Dennis N. Aust

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Innovation. It's at the very heart of business, which must "Innovate or Die." Amazon.com lists over 2500 titles pertaining to innovation. But is innovation all it’s cracked up to be? The relentless advance of technology, the constant churn of creative destruction, and the continuing evolution of our society have fostered an abundance of creative solutions. The technology/internet boom of the late 90's was grounded in such innovations, but many of those innovators have struggled to even stay in business. One reason, as Mohan Sawnhey observes, is that "There are far fewer problems than there are solutions." (On the Road to Nirvana, ACM Ubiquity, Volume 2- Issue 20, 7/17/2001).

The issue isn’t whether to innovate or not, but how to manage and target innovation for maximum benefit. Business is about creating value in a competitive environment. Like any other investment, successful innovation requires assessing this broader business context, then choosing a strategy that makes sense in the context of a firm’s capabilities, customers, competitors, and broader objectives. It’s not just about building a better mousetrap. It’s about building the right mousetrap, and building it when the time is right. A disciplined framework for developing innovation strategy provides a way for companies to focus innovation efforts where they will ultimately provide the greatest benefit.

Innovation comes in many shapes and sizes. Within this discussion, "innovation" refers to "Big I" innovation, specifically those initiatives that represent major investments, risks, major changes in the way a firm does business, or new products and capabilities. It is often, though not necessarily, discontinuous or disruptive in nature. Small scale, incremental innovation is a different animal. "Small i" innovation, the pervasive tweaking and tinkering that takes place on an organization’s front lines, almost always makes sense, so long as it is aligned with the organization’s broader strategy. Investments and risks are small, and results are known quickly. When unsuccessful, "small i" innovations can be discarded with minimal cost or impact. The organization learns from the experience and moves on.

The Innovation Triangle

For any given company, the pace of innovation is driven by the interaction of three broad groups: customers, competitors, and the company and its business partners. These form an "Innovation Triangle" that determines the pace, opportunities, and rewards of innovation. The three don’t necessarily move in rigid lockstep, but they do move as a group. If a company falls behind, it opens a void that is quickly filled by competitors (or substitutes). A company can forge ahead, but not without incurring extra costs or risks. The challenge is to focus on those innovations that provide maximum strategic leverage.

Understanding the Innovation Triangle also requires understanding two fundamental principles of business and economics. First, any time two parties contemplate doing business, a transaction will only be consummated if each party anticipates it will be better off as a result. Buying a new product, offering a new service, or changing behavior in some other way requires an investment of time, money, or both. If one side or the other does not anticipate receiving sufficient benefit from that investment, there is no incentive to participate.

The second principle is that no action takes place in isolation. Any economically valuable interaction will attract imitators. For example, an innovator that undertakes a marketing campaign for a new product affects competitors as well as customers, and the results may or may not be what the innovator originally anticipated. An innovation strategy, in fact any strategy, that does not recognize and incorporate this principle is no strategy at all.

Customers

Every business needs customers. No business can attract or retain customers unless its products (or services) provide enough customers with sufficient value to be worth the price. But buying a product involves much more than the simple exchange of money for goods. For a customer, the cost of a product, particularly a new product, is often significantly greater than the cost represented on the price tag. For example, there’s the time and effort involved in learning about and evaluating a new product, not to mention the effort involved in converting from the old product. If a new product requires discarding or converting old materials (e.g., vinyl LP records or old-format computer files) the conversion cost can greatly exceed the cash purchase cost. Even when a customer believes it makes sense to switch, actually accomplishing the switch takes time. For example, a company committed to implementing an ERP system will need to upgrade computer networks, implement process changes, provide training, and so forth. It can take more than a year just to achieve basic functionality, while it often takes many years before the conversion is complete. There are numerous strategies that compensate consumers for conversion costs or otherwise provide incentives to switch (Information Rules, Carl Shapiro and Hal R. Varian, Harvard Business School Press).

In some cases innovation forces other incremental costs on customers. (One example is the pervasive automated telephone menu that has replaced human operators.) This can still make sense, particularly if the innovation saves the firm more than it costs the customer. While it effectively amounts to a unilateral price increase, that is nothing unusual when justified by the value proposition and market conditions. Some innovations, unfortunately, increase cost to the customer more than offsetting any direct benefit to the seller. This has been successful as a market segmentation strategy when the innovator enjoys a secure competitive advantage (e.g., IBM’s strategy of intentionally slowing down processor speeds on certain mainframe computers to capture additional sales at lower prices), but can expose vulnerabilities in more competitive markets.

Successful innovation requires providing customers an attractive value proposition. Does innovation solve a problem that needs to be solved? Does the innovation provide sufficient value such that customers find it worthwhile to embrace? Remember that the customer's total cost can be many times the posted "purchase price."