By Evangelos Simoudis
Corporations from industries as diverse as agriculture, manufacturing, defense, logistics, retail, insurance and financial services are being out-innovated and some times outright disrupted at an unprecedented rate.
From technological breakthroughs in biotechnology, materials science and big data analytics to business model disruptions like on-demand services, to investment model innovations like crowdfunding, most of these innovations are created by startups, including many that are based in Silicon Valley. As corporations attempt to address the implications of startups to their future, they are trying to determine how to benefit from the startup ecosystems creating these innovations. In this series of posts I present a new model, which I call startup-driven innovation, for corporations to use as they consider how to innovate like startups. The model is very much influenced from my experiences over the past 25 years in Silicon Valley as an entrepreneur, startup and large company executive, and investor, as well as from the interactions on this topic I’ve had with over 100 corporations over the past three years.
As we begin, it is important to recognize that the term innovation has a different meaning for each of us.
Innovation is the transformation of what is possible to something valuable.
The word “possible” means we are looking to capitalize on what is known and what we can create from what is known. Innovation may involve invention, but the two are not synonymous. The word “transformation” implies a focus on execution. The world “valuable” implies that we are looking for transformations that provide value. To be effective, innovation must be continuous and must involve the solution to a problem — perceived or still unperceived.
There are innovations that are about maintaining, prolonging and even improving the life of a successful product, technology, process or business model., the so-called sustaining innovations. For example, through sustaining innovations Boeing continues to extend the life of its 737 commercial aircraft and has also created two adjacent businesses: the Boeing Business Jet corporate aircraft business, and the Boeing P8 Poseidon military aircraft business. Corporations are really good at sustaining innovations that is also consistent with their ability to scale successful business models within well-understood markets.
A second category of innovation can change industry structures, create new markets, or alter the course of existing markets, the so-called disruptive innovations. Amazon disrupted the book-selling industry by utilizing the Internet to make it cheaper and easier to buy books. Apple disrupted the music industry by tightly integrating the iPod (hardware), iTunes (software), and iTunes Store (content). Uber is disrupting the automotive industry through ridesharing (business model innovation) and understanding that an important segment of the market needed a different type of convenience than existing approaches (taxis and limos) were providing. And Salesforce is disrupting the enterprise software industry by offering cloud-based software (technology innovation) through subscriptions (business model innovation). Corporations are not as good at innovations that lead to disruptions; startups are. Therefore, the key of my work is to provide corporations with the “tools” that will enable them to innovate like startups. These tools are not inspired only by the startups but by other participants in the startup ecosystem, e.g., venture investors, recruiters, etc.
Four Observations about Innovation Corporations Must Understand
For the past four years I’m noticing that corporations are increasingly worried about innovation and disruption. They question their ability to innovate, they are intrigued with the innovations created by startups and whether they can become engines of future growth many of which badly need, and worry about the potential of some of these innovations leading to their disruption. Innovation and disruption have become discussion topics in corporate boardrooms, and frequently drive corporate and institutional investment decisions in startups. To address their interest and concerns, corporations have been sending executive delegations to Silicon Valley and other startup ecosystems. The goal of these excursions has been to understand how startups operate, how they innovate, as well as how companies that were once startups are scaling up to become the leaders of their industry and disrupt incumbents. The frequency of these visits has increased dramatically from one per month early on, to over 10 per week now.
As they try to become better innovators and defend against disruption, corporations must understand the following observations about startups and innovation:
- Innovations that lead to disruptions are the result of a multi-step process and require the adoption of long-term horizons. Innovation in general but one that has the potential to disrupt in particular, typically involves searching, experimenting, evaluating each experiment’s results and improving, which often necessitates pivoting, in an effort to identify the product/market fit.
Innovation…typically involves searching, experimenting, evaluating each experiment’s results and improving, which often necessitates pivoting, in an effort to identify the product/market fit.
For example, Google was founded in 1997 but experimented until 2003 to find a monetizable business model which it finally found in online advertising. Successful startups are very adept at repeatedly executing this 5-step process and, along with their investors, adopting a long-term horizon to success. On the other hand, most corporations take a short-term horizon favoring high profits and strong stock performance. So much so that under pressure from their larger shareholders, many corporations are increasingly using stock buybacks (Figure 1) to provide short-term value at the expense of long-term viability and growth. But as Figure 2 shows, the trend line for the Return on Assets (ROA) index, the value corporations provide to their shareholders is decreasing as their long-term growth prospects decrease.
Figure 1: The capital that corporations are deploying for stock buybacks is increasing
Figure 2: Corporate Return on Assets Index
- Few innovations succeed. Even after executing the 5-step process and adopting a long-term horizon to success, most innovations created by startups lead to failures, and often expensive ones, e.g., Quirky, Coda, Theranos. Startup teams and their investors accept this risk from the time they establish and invest in the startup. Nobody likes failure, but all parties accept this risk as part of the “play to win” startup experience. Corporations often find it difficult to accept this type of risk taking the more conservative approach of “playing not to lose.”
- Disruption requires the combination of business model with technological innovation. With a few exceptions, e.g., biotech where one is looking for therapies to existing diseases, disruption doesn’t happen due to technology innovation alone but in conjunction with business model innovations. For example, consider what is happening in the automotive industry. The innovative technologies that make possible electrified, autonomous, connected vehicles in combination with business model innovations have given rise to carsharing and ridesharing that are disrupting the automotive industry. Here again startups have an advantage because of their agility and their ability to innovate with technologies and business models. Corporations are relatively good at responding to technological innovation and scaling their business models to sustain their market advantage. But they have often proven incapable of cannibalizing their existing business models in order to adopt new ones. For example, companies like IBM, SAP, Oracle and Microsoft have shown this inability around cloud computing and the associated on-demand business model.
- Incumbents typically respond late to innovations that may disrupt them. When they start to perceive the possibility for a disruption, corporations don’t stand still. They often use the full set of alternatives available to them (capital, market presence, customer base, partners) to launch actions in an effort to protect their existing business models and market position. For example, BMW, Mercedes and GM have recently launched ridesharing operations to compete with Uber. This could mean that the potential disruptor would require more time and capital to achieve its goal, e.g., see that amount raised by Uber. But their inability to sense the opportunities where startups choose to operate and their lack of timely focus and response to these opportunities, enable startups to grow to the point where it becomes impossible for incumbents to later displace them. For incumbent automakers are finding impossible to marginalize ridesharing startups, leading to the recent investments by incumbent automakers in ridesharing companies.
During this fast-paced period of revolutionary technological and business model innovation, at least for the time being, startups have the edge.
The Insufficiency of R&D to Address the Corporate Innovation Challenge
As I’ve analyzed here, Carlota Perez points out that technology revolutions happen every half-century or so. According to Perez, there have been five of these technology revolutions in the last 240 years and we are in the midst of one right now. Traditionally the R&D and Corporate Strategy organizations were tasked with “looking over the horizon” — analyzing market developments, applying emerging technologies and exploring trends to identify potential disruptors to the corporation’s business even during the last two such revolutions when corporate R&D organizations were in existence. Corporate Strategy would formulate one or more plans for moving the business forward, taking into consideration the over-the-horizon findings. R&D would create and patent the disruptive innovations, addressing important existing and anticipated problems and utilizing plans and findings from the Corporate Strategy organization as needed. Think of storied R&D organizations such as Bell Labs, 3M, Xerox PARC, and Kodak Labs — their work was always driven by technology.
Corporate R&D as a sustaining innovator
However, during the last 15-20 years, corporate R&D organizations have become limited to providing sustaining innovations that protect and prolong the life of existing products, revenue streams and business models. IBM’s mainframe computer business, one of the company’s primary revenue and profit generators to this day, is an excellent example of this trend. Each new generation of mainframe computer released by IBM incorporates several technology innovations, many produced by IBM’s R&D organization. However, the business model for this product line has remained unchanged. The technology innovations in IBM’s mainframe computers are aimed at sustaining the particular business and protecting the financial characteristics derived from its long-running business model while providing value to the customers that continue to rely on these computers for the past 60 years to run major parts of their business.
Traditional R&D organizations can’t keep up with technologies
In part because most corporations have outsourced R&D, reduced it, or completely transformed it to advanced product development, the ability of corporate R&D to anticipate and respond to technology-driven disruptions is lagging. Corporate R&D organizations had been set up by dominant corporations under a model that assumes that their dominance will persist in a slowly-changing world. This model is no longer valid making it difficult, if not impossible, for R&D to keep pace with exponential technologies, the accelerating pace of information technologies (cloud computing, big data, mobility, internet of things, artificial intelligence), biotechnologies (genomic analysis, precision medicine), and materials (nanomaterials, 3D printing). Innovations in many of these technologies become building blocks to further innovations that impact industries such as automotive, manufacturing and food. While corporations have moved from centralized R&D laboratories to more distributed organizational structures, R&D alone cannot address the reality that disruptive innovation is now created by thousands of startups from around the world (see Figure 3) that are funded by VCs as well as several other sources (as shown in Figure 4). Our hyperconnected world is amplifying the effects of these startups and causes them to have global impact, as seen with Uber and Airbnb.
Figure 3: Disruptive innovation is now created around the world
Figure 4: Innovative startups have a variety of funding options
Traditional R&D organizations can’t align technology with business model innovation
As I mentioned above, in most industries today’s disruptors combine technological with business model innovation. Consider Salesforce.com and Tesla Motors: by utilizing technology, business model and sales model innovations they are disrupting the enterprise software and automotive industries respectively. R&D organizations have not been set up to think in terms of such combinations. Methodologies such as Lean Startup, Design Thinking and Minimum Viable Product enable startups to quickly iterate and find the right product/market fit.
R&D spending does not equal success
More importantly, high R&D spending is no longer a necessary and sufficient condition for making a company a disruptive innovator (see Figure 5 for the 2015 ranking of corporations based on the amount they spend on R&D). The annual surveys of Global 1000 executives conducted by Booz & Co demonstrate that with few exceptions, a small number of the companies with high R&D budgets are considered disruptive innovators, since only six of the companies in Figure 5 are included in the list of the top 10 most innovative companies (see Figure 6).
Figure 5: Top 20 global companies in terms of R&D spending
Figure 6: Top 10 most innovative companies
The discrepancy in the two rankings is because the existing corporate R&D model is becoming less capable — and maybe even less relevant — for addressing a corporation’s disruptive innovation needs.
In the next post I will present a new model for corporate innovation that is inspired by the approaches used by the startup ecosystem.
Evangelos Simoudis is a seasoned venture investor and senior advisor to global corporations. His investing career started 15 years ago at Apax Partners and continued with Trident Capital. Today Evangelos is co-founder and Managing Director at Synapse Partners (www.synapsepartners.co) where invests in early and growth stage companies that are developing big data applications. Evangelos writes The Corporate Innovation Blog.