Tenet #2: There are various types of innovation, and the best companies excel at all of them.
Most books divide innovation into a large number of categories. Some authors talk about as many as ten types of innovation. Geoffrey Moore, in his book, Dealing with Darwin
, lists no fewer that fourteen. But I’ve found it useful to think in much simpler terms.
In each quadrant, I give a general sense of the relative level of investment, risk, and return for that type of innovation. For example, a disruptive process innovation can return very large rewards, but to achieve it you have to make a large investment and accept a high level of risk. You should only make this kind of investment if the potential return is high. There may be considerable risk in achieving it, but the potential needs to be there. An incremental product innovation is unlikely to generate large returns, but it is much less risky. It is usually a less expensive undertaking, so it often makes sense to do even if the returns are moderate. Of course these are generalizations; “your mileage may vary.”
Note that I don’t classify any of the quadrants as “low return.” All types of innovation can be worthwhile under the right circumstances. Calling any of the quadrants “low return” would incorrectly imply innovation in that quadrant isn’t a good investment. Not every quadrant makes sense in every business climate, but none of the quadrants are inherently poor choices. The only low-return choice is no innovation at all.
Let’s first look at the horizontal axis. For this simplified view of innovation, think of “product” in broad terms that also includes “services.” Companies like Sony or Procter & Gamble sell physical products you can hold and touch, whether they be high-definition TVs or tubes of toothpaste. Companies like United Airlines or Bank of America sell services, not physical products. The service United sells you is transportation from one city to another. The service Bank of America sells you is the right to use their resources for your financial transactions. For our purposes, the single term, “product” will include services as well as physical products.
Similarly, think of “process” in broad terms. A process includes not only the methodology used to manufacture a physical product but also the channel used to deliver that product or service to the customer. Amazon’s sales channel innovation, for example, was a new process that revolutionized retailing by making on-line purchasing safe, convenient, and less expensive than a traditional brick-and-mortar store. Similarly, Google developed a business model of giving away all of their services for free, funded entirely by advertising. Although not exactly original (network television has done it that way for decades), it has certainly been one of the more successful models of the Internet era.
Product innovation tends to grab the headlines because it results in something readily apparent to customers—BMW’s latest sports car will certainly create a buzz both in the press and with car buyers. Process innovation, though, can be even more important because it benefits every product that uses the process. For example, improving the manufacturing process for integrated circuits will benefit every circuit that goes through it, not just the innovative new microprocessor hyped in the press. This is one reason it is dangerous to gauge a company’s ability to innovate by the number of patents it produces; few companies patent process improvements nearly as frequently as they do product improvements.
As an example of the value of process innovation, let’s compare the impact of two of Amazon’s recent innovations, the Kindle e-book reader and their affiliate marketing programs known as Amazon Associates and Amazon Marketplace. Kindle, introduced in 2007, has captured the media’s attention and become a centerpiece of Amazon’s cachet. Some people even go so far as to worry about Amazon’s future if Kindle is displaced by Apple’s iPad. Although Amazon doesn’t announce sales figures, reliable third parties estimate that by early 2010 Kindle had sold about 3 million units. At an average selling price of around $250, that means Kindle has accounted for about $750 million dollars of revenue in a little over two years.
In contrast, the investment community has largely ignored Amazon Associates and Amazon Marketplace. Associates is a marketing program that allows third party websites to link to Amazon product pages and earn commissions for products purchased through their sites. If I write a blog on outdoor adventuring, for example, I can include links to products like tents, sleeping bags, and GPS receivers so my readers can buy them directly from Amazon. For each sale made through these links, Amazon pays me a small commission. I can create a virtual storefront on my site without having to worry about inventory, billing, shipping, or any of the other headaches of a real store. I've used Amazon Associates in this blog entry to link to Amazon's pages for two books I mention.
Amazon Marketplace is a similar tool that allows me to sell my products directly on Amazon. For example, if I own a bookstore that specializes in used books, I can add my listings to the Amazon pages for those books. Purchasers then have the option of either buying a new copy from Amazon or a used one from me. Amazon doesn’t care which one you buy. According to their annual report, they make about the same profit in either case. (Speaking as a published author, though, I’d rather have you buy the new book so I can earn a royalty!)
Amazon Associates and Amazon Marketplace are examples of marketing process innovations. They touch everything Amazon sells, not just one product. According to knowledgeable sources, combined they account for about 40% of Amazon’s total revenue. That’s 20 times more impact on Amazon’s bottom line than Kindle. It’s a good illustration of how process innovations can be much more powerful than product innovations.
Now study the chart’s vertical axis. Clayton Christensen uses the terms sustaining innovation and disruptive innovation in his classic book, Innovator’s Dilemma
. In it, he defines sustaining innovations as those that improve existing product performance. Disruptive innovations fundamentally change markets. Other authors use the terms incremental innovation and radical innovation. Incremental innovation builds upon existing technology; the changes it introduces aren’t enough to make existing products non-competitive. Radical innovation involves large technology advancements that render existing products obsolete. I believe the two terms that best describe the difference are incremental innovation and disruptive innovation, so those are what I use. Incremental innovation is just that—an improvement to product offerings in an existing market that incrementally improves a user’s experience. Disruptive innovation opens new markets, throws established markets into turmoil, and has the ability to completely rearrange the structure of the marketplace. Companies that were formerly market leaders could be left behind once the dust settles.
Much press has been devoted to the importance of disruptive innovation because large companies historically haven’t been very good a capitalizing on it. The literature is full of examples of market leaders falling by the wayside when they didn’t react to fundamental changes in technology. Western Union failed to follow the transition from telegraph to telephone. Polaroid resolutely stuck with film technology long after the world moved digital. WordPerfect ignored the transition from DOS to Windows and lost their leadership to Microsoft Word. Disruptive innovation rightly gets a lot of attention because the cost of missing such sea changes in markets is catastrophic to those who ignore them. Managers lie awake at night worrying about such a fate and use it as a rallying cry to stimulate innovation in their organizations.
Keep in mind, though, that incremental innovations are usually more important. While disruptive innovations such as the electronic calculator or on-line social networking catch the world’s attention, they occur only rarely. And when they do, the first to market isn’t always the one who reaps the rewards. A company that bases its future primarily on disruptive innovation is taking a long-shot bet. That’s what startups do, and that’s one reason large corporations often acquire rather than invent disruptive innovations. They can let the venture capital world sort out the winners from the losers.
Far more often, incremental innovations are what drive a company’s results. Take Apple, for example. In its early days, Apple pursued a strategy based largely on disruptive innovation. The Lisa computer, introduced in 1983, was the first personal computer to use a mouse and graphical user interface (GUI). In an instant, the fundamental way in which humans interacted with computers was changed. You no longer needed to type cryptic command lines to make things happen. Now you could simply point and click. This fundamental innovation had the potential to obsolete every previous computer overnight.
But it didn’t. Lisa’s high price ($9,995) drove away many potential users, while the lack of supporting hardware and software drove away many more. Although these problems were largely overcome with the release of the Macintosh a year later, it was too late. Far too many people had bought IBM PCs in the interim and were locked into the competition. By the time the Macintosh hit the market most people found the switching costs simply too high to convert. The mouse and GUI that won the market were Microsoft’s, not Apple’s. It was quite a literal example of the old maxim, “the second mouse gets the cheese.”
Another of Apple’s disruptive innovations was the Newton personal digital assistant, introduced in 1993. Although it coined the term “PDA,” it was big, clunky, and used a clumsy handwriting recognition system. (I still remember my manufacturing manager, an early adopter, struggling hopelessly to take notes with it during meetings.) Its lack of success discouraged further development, and as a result, Apple never participated in the eventual PDA market boom.
It wasn’t until the 1998 launch of the iMac, an incremental innovation in personal computers, that Apple finally avoided the threat of bankruptcy. Their most successful introductions of recent years, the iPod and iPhone, are both incremental innovations in existing markets. The iPod, the first digital audio player with a built-in hard drive, was a relative latecomer to the consumer digital audio market, which was then dominated by Sony. To their credit, Apple learned their lesson from the failure of Lisa, which had been hamstrung by lack of compatible software. When the iPod was introduced, Apple had already launched iTunes, a software application reminiscent of Napster that allowed you to choose from millions of songs for the low price of 99 cents each.
When Apple introduced the iPhone in 2007, it was long after such other smartphones as the Treo from Palm and the Blackberry from RIM. But once again, Apple successfully innovated incrementally. For the first time, mobile users could surf the Internet with an experience similar to a computer. And Apple extended their iTunes success with the equally successful iPhone applications store.
One other example of the challenge of the disruptive innovator is worth noting. Somewhat surprisingly, Kodak was an early player in the digital photography market. They introduced a low-resolution digital camera in 1973 and a megapixel-size consumer camera in 1986. But these products were only marginally successful. At the first introduction, few people were willing to spend $20,000 for a camera whose pictures didn’t look as good as those from a simple point-and-shoot film camera. Then, when Kodak launched their megapixel camera, there was little in the way of infrastructure to support it—no Photoshop software for picture editing, no personal computers powerful enough to edit the pictures even if the software existed, and no photo-quality personal printers for making prints. You still had to take your digital files to the photography shop for printing. It was a business model doomed to failure.
This lack of success led Kodak to conclude the future of film was secure. By the time they acknowledged their error and took digital photography seriously, they were impossibly far behind. This kind of faulty decision-making based on the failure of early introductions is not unique. If you don’t understand why a product failed, you won’t know how to predict the future of the market. I’ll relate a similar story from my own experience in a future blog entry.
During my career at HP/Agilent, I have led a variety of innovation programs, including both disruptive and incremental product innovations as well as both disruptive and incremental process innovations. In future blog entries, I will use some of them as examples. Not all of them are positive. Sometimes the best learning experiences come from failure.
Next: Innovation requires commitment from all levels of the organization, starting at the top.
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