An Innovation Crisis?
The ability of firms to innovate is stymied by two factors—the pace of innovation required to maintain and grow profits is increasing, and the productivity of internally driven innovation efforts is decreasing. These two factors are conspiring to create an innovation crisis in large firms.
The "Red Queen" Effect in Innovation
- "Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else—if you run very fast for a long time, as we've been doing." "A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"7
Despite having hundreds of in-house scientists and engineers working tirelessly on innovation projects, managers are discovering that their innovation pipelines are not delivering the results they need to sustain growth. Innovation productivity is declining while the cost of new product development is increasing day by day. Investing more dollars into internal R&D efforts does not seem to produce the desired payoffs. For example, Kraft invests close to $400 million annually and has 2,100 employees in its internal R&D unit. Despite such large investments, the company has been discovering its R&D pipeline to be less and less effective in fueling firm growth.8 The story is not much different in many other large firms in both the technology and the consumer product sectors.
On the other hand, the industry cycle times continue to shrink rapidly across the board. For example, in the automobile industry, 48-month development cycles and six-year model life cycles were the norm. But today, concept-to-production times are down to less than 24 months, and industry leaders like Toyota are talking about 12-month development cycles. In consumer electronics markets (for example, cell phone, digital audio player, and so on), product life cycles are often measured in weeks, not months.
Added to this acceleration is the impact of globalization—global markets breed global competitors. Companies such as Samsung from Korea (in mobile phones and televisions), Tata from India (in automotive), and Lenovo from China (in computers) have upped the ante by producing innovative products at significantly lower costs, driving the rapid commoditization in many product categories.
These forces—rapidly decreasing product life cycles, decreasing internal innovation productivity, and global competition—together are creating a Red Queen effect9 in innovation: Companies have to invest more and more just to maintain their market position.
Consider a simple simulation done by Dave Bayless, an entrepreneur and our friend, to understand the crippling effect of shrinking product life cycles on growth. Assuming a company has base revenues of $500 million per year, the simulation illustrates how a 10% annual increase in industry clock speed would necessitate an immediate and sustained increase in the rate of new product introductions of 50% just to maintain that average level of revenue over ten years.10 And this simulation did not even consider the potential negative impact of reduced innovation productivity or the increasing market risk of new products and services—both clearly evident in many industries. Thus, just one factor alone, shrinking product life cycle, poses a critical innovation challenge. On top of that, if the company wants to grow even at a modest 4% or 5% annual rate, the innovation challenge becomes almost insurmountable.
The Limits of Internally Focused Innovation
It is not just the Red Queen effect that defines the limits of internally focused innovation initiatives. There is also the potentially debilitating effect of a myopic "world-view" that companies often come to possess—particularly when their "successful" innovation and growth strategies have been around for a while.
Dell's direct-to-consumer business model is a good example in this context. As market pressures continue to climb in the personal computer market, Dell's inability to come up with new business models is what continues to drag down its growth. Dell, to its credit, has started considering new ways of doing business and entering into new product categories and markets—but these efforts haven't been met with much success. Granted, business model innovation is not easy. But it is Dell's ingrained perspectives derived from operating its current business model for a long time that makes such business model innovation doubly difficult. Over time, organizations become prisoners of what they know, especially when they have met with sustained success. They fail to see beyond their limited view of the world.
This limited world-view is becoming more dangerous in the turbulent and dynamic business environment that we find ourselves in. In many industries such as consumer electronics, automobiles and software, products have become more complex in terms of their features, their underlying technologies, and their design. Therefore, the knowledge and skills required to design and develop new products and services have become much more diverse and more demanding. Innovating such new products and services thus calls for not only a command of diverse sets of knowledge and expertise but also the ability to make non-obvious connections between such diverse knowledge bases. This feat is very difficult to pull off inside the four walls of any firm, no matter how large.
Clearly, throwing more and more money at the internal innovation engine is not the most efficient way to address the innovation crisis. Doing more of the same can only result in incremental improvement in innovative output. What is really needed to overcome this crisis is a significant increase in the company's innovation reach and productivity—only such an increase will translate into a dramatic shift in innovation output of one or more orders of magnitude. And to gain such increases in reach and range of innovative ideas, companies need to broaden their innovation horizons by looking outside for innovative ideas and technologies.
Consider the case of Kraft. Profits fell 24% in the time period from 2003 to 2005. Top-line growth stalled, and net income in 2005 was $2.63 billion, down from $3.48 billion in 2003. The company that came up with blockbuster products such as Oreo cookies, Miracle Whip dressing, and DiGiorno pizza is hungry for ideas. It is not lacking any internal R&D infrastructure. Kraft has an extensive internal R&D setup, with thousands of talented researchers on staff. However, internally focused innovation efforts are not delivering the goods. So Kraft has turned outwards in its quest for ideas: The company is inviting unsolicited ideas from its customers or for that matter from anybody who visits its Web site and submits ideas. Whether putting such an invitation for ideas on the company Web site is the right approach is debatable, but what is less arguable is the need to start looking outside. Indeed, the limits of internally focused innovation are well illustrated by Kraft's radical departure from past practice. As Mary Kay Haben, senior vice president at Kraft, noted, "In the past we would have said, 'Thank you, but we are not accepting ideas.'"11
The imperative to look outside is not limited to the consumer product sector. Consider Merck, a giant in the pharmaceutical industry. Merck has traditionally been an internally focused innovation organization. However, after a string of failures and a very lackluster R&D pipeline, it made a strategic shift toward looking outside for innovation—specifically, to partner with smaller firms with innovative ideas. Merck's R&D chief, Peter Kim, made it clear that the company's own labs are insufficient to replenish its pipeline for the future, and three years or so back embarked upon a more collaborative and open innovation agenda. Although the results of this approach will likely take years to become evident, the initiative is well underway. Compared to 10 outside alliances in 1999, Merck has entered into 141 such deals between the years 2002 and 2004—an average of 47 each year. And in 2005, Merck reviewed more than 5,000 such external collaboration opportunities.12