Theory of Innovation Strategy

Strategy is a big and complicated area of business theory so its nice to simplify things a bit sometimes.

My favorite simple theory of innovation strategy is what I call the salami theory. The idea of the salami theory came from my days (some time last century) in a share house while studying a science degree. When the money ran out it would be necessary to ‘borrow’ flatmate’s food. This didn’t happen too often, but I worked out very quickly that it was unwise to take a few slices from a small block of cheese but if there was a big salami in the fridge, the owner either didn’t notice or didn’t care that a few slices went into the pot to give some flavor to my pasta sauce. Since then, I’ve always liked businesses that take slices from big salamis. The bigger the better. As an example, think of BPAY. It’s a nice little financial services innovation that only takes a relatively small slice of a transaction. The beauty of BPAY is that the global financial transactions salami is huge.

Putting it in more sophisticated terms, the salami theory is about understanding the value chain within an industry. Some parts of any industry’s value chain are relatively unprofitable, while other parts are highly lucrative, with earnings far exceeding the cost of doing business. To demonstrate this idea in my MBA class, I show a value chain analysis of the cement industry. The small salami is the delivery business where profits are barely ahead of costs while the big salami is the production of fly-ash. The trick is that fly ash is a relatively small part of the value chain, but it’s by far the most profitable. Sometimes salamis that appear to be little can, in fact, be big!

For innovation strategy, this means that an understanding of the value chain will tell you if your innovation efforts are more likely to turn into good businesses. New products and services to enter or service the most profitable parts of the value chain are usually a good investment. It’s possible to target less profitable parts of the value chain but making money here is a lot more difficult.

Another MBA case company that I use is Data Dots, which provides identification markers for prestige cars, so they can be identified and returned to the owner if they are stolen. It sounds like a winning innovation with rivers of money from car companies as they embed the ‘microdiscs’ on the body of the car to make them more difficult targets for thieves. The problem is that the car companies don’t really care enough about theft to pay a lot for the product. They have the usual car antitheft devices, but if Data Dots want to put the discs on their cars, then they have to do it at a low price. The real part of the car industry that data dots are targeting are the insurance companies but car insurance is a very low margin business. At first glance, Data Dots should be a license to print money but the company has never turned a profit. Until the company works out where the big salami is, the future looks grim.