Innovation as a Deep Capability

GARY HAMEL

Winter 2003 19

E X E C U T I V E F O R U M

It is well understood that in today’s world of discontinuous change, there is no con-tinuity without constant renewal. At Strategos, we conducted a survey and foundthat more than 90 percent of large organizations are committed to innovation, as

evidenced by a recent annual report or speech in which top management affirmedinnovation as a critical capability for the organization.Yet when we asked people in-side these companies to describe their corporate innovation system, almost none ofthem could do it. And when we asked them,“Is innovation rhetoric or reality?” theysaid overwhelmingly,“It’s rhetoric.We don’t see the reality.” How do we explain thisgap between word and deed? One explanation is that top management is just payinglip service to innovation and has no intention of really working hard on it. But an-other—and far more likely—explanation is that senior leaders do not have a clear,well-developed model of what innovation looks like as an organizational capability.And since they don’t know what it looks like, they don’t know how to build it.

There are two core challenges to making innovation a deep capability in any organi-zation. First, most companies have a very narrow idea of innovation, usually focusingjust on products and services. We need to enlarge our view of innovation. Second,most companies devote much more energy to optimizing what is there than to imag-ining what could be.We need to create constituencies for “What Could Be.”

Enlarging Our View of Innovation

People assume that innovation equals new products—not pricing, not merchandis-ing, not advertising, not distribution. Gillette presents the classic example of inno-

vation as product extension. Gillette used to make razors with one blade, then it madethem with two blades, and now it has razors with three blades. That is the all-too-typical view of innovation. And there is nothing wrong with it, except at some point

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Innovation as a Deep

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adding another blade is not going to make a substantialdifference to how customers perceive the product. Moreimportant, this narrow view of innovation is very un-likely to create new markets and new wealth. In today’seconomy, it is only radical innovation that will lead tosignificant growth. (See sidebar, Facing Reality.)

To create new markets and new wealth,managers need to begin thinking about in-novation at the level of entire business con-cepts. A business concept or model is aframework for identifying how your busi-ness creates, delivers, and extracts value. Pio-neers do not just make minor adjustmentsto established business concepts, they rethinkthem from the ground up in unconven-tional ways to create entirely new models.Dell, for example, launched a new businessmodel. Starbucks was based on a new busi-ness model. Wal-Mart created a very suc-cessful innovative business model.These andother examples show that the greatestrewards go to companies that create newbusiness models that create new sources ofrevenue based on changing technology, de-mographics, and consumer habits.

Unfortunately, few people think creativelyand holistically about an entire businessconcept. In fact, few managers can describein any detail the current business conceptof their companies. Can you? Try this ex-ercise to see how well you understand how all thepieces fit together for your organization: How do youdefine your served market? What is your basic valueproposition? How you go to market in terms of distri-bution? What are the core competencies you need tofocus on? What choices have you made regarding howintegrated (or not) you are as a company? Most man-agers will have difficulty answering these questions

clearly and in a holistic way. And rarely do they look atany of these different elements as something that rep-resents a designed choice that could have been done dif-ferently. After a while, it’s just “the way we do thingsaround here.” And too often,“the ways we do things”become rigid orthodoxies, never challenged, that stifleinnovation.

True innovation is based on the recognitionthat a business concept represents a dozenor so design variables, all of which need tobe constantly revisited and constantly chal-lenged. A company that is not experiment-ing with new business concepts is probablyliving on borrowed time. Executives whowant to bridge the gap between rhetoricand reality when it comes to innovationneed to define it as a capability-buildingproblem that is truly systemic and that willrequire the same kind of energy, commit-ment, persistence, and investment that theybrought to their other capability-buildingchallenges, such as quality, customer service,or supply chain management.They need torealize that in the long term the most im-portant question for a company is not whatyou are but what you are becoming. Thisbrings us to the second core challenge, cre-ating a constituency for the future, for WhatCould Be.

Creating a Constituency for the Future

In most organizations, when it comes to the funda-mental trade-off of optimizing what is there versus

innovating and creating something that’s new, there’s anenormously powerful constituency for What Is, but nota very powerful constituency for What Could Be. Overthe last several years, I have talked to many people whowere innovators and had helped to change the direc-

Gary Hamel is visit-ing professor of strate-gic and internationalmanagement at theLondon Business

School and chairmanof Strategos, an inter-national consultingcompany. He has

published articles inHarvard Business

Review and Fortune,and is author of

“Competing for theFuture” and “Leading

the Revolution.”■

Winter 2003 21

tion of their company—people like John Patrick atIBM or Ken Kutaragi at Sony, whom I talk about inLeading the Revolution. Again and again these peopletold me that they had succeeded despite the system.Even more troubling is that most people accept that asa normal part of organizational life: of course major in-novation requires bending—or breaking—rules, goingaround people, hiding expenses, and so on.

Why “of course?” If somebody said,“We ship our prod-ucts out every day despite the system,” or “We mail ourpaychecks every month despite the system,” we’d thinktheir organizations were in direstraits. Of course, innovations areexceptions because the system isbuilt for something else; the sys-tem is built for perpetuation,control, and efficiency.

Most companies understandproduct development, certainly,and they have created roles orstructures for product innova-tion. R&D is supposed to workwith Marketing, and they’re sup-posed innovate: invent the nextdetergent at Procter & Gamble,add another blade at Gillette, andso on. But although there is nothing wrong with a spe-cific innovation role or particular units that are focusedon innovation, the danger is that you end up with inno-vation ghettos.When innovation is compartmentalized,everyone else in the organization assumes,“I don’t haveto think deeply, profoundly, and creatively about alter-natives. I just do what I do every day because there’ssomebody else who is worrying about where we gonext or what we can do next.” And if someone outsidethe innovation ghetto doesn’t subscribe to that and pro-duces an original idea, the fact that it doesn’t come fromthe proper place means it’s likely to be shot down.

In the last few years, a lot of companies have gone be-yond R&D to set up dedicated structures for innovation,whether it’s an incubator or a new venture division, orsomething else. Unfortunately, these structures are usu-ally kept separate from innovation in the core business—as if it’s impossible or dangerous to innovate in the corebusiness. In other organizations, real business innovationis kind of a once-every-five-years special project.Youtake a team away, do some brainstorming, hire someconsultants, and generate some new product alternatives.But these approaches too suffer from the danger of put-ting innovation into ghettos.

Radical innovation comes fromgenerating a collective sense ofdestiny, from unleashing theimagination of people acrossthe organization and teachingpeople how to see unconven-tional opportunities. A newsense of direction doesn’t comefrom a few smart people, whohave all been in the companyfor 20 years, getting togetherand thinking about it.You haveto dramatically increase the stra-tegic variety that’s there, createthousands of new ideas out of

which you can look for new themes and directions.And then the role of top management is to be the ed-itor. That is, top managers move from being the cre-ators of strategy to searching for the patterns in thestreams of ideas that—in the most innovative compa-nies—constantly emerge in the organization.

The work we did with Nokia, five or six years ago,provides a good example. At Nokia we got literallyhundreds of people involved in imagining What CouldBe: What new needs can we serve? How can we useour competencies in different ways? How can we

■

If you’re not experimenting

with new business concepts,

you’re probably living

on borrowed time.■

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change the economics of this industry? Out of thatcame hundreds of ideas, and the real work of top man-agement was not to generate the new thinking but tolook at all these ideas and try to find the fundamentalthemes that would give overall direction to the com-pany. As they sifted through all these ideas, they coa-lesced around three themes. There were a lot of ideasthat were focused around the general problem of howto make a mobile phone easier to use, more fun, witha better interface, more colorful—basically focusing onhow to humanize technology.

A completely different set of ideas looked at the productas more than a phone, as something that’s an extension of

you—a virtual presence that could serve all kinds of pur-poses. It could serve, for example, as a credit card, sosomeone could walk up to a vending machine and punchin a code on the phone and get a soda, or it could serveas a security device or a communication device withSMS, or short messaging service.The third set of ideaslargely explored the integration of the phone with thesoftware that sits on the network with the networkequipment, and the idea that the company could go tonetwork operators like AT&T or Vodaphone and sellthem a completely integrated package of mobile phones,the software that determines the services you can offeron those phones, the network hardware behind that, andthey came to call that “seamless solutions.”

FacingReality

Companies are now coming togrips with the fact that the strategiesand the tactics that they used duringthe ’90s to drive share prices andearnings up have largely run out ofsteam or been discredited.The con-fluence of forces that buoyed thestock market higher in the last fiveyears of the decade was both un-precedented and unrepeatable.

1. The tech boom is now just amemory that will not be repeated.In 1990, U.S. companies werespending 19 percent of their capi-tal budgets on information tech-nology (IT), and in the year 2000,they were spending 59 percent of

capital budgets on IT. In otherwords, IT tripled its share of capi-tal spending during the longestcapital-spending boom in history.It’s not going to triple its shareagain and consume more than 100percent of capital budgets. Thehigh-tech boom is finished.

2. Cost-cutting has reached thepoint of diminishing returns. Thisis true for virtually every companyI know—and we have the statisti-cal evidence to back this up. Itdoesn’t mean companies can relax,that cost cutting isn’t still impor-tant; but it does mean that it willbe very difficult to get the same

large increments of cost reductionthey’ve achieved over the last 10years without substantially moreeffort.

3. The ’90s saw a completely un-precedented and unsustainable waveof mergers and acquisitions. In thebeginning of the decade, there wasabout a $.5 billion of M&A annu-ally. In 1999 there was about $3 tril-lion of M&A globally; in 2000,there was $3.5 trillion.The CEOswe celebrated during the late ’90s,people like Bernie Ebbers at World-Com, Dennis Kozlowski at Tyco,Jean-Marie Messier at Vivendi, JackWelch at GE; all of these executives

Winter 2003 23

Out of all this thinking came, in the end, a very simplestrategic architecture that had three dimensions to it:humanize technology, create seamless solutions, andthink about the phone as virtual presence. And over thelast six years, Nokia has innovated along each of thosetrajectories. Its people have used the phone in the mostimaginative ways by far.They have expanded its capa-bilities and its virtual presence much faster than any-body else.They’ve certainly done more to humanize it.

Unleashing the Passion for Innovation

To encourage innovation, to create a real constitu-ency for What Could Be, companies need to un-

leash ideas, passion, and commitment across the com-pany.We have to move from innovations as exceptions;move beyond innovation as a specific role or structure,beyond innovation as a once-in-a-while project, tothinking about innovation as a deep capability.

One of the things that we are now suggesting to ourclients is that they say to divisional executives to look atall the labor hours of the people who work for them andset up ways to ensure that 2 percent to 5 percent of allthose labor hours get devoted to projects that are con-sidered radical.The fundamental idea that every singleemployee,within some risk parameters, should be able todevote some portion of their time to something other

built their success on binge buying.Acquire—in the case of GE, hun-dreds of companies—and then cutcosts.Had the rate of M&A here inthe United States in the year 2000continued, we would have had onecompany left in 2007. So M&A ac-tivity has largely run its course, andindeed it’s now coming down theother side.There are 40,000 invest-ment bankers out of work in theUnited States, and 25,000 out ofwork in Europe.

4. The price/earnings ratio is stillat very high levels. We tend tooverlook the fact that the averageprice/earnings ratio for New YorkStock Exchange companies dou-bled from the historical average ofabout 15 to more than 30 over thelast decade. Average P/E is cer-

tainly not going to double again,and it’s much more likely to returnto the historical average. Over 65years, except for very brief inter-vals, it’s hovered around 15 or16:1. It is hard to escape the con-clusion that we are in for a veryrocky ride for the next many yearsin the stock market.

5. All the fun and games playedthroughout the ’90s are gone.Many companies used share buy-backs to prop up their stock, andsooner or later a company reachesthe limit of how many of its ownshares it can buy back.And as we’veseen, all the creative accounting isnow coming home to roost.Thereis a lot more scrutiny there, andthere’s going to be less and lessspace to play with the numbers.

In sum, almost everything thatmany companies used during the’90s has just reached its natural lim-its. Suddenly every company is leftalone with its own bootstraps.Thefree ride provided by the stockmarket boom is gone: you can’tcount on the P/E ratios going upagain. Cost cutting has reached di-minishing returns. The legitimateand the unseemly shortcuts for cre-ating the illusion of real growth arebecoming unavailable: creative ac-counting, M&A deals, share buy-backs, and so on.

What’s left in our toolbag to sus-tain growth? Real innovation.

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than doing their job 3 percent better.That’s a pretty rad-ical idea in most organizations.

Another idea that we are now working to instantiate isto create a marketplace for ideas. An entrepreneur withan idea in Silicon Valley has many, many different ven-ture capitalists to go to in search of funding. And in to-day’s climate, you have to go to a couple dozen beforeyou get somebody to fund you.

Inside most companies, if I havean idea, there is only one personI can go to pitch that idea, andthat’s up my chain of command.Or maybe there’s some incuba-tor, and I could go off and talkto them. And yet, in the largerworld, there is a marketplace:people with ideas can go todozens and dozens of places to pitch ideas. One way to create a marketplace for ideasinside a company is to say to anyone who has a discre-tionary budget of more than $100,000 (and many, manypeople in big companies are managing budgets of$100,000),“you can take half a percent, 1 percent, 3 per-cent of your budget, and every year you can play therole of angel investor for any project anywhere in thiscompany that interests you.” One of the things thatstrangles innovation is simply the enormous time and

energy it takes for people to get relatively small incre-ments of investment; to even build a prototype, or takea month off to go talk to five smart people and developtheir idea. Creating a marketplace for ideas doesn’t re-move that burden entirely, but it certainly lessens itgreatly.

One of the companies we work with has begun tochange its capital budgeting process to make this mar-

ketplace for ideas a reality inthe organization.The companyhas a capital budget of about abillion dollars a year—and topmanagement has told all the di-visional executives that eachyear for the next five years, wewill take an additional 10 per-cent of our capital budget anddevote it to projects that meetthe test of being radical. Radi-

cal does not mean risky, it means something thatbreaks conventions and has some chance of dramati-cally changing customer expectations and industryeconomics. They’ve essentially said to their divisionalexecutives,“If you don’t bring in such projects, we aregoing to slowly starve you of capital, because WallStreet knows that it’s new ideas that create newwealth.” They realize that the ’90s are gone for good,and innovation is now the only option. ■

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Create a marketplace

for ideas.■