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Jeff DeGraff
  Jeff DeGraff

Innovate Now: Lean Times Can Be the Best Times

10/16/2009 --

Companies must resist the temptation to cut back on opportunities that will pay off later, advises Ross professor.

ANN ARBOR, Mich. — To compensate for the sour economy and pullback on consumer spending, many companies are cutting costs like never before. But are they trimming fat or bone?

It may sound counter-intuitive, but a down economy presents an ideal scenario to invest in talent and new products, says Jeff DeGraff, clinical professor of business administration at Ross. He is one of the founders of Ann Arbor-based Innovatrium, a development community that serves as an idea market, research lab, and think tank for innovation projects and practices. In the following Q&A, DeGraff explains why now is the time to pursue new opportunities, not retreat from them.

How should companies balance fiscal responsibility with a need to position themselves for future growth?
DeGraff: There are three key things to remember about innovating in a down economy. First: you grow a business by investing in innovation when costs are low so you can monetize them when prices are high. During these recessionary times most people cut back on expenditures that lead to growth, the very things that are going to pay off in the future. They cut things like marketing, R&D, and hiring the right kind of people. In a down economy, there's an enormous glut of good talent. All of a sudden the favorable rates on advertising are better. You can do more science for less money because of the depressed economy.

What we see from the numbers, though, is quite alarming. There are two major studies done on innovation every year with thousands of C-level leaders. One is done by the Boston Consulting Group and the other is done by IBM. What both studies suggest is that in the United States, senior leaders are cutting back between 10 and 12 percent on expenditures for breakthrough types of innovation. These studies also seem to suggest that in East Asia, it's almost the opposite: They're spending more on big innovation. This is a great concern. At some point, U.S.-based firms are going to come out of the recession. And there will be a shakeout of those who have invested in the last development cycle and those who have cut back. We call these "stall points," times when incumbents lose ground and nascent competitors overtake them. There's data that suggests about half of all the Fortune 500 companies experience these stall points. The data also suggests about 80 percent of those companies that stalled never regained the trajectory of their growth.

That's what's alarming. This is the best time to become more aggressive about innovation and growth. I'm not just talking about gadgets, fashion, or uses of information. I'm talking about marketing, inbound logistics, business models, design factors, and all forms of innovation. Innovation is really the only value proposition with a shelf life. It's like milk. It goes bad over time. Radical innovation doesn't stay radical for very long. So if you go to Best Buy this Christmas and see something very interesting, I guarantee you by next Christmas it's not going to be that interesting. A recession is usually a time for creative destruction. Down economies are notoriously famous for thinning the herd.

The second opportunity in a down economy is that firms in real trouble have a tendency to try more radical forms of innovation -- show stoppers and category killers. When the risk of innovating and the reward of innovating are reversed, as in a recession, people are more likely to take on increased risk to get the multiplier of a breakthrough. I'll give you some very concrete examples. About 10 to 12 years ago, Apple Computer was basically bankrupt. Now it routinely finishes first in these surveys as the most admired, innovative company in the world. How did Apple go from being dead to the top of the heap in about 10 years? Well, in the words of Bob Dylan, "When you ain't got nothin', you got nothin' to lose."

You're going to do the things you need to do because you have little choice. And it wasn't even a computer that brought them back from the edge but rather the iPod, and they didn't even develop it in their R&D center or build it themselves. They took it outside and created it under the radar. Instead of creating another Byzantine innovation process, their CEO surrounded himself with old Apple fellows, people who knew how to navigate the system and connect the dots. That's part of the brilliance of Steve Jobs. Look at IBM in the late '80s or Nintendo in the early 2000s. Nintendo had been usurped by Playstation and Xbox. But just like with a person, when you have a huge crisis, the risk of changing and the reward of changing is reversed. That is, the more radical the innovation the more likely it is born in a time of crisis. That's why alcoholics stop drinking only when they hit the bottom. That's why the financial crisis has absolutely fundamentally changed some consumer spending activities. Necessity is indeed the mother of invention.

The third point is about the connectiveness of innovation. In a down economy companies have a tendency to innovate in a "federation." Capital is scarce and a firm no longer has the wherewithal to do all the investment or own all the intellectual property, so it connects with suppliers, maybe even competitors, or maybe even joins an organization whose job it is to connect the dots. That's one of the things we do here at the Innovatrium. For example, in the past a pharmaceutical company would have a huge R&D lab and do all of the drug discovery work itself. Now, instead of aligning and optimizing everything as it did five years ago, this company is weaving a web of hundreds of tier-one biotech firms, graduate students, and other service providers, and synchronizing their development efforts across this loose confederation. So they own less of the intellectual property but they've spent less to get it in these hard times. It really comes down to that old philosophy of a rising tide lifts all boats.

That makes sense, but it sounds like too few are doing it.
DeGraff: If the numbers from these surveys are accurate, what's scary is that a very large percentage of these firms are losing ground. Here's why that is important. Because innovation is time-bound, you can't say you're not going to invest in it like you're not going to paint your headquarters building this year. Well, the building will just look a little sloppy. But with innovation what you're doing is losing a product, service, or solution cycle. You're losing a whole generation of profits. The reason to innovate is that you're basically trying to create new markets and higher revenue bands, a uniqueness that creates profits.

You say this is the time to invest when many of the input costs are low, but what about companies with serious cash flow problems that can't borrow in this tight credit market?
DeGraff: That's when you go to the federation. You get wide. There are low-cost Internet companies that connect the person who has the challenge or opportunity with the person who can provide a solution. Virtual innovation site Innocentive is a good example. But this approach raises a lot of concerns about intellectual property. Who owns the rights to an idea in a global matrix? Really, it's putting enormous pressure on the old system of innovation, complete with portfolio processes and a plethora of lawyers, and I believe it will eventually destroy it.

But, okay, the economy is really bad and you can't do everything. But here's what you have to understand. What most leaders do is try something that's just a little different than what they do now, but they try to do a lot of it. They turn innovation into a continuous improvement process. They try to optimize something that's a little better. This is the kind of thing they picked up from their quality controls training.

The breakthrough innovation game is the exact opposite. You take lots of shots on goal, each highly different from the next. These experiments are bold and have a very low success rate, but since they don't require a great deal of capital, there is little risk in failure. This is how venture capitalists quickly separate the wheat from the chaff. In a federation, where many members are starved for capital, the experiments are like mini-joint ventures or hybrid collaborations. You're trying to quickly and cheaply figure out what works and what doesn't work.

The more radical the innovation, the greater the failure cycle. There is always a failure cycle, and the trick is to accelerate it; not avoid it. You don't spend a lot of money on the first version. The first version is going to need a lot of work. So you experiment in succession with versions 1A, 1B, 1C, etc., until you have some real data on the technology, competency, and market, and can begin to shape and integrate the product, service, or solution into an initial offering. Of course you are burning some resources to run these experiments and proof the concept, but you also are plotting a solution much faster than a protracted design approach where the risk of failure is often cataclysmic because of the consequences of a "big miss." You're arriving at the market faster than somebody who is trying to perfect it.

Innovation has both a forward and aft position. In the forward position, it is imperative that a firm experiments to the full extent of its capability and ambition. In the aft, the firm needs to operationalize, streamline, and scale the innovation. You're trying to churn and create forward momentum, quickly learn what works and what doesn't, and integrate these insights into the full-scale development.

I've worked with a lot of clients on a lot of projects that became very successful innovations. It's the handoff between the forward and aft positions where most innovations are fumbled. Nobody wants to be associated with failure, so most leaders are unwilling to look at something objectively and ask why it didn't work. After-action reviews are mission-critical to success but they require a lot of honesty and courage particularly in a down market. I tell students that successful innovators never bet on one horse to win but rather bet on three horses to show. It's never the one you expect that brings a good pay day.

What are some other common pitfalls companies make?
DeGraff: Here's the challenge for all of us who advocate for radical innovation. When will the dollar go up? What will healthcare reform look like? What's going to happen in the Middle East next year? There's an important thing to understand -- innovation pays in the future where there is no data. It's an epistemological problem. The only thing you can really measure are enablers: things that help you get to the future. This is the classic trap everybody falls into. Leaders love to measure innovation by looking backwards. It tells them a lot about last year but little about the market today or next year. The year 2008 was so disruptive that it laid most of these types of metrics to waste. These types of measure are not going to be predictive and they may actually be counter-predictive. Measuring the pathway to today could be the worst thing you could possibly do. So when we start measuring how to get to the future, we're not going to measure the future. We're going to measure things like the diversity of our product pipeline, technology adaptation rates, and markets we are speculating.

Once you have a handle on what's really happening now, you can begin to optimize and employ more efficient measures. How you innovate is what you innovate! And the same is true for how you measure it. When you don't, when it becomes discontinuous, you hedge. You hedge not just for typical business school reasons (to mitigate risk), you hedge to prospect upside opportunity: Where's the new market? I'll tell you who's done a great job with this: Google. Google makes 97 percent of its profits on a single item, Adwords. Now go to the Google beta page and you'll see dozens of beta products. Consider their foray into phones and other new technology, which is very exciting. Why would Google spread out like that? They are trying to get a line of sight as to what's next. People often say Google is trying to turn all these initiatives into winning products. Not so. They're just trying to find the next one that breaks big.

How much of a barrier can corporate culture be to innovation?
DeGraff: I think culture is infinitely more powerful than strategy. Just because you have the right strategy doesn't mean you have the right culture to pull it off. An innovation culture has to be sufficiently flexible to promote enlightened trial and error and sufficiently inclusive to encourage diverse skills and points of view. Innovation requires linking disparate functions, like finance with HR or marketing with manufacturing.

The culture needs to support the four key elements of innovation. One, you have to have high-quality targets. Innovation rookies read the latest "you can do it" business book and try to boil the ocean. On the other hand, you get leaders beaten down by years of bureaucracy and "no-no-no" bosses who say you are powerless to do anything fresh. You have to get that magnitude and speed right. You have to set a target you can hit, something beyond the incremental and short of the inconceivable. That requires understanding how to spot an opportunity. The way to do that is to pay attention to what moves. Just like in real life, the more animate something is the more alive it is. It's searching for power, progeny, or pleasure. If it is moving less, it's in decay, decline. Innovation happens where the world is growing. People think they create growth. You ride these big trends, these big movements. They're not created by any one person or any one government and no one person or government can stop it.

The second element is deep and diverse domain expertise. Innovation happens at the edges of disciplines. It happens in between business and engineering, medicine, and law. It doesn't just happen in them, it happens in the space between them. So if you're going to make this work, you need experts from a variety of fields relevant to your endeavor.

Innovation is not an amateur sport. It may be true that Larry Paige and Sergey Brin built Google in a garage in Palo Alto. But they were two PhD students in computer engineering at Stanford. Do they sound like amateurs to you? If you're building a new business model for financial services or designing an artificial heart valve, you need experts; not amateurs. Put together a diverse advisory team. These should be people who do not always agree with you because the death of innovation is homogeneity and too much alignment. Constructive conflict is good. It produces productive tension. Alignment is overrated. Biodiversity is underrated.

The third element of innovation is to take multiple shots on goal, which we have already discussed. The first version won't be very good, but you keep learning with each version as you quickly move through that process.

The fourth element is that you learn from your mistakes through after-action reviews. You have to get smart. A lot of people take shots on goal and they remain in the dark about why things are not working. Pay attention to the mistakes, because that's where you're going to find the next set of questions and, if you're lucky, a few answers. Find out how you created a solution and who was involved.

That raises another interesting point. Companies love to bet on innovation processes. What you discover in a down market is that it's people and projects that connect organizations. So who are your innovators? And it's not your inventors. It's the person who knows how to navigate the system, someone who can get through the capital committee and hire some smart folks outside the traditional gene pool.

What are your client companies asking you most about right now?
DeGraff: The first big thing they're asking me is how they can develop innovation black belts. They love Google, they love Genentech, they love IDEO, but what they really want is their own capability to do that. The craft of innovation is no different than learning to play an instrument or speak a language or become a doctor: See one, do one, teach one. Innovation leaders need to be apprenticed, given tools, coaching, and the practical experience that comes from working on real innovation projects. To be honest, not everyone can do it. You can be a great innovator playing many different positions, but you definitely have to have some of the self-authorizing behavior and field of view to do this.

Second, which product and service companies are racing to remake themselves as solution companies? This partially comes from these federated agreements. They are looking to connect with the supply chain, with customers, with universities, and thread them together as valuable bundles. The great news is that they have all of these technologies, but the real challenges are the cultural elements, and how to monetize solutions. People are trying to put this cross-boundary form of innovation together but none of the traditional mechanisms really fit.

We have to reinvent the apparatus. In the old days, the intellectual property was run by the legal division. They basically told you that you couldn't do anything. Now try to develop a solution with a dozen businesses in a federation. If a peer has the same restrictions, it'll take you a year to make that deal. So people are now going around these traditional functions and approaches. They're creating these deals that say, if it's the source code or platform, we all own it, and we all kick in X amount to fund it. If it's an application built on top of it, we own the Y part of that and of course our specialty is Z, so we're going to make that proprietary and use it as our competitive advantage.

Finally, clients are asking us to create integrated innovation systems for them based on what we have learned from this array of projects, people, and solutions. The trick is to create the integrated system last. That's because you don't know what you don't know yet. As they say in the Nike ads, "Just do it."

—Terry Kosdrosky

For more information, contact:
Bernie DeGroat, (734) 936-1015 or 647-1847,