Thursday, August 1, 2013

INNOVATION SPECIAL............. BCG's Harold Sirkin on How Firms can Reap the Rewards of Innovation


BCG's Harold Sirkin on How Firms can Reap the Rewards of Innovation
 
These days almost every company worth its balance sheet insists that it invests in "innovation." But does it make or lose money on these investments? That is a tougher question -- and one that James Andrew and Harold Sirkin tackle in their new book titled, Payback: Reaping the Rewards of Innovation. According to the authors, who are senior vice presidents and directors of The Boston Consulting Group, a new idea is just an invention -- and not a true innovation -- unless it generates financial returns. "Thousands of good ideas exist within every organization, even those that don't think of themselves as innovative," they write. "The real problem these companies have is how to turn their ideas into cash."
That is where Payback hopes to help. Andrew and Sirkin believe that in order to profit from their innovations, companies need to develop a process to collect, screen and nurture new ideas and "commercialize and realize them in a way that achieves payback." They explain concepts such as the "cash curve" -- which lets firms track and manage the innovation process -- and the "cash trap" -- which refers to supposedly innovative products that perpetually hemorrhage cash. In an interview with Knowledge@Wharton, Sirkin discusses these and several other challenges companies face as they seek to innovate and -- hopefully -- make a few bucks along the way.
An edited version of the transcript follows:
Knowledge@Wharton: Why is it so hard for companies to generate returns on their investment in innovation?
Sirkin: It's very hard because most companies think about the idea -- the invention, as opposed to the innovation. By innovation we mean an idea that is driven to the profitability of return on investment. Most companies focus on invention. They focus on the ideas. They spend a lot of effort looking at ideas, sorting through ideas and trying to generate ideas.
But very little of the process that they go through is focused on [then] turning those ideas into something that delivers payback. They spend little time screening those ideas for the ones that would be commercially viable or technically feasible before they move forward with them. They spend little time focusing on how they're going to develop them. And they spend very, very little time thinking about how they're going to manage them over the life cycle.
What they don't have is the fundamental discipline of operating the entire process. They get enamored with the invention, but not with the process of making it work.  Therefore they don't focus on innovation; and by not focusing on innovation, they don't achieve payback.
Knowledge@Wharton: So it's not that they lack imagination or resources. It's mainly an understanding of the process to move it from one step to the next?
Sirkin: Exactly. We think most companies are putting in at least twice as much of what they need to spend and getting about half the value of what they should be achieving because their focus is in the wrong place. It's very rare that we go into companies and find that there aren't good ideas. In most companies, when we do some research, we find out that they have five or 10 times as many good ideas as they can possibly move forward. The problem is that they're often trying to move all those ideas forward at the same time.
Knowledge@Wharton: Your book discusses how many companies have products that lose money and they become what you call cash traps. How exactly does that work and how do you identify a cash trap?
Sirkin: Cash traps are obvious when you see them, although in most companies it's hard to find them right away. A cash trap is a product that just fundamentally does not, has not, and will never make money. It survives either because it's viewed as a core product in the operation of a company, or a core product line in an operation. No one does the accounting that would show on a cash basis that these products lose money.
Identifying them is pretty simple. You can often see them because they tend to not grow very fast. They tend to take a lot of resources and continue to demand even more and more resources. You can start to look at those and ask if they are really worth the investment. We find that many companies are riddled with capital cash traps. By just removing those cash traps you can improve the productivity of innovation.
Knowledge@Wharton: Could you give an example of a cash trap? I know the one that you cited in the book was the Concorde.
Sirkin: The Concorde was the ultimate cash trap. Of course, it wasn't an invention from a company; it was a joint venture between the British and French governments. So it's a different situation from what many companies may have. But the Concorde was a great example. It was meant to develop technology and it was the first supersonic transport that existed.
The U.S. looked at it. I think Boeing had a model of a supersonic transport but did the math and realized that the company could not sell enough aircraft at a price where it could make money. The Anglo-French joint venture, funded by a lot of government money, decided that it would move forward with this idea. The reasons, in many ways, involved the prestige of the countries and the development of technology to build a very good aerospace business and the benefits that came from that.
But if you look at the economics of Concorde, they only sold I believe, 13 or 14 planes. They spent billions on development and their largest customer(s) were [of course] only Air France and British Airways. The sale of Concorde to British Airways was not at a price that you would expect for an airplane, but it was one English pound. This was a most amazing thing because they had to sell the airplanes and British Airways understood that they had to sell the airplanes and would have refused to pay anything more than one pound per plane. So it's a tremendous example of a cash trap.
Cash traps show up in many companies in other ways as well. You can find them in industrial goods companies. You can find them in consumer goods companies where someone is enamored of a particular product or technology, often at a very senior level, and people feel that they can't touch that product. And because they can't touch it, the investment continues and you get a cash trap.
Knowledge@Wharton: A couple of weeks ago, Microsoft CEO Steve Ballmer was at Wharton speaking to students. He took exception to one of the questions from a student suggesting that Microsoft is not an innovative company, mainly because they often go into markets where there's already a competency established and then they try and blow their competitors out of the water. According to your definition of innovation, is Microsoft innovative?
Sirkin: In our book we say Microsoft is probably the most innovative company. We may define innovation differently than others do, and we think that definition is very important. We think without getting payback, ideas are ideas but they're not very valuable. Businesses are in business, like Microsoft, to make money. That is their mission.
They may have other social goals to achieve as well, but making money is the one thing that a company has to do -- and because of that you have to have payback. Microsoft is one of the most innovative companies because it is very good at not just identifying ideas but at driving them into the marketplace and driving them successfully to earn a return. That makes Microsoft, by our definition, the most innovative company.
Knowledge@Wharton: Which other companies do this well?
Sirkin: There are many companies. P&G [Procter & Gamble] is another great example of an innovative company. BMW is a very innovative company. They all do it in very different ways, but they are all very, very focused on not just the idea, but how you drive that idea to reality and a reality that earns a return, not just a reality that produces a product.
Knowledge@Wharton: Even if an innovation doesn't quite make money, there may be some other intangible benefits that a company might derive from that product or service. This in turn helps other parts of the company to make money and establish payback. How does that process work, and do you have some examples?
Sirkin: Sure. Let's go back to Concorde because that's an example where there were some benefits. Clearly on a direct cash basis, Concorde didn't make any money, particularly if the airplane was sold for one pound. But there were a lot of indirect benefits. As the Anglo-French joint venture had expected, it did enable the two countries to build a technology base for aerospace in Europe. Out of that eventually grew AirBus and the whole AirBus fleet of airplanes. That's an indirect benefit; it helped Britain and France build a set of capabilities.
We think there are several different kinds of indirect benefits that you can have. One is knowledge - technical knowledge. Another is brand: you may decide to spend money and create a cash trap with the goal of building a brand. Of course when you do that, there's a point in time when you've built the brand and you need to turn the cash trap off. And that's where people make the mistake [of not doing that].
You may think about an ecosystem. A lot of what Apple does with the iPod is they've built an ecosystem around it for all the products that go with it. This helps Apple make more money in that area.
The last reason is you may do it for organizational vitality. For example, Toyota invests in racing cars. They're not going to make money in racing cars, but it's part of the organizational vitality of Toyota. It's something to rally around and of course it also gives them more knowledge, because you put those cars under a lot more stress.
So there are many reasons why you would have businesses that don't earn cash, or that don't earn payback. But what you have to keep coming back to is making sure that those things are valuable because those indirect benefits have got to eventually yield payback.
Knowledge@Wharton: You've pointed out that many companies look for organic growth these days mainly through innovation as opposed to, say, mergers and acquisitions. But isn't M&A coming back with a vengeance?
Sirkin: Well, it's a balance question. It's not that you would do one or the other. You would want to do both at the same time because the stock market rewards growth of any kind that achieves a high return.
Organic growth through innovation, if you do it right and you manage your process right, will achieve a high return, so you do both. We're not saying that you can't do M&A. We're not saying that M&A is a bad thing at all. What we are saying is that most companies have taken some of the easy routes through M&A and that they're missing opportunities through innovation.
Knowledge@Wharton: How does a company like BCG innovate?
Sirkin: Well, that's a long process for us and something that we focus on tremendously. We have the ability to pull people aside in our organization, when good ideas come up and ask them to work on them. We have a screening process in place to be able to think through what are the good ideas and which ones we're going to invest in to make sure that we don't create a lot of cash traps.
We take prudent risks and we think about the risks of each investment. We have small investments and large investments, risky investments and low-risk investments in our portfolio. And then we have a process to push each idea forward so that we can turn it into something that our clients can use, to be able to help them improve the payback in their businesses.
Knowledge@Wharton: There's a section in your book about what models companies use for innovation. For example, some companies are integrators while others orchestrate innovation. Could you give some examples of the models of innovation and how they work for different companies?
Sirkin: Sure. An integrator tries to do most of everything on its own. A great example of that is Seagate, the disk drive manufacturer. The company specifically chose to be an integrator. It had considered being an orchestrater, which is an organization that works with a lot of outside parties.
But they realized that different pieces of the disk that needed to be put together have to work in tandem in an incredibly important way. And, if they were going to put a lot of those on the outside, they could never get the coordination to work. So, they made a decision that it would actually be faster to produce a quality product by integrating.
Other companies have made an orchestrater decision when they recognize that they can't do everything internally and it's actually faster, lower cost and a lower risk to have things done outside. Boeing is a company doing more and more orchestration and having its suppliers provide more of the value-added content. They are focusing on the engineering and manufacturing of the actual plane itself, but outsourcing systems. It becomes more and more an orchestrater.
Perhaps the ultimate orchestraters are people in the apparel business who often have a brand, outsource the design, and outsource just about everything else in terms of manufacturing, including the supply chain. They are responsible just for bringing the product to market.
Knowledge@Wharton: Is orchestration the same as outsourcing, or is there a difference?
Sirkin: [There is a difference between the two.] Outsourcing can be a piece of it. Orchestration is when you put a lot of the value added on the outside. If you take low value operations and you give them to somebody else -- you can still be an integrator. When you're an orchestrater you are taking a lot of the value and putting it outside, recognizing that you will get benefits from it. The benefits could be reduced risk because you're not taking all of it on yourself, faster time to market because they can do a lot of it faster, and other factors that are very important in terms of those decisions.
Knowledge@Wharton: Is the idea of innovation different in a country like China or India? How is it viewed in those countries? Is the process more challenging?
Sirkin: I think it's different everywhere. And it may be even more different by company philosophy than it would be by country. You know there are many things that make innovation more difficult. So, companies that create an environment where risk taking is not in anyway allowed or risk taking gets you no rewards, you only get punished for taking risks -- that's a real problem. I'm not sure that you can say that it is different by country, but you can say that it is different by some cultural characteristics.
Knowledge@Wharton: Would China, for instance, be considered a country of risk takers? Or is there so much government regulation and government watchfulness that it's very hard to be a risk taker there?
Sirkin: There are companies in China that take risks. I don't think there is something about that environment that is problematic. There are a lot of risk takers in China. They've made many, many investments as individual organizations. So, I don't think there is a barrier to innovation in China.
Knowledge@Wharton: If a group of CEOs were to come to you for advice on how to get started on getting some payback on their ideas, so they could turn them into innovations in which the investment pays off, what advice would you give them?
Sirkin: The first thing we would say is let's draw a cash curve. Let's take a look at the profile of several of your ideas that you tried to take to innovation and let's see what happened. Let's see where you invested, how you invested and let's take a look at the ones that you feel didn't work so well and see if they could have worked had you done things differently.
This is because we think the big problem often isn't with the idea -- although there are many ideas that are not the right ones to take forward -- but with how you take the idea forward. And for many ideas that have failed and never become innovations, when you go back and take a look at what happened -- they could have been successful had you chosen to do things differently. So we ask people to go back and look at the cash curve and see what it was and what could it have been if they had done it differently. That is often a good place to start. 
The other place where we ask people to start is to look at the portfolio of what they're doing and ask, can you really move all these ideas forward? Do you really have the resources? Are you under-funding some and should you not be funding others? And oftentimes we help them sort that portfolio down to a portfolio of about a third to half the size. But the result is that the right project is being funded with the higher probability of getting them out the other side in a reasonable period of time, with a reasonable amount of cost, which gives them a good chance of becoming innovations.
Knowledge@Wharton: Whom do you consider the most famous individual innovator in the U.S.?
Sirkin: The one who gets named the most, of course, is Thomas Edison. He was both an innovator and not an innovator in many ways. He got commercial value from some of his ideas, but very little from most of them. Often he had to sell the ideas too early in order to pay for his inventions.
He was an interesting character in that sense because he was both an inventor and had some innovations. Others might be better at innovations with fewer inventions. But he was too curious and had too many ideas. And like many companies, his portfolio was such that he couldn't move them all forward.
http://knowledge.wharton.upenn.edu/article.cfm?articleid=1640

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