The Innovation Premium

INSEAD Knowledge had an intriguing article that I have been meaning to write about. The Innovation Premium meanders along multiple themes (some of them untenable) but in the end has a couple of interesting observations. The article discusses the book The Innovator’s DNA:

“Innovation makes millionaires and undermines monopolies. It raises the profitability of companies and puts a premium on the shares of the most successful. But how can companies foster it? New research sheds light on the innovation process and how firms can tap into it to raise their performance and their share price.”

To that end, the article defines innovative companies purely based on share prices:

Common to all companies on the list is the fact that their share prices are 25 percent or more above what would be justified by cash flow alone. The leader is cloud computing company Salesforce.com, with its AppExchange that offers more than 1,000 applications for businesses, and which recently launched Chatter draws on features of Facebook and Twitter to provide social software for enterprise collaboration. Market expectations for further innovations have given it a premium based on 2010 results of no less than 75 percent.

We have discussed in the past that Wall Street is NOT a consistent or dependable evaluator of innovation. In fact, Wall Street rewards predictability more than disruptive innovations. The share price measure would move companies like Netflix from innovative to not in the matter of weeks! RIM and Blackberry has moved into the non-innovative group since the article was written a few weeks ago…

The lack of universally acceptable definition of innovation (such as the Oslo Framework) notwithstanding, the article still had some interesting points. A key point is that the leaders in innovative companies ask a lot of questions, challenge the status quo and do so based on personal involvement / observation (as opposed to through subordinate presentations):

They, too, are always asking questions and looking out for the unexpected: “Why not this? Why couldn’t we do that? What’s going on here? How could we do this better?” When someone “behaves that way, acts differently, asks lots of questions, observes like an anthropologist, experiments constantly, networks for new ideas,” Gregersen observes, “they’re likely to get incredibly insightful ideas about new businesses, new products, new services, breakthrough processes: things that will make a difference for any company or country.”

The article also suggests (as we have discussed many times) that innovation starts from the top and that the leaders actually have to start the innovation process – not wait for it to bubble up from the bottom. The article also disruptive innovation is hard to manage and integrate into the product line. Innovative leaders have to actually nurture innovation. Since the article mentions Steve Jobs, and we can certainly learn from him as well.

Unmanned aerial warfare: Flight of the drones

The Economist has an interesting article Unmanned aerial warfare: Flight of the drones. In addition to providing an overview of the market, it provides lots of interesting statistics and graphics that will be very useful. To kick it off, the article says:

Over the past decade UAS have become the counter-terrorism weapon of choice. Since 2005 there has been a 1,200% increase in combat air patrols by UAVs.

A suprising statistic for me was the number of people involved in keeping each Reaper UAV flying (I am not sure how they arrive at that information. Sounds a bit too high)

There may not be a man in the cockpit, but each Reaper, a bigger, deadlier version of the Predator, requires more than 180 people to keep it flying. A pilot is always at the controls (albeit from a base that might be 7,500 miles, or 12,000km, away); and another officer operates its sensors and cameras.

Here is the market size and forecast:

It is amazing that US is by far the largest market much larger than the rest of the world put together! I wonder how the competitive landscape is going to change in the time of austerity. Another key concern is new innovations or breakthrough technology such as artificial intelligence that may change the landscape completely.

The article is an interesting read. Please check it out.

Role of Government in Nurturing Innovation (Part II): China’s Awkward Quest for Bullet Train Technology

We recently talked about the role of government in nurturing innovation. The clear evidence was that China would not be in the wind power industry had it not been for government regulation:

But the fact is that none of this would have been remotely possible if China did not regulate the market to allow its own industry to become strong. May be there is a place for regulation – as long as the protection is for a short time, targeted and with significant competition. We know that rivalry and scarcity are drivers of innovation – so as long as money is not given out freely, it might encourage innovation and give national companies a chance to become strong. Countries could consider outsourcing innovation when necessary, not just buy the whole system from a foreign provider. May be the reason why Indian regulation did not work was because they did not have a large number of companies competing for contracts. In fact, they probably regulated the number of companies…

The article China’s Awkward Quest for Bullet Train Technology in Knowledge@Wharton highlights a few more considerations. Here is the overall background:

It took just seven years for China to build the world’s biggest — and purportedly most advanced — bullet train system. That lightning speed and the political capital invested in the showcase program come with more liabilities than acclaim. The collision on July 23 on a high-speed line near Wenzhou may not have derailed Beijing’s ambitions to dominate cutting-edge passenger rail technology, but it has shed light on the program’s shortcomings.

Some problems should have been expected because development of large systems such as wind mills or high speed rail (HSR) is complex and requires time. There is only so much a country can do to accelerate implementation to catch-up with others.

Transportation experts assert that the accident was a consequence of China’s haste. New lines have opened in quick succession, and corners inevitably cut to meet deadlines — the most visible evidence of which being the low-tech, crumbling rail stations dotted across the country that have yet to be upgraded. “China’s high-speed rail program proceeded at breakneck speed, with a far faster roll-out than any other country has attempted, and this was seen as a matter of pride,” says Richard Di Bona, technical director of LLA Consultancy, a transport consulting company based in Hong Kong.
According to Tsung-Chung (T.C.) Kao, a professor at University of Illinois’s Rail Transportation and Engineering Center at Urbana-Champaign, China is facing up to the fact that it failed to spend enough time testing the high-tech system. “They built the HSR system and networks too quickly and there are many bugs … that have to be fixed now,” adds Kao, a former vice president of Taiwan High Speed Rail Corporation, who was part of an 11-year HSR project on that island.

The rush to speed-up innovation caused problems in Chinese wind power industry as well. I still believe that there is a role for government in nurturing innovation. However, the overall scale/type of problems in the high speed rails is a bit different. Here are some lessons from the article:

Unlike wind mills, there were only a couple of companies developing HSR in China. Unlike wind mills, there was only one major customer (Railway Ministry). The lack of customer and supplier diversity actually prevented true competition / rivarlry and and reduced the drive for innovation. The lack of diversity also drove corruption.
HSR became primarily driven by politics and national pride instead of innovation. This is much harder to do when there is a diversity of customers and suppliers.

So in the contract decisions was based on politics, rather than technology, says Ryoji Nakagawa, a professor of international relations at Ritsumeikan University in Kyoto.
National pride reached its apex this spring when a Railway Ministry spokesperson boasted during the unveiling of the Beijing-Shanghai bullet train that the Chinese rail system had surpassed Japan’s renowned Shinkansen
HSR is much more complex compared to wind power and requires significantly larger investment. It is difficult to maintain government nurturing environment for very long-term. Even at break-neck speed, roll out of HSR probably takes a order of magnitude higher resources and time.

“It took 18 years for Japan to develop a bullet train that could run at 300 km/h after the Tokaido Shinkansen opened in 1964,” says Kamiura. “We spent so much time just improving rail track technology to be able to take the speed from 200 km/h to 300 km/h.” Even today, the maximum speeds for most of Japan’s bullet trains are 240 km/h and 270 km/h. The Sanyo line, connecting Osaka to Hakata in Kyushu, raised its maximum speed to 285 km/h in 1997 and to 300 km/h in 2006.
Chinese HSR companies were very closely tied to foreign partners and the project became technology transfer instead of innovation.

The reality, experts say, is that at best China has integrated the technology of its overseas partners, rather than leapfrogging it. The main so-called CRH2 trains rolled out as China’s own were produced under a joint venture between state-owned CSR Qingdao Sifangand Kawasaki Heavy Industries. According to experts, the CRH380A is based on the same technology as the CRH2 and Japanese bullet trains, and on July 23,it was a CRH2 train that slammed into a train developed in a joint venture between Bombardier of Canada and CSR Sifang Locomotive and Rolling Stock Company, known as a CRH1.

Finally, the national pride also led to pressure to file for patent protection (to demonstrate that China was innovating). It is important for R&D managers to remember that Trade Secrets are probably as important as – in not more than – patents in a true IP-based innovation protection strategy.

Seeking such patents is a double-edged sword. Commercial considerations are only part of the reason why China wants such patents. “Again, this is a political statement,” says Kao. “They want to show off their success to the top leaders and bosses,” who want evidence that the government’s huge investment in the bullet train program is paying off.
But the process would force China to reveal details of its technology — even possibly that it made limited changes to the technology transferred by its foreign partners, Nakagawa contends.

Is communication with supervisor more important than other team members?

The motivation and management of global or virtual R&D teams has been a constant theme on this blog . Since direct in-person communication is always diminished in virtual teams, I have been trying to understand the impact on communication between R&D teams and with managers on performance. I recently found an article in the R&D Management Journal describing The impact of team-member exchange, differentiation, team commitment, and knowledge sharing on R&D project team performance:

This paper integrates team-member exchange (TMX), affective commitment, and knowledge sharing to examine how work unit TMX influences employees’ R&D project team commitment and intention to share knowledge, and how team knowledge-sharing intention and TMX differentiation influences team performance.

It appears that Team Member Exchange (TMX) and Leader-Member Exchange (LMX) are well known concepts used to understand the impact of communications on team performance. A recent Ph.D. thesis from Hong Kong University (Thanks Google!) provides some background:

According to Seers A. (1989), TMX defined as “an individual’s perception of his or herexchange relationship with the peer group as a whole”. It was developed as one way to measure the level of exchange quality among coworkers. The concept of TMX has been applied to both traditional work groups as well as to self-managing teams

Similarly LMX is defined as:

Graen (1976) defined Leader-Member Exchange (LMX) as “an interpersonal exchange
relationships between a subordinate and his or her leader”. Through researching and studying over a quarter century, LMX has evolved into a general assessment of a work relationship between leader and member, measured by the extent to which there is a mutual sense of trust, loyalty, understanding, and support (Keup, L.C., 2000).

It appears that manager communication (LMX) only impacts job satisfaction. While enhanced team communication improves performance and job satisfaction. Hence R&D managers need to focus on deploying processes and tools that enhance communication between team members – especially virtual or global teams. Back to the R&D management journal paper: increased interactions and communications between team members enhances knowledge sharing, team commitment and team performance.

The results support the relationships between work unit TMX and employees’ intention to share knowledge and team commitment. In addition, the results show that work unit TMX increases intention to share knowledge through increasing group members’ team commitment. At the group level, the results support the relationships between team knowledge-sharing intention and team performance. The results also show that TMX differentiation moderates the relationship between work unit TMX and team performance. That is, greater work unit TMX is more likely to achieve higher team performance in a team with low TMX differentiation as opposed to a team with high TMX differentiation.

The Big Idea: Before You Make That Big Decision

Deciding which R&D ideas to invest in and how to prioritize product portfolio opportunities is difficult. CTOs of several large companies have actually reported that R&D performance increases with cuts in budgets (TI, Pfizer). However, we have often discussed the problems with reliance on gut feelings or irrationality of decision making. Here is an interesting article from the Harvard Business Review about The Big Idea: Before You Make That Big Decision…:

Thanks to a slew of popular new books, many executives today realize how biases can distort reasoning in business. Confirmation bias, for instance, leads people to ignore evidence that contradicts their preconceived notions. Anchoring causes them to weigh one piece of information too heavily in making decisions; loss aversion makes them too cautious. In our experience, however, awareness of the effects of biases has done little to improve the quality of business decisions at either the individual or the organizational level.

Clearly, some intuition will always be necessary to make decisions about the future. However, should we try to minimize the impact of biases in our decision making?

Though there may now be far more talk of biases among managers, talk alone will not eliminate them. But it is possible to take steps to counteract them. A recent McKinsey study of more than 1,000 major business investments showed that when organizations worked at reducing the effect of bias in their decision-making processes, they achieved returns up to seven percentage points higher.

Cost of questioning and examining decision-making can be large. The article has some great pointers about when and how to dig into decisions. Here is my version of a checklist based on the article to eliminate decision bias. (as you know, I love checklists):

Is the decision sufficiently large to warrant an evaluation of bias? (do not question all decisions)
Is there a reason to suspect the self-interest bias in the team making the recommendation? (do a thorough review)
Has the team has clearly fallen in love with its proposal and not evaluated other options? (Are credible alternatives included along with the recommendation?
If there seems to be Groupthink because dissenting views were not solicited or explored. (Solicit dissenting views, discreetly if necessary).
Are the people making the recommendation overly attached to past decisions?

Is the team is relying mainly on a memorable success?
Is the team assuming that a person, organization, or approach that is successful in one area will be just as successful in another?

Do you know where the numbers came from? Can you get better numbers / results from other models?

If you had to make this decision again in a year’s time, what information would you want, and can you get more of it now?
Is the base case overly optimistic?
Is the worst case bad enough?
Is the recommending team overly cautious?

As the article points out, a key to eliminating decision bias (and literally, the success of all change), is discipline on the part of the R&D manager. If we do not follow the same process that is required of all teams, the biases will never be questioned or eliminated.

Summary of Steve Jobs Related Posts

Hello Everyone! Sorry for the sparse posting for a few weeks. I have been out on vacation. I am back now and hope to have more content soon.

As most of you have heard, Steve Jobs resigns as CEO of Apple:

“I have always said if there ever came a day when I could no longer meet my duties and expectations as Apple’s CEO, I would be the first to let you know. Unfortunately, that day has come. I hereby resign as CEO of Apple. I would like to serve, if the Board sees fit, as Chairman of the Board, director and Apple employee.”

I personally have learned a lot from Steve Jobs. Some observers are saying that his role as the chairman of the board will be similar to CEO (see Steve Jobs resigned, but he’s still Apple’s employee No. 2 – The Washington Post):

“So what Apple looks like today, tomorrow, and maybe even years down the road isn’t going to dramatically change. Steve will still be there, navigating — if not outright piloting — the big ship in Cupertino, still bringing his strange and brilliant mixture of talents to the table, still being the company’s toughest critic and most ardent defender. “

But from what I have learned, it is going to be very difficult. The key to Steve Jobs’ success in my mind is that he was a hands-on leader – bringing technologies, user experience, design and marketing/sales together.

Here are some lessons and posts related to Steve Jobs method for R&D management:

Minority rules: Scientists discover tipping point for the spread of ideas

Some good insights for R&D managers trying to drive change in their organizations in the article Minority rules: Scientists discover tipping point for the spread of ideas:

Scientists at Rensselaer Polytechnic Institute have found that when just 10 percent of the population holds an unshakable belief, their belief will always be adopted by the majority of the society.

We can use this to form concrete communications strategies. We should plan on getting at least 10% of the stakeholders committed to a change. The 10% number can be used as a metric to guide success of change related training or buy-in…

When the number of committed opinion holders is below 10 percent, there is no visible progress in the spread of ideas. It would literally take the amount of time comparable to the age of the universe for this size group to reach the majority,” said SCNARC Director Boleslaw Szymanski, the Claire and Roland Schmitt Distinguished Professor at Rensselaer. “Once that number grows above 10 percent, the idea spreads like flame.

The Business Models Investors Prefer

MIT Sloan Management Review has an interesting breakdown of business models in the article The Business Models Investors Prefer:

Creators, which sell ownership of products they have created by transforming or assembling raw materials or components. Ford, 3M and Intel are examples of this type of company;
Distributors such as Wal-Mart or Amazon.com’s retail business, which sell ownership of products they bought but did not substantially change, except by transporting, repackaging or marketing;
Landlords, which sell only the right to use assets for a specified period of time; Marriott, Hertz, Accenture and Citigroup are examples of the landlord model. We included in this category companies that employ licenses or subscriptions to sell limited rights to use their intellectual property (IP) assets — companies such as Microsoft and The New York Times;
Brokers, which receive a fee for matching buyers and sellers without ever taking ownership or custody of the product; examples include Charles Schwab, eBay and realtors.

There are four types of assets as well:

Financial assets, which include cash as well as securities like stocks, bonds and insurance policies that give their owners rights to potential future cash flows;
Physical assets, which include durable items such as computers, as well as nondurable items such as food;
Intangible assets, which include intellectual property such as patents and copyrights, as well as other intangible assets like knowledge, goodwill and brand value;
Human assets, which include people’s time and effort. People of course cannot be legally bought and sold, but their time and knowledge can be “rented out” for a fee

The overall conclusion (in my opinion less important and somewhat questionable) is:

“In research we conducted at the MIT Sloan School of Management, we found that the stock market consistently values certain types of business models more highly than others. Specifically, we found that in recent years, investors have favored business models focusing on licensing intellectual property (such as Walt Disney’s business model) and a certain kind of highly innovative manufacturing (such as Apple’s).”

5 Myths of Innovation

Prof. Birkinshaw has a must read article for all innovation managers in the MIT Sloan Management Review: The 5 Myths of Innovation. Here are my learnings from it:

Innovation is NOT about the Eureka moment. Innovation is 5% inspiration and 95% perspiration. Companies are good at generating ideas, but it is in the detailed development and getting the innovation ready for market is where most failures are identified (the valley of death). The research shows that many companies are good at generating ideas (or at least ideas that sound good), but the performance drops through successive steps of development.

Most innovation efforts fail not because of a lack of bright ideas, but because of a lack of careful and thoughtful follow-up. Smart companies know where the weakest links in their entire innovation value chain are, and they invest time in correcting those weaknesses rather than further reinforcing their strengths.

The eureka moment is the driving force behind ideation workshops. I have myself conducted several and have been amazed at the lack of results. Many ideas sound good on the surface but digging into them is expensive. Also, it is very hard to find budget to explore ideas beyond the ideation workshop.
Innovation does not come from social interaction: There has been many suggestions of using social networks (here and here) and online forums to gather innovation ideas and nurture innovation (Tata’s learn to innovate). However, the success of tehse forums is not guaranteed. As we have seen in the past, active engagement from the managers/executives is key to success of any online forum. Here are some more thoughts:

So what should you do to avoid these problems? The most important point is to understand the types of interaction that occur in online forums, so that you use them in the right way. If you are looking for creative, never-heard-before ideas, and if you want people to take responsibility for building on one another’s ideas, then a face-to-face workshop is your best bet. But if you are looking for a specific answer to a question, or if you want to generate a wide variety of views about some existing ideas, then an online forum can be highly efficient. (See “Questions That Work — and Don’t — in Online Innovation Forums” for examples.)
Open Innovation is not critical: Borderless or open innovation where companies access innovation from the outside has been much revered as the next big wave (See hotbeds of innovation, quirky innovation, etc). However, nurturing innovation from the outside is an order of magnitude more complex than internal ideas. R&D teams are often weary of outsiders. Organizations often have a problem with not-invented-here. Finally, outsiders often speak a different language from internal teams, which makes it difficult to internalize their innovation. Add to it complexity of IP licensing and costs of evaluating thousands of ideas that you might receive from the outside, and it becomes unmanageable. The key is to access innovation from the outside when the problem can be very narrowly and precisely defined and there is not much overlap between external/internal teams.

External innovation forums have access to a broad range of expertise that makes them effective for solving narrow technological problems; internal innovation forums have less breadth but more understanding of context. Smart companies use their external and internal experts for very different types of problems.
Financial Incentives are not the best way to drive to innovation: As we have discussed many times (the problem with financial incentives, impact of incentive bonus plans, etc), financial / monetary incentive are probably not the best approach to driving innovation. Prof. Birkinshaw has the following to say:

Rewarding people for their innovation efforts misses the point. The process of innovating — of taking the initiative to come up with new solutions — is its own reward. Smart companies emphasize the social and personal drivers of discretionary effort, rather than the material drivers.
Top-down innovation is as important as bottom up: There is a misconception that all innovations start from disruptive technologies and key R&D. However, even when the ideas come from R&D, they need to be actively funded and managed to succeed. Also, it takes a lot of discipline and cultural change to get disruptive innovation to market.

Bottom-up innovation efforts benefit from high levels of employee engagement; top-down innovation efforts benefit from direct alignment with the company’s goals. Smart companies use both approaches, and are adept at helping bottom-up innovation projects get the sponsorship they need to survive.

Why Stock Options Lead to More Risk Taking

We have recently discussed some interesting research on the use of incentives to drive R&D performance. We learned that incentive bonus plans tend to make executives modify goals to ensure incentives are obtained. We also learned that stock options are not actually seen as performance drivers but gifts from the company. Financial incentives themselves have been seen as not very effective towards driving true performance. Now there is one more piece of the puzzle from Knowledge@Wharton (The Making of a Daredevil CEO: Why Stock Options Lead to More Risk Taking):

The research is laid out in a new paper, ‘CEO Compensation and Corporate Risk Taking: Evidence from a Natural Experiment,’ by Gormley, David Matsa, a professor at Northwestern University’s Kellogg School of Management, and Todd Milbourn, a professor at Olin Business School at Washington University in St. Louis. ‘Options do have an effect on risk taking,’ Gormley says. ‘That is something that should be factored into compensation structure by boards of directors.’

As we have discussed earlier, stock options are increasingly used as part of the compensation package:

Stock options are a critical element of CEO compensation — making up one quarter of total pay for executives these days. But what does that mean for the risk profiles of the companies those CEOs lead?

The problem is that stock options only work in one way – towards the upside. If the stock price falls below the option value, they are worth zero (not negative).

At the heart of that question are two opposing forces: There is a risk-tempering aspect to options, because when those options are “in the money” — meaning the exercise price is less than the current market price — the value of those options moves in line with the stock price. That tends to dampen risk taking because CEOs want to preserve the value of those options.
At the same time, however, the downside of risk taking is limited because once the options are worth zero, they do not decline further in value if the stock price falls. And that limited downside increases the tendency to take on risk.

In summary use straight equity instead of options to moderate risk taking :

Research has shown that senior executives at financial firms have a large part of their compensation in the form of restricted stock — securities that, like straight equity, tend to reduce risk taking. But at the lower levels of those firms — areas like sales and trading — a large chunk of compensation is tied to bonus pools. Like options, those bonus pools have a large upside and limited downside. After all, once the pool is worth zero, managers have little to lose. That sort of compensation does, in fact, encourage risk taking, Gormley notes.

I am getting more and more convinced that the best approach is to measure risk taking and reward it using concrete metrics instead of using indirect tools such as options…