STRATEGY & INNOVATION ARTICLES

By Braden Kelley

Braden Kelley, editor of well-known innovation site Blogging Innovation, recently interviewed Innosight Chairman and Seizing the White Space author Mark W. Johnson about business model innovation.

Q: When it comes to innovation, what is the biggest challenge that you see organizations facing?

A: Organizations don’t fully understand the term innovation. They think about it as some kind of monolithic term. But the fundamental challenge that organizations face with innovation is something most of them aren’t really aware of. That’s the fact that there are really two kinds of innovation — innovation to sustain the core and innovation for creating new business platforms in the long term.

The two couldn’t be more different. They play different roles in strategy. They need to be developed according to different timetables, with different levels of resources and different people, rewarded in different ways.

Innovations meant to sustain the core — like Windows 7 or the next Nokia camera phone — are developed within a company’s current business model and so fit very comfortably within its existing processes. These are generally short- and medium-term projects. The company devotes large teams and substantial funding to these and then rightly expects large revenue payoffs pretty soon in return.

But innovations meant to fuel the future — those like the Apple iPhone-iTunes combination or the iPad — need to operate more like start-ups do, starting as small projects overseen full-time by a small group of people given a small amount of funding. And, critically, they need to be understood as long-term seeds for growth. They need to be given enough time — five to seven years in many cases — to find their path to fulfilling their potential before demands are made on them to contribute significantly to the top line.

All too often, companies fail to distinguish between the two and treat all innovation efforts as short-term, core initiatives. So as a practical matter, the people chartered with fueling the company’s future end up having to split their time over too many projects both short and long term. Worse, they subject both kinds of projects to a single time scale and are rewarded with the same incentives. In my view, that’s the critical problem that companies trying to innovate need to confront.

I was just on the phone with the CEO of a large healthcare company, who was asking, “How are we going to think about innovation?” And I said, “First off, your teams — your game changers who you want to develop your new business platforms — are being asked to do innovation part-time. How are they going to be successful when they’ve got their day job and that job is from a totally different discipline from the one you want them to do as new-growth innovators?” One job is control and execute the core, and the other is create something new.

Q: Are any of the boxes in the four-box model more important than the others?

A: The short answer is no: The essence of a company’s competitive advantage lies in the way all the elements of the model come together. Southwest Airlines’ business model works because all of its elements — flying from low-cost hubs, using a single type of plane to cut maintenance costs, eliminating reservations to increase turnaround times at airports, and so on — come together to fulfill its low-cost, no-frills customer value proposition. Song Airlines was not able to replicate that because it tried to combine elements of a low-cost business model — it emulated the single plane, for instance — with elements of parent Delta’s traditional higher-cost model — union pilots, high-cost hubs, expensive in-flight service, etc. Song never found a viable way to deliver on its vision of low-cost but fun travel for its “discount divas.” Was the concept bad? Not necessarily. But the devil is clearly in the integration details.

In our own work, we use an expanded diagram of our four-box model, which includes many of the aspects of each category (so, say, under Key Resources we lay out the set of subcategories — people, brand, technology, partnerships, channel). As we use it to analyze companies’ business models and to conceive of new ones, it forces an interdisciplinary approach. You have to start thinking about marketing and finance and operations and so on in terms of how they all fit together.

Ordinarily, everyone stays in their silo — the marketing, the finance, the ops, and the supply chain people — they all do their jobs within their silos. That’s why corporations struggle so much with business model innovation and creating new growth. Even the new-guard kind of ventures like Intel Ventures—really all they’re doing is providing breakthrough ideas to feed the core. And the people I’ve spoken with there would admit that. The current model has created the organizing principle that has created the silos in the first place, so it’s very difficult for people to escape it. There’s no way anyone can think of anything beyond what can be delivered inside their current model.

That said, there is an orderly way to go about constructing and implementing a new business model, which generally requires considering the elements of the model in a certain order — devising the CVP first, then considering a range of possible profit formula scenarios, which you narrow down through a set of carefully designed, small-scale experiences in which you work out which resources are truly key to carrying out the necessary processes that allow you to deliver the CVP reliably and at scale. And I can’t emphasize enough that that is a process that takes — not money — but time.

Q: What can organizations do to get smarter about failure and to tolerate the long lead times that innovation often requires?

A: Say a $40 billion company wants to grow 10 percent a year. That means it has to come up with an additional $4 billion in revenues every year — $4 billion is a lot of growth to get. Companies want to innovate to fill that annual gap, but here’s the problem: The biggest opportunities for transformational growth need to start small and take time to develop. You can’t use transformational growth innovations to keep growing your core year to year.

The only way you can use innovation projects to generate sustained revenue growth from year to year is to manage them as you would, say, a Christmas tree farm. The trees you harvest each year were planted years ago. Successive revenue gains are the result of seedlings planted in successive years and nurtured appropriately as they grow larger. Some companies understand this and build new growth year after year. Apple is probably the most obvious example, but IBM is pretty good at this too, and Amazon is perhaps the best at it. But that growth is not the result of a succession of $4 billion innovation projects they produce every year — it’s the result of long-term investments they’ve made in the past.

You have to recognize that there is a business rhythm to developing new-growth initiatives, and that business rhythm requires a patience for growth. The only way to tolerate the long lead times is to set expectations correctly — internally and with Wall Street. If you set the expectations that you are engaging in a tree-harvesting process that will grow to maturity in the future, if you have built up a portfolio of innovation projects that includes both long-term transformational innovation projects and more near-term sustaining innovations — and you properly distinguish between the two in the way you manage them — then you can overcome that impatience for growth in your new-growth businesses and resist the temptation to apply near-term success metrics to the wrong projects. You can develop them in the right way so that the future revenue will arrive.

If you don’t do it, some other company will. Five to seven years from now, the future will be the present, and if you did what you should have done correctly now, you will be able to use new-growth initiatives to close your growth gaps. But there are simply no shortcuts and no substitute for good planning.

Q: Are companies better served by moving into white space or by licensing their IP to someone for whom the activity is core (or pursuing some other type of external collaboration)?

A: I don’t think it’s an either-or choice. Though I have seen many companies think that it is. Some major defense contractors, for instance, have a deliberate strategy of licensing selected technologies for commercial application.

But think about what licensing does: What you’re basically doing is getting value for the nugget. That’s helpful, and you’ll get some money for it — a quick hit to your bottom line, since it’s pretty much 100% profit. But what you’re giving up with that is real growth. Think of what DOS became for licensee Microsoft, for example, versus the rents the original developer got for it.

So the question is, when should you pursue that kind of growth, when is it an innovation too far?

I can think of two broad ways to structure that choice. One is in terms of your stage of growth:

• If your business is booming in the core, and you have more growth than you know what to do with, I probably would support licensing. You don’t have time to develop this thing but could get some money for it, so you might as well get that.

• But if your business is starting to show a growth gap, you may want to seriously consider whether there’s some real opportunity to close that gap with some of these technologies. You could actually incubate a business around the technology and generate growth that adds to the top line and the bottom line in a very real way.

The other way to look at it is the question of how far are you from the core:

• If you’ve come up with some technology whose application isn’t remotely connected to any kind of assets you could bring to bear, then you might say, “This is just too far out of our wheelhouse and forget about it.”

• But if the technology connects to your basic customer mission in some way, then that’s a different story. I like the way Jeff Bezos puts it: “Boy, if there’s a real customer here who has a real problem that we actually should consider addressing, and it actually helps enhance our strategy, then regardless of what you have to learn to do differently, you better go get good at it.”

Q: What are some of the biggest barriers to innovation that you’ve seen in organizations?

A: Some of them I’ve already mentioned:

• Failing to distinguish between the two types of innovation and as a result failing to embark on enough — or any — disruptive, new-growth projects

• Splitting up innovators’ time among new-growth and incremental innovation projects

• Being impatient for revenue growth

• Using the wrong metrics to measure success for new-growth innovation projects and otherwise trying to shoehorn new-growth initiatives into your existing business model.

The most important barrier is created by the most fundamental mistake — when companies don’t have an explicit strategy for innovation in which they develop a balanced portfolio of incremental and new-growth initiatives. Too many companies really just run with an ad-hoc set of projects, and they don’t even think about which ones are incremental and which ones are fundamentally new. Among those incremental projects too often are simply efforts to make existing offerings better when those offerings are already as good as they can be in terms of what people will pay for. You can improve them, but that won’t allow you to raise prices.

Essentially, what this boils down to is that too many companies are in denial about commoditization. When faced with commoditization pressures, big consumer companies that depend on their brands to command premiums say, “We’re going to innovate our way out of this death-march competition to the bottom.” It’s just so sad, because, let’s face it, for many companies no matter what they do, people aren’t going to pay any more for it.

This is even so for Windows — is Windows 7 really any better than the last version? Microsoft is still operating as if it had a captive market and it can keep making its own products obsolete and force upgrades to maintain compatibility. But they are in denial about how high the barriers to entry really will remain in their operating-system market with new entrants coming in from the iPad and Google.

Q: What skills do you believe managers need to acquire to succeed in an innovation-led organization?

A: The primary skill leaders need is to understand that sustained growth arises from what Dick Foster in Creative Destruction refers to as a “create, operate, trade,” dynamic. Companies that grow sustainably create businesses, operate them, plant the seeds of the new growth that will eventually supplant the current growth, and — when the time comes — trade off the businesses that have reached the limits of growth. That means leaders have to operate the core and think about what will replace it at the same time. To do that, of course, requires that they recognize the difference between the two kinds of innovation efforts.

But beyond that, leaders have to take an active role — they have to embrace, support, and sponsor both kinds of innovation efforts, and adjudicate, protect, and nurture the needs of each in different ways. Very often they have to prevent the creative efforts of the new-growth projects from getting squashed by the engine of the core, especially when the company gets in trouble and the core is demanding resources. That requires two sets of skills: Leaders have to be able to coach and nurture the seedlings as well as to oversee current operations and expect the numbers.

Q: If you were to change one thing about our educational system to better prepare students to contribute in the innovation workforce of tomorrow, what would it be?

A: Innovation is really about having a passion for continually learning. How do we get students to be curious, to be willing to ask questions — “Why is that?” “How does that work?” — and get those questions answered in the context of the educational system?

The more I think about it the more I come to believe that there’s so much power in holistic, integrative thinking. Look at Edison, who some would argue is the greatest innovator of all time (certainly he’s in the top 10).

He’s the poster child for integrative thinking. Lots of people were working on inventing the light bulb. The reason Edison was the one who did it successfully is that he didn’t just think about the bulb. He thought about the whole system that would be required to create a new market — and not only the physical electric distribution system but the broader systems of economics and regulatory schemes and human motivation.

So the question for educators is, How do you get students to think not just about one subject at a time — about history, then English, then math, then science — but about how those ways of thinking relate to one another? I guess that’s a pitch for interdisciplinary, theme-based approaches to education that help children integrate different kinds of knowledge.

This article originally appeared at Blogging Innovation.