InnovationAsADeepCapability

Innovation as a Deep Capability GARY HAMEL

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t is well understood that in today’s world of discontinuous change, there is no continuity without constant renewal. At Strategos, we conducted a survey and found that more than 90 percent of large organizations are committed to innovation, as evidenced by a recent annual report or speech in which top management affirmed innovation as a critical capability for the organization.Yet when we asked people inside these companies to describe their corporate innovation system, almost none of them could do it. And when we asked them,“Is innovation rhetoric or reality?” they said overwhelmingly,“It’s rhetoric. We don’t see the reality.” How do we explain this gap between word and deed? One explanation is that top management is just paying lip service to innovation and has no intention of really working hard on it. But another—and far more likely—explanation is that senior leaders do not have a clear, well-developed model of what innovation looks like as an organizational capability.

And since they don’t know what it looks like, they don’t know how to build it.

There are two core challenges to making innovation a deep capability in any organization. First, most companies have a very narrow idea of innovation, usually focusing just on products and services. We need to enlarge our view of innovation. Second, most companies devote much more energy to optimizing what is there than to imagining what could be. We need to create constituencies for “What Could Be.”

Enlarging Our View of Innovation

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eople assume that innovation equals new products—not pricing, not merchandising, not advertising, not distribution. Gillette presents the classic example of innovation as product extension. Gillette used to make razors with one blade, then it made them with two blades, and now it has razors with three blades. That is the all-tootypical view of innovation. And there is nothing wrong with it, except at some point For bulk reprints of this article, please call 201-748-8789.

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clearly and in a holistic way. And rarely do they look at any of these different elements as something that represents a designed choice that could have been done differently. After a while, it’s just “the way we do things around here.” And too often,“the ways we do things” become rigid orthodoxies, never challenged, that stifle innovation.

adding another blade is not going to make a substantial difference to how customers perceive the product. More important, this narrow view of innovation is very unlikely to create new markets and new wealth. In today’s economy, it is only radical innovation that will lead to significant growth. (See sidebar, Facing Reality.)

To create new markets and new wealth, managers need to begin thinking about innovation at the level of entire business concepts. A business concept or model is a framework for identifying how your business creates, delivers, and extracts value. Pioneers do not just make minor adjustments to established business concepts, they rethink them from the ground up in unconventional ways to create entirely new models.

Dell, for example, launched a new business model. Starbucks was based on a new business model. Wal-Mart created a very successful innovative business model.These and other examples show that the greatest rewards go to companies that create new business models that create new sources of revenue based on changing technology, demographics, and consumer habits.

Gary Hamel is visiting professor of strategic and international management at the London Business School and chairman of Strategos, an international consulting company. He has published articles in Harvard Business Review and Fortune, and is author of “Competing for the Future” and “Leading the Revolution.”

Unfortunately, few people think creatively and holistically about an entire business concept. In fact, few managers can describe in any detail the current business concept of their companies. Can you? Try this exercise to see how well you understand how all the pieces fit together for your organization: How do you define your served market? What is your basic value proposition? How you go to market in terms of distribution? What are the core competencies you need to focus on? What choices have you made regarding how integrated (or not) you are as a company? Most managers will have difficulty answering these questions

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True innovation is based on the recognition that a business concept represents a dozen or so design variables, all of which need to be constantly revisited and constantly challenged. A company that is not experimenting with new business concepts is probably living on borrowed time. Executives who want to bridge the gap between rhetoric and reality when it comes to innovation need to define it as a capability-building problem that is truly systemic and that will require the same kind of energy, commitment, persistence, and investment that they brought to their other capability-building challenges, such as quality, customer service, or supply chain management. They need to realize that in the long term the most important question for a company is not what you are but what you are becoming. This brings us to the second core challenge, creating a constituency for the future, for What Could Be.

Creating a Constituency for the Future

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n most organizations, when it comes to the fundamental trade-off of optimizing what is there versus innovating and creating something that’s new, there’s an enormously powerful constituency for What Is, but not a very powerful constituency for What Could Be. Over the last several years, I have talked to many people who were innovators and had helped to change the direc-

tion of their company—people like John Patrick at IBM or Ken Kutaragi at Sony, whom I talk about in Leading the Revolution. Again and again these people told me that they had succeeded despite the system.

Even more troubling is that most people accept that as a normal part of organizational life: of course major innovation requires bending—or breaking—rules, going around people, hiding expenses, and so on.

Why “of course?” If somebody said,“We ship our products out every day despite the system,” or “We mail our paychecks every month despite the system,” we’d think their organizations were in dire straits. Of course, innovations are exceptions because the system is built for something else; the system is built for perpetuation, control, and efficiency.

If you’re not

In the last few years, a lot of companies have gone beyond R&D to set up dedicated structures for innovation, whether it’s an incubator or a new venture division, or something else. Unfortunately, these structures are usually kept separate from innovation in the core business— as if it’s impossible or dangerous to innovate in the core business. In other organizations, real business innovation is kind of a once-every-five-years special project.You take a team away, do some brainstorming, hire some consultants, and generate some new product alternatives.

But these approaches too suffer from the danger of putting innovation into ghettos.

Radical innovation comes from generating a collective sense of destiny, from unleashing the ■ imagination of people across the organization and teaching experimenting people how to see unconvenwith new business concepts, tional opportunities. A new Most companies understand sense of direction doesn’t come product development, certainly, you’re probably living from a few smart people, who and they have created roles or on borrowed time. have all been in the company structures for product innovafor 20 years, getting together tion. R&D is supposed to work ■ and thinking about it.You have with Marketing, and they’re supto dramatically increase the straposed innovate: invent the next tegic variety that’s there, create detergent at Procter & Gamble, thousands of new ideas out of add another blade at Gillette, and which you can look for new themes and directions. so on. But although there is nothing wrong with a speAnd then the role of top management is to be the edcific innovation role or particular units that are focused itor. That is, top managers move from being the creon innovation, the danger is that you end up with innoators of strategy to searching for the patterns in the vation ghettos.When innovation is compartmentalized, streams of ideas that—in the most innovative compaeveryone else in the organization assumes,“I don’t have nies—constantly emerge in the organization. to think deeply, profoundly, and creatively about alternatives. I just do what I do every day because there’s The work we did with Nokia, five or six years ago, somebody else who is worrying about where we go provides a good example. At Nokia we got literally next or what we can do next.” And if someone outside hundreds of people involved in imagining What Could the innovation ghetto doesn’t subscribe to that and proBe: What new needs can we serve? How can we use duces an original idea, the fact that it doesn’t come from our competencies in different ways? How can we the proper place means it’s likely to be shot down.

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change the economics of this industry? Out of that came hundreds of ideas, and the real work of top management was not to generate the new thinking but to look at all these ideas and try to find the fundamental themes that would give overall direction to the company. As they sifted through all these ideas, they coalesced around three themes. There were a lot of ideas that were focused around the general problem of how to make a mobile phone easier to use, more fun, with a better interface, more colorful—basically focusing on how to humanize technology.

A completely different set of ideas looked at the product as more than a phone, as something that’s an extension of

you—a virtual presence that could serve all kinds of purposes. It could serve, for example, as a credit card, so someone could walk up to a vending machine and punch in a code on the phone and get a soda, or it could serve as a security device or a communication device with SMS, or short messaging service. The third set of ideas largely explored the integration of the phone with the software that sits on the network with the network equipment, and the idea that the company could go to network operators like AT&T or Vodaphone and sell them a completely integrated package of mobile phones, the software that determines the services you can offer on those phones, the network hardware behind that, and they came to call that “seamless solutions.”

Facing

Reality Companies are now coming to grips with the fact that the strategies and the tactics that they used during the ’90s to drive share prices and earnings up have largely run out of steam or been discredited.The confluence of forces that buoyed the stock market higher in the last five years of the decade was both unprecedented and unrepeatable.

1. The tech boom is now just a memory that will not be repeated.

In 1990, U.S. companies were spending 19 percent of their capital budgets on information technology (IT), and in the year 2000, they were spending 59 percent of

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capital budgets on IT. In other words, IT tripled its share of capital spending during the longest capital-spending boom in history.

It’s not going to triple its share again and consume more than 100 percent of capital budgets. The high-tech boom is finished.

2. Cost-cutting has reached the point of diminishing returns. This is true for virtually every company I know—and we have the statistical evidence to back this up. It doesn’t mean companies can relax, that cost cutting isn’t still important; but it does mean that it will be very difficult to get the same

large increments of cost reduction they’ve achieved over the last 10 years without substantially more effort.

3. The ’90s saw a completely unprecedented and unsustainable wave of mergers and acquisitions. In the beginning of the decade, there was about a $.5 billion of M&A annually. In 1999 there was about $3 trillion of M&A globally; in 2000, there was $3.5 trillion. The CEOs we celebrated during the late ’90s, people like Bernie Ebbers at WorldCom, Dennis Kozlowski at Tyco, Jean-Marie Messier at Vivendi, Jack Welch at GE; all of these executives

Out of all this thinking came, in the end, a very simple strategic architecture that had three dimensions to it: humanize technology, create seamless solutions, and think about the phone as virtual presence. And over the last six years, Nokia has innovated along each of those trajectories. Its people have used the phone in the most imaginative ways by far. They have expanded its capabilities and its virtual presence much faster than anybody else. They’ve certainly done more to humanize it.

Unleashing the Passion for Innovation

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o encourage innovation, to create a real constituency for What Could Be, companies need to un-

built their success on binge buying.

Acquire—in the case of GE, hundreds of companies—and then cut costs. Had the rate of M&A here in the United States in the year 2000 continued, we would have had one company left in 2007. So M&A activity has largely run its course, and indeed it’s now coming down the other side.There are 40,000 investment bankers out of work in the United States, and 25,000 out of work in Europe.

4. The price/earnings ratio is still at very high levels. We tend to overlook the fact that the average price/earnings ratio for New York Stock Exchange companies doubled from the historical average of about 15 to more than 30 over the last decade. Average P/E is cer-

leash ideas, passion, and commitment across the company. We have to move from innovations as exceptions; move beyond innovation as a specific role or structure, beyond innovation as a once-in-a-while project, to thinking about innovation as a deep capability.

One of the things that we are now suggesting to our clients is that they say to divisional executives to look at all the labor hours of the people who work for them and set up ways to ensure that 2 percent to 5 percent of all those labor hours get devoted to projects that are considered radical. The fundamental idea that every single employee, within some risk parameters, should be able to devote some portion of their time to something other

tainly not going to double again, and it’s much more likely to return to the historical average. Over 65 years, except for very brief intervals, it’s hovered around 15 or 16:1. It is hard to escape the conclusion that we are in for a very rocky ride for the next many years in the stock market.

5. All the fun and games played throughout the ’90s are gone.

Many companies used share buybacks to prop up their stock, and sooner or later a company reaches the limit of how many of its own shares it can buy back. And as we’ve seen, all the creative accounting is now coming home to roost. There is a lot more scrutiny there, and there’s going to be less and less space to play with the numbers.

In sum, almost everything that many companies used during the ’90s has just reached its natural limits. Suddenly every company is left alone with its own bootstraps. The free ride provided by the stock market boom is gone: you can’t count on the P/E ratios going up again. Cost cutting has reached diminishing returns. The legitimate and the unseemly shortcuts for creating the illusion of real growth are becoming unavailable: creative accounting, M&A deals, share buybacks, and so on.

What’s left in our toolbag to sustain growth? Real innovation.

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than doing their job 3 percent better.That’s a pretty radical idea in most organizations.

Another idea that we are now working to instantiate is to create a marketplace for ideas. An entrepreneur with an idea in Silicon Valley has many, many different venture capitalists to go to in search of funding. And in today’s climate, you have to go to a couple dozen before you get somebody to fund you.

energy it takes for people to get relatively small increments of investment; to even build a prototype, or take a month off to go talk to five smart people and develop their idea. Creating a marketplace for ideas doesn’t remove that burden entirely, but it certainly lessens it greatly.

One of the companies we work with has begun to change its capital budgeting process to make this marketplace for ideas a reality in the organization. The company Inside most companies, if I have has a capital budget of about a an idea, there is only one person ■ billion dollars a year—and top I can go to pitch that idea, and management has told all the dithat’s up my chain of command.

Create a marketplace visional executives that each Or maybe there’s some incubafor ideas. year for the next five years, we tor, and I could go off and talk will take an additional 10 perto them. And yet, in the larger ■ cent of our capital budget and world, there is a marketplace: devote it to projects that meet people with ideas can go to the test of being radical. Radidozens and dozens of places cal does not mean risky, it means something that to pitch ideas. One way to create a marketplace for ideas breaks conventions and has some chance of dramatiinside a company is to say to anyone who has a discrecally changing customer expectations and industry tionary budget of more than $100,000 (and many, many economics. They’ve essentially said to their divisional people in big companies are managing budgets of executives,“If you don’t bring in such projects, we are $100,000),“you can take half a percent, 1 percent, 3 pergoing to slowly starve you of capital, because Wall cent of your budget, and every year you can play the Street knows that it’s new ideas that create new role of angel investor for any project anywhere in this wealth.” They realize that the ’90s are gone for good, company that interests you.” One of the things that and innovation is now the only option. ■ strangles innovation is simply the enormous time and

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