Innovation as a Deep Capability
by Gary Hamel
Leader to Leader, No. 27 Winter 2003
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, welldeveloped 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.
IT
Thought
Leaders
Forum:
Gary
Hamel
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. (1/2003)
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
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-too-typical view of
innovation. And there is nothing wrong with it, except at some point 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.)
PEOPLE
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.
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 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.
True innovation is based on the recognition that a business concept
If you're not
experimenting
with
represents a dozen or so design variables, all of which need to be
new business concepts,
constantly revisited and constantly challenged. A company that is
you're probably living
not experimenting with new business concepts is probably living
on borrowed time.
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
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 direction 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
IN
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.
Most companies understand product development, certainly, and they have created roles
or structures for product innovation. R&D is supposed to work with Marketing, and
they're supposed innovate: invent the next detergent at Procter & Gamble, add another
blade at Gillette, and so on. But although there is nothing wrong with a specific
innovation role or particular units that are focused on innovation, the danger is that you
end up with innovation ghettos. When innovation is compartmentalized, everyone else in
the organization assumes, "I don't have to think deeply, profoundly, and creatively about
alternatives. I just do what I do every day because there's somebody else who is worrying
about where we go next or what we can do next." And if someone outside the innovation
ghetto doesn't subscribe to that and produces an original idea, the fact that it doesn't come
from the proper place means it's likely to be shot down.
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 people how to see
unconventional opportunities. A new sense of direction doesn't come from a few smart
people, who have all been in the company for 20 years, getting together and thinking
about it. You have to dramatically increase the strategic variety that's there, create
thousands of new ideas out of which you can look for new themes and directions. And
then the role of top management is to be the editor. That is, top managers move from
being the creators of strategy to searching for the patterns in the streams of ideas that -- in
the most innovative companies -- constantly emerge in the organization.
The work we did with Nokia, five or six years ago, provides a good example. At Nokia
we got literally hundreds of people involved in imagining What Could Be: What new
needs can we serve? How can we use our competencies in different ways? How can we
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."
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
encourage innovation, to create a real constituency for What Could Be, companies
need to unleash 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.
TO
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
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
Create a marketplace
for ideas.
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.
Inside most companies, if I have an idea, there is only one person I can go to pitch that
idea, and that's up my chain of command. Or maybe there's some incubator, and I could
go off and talk to them. And yet, in the larger world, there is a marketplace: people with
ideas can go to dozens and dozens of places to pitch ideas. One way to create a
marketplace for ideas inside a company is to say to anyone who has a discretionary
budget of more than $100,000 (and many, many people in big companies are managing
budgets of $100,000), "you can take half a percent, 1 percent, 3 percent of your budget,
and every year you can play the role of angel investor for any project anywhere in this
company that interests you." One of the things that strangles innovation is simply the
enormous time and 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 has a capital
budget of about a billion dollars a year -- and top management has told all the divisional
executives that each year for the next five years, we will take an additional 10 percent of
our capital budget and devote it to projects that meet the test of being radical. Radical
does not mean risky, it means something that breaks conventions and has some chance of
dramatically changing customer expectations and industry economics. They've essentially
said to their divisional executives, "If you don't bring in such projects, we are going to
slowly starve you of capital, because Wall Street knows that it's new ideas that create
new wealth." They realize that the '90s are gone for good, and innovation is now the only
option.
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 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 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 certainly 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.