Innovation: The New Route to Wealth

here does new wealth come from? Like a four-year-old asking how babies are born, it’s a deceptively direct question that often disarms our conventional capacity to answer. To be sure, we’re ready with pat responses peppered with references to ROI, RONA and EVA, but these measures tell us more about how existing revenues are rearranged rather than created anew. After all, we’re not talking about market share sliced loose from a competitor, or revenues boosted by an M&A binge—but truly new wealth: revenues from new customers buying products or services that yesterday they didn’t know they needed, but today they can’t live without.

Creating new wealth requires more than simply responding to market demand. Think about some of the path-breaking products of the past few decades. No car buyer walked into a Chrysler dealership in 1983 saying that what he really wanted was a van mounted on a car chassis with folding seats—and don’t forget some cup holders. No customer told Sony the only thing wrong with its tape players was that you couldn’t strap one on your head. Neither the BBC nor the U.S.’s Big 3 TV networks saw a market for 24-hour news; it took a renegade named Turner operating out of Atlanta to wed three trends—the advent of the shoulder-held minicam, more affordable access to satellite transmission and the fact people no longer make it home in time for the 6 o’clock news—into the concept of a continuous news format. Innovations like the minivan, the Walkman and CNN succeeded not because they responded to market need but because they created a need consumers had yet to sense themselves.

All of which attests to the fact that in the New Economy, the greatest rewards go to companies that create new business models—ideas that spark new sources of revenue based on changing technology, demographics and consumer habits. By definition, new business models destroy old ones, which is why creating new wealth is a threat to every traditional, unimaginative business. Never before have strategy life cycles been shorter and has market leadership counted for less. Call it the First Law of the Innovation Economy: Companies that are not constantly pursuing innovation will soon be overwhelmed by it. Strategy innovation is the only way to deal with discontinuous—and disruptive—change.

THE INNOVATION IMPERATIVE

Some companies seem to understand the innovation imperative instinctively. Consider Charles Schwab’s daring plunge into the online unknown: When the bricks-and-mortar broker took the view that online trading was inevitable, it faced a choice between leading the brokerage industry to the future or being a victim of some dot.com start-up getting there first. Thus, on the fateful day in 1995 when a technology team within Schwab presented a demo of what the Web could do, senior managers almost instantly recognized how the Internet could make life better for Schwab customers. Schwab invested in the Web even before it realized it would face aggressive price-based competition from other Web brokers. By committing to the goal—and pursuing it through a series of low-risk experiments—Schwab was able to establish a dominant position in the online trading world.

Today, Schwab controls some 30% of all the stock trading that takes place on the Web. Even more impressive, Schwab’s market cap—$3.5 billion in 1995, less than half that of Merrill Lynch—has now pulled even with Merrill’s, which instead of engaging the Internet pursued until recently a policy of digital denial.

YOU’RE NEVER TOO OLD TO INNOVATE

Schwab is not an upstart. And innovation isn’t the special preserve of Internet upstarts or the denizens of the dot-com motels of Silicon Valley. In fact, innovation can happen at any company, regardless of its line of business, age or location.

Can a century-old company learn to innovate like an industry ingnue? The answer is yes—provided the company is willing to examine its orthodoxies, abandon its strategy-by-habit ways and engage its employees broadly and deeply in the effort to envision the new markets and new opportunities that promise new wealth.

Consider the experience of PECO Energy Corporation—the old Philadelphia Electric Company. Founded in 1881, PECO had operated for its entire existence within the public utility paradigm, with a regulatory strategy that brought it significant success. In June, 1997, however, the company was looking to transform its regulatory strategy to fit the dawning deregulated environment.

Working to examine its hidden assumptions, PECO uncovered a core competency in operating large, reliable infrastructure—a competency honed in time of crisis a decade earlier when PECO grappled with bringing its own Peach Bottom nuclear plant into federal compliance. PECO emerged from the Peach Bottom process with a proven ability to bring “problem plants” to high-capacity performance with low operating costs.

As a result, where other companies saw liabilities, PECO saw opportunity. PECO would follow its competency into places other companies feared to tread—taking on responsibility for running environmentally risky nuclear plants in a safe, efficient manner. PECO has now bought three U.S. nuclear plants that have been for sale for years—including a reactor at Pennsylvania’s notorious Three Mile Island, obtained for $23 million—a substantial discount from its $640 million book value.

The problem-plant strategy proved just one element of a broader innovation agenda. PECO teams looked beyond their traditional market to tomorrow’s opportunities. A prime example: PECO conceived of the wire that delivers electricity into each home as a pipeline permitting a far wider carrying capacity. The company built on its core competency in power delivery networks to launch a new communications platform. Exelon, a subsidiary of PECO Energy, has strung 27,000 miles of high-speed telecom line atop electrical transmission poles—and signed up over 100,000 phone customers in its first year in operation. PECO now looks to combine the installation of electric, gas, telephone and cable to provide a single-source installation service for its customers.

THREE SIGNS

What’s standing in the way of companies that fail to innovate? In many cases, it is the tried-and-true recipe, which brought them past success.

It’s understandable: Businesses with a winning formula are logically reluctant to change horses in midstream. Over time, however, every business model and every strategy go stale—and in our fast-forward economy, strategies reach their “sell-by” date faster than ever. Indeed, the lifecycle of successful business strategies has been rapidly declining in a period of high competition and innovation. In the Industrial Age, a successful business strategy for steel manufacture or durable goods might power a company for a generation or more; today, Moore’s Law (which states that computing power and speed double every 18 months) is setting the terms for strategy life cycles that are measured in months, not years.

How can a company tell its present profits come from spending down past success? Here are 3 warning signals:

The inevitability of commoditization. Every new product or service will be commoditized in time. Not too many years ago, cell phones cost upwards of $100; today, companies will give you a cell phone to sell you their service. Likewise, look at the commoditization of phone service itself: Traditional telecoms—local as well as long-distance—are engaged in a race to the bottom to see who can sell the price of a dial tone for how little. Meanwhile, Internet upstarts are considering giving away long-distance calls as a come-on to bring people to their sites, while deriving their revenue from advertising and other sources.

The impossibility of forecasting future trends. Most forecasts aren’t worth the spreadsheet paper they’re printed on—and not just because small adjustments in key variables create wildly different projections over time. The larger problem is that traditional forecasting projects past assumptions forward, providing a sense of false comfort to established companies wedded to existing business models. It’s like auto industry forecasters painting a reassuring picture of steadily rising minivan and family sedan sales—the year before Ford rolled out something it called the Sports Utility Vehicle. Whatever industry you’re in, you can’t drive change looking in the rear view mirror.

The futility of waiting for inspiration. If it’s a given that great companies are built on a brilliant idea, the successor question is where the next great idea will come from. Don’t be fooled by the rosy glow of growth: Companies living off a single great insight are the corporate equivalent of dead stars—in spite of their sparkle they’re cold at the core. Like grandma’s favorite “Five and Dime” store in the age of category-killers and cyber-shopping info-bots: Stand pat with your original business model, and burn out is only a matter of time.

CREATING AN INNOVATION ENGINE

If companies can’t depend on the lightning-bolt of sudden inspiration or serendipitous discovery, then what? An innovative environment can be consciously created if a company is willing to abandon old rules, shed old habits and upend cherished conventions. The key is recognizing that past achievement militates against future adaptability, by creating well-worn ways of doing things that cause a company to undervalue or ignore rule-breaking insights.

Yesterday’s laser-like focus becomes today’s set of blinders, narrowing an enterprise’s field of vision from what it truly new to what it already knows. Glimmers of great ideas are evident in most organizations; the problem is that in direct proportion to the degree those great ideas are different, the part of the challenge is demystifying innovation, by breaking it down to its constituent parts. Here are three ways to begin the process of awakening innovation in your company:

Recognize that innovation doesn’t follow a schedule. Most companies are so boxed in and bounded by existing orthodoxies that have hardened around yesterday’s business model that they think they can schedule strategic insight the way an executive records a reminder in his day-planner. But the truly innovative bursts of insight that trigger new ideas don’t obey the corporate planning calendar.

Consider the fact that the idea for Nokia’s wildly successful rainbow-hued cell phones emerged not from a day-long strategy session in the corner office but from an afternoon at California’s Venice Beach, as company execs watched sun-drenched roller-bladers slash down the boardwalk, sporting color-coordinated shades, blades and bathing suits. The realization: Mobile phones are as much fashion accessory as communications tool, an inspiration that’s pushed Nokia to the cutting edge of cells.

Shatter the “strategy monopoly.” In any company, a hierarchy of organization dominates a hierarchy of ideas. The antidote: To encourage innovation, unlock ideas from across the company. Bring together a cross-section of employees at all levels, to share the new perspectives that may just contain the kernel of a bold new idea. Realize that every company promotes success as defined by today’s reigning strategy; the question is how to promote new ideas that may have nothing to do with that strategy—or may even cut against it.

That’s how Virgin Enterprises operates under the lead of Richard Branson. Every employee has Branson’s phone number and can pitch new project ideas directly to the top. That’s how a Virgin Airlines flight attendant turned her difficulties in planning her own wedding into a new Virgin venture: the wedding planning boutique Virgin Bride.

Institutionalize innovation by building a safe place for people to think new thoughts. In some companies, new ideas are in short supply—stifled by a corporate climate that cuts off intellectual oxygen, discourages change and demands conformity. At other companies, ideas abound—and the challenge takes a different shape: Creating the conceptual conveyor belt that moves from ideas to action.

FROM IDEAS TO ACTION

Can a company really institutionalize innovation? Witness the effort of Royal Dutch/Shell, the Anglo-Dutch oil giant. With $138 billion in revenues, 102,000 employees and nearly a century-old tradition, Shell is the epitome of a lumbering industrial behemoth—the last place you’d expect to find entrepreneurial zeal. Within Shell’s Balkanized organization—which one employee compared to a maze of 100-foot-high brick walls—access to capital is tightly controlled, investment hurdles are daunting and radical ideas move slowly, if at all. Shell’s globetrotting managers are famously disciplined, diligent, and methodical. Still, in cataloguing their character and capabilities, “wild-eyed dreamers” is not a term that comes to mind.

Enter Shell’s GameChanger initiative, begun in 1996. As an incentive to innovate, a group of Shell employees were given the authority to allocate $20 million to rule-breaking, game-changing ideas submitted by their Shell peers. Proposals would be accepted from anywhere within the company—no need to squeeze radical new ideas through the keyhole of existing programs and priorities.

Shell’s GameChanger team embarked on an Action Lab: An intensive 5-day experience, designed to dramatically accelerate the translation of “gamechanging” ideas into practical venture plans for the launch of new businesses—plans of the kind that would pass muster with venture capitalists in Silicon Valley. The goal was for each team to present its story to a “venture board” consisting of a panel comprising senior Shell executives and representatives from Shell Technology Ventures Inc., a unit whose job is to fund late-stage technology commercialization. The venture board was empowered by GameChanger to “sponsor” winning concepts and fund the next round of business development. In the end, four teams out of the original twelve received 6-month funding to put them on a path toward full-fledged business plans.

For Shell, GameChanger was the beginning of an attempt to institutionalize innovation. Today, any employee with a promising idea is invited to give a ten-minute pitch to the panel, followed by a 15-minute Q&A session. Ideas that get a green light often receive funding—on average, $100,000, but sometimes as much as $600,000—within eight or ten days. Ideas that don’t pass muster enter a database accessible to anyone within Shell, a kind of innovation stockpot that helps entrepreneurial employees shape their own ideas, or bring new insight to existing ones. To date, several of GameChanger’s ventures have found homes in a Shell operating unit or in one of the company’s various growth initiatives. Still others have been carried forward as R&D projects, while the remainder have been wound down and written off as interesting but unproductive experiments.

GameChanger is producing measurable results: Of Shell’s five largest growth initiatives for 1999, four had their genesis in the GameChanger—including one exploring an entirely new business focused on renewable geothermal energy sources. Fully 30% of Shell’s exploration and production R&D budget is now devoted to ventures that are GameChanger “graduates.”

As the Shell story suggests, it is possible to create an internal constituency for change—inspiring a new breed of “innovation activist” to find an ear and an outlet for creative new concepts within a company. Compared to innovation-unfriendly organizations that leave their iconoclasts no option but to take their bright ideas elsewhere, Shell’s experience proves that established companies can create a hospitable climate for change.

HAMMER TIME

What can innovation-minded executives do to create such a culture in their company? Here are three ways to kick-start the innovation process:

Start New Conversations. New ideas don’t obey an organizational chart. Companies that want to get serious about innovation need to break the “strategy monopoly” that closes off the executive suite from new ideas percolating in other corners of the company. Innovation-minded companies spark new conversations by bringing together executives with employees of all ranks to question corporate orthodoxies and search for new ways to do business.

Seek New Perspectives. If you want your company to do a better job of envisioning the future, ask the people who will get to the future first: Your youngest employees. If you want to know how consumers act, don’t observe them in focus-group captivity—join the Nokia execs for a day at the beach. Want a new vision? Try a new vantage point, and see a world of opportunity open up.

Spark New Passions. Innovation comes from the heart as well as the head. Companies that aren’t afraid to innovate engage employee energies in a new and profoundly different way. When people are part of a cause and not just a cog in the wheel, their IQ—innovation quotient—skyrockets. And above all, recognize that in today’s economy, capital is plentiful; good ideas are scarce. Companies that look to incremental change to generate additional revenue will tend toward subsistence at best—eclipsed by companies that create an environment of innovation, spawning the new ideas that generate new wealth. That’s why an ambitious enterprise must replicate within itself the basic DNA of innovation: A culture of continuous experimentation imbedded broadly and deeply throughout a company.

All of which brings us to the final characteristic of the true innovator. Courage: The guts to realize it’s time to take a hammer to your own business model—before someone else does it for you.

GARY HAMEL is Visiting Professor of Strategic and International Management at the London Business School and Chairman of Strategos, an international consulting company. His e-mail address is gh@strategos.com . PETER SKARZYNSKI is CEO and a founding partner of Strategos. His e-mail address is pskarzyn@strategos.com .