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July 1, 2008

THE NEXT BIG IDEA

How businesses can best find opportunities in innovation.

Every day, millions of us confront unexpected changes in our lives, and our responses typically are based on how we perceive those changes. A threat? Then we act defensively. An opportunity? We tend to wait and see how the change plays out before we act.

The business world is no different. If a company anticipates a major disruption in its market, how its managers perceive the disruption influences how it will respond and allocate resources.

If perceived as a threat, managers likely will overreact and allocate resources too quickly. If perceived as an opportunity, they’re likely to be more reasoned in their approach, but may be too cautious and commit insufficient resources to its development. The strategy adopted is based entirely on how managers frame it.

Consider Kodak, which responded with the classic approach of a company threatened. In 1996, then CEO George Fisher knew that digital photography would soon enter the scene and might very well replace Kodak’s core business. He could have opted to ignore it, since Kodak’s traditional customers weren’t likely to be early adopters. Plus, the profit margins were lower than those of its core business. But he recognized that digital photography was the future of the industry and would eventually overtake film. As a result, he wisely invested more than $2 billion into R&D for digital imaging.

However, because he and his team were so worried about the threat posed by the new technology, they overreacted, which biased the way those resources were allocated. They spent most of the money before they knew how the market would develop. They committed to prices and product specifications that later proved difficult to change, and hastily installed 10,000 digital kiosks in Kodak’s partner stores. As a result, the business failed in both traditional and new markets in the short term.

Hewlett-Packard, Canon and Sony took a different tack and succeeded. They launched products based on home storage and home printing capabilities, and uncovered new demand for convenience, storage and selectivity.

It is, indeed, important to pay heed to anticipated new platforms. What most often happens is that an industry goes through the innovation, growth, maturity and decline cycles, but puts all of its innovation dollars into the maturity and decline phases. The question that should be asked is, “Am I pouring all our dollars into something that can no longer be pumped up?” It’s what has been called the last gasp theory. Right before an industry matures and goes into decline, there’s one last push within the old trajectory of innovation. That may yield a short-term resurgence, but it also sets up the industry for a longterm collapse. It’s tempting to say, “If we make this, the company will be a little stronger, quicker, better protected.” However, if the basis of competition has changed, that approach simply won’t work.

Cautious Approach

Look at bias and radial tires. Bias tires were the standard until Michelin in France developed the radial tire in 1946. Radial tires were an innovation that reduced the rolling friction of the tire, allowed vehicles to achieve better fuel economy and more. But the U.S. auto industry waited and waited, and kept investing the majority of its dollars in bias tires. That’s the way it had always been done. They took the “we’ll-look-into-the-alternative-but-keep-investing-in-the-same-old-thing” approach.

Inertia can become a type of value system for a company, a philosophy that concludes that innovation on the tried-and-true trajectory is the only good improvement. Take the medical field. Hospitals have always held the attitude that the better the doctors and the better the equipment, the better the hospital. Then, suddenly (or what felt like suddenly), urgent care centers began performing medical work that hospitals were perfectly capable of handling. Along came retail kiosks, staffed only by nurses, which took away business from the urgent care centers. Down the levels of the trajectory, that’s where innovation typically occurs. It starts moving up again, but it begins downstream.

A similar situation happened with integrated steel mills and mini-mills. In the 1960s and 1970s, there was a down-market shift to minimills, which lowered cost at the bottom of the market and opened up markets to new customers. But if you’re a mini-mill, where do you go next? Upmarket, of course. And that’s what happened, changing the old tried-and-true metals industry business model.

As long as a company’s trajectory is aligned with what the market will accept, inertia can be a powerful force. But it’s only powerful when aligned. When a company is out of sync with the marketplace, things get tough because change has to happen. When the motivation to change comes from perceived threats, managers usually respond rigidly, defending the existing business model and tightening the existing organization’s authority.

The irony is that most disruptions create a net growth in the economy. Innovations create new markets and attract new customers. While Kodak was right to worry about digital imaging, the digital market itself wasn’t cannibalistic. Nor were medical kiosks, which ultimately created a separate category of market growth.

Teaching Moment

Innovation isn’t necessarily the result of a divine spark of genius. It can be taught, but a company must have a culture built around tests, experiments, pilots and staged investments. It also must build a common language that embeds intuition, dialogue and thought processes that encourage its team to think toward the future, to consider foothold markets as opposed to established markets.

And while it’s possible to have multiple great ideas, it happens rarely. Scott Cook, cofounder of Intuit Inc., started with one brilliant idea when he realized that people didn’t want to do their taxes in Excel. That resulted in Quicken. Then, he recognized that small businesses didn’t want to depend on a complicated financial software tool. So he created QuickBooks. Both huge ideas that revolutionized markets. But typically I tell companies and people, be happy with one great idea.

About 10 years ago, I met with the CEOs of Intel, Kodak, EMC and Hallmark, as well as the head of the U.S. Navy. Each was facing disruptive innovation threats and didn’t know what to do about them. Very different industries and people, but the pattern for disruptive innovation is identical, no matter what you make or who you are, so we could identify very clearly how the scenario for each would play itself out. Here’s how it works: 1) customers can only consume so much innovation, 2) when an industry overshoots what the market can consume, it creates the conditions for disruptive innovation, 3) a down-market innovation finds a foothold below the radar of established industry leaders, and 4) the new product moves up the market stream until it’s good enough for the mainstream market and competes on a lower-cost basis, typically wreaking havoc on the old industry.

Mini-computers famously moved upmarket to attack the mainframe business after they had created a sizeable and separate category of market growth. That’s the way innovation works.

My suggestion to avoid seeing a market challenge as a threat is to build a separate organization where it’s possible to reframe the challenge as an opportunity, fund the new business in stages as new markets emerge rather than all at once, and, of course, continue to pay attention to the old business. As corporate leaders learn to frame innovations in a more nuanced, balanced way, they’ll be able to unlock the potential of both the old and the new.

Clark Gilbert is a director with Innosight and a former professor of entrepreneurial management at Harvard Business School. He has published several articles on innovation in Harvard Business Review and MIT/Sloan Management Review.