siren

Beware the siren voices of innovation

Beware the siren voices of innovation

It is a funny thing that people who write and think about strategy and about marketing almost never seem to read each other's books and articles. This means that the two areas of management thought have diverged much further than an outsider could have believed possible. But one topic that both parties write about extensively is innovation – perhaps because marketers think it is a marketing topic, and strategists think it is a broader strategic topic.

Whatever the reason, the facts from the strategic work are clear: most radical innovations fail, most innovative companies fail, and most successful innovations do not come from large companies. I would add that even fewer successful innovations come from the marketing departments of big companies.

An example of this theory is the book Fast Second by Constaninos Markides and Paul Geroski. They suggest a simple characterisation of different types of innovation, depending on the degree of change the value proposition creates in consumer behaviour on the one hand, and on the necessary extent of change in the established firms' competences on the other (see Figure 1). I have populated the matrix with some well-known examples.

RADICAL INNOVATION RARELY COMES FROM LARGE COMPANIES

Markides and Geroski's argument (summarised in Market Leader Spring 2004) is that first-mover advantages for radical innovations have been misunderstood. They demonstrate that it is not the first company that enters a new market that gets the advantage (indeed it usually exits fast too) but rather the first company that succeeds in the market that gets these advantages and becomes the big winner. This is why I have put product categories rather than brands in the matrix in the radical innovation box. None of the successful, well-known brand names actually created the market: for example, Charles Stack was first in online bookselling, not Amazon.com, while Napster held sway before iTunes.

They also argue that most radical innovations such as television, the internet, mobile phones or aspirin are supply–push innovations (i.e. they start from supply and try to create demand), not demand–pull ones at all (i.e. identifying needs and then creating products that meet them) and therefore not driven in any way by marketers. They conclude by arguing that large companies should not worry about the initial stages of 'colonising' the new market, but rather wait to be fast-second 'consolidators' of the market. I will return to the potential for marketing in the other categories of innovation.

The Innovator's Dilemma by Clayton Christensen examines in greater depth why large companies are unable to create or even compete with 'disruptive innovations' – demonstrating that these innovations typically fail the screening criteria of large companies because they do not meet current customers' needs. They also fail on quality hurdles, they make lower margins and they risk cannibalising existing products.

The response to this work, to the extent it has filtered into the marketing arena, has been to develop recommendations of how a company and its marketing can become more entrepreneurial, more innovative, etc. But the point of 'fast second' is that even after all this, most radical innovation comes from upstarts who mostly exit the new industry soon after entering. Fast second is less sexy, but strategically smarter and much more practical to execute.

UNPREDICTABLE BLACK SWANS

Another recent book from the field of finance rather than strategy, examines very low probability events. NN Taleb calls his book The Black Swan because these events can happen even after many, many occasions of them not happening – just as black swans were first seen after everyone had concluded that all swans were white on the basis of only having seen white swans. In financial theory, black swans are very important in spite of being rare, because they can dominate the overall results from history.

For example, if the best 10 days are taken out of the performance of the stock market over the past 50 years, returns reduce by 50%! Furthermore, if they are predicted, they are not black swans: by being predicted, their most surprising consequences are most likely negated and thus no longer a surprise. I would argue that innovations such as Amazon and Starbucks, while easily explainable after the event, were in fact black swans that could not be accurately predicted beforehand. (If you doubt this, think how many different retail propositions and dotcom companies set up shop and have never been heard of again.)

This unpredictability pervades life and business, causing persistent failure in spite of all best efforts. We have all seen statistics suggesting that around eight out of ten line extensions fail. In biology, 99.99% of all biological species that have ever existed are extinct. In business 10% of all companies in the US disappear each year. We know that smaller companies fail more often, so you might assume that perhaps big companies survive. Unfortunately not. In 2001 my colleagues at McKinsey, Dick Foster and Sarah Kaplan, wrote in Creative Destruction that of the first list of top 100 companies formed in the US in 1917, by 1987 61 had ceased to exist; 21 still existed but were no longer in the top 100; and only two of them outperformed the overall market in share performance.

PREDICTING THE UNPREDICTABLE?

It is bad advice to tell people to keep trying to predict the unpredictable by aiming for a few, major innovations.

The problem with all the research in strategy, finance and economics is that it appears quite fatalistic – most things fail, so you will fail too. The response of most managers and consultants is, perhaps unsurprisingly, to produce prescriptions of how not to fail. Managers and consultants are by nature optimists. This helps us all get up in the morning, which waiting for a black swan to wipe us out might not.

But this is neither good science nor, it appears, good advice. Companies are if anything failing faster than ever before, and in spite of decades of management advice, major innovations are still coming from outside the large companies. This advice, of which I too have frequently been guilty, is akin to saying: 'We are surrounded by water. Fish are good at swimming in water; you are not. So become a fish.' The better life strategy is, if you can't swim, avoid water.

On top of this, there is also a risk that recommendations on how to improve innovation suffer from business delusions. So-called successes may not be as great as they are believed to be, there may be luck more than judgment involved, and there may even be logical flaws in the research.

TEST, LEARN AND COMMIT

To understand how marketing can contribute to successful innovation when the changes in value proposition are smaller, we can learn a lesson from evolution. In biology, progress is made in small steps, with lots of failure, relying on variation, selection and scaling.

Variation is where it all starts. If there is no variation, so that all creatures are the same, then obviously there can be no progress. Variation in marketing means changing the value proposition or how it is communicated. Trying out new variations is a necessary element of making improvements. Selection is critical because evolutionary progress rests on the assumption that fitter creatures are more likely to survive. We need to be confident that the better marketing variation is selected. If not, inferior marketing offers will survive. This is particularly important in the realm of marketing communications for example, where it is notoriously hard to assess which advertisement has been most successful, and thus less good ones may be selected, leading to slower progress. Selection is enhanced by good research.

Scaling is key because it is necessary for the offers in the marketplace to reflect what was selected. If there is constant chopping and changing, evolution would be stopped in its tracks since the step by step progress would be lost. In marketing this means committing wholeheartedly to the improved value propositions.

SO WHAT IS MARKETING'S ROLE IN INNOVATION?

Marketing's role is to maximise the potential of the existing consumer environment by testing new ideas at low cost, being rigorous in identifying which tests work best, and being good at scaling up successful ideas.

Marketing is concerned primarily with making improvements on the customer dimension of Figure 1. I believe that marketers are kidding themselves if they believe they can reliably predict major changes in consumer behaviour. There are too many uncertainties in how consumers may react and too much unpredictability in competitive response for single-shot leaps into the unknown to be relied upon. This explains why Markides and Geroski emphasise the importance of supply–push rather than demand–pull. Neither radical nor major innovation can reliably be produced through market research, no matter how imaginatively the research is designed. These large leaps are best made by R&D labs or from new smaller companies simply trying out new value propositions.

In other words, marketing can lead evolution in value propositions, not revolution. Steady improvements in performance are marketing's natural domain; huge leaps are not.

Primary Leadership in Incremental Innovation

This means that marketing's primary leadership role is in incremental innovation, the bottom left box in Figure 1, where the limited change in consumer behaviour required for success means it is predictable. Furthermore, since little change is required of business systems, marketing can take the lead. Incremental innovations can be much more than line extensions, such as plain chocolate KitKat; I would argue that industry icons such as Innocent drinks or Dove or Mars Ice-Cream also fall into this category. In addition almost all of Tesco's marketing, under the self-explanatory 'Every little helps', is of this type.

This does not mean there is no role in major or strategic innovation. Far from it. Once the big leap has been made, marketing has a critical role in exploiting the initiative. In other words, companies can be 'fast second' in radical and major innovations by using the same approaches that are normally used for incremental innovations.

Apple was not first with hard disc music players with the iPod, but its incremental changes to the earlier offer from Creative Technology have made it the big winner. The essence of marketing is to understand how consumers are reacting to products and why, and to make the necessary small adaptations to value propositions.

These changes may be to the product if initial customer response shows weaknesses, but equally may be around price, which will have been even harder to predict, or other 'traditional' marketing activities such as advertising, promotion, packaging and distribution.

A Support Role in Strategic Innovation

Finally for the bottom right box of Figure 1, strategic innovation (where the business system is redesigned although the customer demand is not that different) marketing will play a support role to the initial business process redesign. Its role is to ensure that small changes to the customer demand are positive, although the major challenge will be to the operations of the business. (In consumer terms, Skype, after all is just a more dramatic way of delivering standard telephony; Pret A Manger is just a different way of delivering M&S fresh sandwiches; easyJet delivers air travel cheaper than British Airways.)

Once in place, incremental marketing can again take the lead in modifying the offer and communicating the improvements created by the more efficient business approach.

For those who argue that marketing is all about creativity, and fear that I am ignoring that, please note the critical role of variation of the value proposition to test and learn in my argument. Variation is where creativity comes in – and there can be loads of creativity in these incremental changes. I would argue that all advertising, promotion, line extensions, new segmented offers and international expansion lies within the domain I have outlined for marketing. It is really only the heroic innovation leaps that I am excluding.

MARKETING'S INNOVATION OPPORTUNITIES

In my previous contribution to Market Leader with Fiona Stewart and Fran Cassidy we presented the finding that CEOs felt that marketers were often undisciplined, uncommercial and not accountable. The argument in this article suggests one way to address this challenge.

Big leap innovations may remain the sexy part of organic growth, but it is not what CEOs are, or should be, looking for from their marketing departments. By improving the evolution of marketing offers and focusing on rigorous exploration of smaller changes, marketers could reverse this opinion by giving CEOs what they expect in terms of market share and profit growth.

COMMON BUSINESS DELUSIONS THAT AFFECT JUDGMENTS ON INNOVATION

The Halo effect

One of the most pervasive delusions in business is the halo effect – when a company does very well, people conclude that everything about that company is fantastic – the leader, the people, the strategy, the culture and execution. So a company that is successful at innovating is immediately viewed by commentators as all of these things. And, often the same company a few years later, when its performance dips, is terrible at everything – awful leader, processes that did not adapt to the new reality, sclerotic culture, unable to execute in the new world – Enron is the classic example.

Confusing Luck With Skill

A second error that I fear is often present in discussions of innovation is confusing luck with skill. We have already seen that there is a big chunk of luck involved in innovation, so how can we know that a successful company has been skilful as opposed to lucky? We see a company that has successfully innovated and we conclude that it is a great company (no doubt influenced by the halo effect). But we cannot be sure that it has not just been lucky – any more than seeing a lottery winner allows us to conclude they are great at picking tickets.

Connecting the Winning Dots

Another problem with discussion on innovation is that much analysis only looks at the winners. But if you only look at the winners, you are falling into a logical trap. The advice we are giving managers is of the form 'If you do this, then you will be successful at innovating.' But logically you cannot conclude that statement from the statement 'If you are successful at innovating, you will have done this.' Why not? Suppose 'this' is 'get up in the morning'. Our analysis of successes indeed shows that those successful at innovating get up in the morning, yet suggesting that getting up in the morning will guarantee innovation success is worthless. Instead, we need to have demonstrated that 'If you fail at innovating, you will not have done this.' We must examine failures and how they differ from successes, with facts that are not sullied by the halo effect, before making conclusions.

Applying Lessons From One Domain To Another

A last logical error we must avoid is to assume that because something improves innovativeness for one company, it will improve it for others. We need to be confident that there is sufficient similarity between the two situations for such a conclusion to be drawn. What works in packaged goods may not have much relevance for computer makers (where the role of technology may be much higher). What works in grocery retailing may not have much relevance in packaged goods (because the ease of experimentation in retailing is so much higher). What works for a challenger may not have much relevance for a market leader. Good science pays a lot of attention to categories – trying to group observations into categories that differ on critical dimensions and then using scientific method to test hypotheses about these categories. In innovation we must take the same care (source: Phil Rosenzweig (2007) The Halo Effect).

WHY OPEN INNOVATION CAN OUTPERFORM ALTERNATIVE APPROACHES

To illustrate the power of increasing variation combined with selection and scaling, let's examine the often-cited example of P&G's Connect + Develop initiative. This programme has its roots in the announcement by AG Lafley, P&G CEO, in 2003 that his vision was that in future '50% of P&G's discovery and invention could come from outside the company'. At the time less than 10% of P&G's programme arose from this source. The big advantage in evolutionary terms of looking outside through what has become known as 'open innovation' is an increase in variation. By limiting yourself to new ideas only from inside, there is a massive reduction in variations that can be put out there, giving evolution less material to work on. But as we have seen, evolution also requires selection and scaling.

This is arguably where P&G's traditional strengths as a marketing company come to the fore. With its passion for measurement, it is able to ensure selection on the grounds of true success in the marketplace, not merely initial observation of a range of image measures, or worse, gut feel of the marketing department. And with its strength in processes, it is able to ensure successful tests are committed to and scaled up.

THE POWER OF SMALL ADAPTATIONS

Consider what happened in the early days of loyalty grocery cards, when Safeway launched the ABC card and Tesco its Clubcard. Both marketing departments recognised that the greatest long term value would lie not in increased sales due to the 1% discount it provided, but rather in using the data that the cards provided, for the first time allowing them to link sales to individual customers. Loyalty card members would opt in to a relationship in which they permitted the grocer to learn more about their behaviour, and in return the grocer would tailor their offer to the individual consumer, in particular through targeted promotional offers.

However, the two companies approached this opportunity in quite different ways. Safeway adopted an approach seeking to analyse every element of every transaction. They attempted to understand their customers better through this enormous analytical undertaking, developing a segmentation approach capturing all the intricacies of shopper behaviour. This enormous effort failed as it resulted in an analytical load beyond their capability.

Tesco, on the other hand, consciously threw away most of the data in an attempt to develop a few useful insights initially. When these insights were proven to be of value, they slowly added complexity to their analysis and to the activities they prompted, with the complexity increasing every year.

Today Tesco delivers a huge number of different promotions to its customers, each driven by an understanding of their own specific purchase patterns. Investment analysts have credited Clubcard with being the most significant driver of Tesco's success, so important has it become to the Tesco way of doing business.

By making many small adjustments to its strategy, over time evolving to a very complex set of tactics, Tesco was able to find much greater value from its loyalty card than Safeway in its attempt to leap straight to a fantastic solution.

This article featured in Market Leader, Autumn 2007.

REFERENCES

Christensen, C. M. (2003) The Innovator's Dilemma: The Revolutionary Book that Will Change the Way You Do Business, Collins.

Foster, R. & Kaplan, S. (2001) Creative Destruction: Why Companies that Are Built to Last Underperform the Market – And How to Successfully Transform Them, Currency.

Markides, C.,C. & Geroski, P. A. (2004) Fast Second: How Smart Companies Bypass Radical Innovation to Enter and Dominate New Markets, Jossey-Bass.

Rosenzweig, P. (2007) The Halo Effect ... and the Eight Other Business Delusions That Deceive Managers. New York, Free Press.

Taleb, N.N. (2007) The Black Swan: The Impact of the Highly Improbable. London, Allen Lane

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