BCG's Harold Sirkin on How Firms can Reap the Rewards of Innovation
These days almost every company
worth its balance sheet insists that it invests in "innovation." But
does it make or lose money on these investments? That is a tougher question --
and one that James Andrew and Harold Sirkin tackle in their new book titled, Payback:
Reaping the Rewards of Innovation. According to the authors, who are senior
vice presidents and directors of The Boston Consulting Group, a new idea is
just an invention -- and not a true innovation -- unless it generates financial
returns. "Thousands of good ideas exist within every organization, even
those that don't think of themselves as innovative," they write. "The
real problem these companies have is how to turn their ideas into cash."
That is where Payback hopes
to help. Andrew and Sirkin believe that in order to profit from their
innovations, companies need to develop a process to collect, screen and nurture
new ideas and "commercialize and realize them in a way that achieves
payback." They explain concepts such as the "cash curve" -- which
lets firms track and manage the innovation process -- and the "cash
trap" -- which refers to supposedly innovative products that perpetually
hemorrhage cash. In an interview with Knowledge@Wharton, Sirkin discusses these
and several other challenges companies face as they seek to innovate and --
hopefully -- make a few bucks along the way.
An edited version of the transcript
follows:
Knowledge@Wharton: Why is it so hard for companies to generate returns on their
investment in innovation?
Sirkin: It's very hard because most companies think about the idea
-- the invention, as opposed to the innovation. By innovation we mean an idea
that is driven to the profitability of return on investment. Most companies
focus on invention. They focus on the ideas. They spend a lot of effort looking
at ideas, sorting through ideas and trying to generate ideas.
But very little of the process that
they go through is focused on [then] turning those ideas into something that
delivers payback. They spend little time screening those ideas for the ones
that would be commercially viable or technically feasible before they move
forward with them. They spend little time focusing on how they're going to
develop them. And they spend very, very little time thinking about how they're
going to manage them over the life cycle.
What they don't have is the
fundamental discipline of operating the entire process. They get enamored with
the invention, but not with the process of making it work. Therefore they
don't focus on innovation; and by not focusing on innovation, they don't
achieve payback.
Knowledge@Wharton: So it's not that they lack imagination or resources. It's
mainly an understanding of the process to move it from one step to the next?
Sirkin: Exactly. We think most companies are putting in at least
twice as much of what they need to spend and getting about half the value of
what they should be achieving because their focus is in the wrong place. It's
very rare that we go into companies and find that there aren't good ideas. In most
companies, when we do some research, we find out that they have five or 10
times as many good ideas as they can possibly move forward. The problem is that
they're often trying to move all those ideas forward at the same time.
Knowledge@Wharton: Your book discusses how many companies have products that
lose money and they become what you call cash traps. How exactly does that work
and how do you identify a cash trap?
Sirkin: Cash traps are obvious when you see them, although in most
companies it's hard to find them right away. A cash trap is a product that just
fundamentally does not, has not, and will never make money. It survives either
because it's viewed as a core product in the operation of a company, or a core
product line in an operation. No one does the accounting that would show on a
cash basis that these products lose money.
Identifying them is pretty simple.
You can often see them because they tend to not grow very fast. They tend to
take a lot of resources and continue to demand even more and more resources.
You can start to look at those and ask if they are really worth the investment.
We find that many companies are riddled with capital cash traps. By just
removing those cash traps you can improve the productivity of innovation.
Knowledge@Wharton: Could you give an example of a cash trap? I know the one
that you cited in the book was the Concorde.
Sirkin: The Concorde was the ultimate cash trap. Of course, it
wasn't an invention from a company; it was a joint venture between the British
and French governments. So it's a different situation from what many companies
may have. But the Concorde was a great example. It was meant to develop
technology and it was the first supersonic transport that existed.
The U.S. looked at it. I think
Boeing had a model of a supersonic transport but did the math and realized that
the company could not sell enough aircraft at a price where it could make
money. The Anglo-French joint venture, funded by a lot of government money,
decided that it would move forward with this idea. The reasons, in many ways,
involved the prestige of the countries and the development of technology to
build a very good aerospace business and the benefits that came from that.
But if you look at the economics of
Concorde, they only sold I believe, 13 or 14 planes. They spent billions on
development and their largest customer(s) were [of course] only Air France and
British Airways. The sale of Concorde to British Airways was not at a price
that you would expect for an airplane, but it was one English pound. This was a
most amazing thing because they had to sell the airplanes and British Airways
understood that they had to sell the airplanes and would have refused to pay
anything more than one pound per plane. So it's a tremendous example of a cash
trap.
Cash traps show up in many companies
in other ways as well. You can find them in industrial goods companies. You can
find them in consumer goods companies where someone is enamored of a particular
product or technology, often at a very senior level, and people feel that they
can't touch that product. And because they can't touch it, the investment
continues and you get a cash trap.
Knowledge@Wharton: A couple of weeks ago, Microsoft CEO Steve Ballmer was at Wharton speaking to students. He took exception to one of the
questions from a student suggesting that Microsoft is not an innovative
company, mainly because they often go into markets where there's already a
competency established and then they try and blow their competitors out of the
water. According to your definition of innovation, is Microsoft innovative?
Sirkin: In our book we say Microsoft is probably the most innovative
company. We may define innovation differently than others do, and we think that
definition is very important. We think without getting payback, ideas are ideas
but they're not very valuable. Businesses are in business, like Microsoft, to
make money. That is their mission.
They may have other social goals to
achieve as well, but making money is the one thing that a company has to
do -- and because of that you have to have payback. Microsoft is one of the
most innovative companies because it is very good at not just identifying ideas
but at driving them into the marketplace and driving them successfully to earn
a return. That makes Microsoft, by our definition, the most innovative company.
Knowledge@Wharton: Which other companies do this well?
Sirkin: There are many companies. P&G [Procter & Gamble] is
another great example of an innovative company. BMW is a very innovative
company. They all do it in very different ways, but they are all very, very
focused on not just the idea, but how you drive that idea to reality and a reality
that earns a return, not just a reality that produces a product.
Knowledge@Wharton: Even if an innovation doesn't quite make money, there may be
some other intangible benefits that a company might derive from that product or
service. This in turn helps other parts of the company to make money and
establish payback. How does that process work, and do you have some examples?
Sirkin: Sure. Let's go back to Concorde because that's an example
where there were some benefits. Clearly on a direct cash basis, Concorde didn't
make any money, particularly if the airplane was sold for one pound. But there
were a lot of indirect benefits. As the Anglo-French joint venture had
expected, it did enable the two countries to build a technology base for
aerospace in Europe. Out of that eventually grew AirBus and the whole AirBus
fleet of airplanes. That's an indirect benefit; it helped Britain and France
build a set of capabilities.
We think there are several different
kinds of indirect benefits that you can have. One is knowledge - technical
knowledge. Another is brand: you may decide to spend money and create a cash
trap with the goal of building a brand. Of course when you do that, there's a
point in time when you've built the brand and you need to turn the cash trap
off. And that's where people make the mistake [of not doing that].
You may think about an ecosystem. A
lot of what Apple does with the iPod is they've built an ecosystem around it
for all the products that go with it. This helps Apple make more money in that
area.
The last reason is you may do it for
organizational vitality. For example, Toyota invests in racing cars. They're
not going to make money in racing cars, but it's part of the organizational
vitality of Toyota. It's something to rally around and of course it also gives
them more knowledge, because you put those cars under a lot more stress.
So there are many reasons why you
would have businesses that don't earn cash, or that don't earn payback. But
what you have to keep coming back to is making sure that those things are
valuable because those indirect benefits have got to eventually yield payback.
Knowledge@Wharton: You've pointed out that many companies look for organic
growth these days mainly through innovation as opposed to, say, mergers and
acquisitions. But isn't M&A coming back with a vengeance?
Sirkin: Well, it's a balance question. It's not that you would do
one or the other. You would want to do both at the same time because the stock
market rewards growth of any kind that achieves a high return.
Organic growth through innovation,
if you do it right and you manage your process right, will achieve a high
return, so you do both. We're not saying that you can't do M&A. We're not
saying that M&A is a bad thing at all. What we are saying is that most
companies have taken some of the easy routes through M&A and that they're
missing opportunities through innovation.
Knowledge@Wharton: How does a company like BCG innovate?
Sirkin: Well, that's a long process for us and something that we
focus on tremendously. We have the ability to pull people aside in our
organization, when good ideas come up and ask them to work on them. We have a
screening process in place to be able to think through what are the good ideas
and which ones we're going to invest in to make sure that we don't create a lot
of cash traps.
We take prudent risks and we think
about the risks of each investment. We have small investments and large
investments, risky investments and low-risk investments in our portfolio. And
then we have a process to push each idea forward so that we can turn it into
something that our clients can use, to be able to help them improve the payback
in their businesses.
Knowledge@Wharton: There's a section in your book about what models companies
use for innovation. For example, some companies are integrators while others
orchestrate innovation. Could you give some examples of the models of
innovation and how they work for different companies?
Sirkin: Sure. An integrator tries to do most of everything on its
own. A great example of that is Seagate, the disk drive manufacturer. The
company specifically chose to be an integrator. It had considered being an
orchestrater, which is an organization that works with a lot of outside
parties.
But they realized that different
pieces of the disk that needed to be put together have to work in tandem in an
incredibly important way. And, if they were going to put a lot of those on the
outside, they could never get the coordination to work. So, they made a
decision that it would actually be faster to produce a quality product by
integrating.
Other companies have made an
orchestrater decision when they recognize that they can't do everything
internally and it's actually faster, lower cost and a lower risk to have things
done outside. Boeing is a company doing more and more orchestration and having
its suppliers provide more of the value-added content. They are focusing on the
engineering and manufacturing of the actual plane itself, but outsourcing
systems. It becomes more and more an orchestrater.
Perhaps the ultimate orchestraters
are people in the apparel business who often have a brand, outsource the
design, and outsource just about everything else in terms of manufacturing,
including the supply chain. They are responsible just for bringing the product
to market.
Knowledge@Wharton: Is orchestration the same as outsourcing, or is there a
difference?
Sirkin: [There is a difference between the two.] Outsourcing can be
a piece of it. Orchestration is when you put a lot of the value added on the
outside. If you take low value operations and you give them to somebody else --
you can still be an integrator. When you're an orchestrater you are taking a
lot of the value and putting it outside, recognizing that you will get benefits
from it. The benefits could be reduced risk because you're not taking all of it
on yourself, faster time to market because they can do a lot of it faster, and
other factors that are very important in terms of those decisions.
Knowledge@Wharton: Is the idea of innovation different in a country like China
or India? How is it viewed in those countries? Is the process more challenging?
Sirkin: I think it's different everywhere. And it may be even more
different by company philosophy than it would be by country. You know there are
many things that make innovation more difficult. So, companies that create an
environment where risk taking is not in anyway allowed or risk taking gets you
no rewards, you only get punished for taking risks -- that's a real problem.
I'm not sure that you can say that it is different by country, but you can say
that it is different by some cultural characteristics.
Knowledge@Wharton: Would China, for instance, be considered a country of risk
takers? Or is there so much government regulation and government watchfulness
that it's very hard to be a risk taker there?
Sirkin: There are companies in China that take risks. I don't think
there is something about that environment that is problematic. There are a lot
of risk takers in China. They've made many, many investments as individual
organizations. So, I don't think there is a barrier to innovation in China.
Knowledge@Wharton: If a group of CEOs were to come to you for advice on how to
get started on getting some payback on their ideas, so they could turn them
into innovations in which the investment pays off, what advice would you give
them?
Sirkin: The first thing we would say is let's draw a cash curve.
Let's take a look at the profile of several of your ideas that you tried to
take to innovation and let's see what happened. Let's see where you invested,
how you invested and let's take a look at the ones that you feel didn't work so
well and see if they could have worked had you done things differently.
This is because we think the big
problem often isn't with the idea -- although there are many ideas that are not
the right ones to take forward -- but with how you take the idea forward. And
for many ideas that have failed and never become innovations, when you go back
and take a look at what happened -- they could have been successful had you
chosen to do things differently. So we ask people to go back and look at the
cash curve and see what it was and what could it have been if they had done it
differently. That is often a good place to start.
The other place where we ask people
to start is to look at the portfolio of what they're doing and ask, can you
really move all these ideas forward? Do you really have the resources? Are you
under-funding some and should you not be funding others? And oftentimes we help
them sort that portfolio down to a portfolio of about a third to half the size.
But the result is that the right project is being funded with the higher
probability of getting them out the other side in a reasonable period of time,
with a reasonable amount of cost, which gives them a good chance of becoming
innovations.
Knowledge@Wharton: Whom do you consider the most famous individual innovator in
the U.S.?
Sirkin: The one who gets named the most, of course, is Thomas
Edison. He was both an innovator and not an innovator in many ways. He got
commercial value from some of his ideas, but very little from most of them.
Often he had to sell the ideas too early in order to pay for his inventions.
He was an interesting character in
that sense because he was both an inventor and had some innovations. Others
might be better at innovations with fewer inventions. But he was too curious
and had too many ideas. And like many companies, his portfolio was such that he
couldn't move them all forward.
http://knowledge.wharton.upenn.edu/article.cfm?articleid=1640
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