November 21, 2005

How Can David Beat Goliath?- Strategy #5: Create the Innovation Advantage!

Posted in David vs. Goliath, Innovation, management, Product Development at 8:23 pm by scottmaxwell

I always get confused when I read about innovation. There seem to be a lot of different working definitions, new and interesting terminology, tremendous academic and government attention, reports, books and many, many frameworks and methodologies. I generally get confused because the topic is not as complicated as people make it, especially from the perspective of the emerging growth company.

Below, I try to distill all the concepts down to their essence (at least from my point of view) and, more importantly, describe how the emerging growth company can gain an innovation advantage vs. the large company.

Innovation defined…

So what is innovation? It is one of those words that seems to have many different meanings. My meaning here is that innovation is “the creation and application of new ideas that someone finds useful or entertaining.? The key points here are:

  • Someone needs to find the new idea useful or entertaining-In my (strong) view, innovation both starts and ends with the “customer? (see, for example, Ali Alwattari’s article “Need breakthrough innovation? Resist the temptation to build a better mousetrap?)
  • The idea needs to be new– this is a key point for the purposes of this post, as extrapolations or extensions of older ideas do not fit this definition, nor does borrowing ideas from other companies that have already successfully used the idea (these are great activities, just not what I mean by innovation here.)
  • The idea needs to be applied and used– an idea by itself is just an idea.

The innovation terminology boils down to degree of change…

The innovation can be relatively easy or difficult to apply depending on:

  • The users’ degree of change or effort implementing the innovation until it becomes “intuitive.? This includes:
  • Understanding the benefits of the idea initially
  • Convincing the decision-maker(s) to implement the idea
  • Implementing the idea
  • Getting the user(s) up the learning curve
  • The innovator’s degree of change or effort applying the idea, introducing it to the prospective users, and getting them to become users. This can include real effort in one or more departments, including:
  • Research
  • Development
  • Manufacturing
  • Suppliers and partners
  • Logistics
  • Marketing
  • Distribution (both direct sales and indirect channel)
  • Customer service

All of the different terms that people put on innovation seem to boil down to the degree of change and where the ideas are coming from. This includes:

  • Incremental innovation, evolutionary innovation (less change)
  • Radical innovation, revolutionary innovation (more change)
  • Closed innovation (ideas and application approaches come from inside a single organization)
  • Open innovation (ideas and application approaches come from inside and outside an organization)

The Large Company Challenge…

The list of issues faced by well-run large companies (large companies that are not well run have a significantly larger list), includes the following:

  • Large companies must focus mostly on their core product markets
  • Most large companies are public and need to show revenue and earnings growth each quarter…the best way to do this is to focus on the larger opportunities in their core markets. For example, a 2 percent revenue improvement on a $1 billion revenue, $100 million profit company with 90% gross margins (from their core business) is as much as $18 million in new profits (that is an 18% increase in profits!). Most new initiatives will take several years to get to $18 million in revenue, let alone $18 million in profit!
  • Large companies get this huge economic benefit from leveraging their strengths, including products/platforms already in place, customer relationships, channels of distribution already in place.
  • Large companies tend to be fact-based and sometimes political in their decision-making, which rejects a lot of the new ideas in favor of “lower risk? initiatives (ideas are very fragile when they are new).
  • Decision-making at Large companies need fact-based analysis in order to make good decisions. The need for fact-based analysis comes from some combination of management training (business schools teach fact-based analysis), some level of needing “proof? or evidence that a project will be successful, and the need to reduce proposed new initiatives to numerical analysis, which makes it easier to set priorities.
  • I also find that mental models get in the way of decision-making for new ideas. The model, or intuition, is based on the fact pattern that a person has learned over time (again, fact-based analysis, just expressed differently). New ideas a lot of time conflict with various unknown mental models in the organization. The immediate reaction from the person with the mental model is that “this must be wrong?, and if the conversation takes place away from a person that can defend the new idea, it could kill the initiative.
  • Politics at large companies also gets in the way of appropriate decision-making. As companies grow, the incentive for individuals to “grow the pie? reduces relative to the incentive of individuals to “get a larger piece of the pie.? Also, individuals are concerned with their career advancement, which generally aligns them with the needs of their supervisors and other “power centers? which don’t always align with the needs of the company. (Note, this can happen at small companies as well, but the larger companies have amplified structural issues).
  • Large companies tend to be very difficult to change, let alone to change quickly. And if the change must be coordinated across departments, the difficulty level grows geometrically.
  • Large companies rely on economies of scale and economies of scope, which are powerful economic concepts that help them reduce their cost structure and get higher operating margins. Essentially, this means that different products share manufacturing processes, distribution, finance, marketing, and all of the other areas of the company. This economic gain creates less ability to change (due to complexity in each department), especially when change is significant.
  • New initiatives generally work better when there is one person that controls and coordinates ALL the resources. The problem with the large company is that the one person is generally the CEO, who has a core business to run!
  • Large Companies are older. Most of the time the people who originally did the thinking behind the processes in each department are gone from the company or at least the department. The employees that are left generally know how things work but they don’t know why things work the way they do. When asked why they do things a certain way, they generally respond “that’s the way we do things around here? or “not sure, but it seems to work? or “good question.? This creates much more work, as people need to think through all of the interdependencies before they can make changes (think about taking on someone else’s software code and being expected to add feature/function to it…a lot of work!)

A partial solution for the large companies…

Even with the difficulties, department level change efforts can and do get done. But when it comes to significant multi-departmental innovation, the best way large companies can set up is to put together a separate “company? which has all of the control over the innovation resources and, therefore, is not bound by the constraints of the overall organization. However, even if the large company sets up this approach, they still face a number of significant limitations:

  • The governance of the effort is 100% in the hands of the large company, rather than shared with the person in charge of the effort and a small number of others who have a significant incentive to make the project succeed (and who are very involved in the project and give ongoing guidance). This governance structure reduces the robustness of decision-making, which is particularly important during difficult periods (Note the contrast to the emerging growth company governance structure!).
  • It is difficult to assign their best managers to a new project.
  • Most large companies have constraints on the number of “A? caliber senior managers. The companies are better off if their “A? producers are focused on evolution of current core of the company rather than new, small innovations.
  • The large company functional-department heads want to keep their “rising stars? not give them up for a “speculative? project. They did all the work finding, hiring, and grooming their staff…how do they benefit?
  • The best managers also want to work in the core of the company, as that is where they will find the better risk adjusted economic gain and career opportunities. Why take the risk on innovation, as the downside is career suicide and the upside is not high on a risk-adjusted basis.
  • The net result is that the large companies have difficulty staffing the unit internally with the best people.
  • It is difficult to recruit, motivate, and retain the entrepreneurial innovation leaders from the outside.
  • Companies can’t pay “A? leaders from outside the company what they can make in a successful emerging growth company stock price appreciation is key!
  • Many of the personalities of the entrepreneurial leaders don’t fit with the large company cultures.
  • The net result is that the large companies have difficulty staffing the unit externally with the best people.
  • While large companies in total have large networks, the staff of the new small unit generally lacks the “ecosystem? that develops around the best small companies. In fact, most large companies don’t even recognize that the ecosystem is available. This ecosystem includes quite a few individuals and professional groups that enjoy helping to build something great (strong personal satisfaction and economic incentives!), such as former and existing large company managers, accountants, lawyers, third party marketing, sales, development firms, and of course venture capitalists. These networks allow the small companies to tap into expertise and advice (for innovation) that the small units of the large companies have more difficulty tapping into. This is partly due to the information disadvantage and partly due to the scale disadvantage of the larger companies.
  • Large companies need to put constraints on the innovation (they can’t let the group go for the largest financial gain). When new companies form around an idea, they can start in one direction and morph into another direction very easily. My early stage VC friends tell me that this happens all the time and is necessary to truly “find the market?. This morph may include the product and the target customer but also will ultimately include the channels of distribution. It also includes bringing on new experts in various areas to help. This is very difficult for an established company to do. They put more constraints on the target customer, the technology, and the channels of distribution.

The emerging growth company opportunity…

Emerging growth companies can create an innovation advantage on the issues of the large company if they focus on the right opportunities:

  • Hire the “A? team into the company.
  • Focus on innovations that conflict with the large companies’ decision-making process. The fewer facts available, the more difficulty the large companies will have, as their fact-based analysis will get in the way. This suggests going after
  • New technologies for the product (note: this point is not valid for large companies with reasonably sized research budgets, as they will be very good at experimenting with new technologies)
  • Customer segments not addressed by the large competitor
  • Latent markets
  • Channels of distribution that are completely new
  • Approaches to customer service that are completely new
  • Make it difficult to incorporate into the core business of the large companies. For example,
  • A technology that they would have difficulty building into their current platform,
  • An approach that requires changes to more than one department in order for them to implement (the more departments the better), or
  • An approach that requires significant changes to at least one department.
  • If you aim directly at the core business of a large company, you need an innovation that completely disrupts their business or economic model (you are going after their core strengths). For example, price the product or service considerably lower, go through much lower cost distribution (such as the internet-based approaches), and have a product or service that uniquely meets the user’s need. The large company needs the economic results, so will protect their margin as much as they can.
  • Choose innovations where you have a long runway. This will allow you to continue innovating and make it harder for the large company to catch up.
  • Accelerate down the innovation runway. The more advances you can make increasing your lead, the better. This generally means that you will want to
  • Focus on rapid development cycles,
  • Distribute early adopter versions (e.g., beta versions) of your products and services to get feedback and build it into your products,
  • Really, really, really work hard at getting your customers to help you innovate (take a look at Eric Von Hippel’s new book, as an example),
  • Make sure that your technology platform supports rapid development cycles. For digital technologies, browser-based services will be easiest to innovate, followed by rich/thick client applications, followed by installed server/appliance applications. The most difficult will be hardware
  • Make the change required by the customers as small as possible. Change includes their decision-making to use your innovation, installation, configuration, training, usability, how the product fits into users’ environment/process, etc. The more the change can be “one click of the button? and the more the technology is intuitive, the better.
  • Build the best network possible to help guide you. There is a tremendous ecosystem of potential users, senior managers (both retired and active), Venture Capitalists, consultants, accountants, and lawyers that are all interested in helping emerging growth companies get up the innovation curve and build their companies. The more you build your network, the more it will help your innovation.

Set up right, emerging growth companies can have a significant innovation advantage over the large companies. The key is to really understand the leverage points!

Note: Clayton Christensen has some great ideas and data supporting some of these points in his book The Innovator’s Dilemma. He and Michael Raynor also work to help large companies address these issues in their book The Innovator’s Solution. Some of the ideas overlap with their conclusions and recommendations, but my advice is targeted specifically at the emerging growth company’s efforts. Also, I do not believe that there is a true “solution” for large companies, only best practices that can still leave them at a disadvantage to enterprising emerging growth companies (assuming the small companies approach it correctly!). A possible approach for large companies is to help the small companies build and then purchase them. Some companies, such as Cisco, have had great results with this strategy.

Next Time: Strategy #6: Set Your Operating Point Closer to the Funnel Singularity!

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