Wharton on Innovation

8/8/2019 Wharton on Innovation

1/19http://executiveeducation.wharton.upenn.edu http://knowledge.wharton.upenn.ed

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WHARTON on...

Innovation
http://executiveeducation.wharton.upenn.edu/http://knowledge.wharton.upenn.edu/http://knowledge.wharton.upenn.edu/http://executiveeducation.wharton.upenn.edu/


2/19Wharton on Innovation I 2009 University of Pennsylva

Innovation

3Sustaining Corporate Growth

Requires Big I and small iInnovation

All companies face a common challenge: how togrow their businesses so they can boost earnings

and enhance the value of their shares. Far toooften firms find it difficult to sustain growth

because they become risk averse and opt forincremental product and service improvements

instead of major initiatives, according to a studyby George S. Day, co-director of WhartonsMack Center for Technological Innovation.

7Philips Lighting CEO Rudy

Provoost: Innovation MeansPutting Consumers Needs First

Philips, the world's largest producer of industrialand consumer lighting products, has a big role

to play in the ongoing transformation fromincandescent to solid-state lighting using LED

technology. Figuring out needs, weeding outneedless complexity and innovating with an

eye on the bottom line are the keys to growth.

12Innovation Out of Necessity:

Entrepreneurship during aDownturn

Looking for ways to incentivize entrepreneurialactivity and enhance corporate liquidity duringa recession has become a strategic focal point

for Spanish companies. Ignacio de la Vega,director of the IE Business School's Center forEntrepreneurial Management and president of

the Global Entrepreneurship Monitor (GEM),discusses the impact of economic crisis on

innovation and entrepreneurship in Spain.

15Finding Money for Innovation:Develop Those People SkillsInnovations typically involve trial, error andoutright failure before turning into successfuproducts or services. For decades, leading

businesses have willingly shouldered theexpense and the risk of innovating as theprice of staying ahead of competitors. Butinnovating has become a lot tougher lately,according to a panel who recently spoke atthe University of Pennsylvanias EMTM progra

17Why an Economic CrisisCould Be the Right Time forCompanies to Engage inDisruptive InnovationWhile globalization has witnessed the declinof U.S. dominance in manufacturing, energyand even finance, one thing had long beenpresumed unassailable: good old Americaningenuity. Now it appears thats not safe, eith

EVERYONE TALKS ABOUT THE IMPORTANCE OF INNOVATION, but

talking is not walking the walk. For instance, by the time of its initial public

offering in 2004, Google was already a formidable rival of Microsoft, Amazonand Yahoo. Why didnt they see the same opportunities? One crucial reason

appears to be that industry giantsand large companies generallyconcentrate

too much on relatively safe, incremental product improvements instead of

focusing on potentially more profitablebut riskierbreakthrough innovations.

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Contents


3/19Wharton Executive Education I Knowledge@Wharton

George S. Day, who also serves asco-director of Whartons Mack Centerfor Technological Innovation, sayscompanies can avoid lackluster growthby better understanding the risks inherentin different levels of innovation andachieving a balance betweenusing twoterms he has coinedBIG I innovationand small i innovation. In his study, Daydiscusses how executives can properlyassess risks and then seek creative waysto reduce risk exposure.

Day, a consultant to many Fortune 500companies, says his research is theoutgrowth of years of thinking about theproblems that companies face in trying toset and achieve growth targets. Growthparticularly organic growth that comesfrom improving a companys performancefrom within rather than relying onacquisitionsis so important that it is at thetop of the agendas of some 80% of U.S.chief executive officers, according to Day.

These executives know that theexpectation of superior organic growth the most important driver of enterprisevalue in capital markets, Day writes inthe paper, titled Closing the Growth GaBalancing BIG I and small i Innovation.It is also a less expensive way to growbecause a firm typically pays a premiumto acquire another business. Yet studieshave shown that only 29% of managersof major corporations are highly confidethey can reach their organic growth targe

A combination of factors can makeorganic growth hard to sustain. For onething, firms often find themselves insaturated, price competitive marketspressured by customers who themselveare squeezedand are forced tocompete for incremental share gains wirivals who follow similar strategies. Oneanswer to this challenge is to explore neblue ocean markets with new businesmodels and offer a better customerexperience. While this is an appealing

All companies, from major multinationals to start-ups,face a common challenge: how to grow their businessesso they can boost earnings and enhance the value of theirshares. Far too often, however, firms find it difficult tosustain growth because they become risk averse and, as aresult, opt for incremental product and service improvementsinstead of major initiatives, according to a study by aWharton marketing professor.

Sustaining Corporate

Growth Requires Big

I and small i

Innovation


4/19Wharton on Innovation I 2009 University of Pennsylva4

growth path, the returns may notcompensate for the higher risk andlong delay before any returns are realized.This approach also does not account forthe consistent growth records of Wal-Mart,Dell and IKEA, which have been methodicallyleveraging their low-cost businessmodels in closely adjacent markets.

In other cases, disappointing growth can

stem from organizational impediments(such as short-term incentives thatsubvert long-term objectives), risk-aversecultures and inferior innovationcapabilities. Day says 80% of CFOs ofmajor corporations would reportedly hold

back on discretionary spending designedto fuel growth if they were likely to misstheir quarterly earnings target.

The combined effect of these external

and internal impediments to growth isthat incremental small i innovationdisplaces BIG I innovation growthinitiatives. Small iprojects make up 85%to 90% of the average corporatedevelopment portfolio. These projects arenecessary for continuous improvementbut do not change the competitivebalance or contribute much toprofitability. By contrast, 14% of a sampleof business launches that weresubstantial innovations accounted for

61% of profits, according to a study citedin Days paper.

This bias toward safer, incremental lineextensions and product improvementsseems to be intensifying. Between 1990and 2004, the proportion of new-to-the-world, true innovations in developmentportfolios dropped from 20% to 11.5%,Day writes. Even the less ambitious

development of products new to thecompany dropped by a third.

Crippling Consequences

There are any number of reasons whycompanies are placing a growing

emphasis on small i innovations. Longestablished, incumbent firms may sufferfrom tunnel vision, that is, they miss earlysignals of market opportunities that offeropenings for rivals. For instance, by the

time of its initial public offering in 2004,Google was already a formidable rival ofMicrosoft, Amazon and Yahoo. Whydidnt they see the same opportunitysooner?

In other cases, firms may opt forexploitation activities over explorationactivities. There is a well-knownorganizational trade-off between activitiesthat exploit existing capabilities and thosethat explore new market spaces and

create breakthrough innovations thatstretch capabilities, Day writes. Thisuneasy trade-off is tilted towardexploitation by process managementmethods that emphasize the reduction variance in organization processes. Whthe mindset and methods of businessprocess re-engineering, Six Sigma andISO 9000, are applied to innovationprocesses, they tend to displace the

inherently divergent and varianceincreasing activities needed for creativeexploration. Slowlyand perhapsimperceptiblythe choices of researchprojects to select and products todevelop are steered toward the

incremental and more certainopportunities.

At other times, companies may succumto short-term thinking. Most financial

yardsticks used to choose whichdevelopment projects to fund are biaseagainst the lengthy pay-offs anduncertainty of BIG I innovations.

Finally, longer-term investments ininnovation may decrease whencompanies use up scarce developmenttime and resources to react to urgent,short-term requests from customers ansalespeople. These requests stem fromfragmenting markets, demanding chann

14% of a sample

of business

launches that

were substantial

innovations

accounted for61% of profits.



partners and new forms of competitionthat require a proliferation of productofferings and accelerated developmentcycles, Day writes. Meanwhile, R&Dbudgets are being held constant ortightened to meet short-term earningstargets. This leaves firms with moreprojects than they can handle, andpressing small iprojects get priority.

Companies that avoid BIG I initiativesalso believe that the potential rewards willbe received too far in the future at toohigh a risk. But this risk aversion imposescosts that need to be understood andcontained. For example, while the actualrewards may be realized far in the future,the equity markets account for them intheir expectations of earnings. If the firmis viewed as mired in slow-growthmarkets, vulnerable to emergingtechnologies and lacking a compellingstory about its future growth thrust, its

stock price will suffer.Indeed, risk aversion may have evenmore crippling consequences. Certainlythe probability of failure goes up sharplywhen the business ventures beyondincremental initiatives in familiarmarkets, according to Day. But thisshould not be an excuse for passivity. Itshealthier to properly assess the risks andthen seek creative ways to reduce therisk exposure.

McDonalds vs. GE

In his paper, Day includes a risk matrixdiagram that can help firms assess theprobability of failure of different growthpaths and calibrate the risks of unfamiliarmarkets and technologies. In essence,the matrix shows that it is far less riskyfor a business to launch a new product ortechnology into a familiar served marketthan to adapt the current product to anew end-use market.

Market risks are much greater thanproduct risks because there are more

dimensions of uncertainty, includingcompetitors, channels and consumers,writes Day. If the market is entirelyunfamiliar, the firm doesnt even knowwhat it doesnt knowand theknowledge is hard to acquire. Marketrisks are not only less controllable thantechnology risks, they tend to beconfronted much later in the productdevelopment process, and are harder toresolve. A further complication is that an

existing brand name has no meaning in anew-to-the-company market. It is notsimply a lack of awareness. Because theprospective buyers lack any experience,they view the new entrant as risky andhave to be given special inducements totry the new product.

For example, McDonalds abortive effortto offer pizza in its restaurants was

initially viewed as a related product forthe current market. But pizza was actuallya new-to-the-company productbecause it didnt fit the basic servicedelivery model. No one could figure outhow to serve a pizza in 30 seconds orless, according to Day. This meant thatservice flow rates were disrupted, andpizzas couldnt be served through thedrive-in window. The post-mortem of thefailure revealed that the brand namedidnt give them permission to offer pizza.They lacked credibility.

Day says GE is an example of a firm thathas struck the right balance in working toachieve organic growth by growing on anumber of fronts. After he replaced JackWelch, CEO Jeff Immelt boosted theorganic growth goal from 5% to 8% peryear, which translates into finding anadditional $3.4 billion in organic growthannually. Many moves were made withinGE to encourage fresh thinking. Theseranged from diversifying the top rankswith outsiders, in a break from thecompanys promote-from-within history,

to keeping executives in their positionslonger so they become immersed in theirindustries, and then tying more of theircompensation to new ideas, improvedcustomer satisfaction and top-linegrowth.

The leaders of each GE business wererequired to submit at least threeImagination Breakthrough proposalsper year promising at least $100 million inadditional growth. Day notes that suchgrowth initiatives, which offer truebreakthrough potential, are awkward tomanage within the constraints of theexisting organization. There will inevitablybe conflicts over resource allocation, withsmall i initiatives gaining the upper hand.Yet the fledgling Big I initiatives may needto share resources, such as brandpresence, manufacturing expertise ormarket access, with the established units.

An ambidextrous solution to the tensionbetween small iand BIG I initiatives is to

house the initiative in a structurallyindependent unit with its own processestructures and culture, but still integratewithin the existing senior managementhierarchy, according to Days paper.The lead role for the ImaginationBreakthrough growth initiative within Gwas given to the marketing team withineach of the 11 business units, whileholding the business leaders accountab

for results. This is a startling departure fa company with a belief that superiorproducts and technology are what reallycount. Until recently, there were nomarketers among the senior ranks and coherent approach to marketing beyondbuilding communication programs anddesigning product launches.

The Imagination Breakthrough effortaims to shift the balance toward BIG Igrowth initiatives by giving theorganization permission to break away

from the tyranny of past success andtake calculated risks with departures frothe way the business has been run. Byearly 2006, there were about 100 growtinitiatives underway within GE, rangingfrom business-model innovations andnew ways to segment and serve theglobal energy market, to products for nemarket spaces, such as bio-detection osecurity threats and small super-efficienjet engines for the next generation of aitaxis, according to Day.

Preliminary projections were for an extra

$33 billion to $35 billion of top-linegrowth from three to five years in thefuture. GEs 35 best projects are subjecto monthly CEO reviews, a strong signaof commitment. This procedure alsoencourages the sharing of best practiceand the further search for cross-divisionbusiness opportunities.

The Praxair Case

Another company with a noteworthyapproach to organic growth is Praxair, aFortune 300 global producer of industria

gases based in Danbury, Conn.

In 2003, Praxair set out to find $2 billionin revenue growth by 2008, Day says.One half was to come from acquisitionsthe other half required double-digitorganic growth of $200 million per year.This was far beyond the annual growththat could be realized from repackaginghelium, hydrogen, oxygen and othergases. So the company broke down its



organic growth into actionablecategories: The first 15% would comefrom incremental growth in the basebusiness and new channels for servingcurrent markets; the rest would comefrom new services, such as nitrogeninjection of oil and gas wells, servicingthe helium coolant used in magnets inmagnetic resonance imaging machinesand developing new reactor cooling and

nitrogen injection cooling methods for thebioscience industry.

These initiatives grew out of intimateknowledge of changing customer needsthat could be met with Praxairs existingcapabilities, writes Day. The lead role inexploring the market, articulating andscreening the opportunities, andorchestrating the specific projects wasassigned to marketing, with sustained topmanagement support and oversight. As aclear signal of commitment, the CEO of

Praxair spent one day per quarterreviewing the growth prospects for each

business. Day adds that the pay-off wasimmediate: The $200 million growthtarget was exceeded by $30 millionin 2004.

Day says that the ideas presented in hispaper began to come together severalyears ago when he attended a CMOsummit conference on innovationsponsored by Wharton, McKinsey and

the Marketing Science Institute. Therewas a persistent theme to theconversation: Our companies havescarce resources and were alwayspressured to think about the short term,Day notes. At the same time, I had beenreading about how process managementmethods, such as Six Sigma, tend to cutdown on a companys willingness to takerisks. It then occurred to me that maybethere was an increase in the tendency forcompanies to rely too heavily on what Icall small i incremental innovations like

product-line extensions, productupgrades and feature improvements.

If you have constrained budgets, theseincremental efforts tend to soak up a lotof that budget at the expense of BIG Iprojects, which are risky and long termso long term, in fact, that seniormanagers may no longer be with thecompany once the project finally iscompleted. Then I read a great study byanother researcher, who demonstratedpersuasively that there was a relative

shrinking of innovations in corporatedevelopment portfolios. So the evidencwas mounting that there was a trendworking against Big I innovation. Thatswhen I asked, How can companies fighthat tendency?

The antidote described in the paper, Dasays, is a disciplined process forrealistically assessing the growth gap tobe filled, expanding the search foropportunities, calibrating the risks andusing the latest thinking on screening,

real option analysis and partnering tocontain but not avoid these risks.



An edited transcript of the conversation

follows.

Day: Tell us a little bit about why you arehere at Wharton, and about thetransformation that you are undergoing,both in a new job and in an industry thatis undergoing a transformation.

Provoost: I recently became the CEOof Philips Lighting, after having been, for

three years, the CEO of [Philips]Consumer Electronics, which I call theUniversity of Life. So, I thought that itwas the right way to start a new life bygoing through a full immersion to refresheverything that Ive ever been exposed towhen it comes to strategies and how tomake growth happen and driveinnovation. Its Ful-Spectrum Innovationweek [at Wharton], and that fits into myfull immersion program.

Day: Philips is the worldwide leader inlighting and has been for many, manyyears. Youre coming into this business a pivotal time, with a very interestingbackground. The pivotal time, of courseis the steady and perhaps acceleratingtransition into solid-state lighting. Couldyou tell us what the consequences of thbig transformation are for PhilipsLighting? And, at the same time, maybetalk a little bit about how youre going to

Approximately 19% of the worlds electricity bill comes from

lighting, according to Rudy Provoost, CEO of Philips Lighting. As

such, Philips, the worlds largest producer of industrial and consumer

lighting products, has a big role to play in the ongoing transformation from incandescent to

solid-state lighting using LED [light-emitting diode] technology. Provoost, who until 2007was CEO of Philips Consumer Electronics, is no stranger to new technologies, which he

says are just a vehicle to respond to needs. Figuring out what those needs are, weeding

out needless complexity and innovating with an eye on the bottom line are the keys to

growth, Provoost says. He recently spoke with Wharton marketing professor George Day,

academic director of Wharton Executive Educations program Full-Spectrum Innovation:

Driving Organic Growth, and with Knowledge@Wharton, about the challenges of staying

ahead in a rapidly changing industry.

Philips Lighting CEO Rudy Provoost:Innovation Means Putting Consumers Needs First


8/19

manage the decline of the traditionalbusiness while this is going on?

Provoost: [Those are] many questionsat the same time, but indeed lighting is atthe crossroadsand I say that both froma marketing perspective and from acompany perspective. There are somevery important real trends that change thedynamics of the business and even the

business models that go with it. Theresthe whole shift from incandescent lightingto new forms of lighting, solid-statelighting in particular.

There is the whole energy efficiencygreen wave that really forces societyto change, and lighting can contributesignificantly. I mean, 19% of theelectricity bill in the world is lighting,and so we have a contribution to make.Obviously, there are many, manycompanies with new disruptivetechnologies that are coming in, who

maybe will become part of the lightinggamewhich until now was very muchan oligopolistic game, where the giantslike Matsushita, GE, OSRAM and Philipswere fighting the war.

The whole landscape is changing. Now,change means opportunity, and in thatsense we have actually been anticipatingwhat is happening. In the past two years,we did a $4 billion acquisition program.We acquired five companies: ColorKinetics, Genlyte, many of them are U.S.-

based. That allows us to step upsignificantly. I think that we have all of theingredients and we have the buildingblocks. And now the fact of the matter isthat we need to put the pieces of thejigsaw puzzle together, take all of thoseingredients and bring them together intoa winning formula. That is what Imsupposed to do. Its a very excitingmoment and I look forward to it. This islike writing history.

Day: Yes, its a daunting prospect. But,youve had some really exceptional

experience that I think equips you for thisparticularly, and maybe you can reflect onyour experience in consumer electronicsand how that might help guide youthrough this transformation.

Provoost: There must be a reason whythey have asked me to do this job.[Laughs] And so, yes, Ive been workingin different businesses: Procter &Gamble, Canon, Whirlpool, and PhilipsLightingthe last seven years in Philips

Consumer Electronics, which I always calla life-altering experience. Thats a placewhere all forces come together. Youknow, consumer electronics, the wholeICT sector has gone through a dramatictransformation.

Also, there are the shifts from analog todigital; in the TV business, there are theshifts from CRT to LCD and plasma.There was a notion before that when we

talked about consumer electronics, theemphasis was on the electronics, on thehardware. And now its about a uniquecombination of hardware, softwareservices and content.

So, if you think about paradigm shifts atransformational changethat is what Ihave been dealing with for the past sevyears. And theres no escape: I will have

to deal with it again in lighting. But,having gone through that University ofLife and having been exposed to it, Ithink that weve found a successfulformula to compete in a very global anddynamic market. It is hopefully going tohelp me to be successful going forwardSo, yes, I hope that I can use everythingthat I have learned in the past years andapply it again and add to the learning.

Day: I have this vision of a lighting planthat I was in one time which wasimmense and automated, and they cou

tell me the cost of everything down to atenth of a pfennig. They managed that afor efficiency. And Im sure that Philips ifabulous at that sort of thing. And so,youve got that kind of model, that cultuand that system. How are you going totransform and disrupt that? And, what athe assets that you bring from that intothe new game?

Provoost: I think the issue is not somuch how good we are in the processindustry, or whether we should

manufacture everything ourselves. Ireally believe that the issue is: Wheredo we have to be a vertically integratedbusiness? And/or, where should wedepend on others or partner with otherswhoever that might be?

In that sense, again, we will not be asuccessful lighting company byexcelling in manufacturing processes.Its really about [looking] outside andunderstanding what the market needsare, what the future applications are, whthe requirements are for lighting solution

and experiences in various places andspaces: What does it mean in the officeWhat does it mean in the shop? Whatdoes it mean in terms of citybeautification, street lighting?

On the technology side, we very muchknow what is possible. On the marketinside, we have to be more specific inanswering the question of what isrequiredand then bring the twotogether. Technologies are just a vehicle

Wharton on Innovation I 2009 University of Pennsylva8

The whole energy

efficiency green

wave really forces

society to change,

and lighting can

contribute

significantly.

Rudy Provoost,

CEO, Philips Lighting



to respond to needs and come up withabsolutely brilliant solutions andapplications. In that sense, my focus will[much more] be outside-in, understandingwhat needs to be done and how I canconnect the dots also between thecapabilities and competencies we havenow in the new lighting company, whichis a mix of existing Philips businessesand acquired companies, then make sure

that we are obsessed with end-user-driven innovation and just take that to itsfull consequence.

Again, if you want to be successful and interms of business model control points, insome aspects, if we need to be verticallyintegrated, we will be. Its really moreabout the business model than about bitsand pieces of processesyou cannotdisconnect the two.

Day: Its market-driven innovation at ascale beyond anything that youve ever

had to manageor at least PhilipsLighting has ever had to manage.What will be the biggest barriers thatyou think you will have to overcome,[especially] around maintaining yourleadership position?

Provoost: I guess its a bit of a paradox,but the success of the past could be thebiggest barrier for the future. This lightingcompany has been extremely powerful andhas invented the space and came up withparticularly winning technologies and there

were many control points. Right now, its allabout mindset. Its about, at the end of theday, we, me, the people are probably themost important limiting factors, and sothats where the challenge is.

What I learned here is that statement ofDarwinsthat its not about being thestrongest, but its about being the mostresponsive and agile [when it comes to]change. That is what its really all about.And so, making sure that we have theculture right and that we use the DNA ofsuccess in the past, but blend it with

new DNA.

As a matter of fact, in the world of solid-state lighting, LEDs, everybody hasaccess to LEDs; everybody has access tothe basic technologies. If you have IP,fine, but a lot of the IP can be bought. Itsreally about a more segmented end-userapplication solution approach to it, ratherthan a pure technology view of it. This willrequire people changing, it will requiredifferent prioritization, and it will require

different ways of spending our moneyand allocating resources.

Day: We did talk about one of yourcompetitors, GE, who has seen the needto bring in a lot of outsiders, a lot of freshfaces, different mental models. Do yousee a substantial number of newemployees, or will the acquisitions thatyou have already made bring in enough

fresh talent for you?

Provoost: We have got all of the freshtalent, of course, through theseacquisitions. There is a very intenseexchange of talent between the differentsectors, within Philips. And, it isremarkable how you can blend everythingtogether. We have a consumer lifestylebusiness, a lighting business, ahealthcare business. There is a lot ofinternal talent. But, absolutely, the teamof today is not the team of the future andso we will have to strengthen it.

But the answer is not only in our owntalent pool. Its also about connecting withthe world and working with the rightpartners. I mean, just here, during thisweek, we had the chance to listen to thelighting science group and CEOwell,hes actually a partner. And that istypically the case, where you work withcompanies who, for example, can act as,to put it in IT terminology, value-addedresellers or system integrators. So, its notonly about your own talent pool; its about

an extended pool of resources. To win, inthe future, we need to add brain powerand horsepower; and then, make sure thatwe have the willpower to stay the course.

Day: So, youve got a number of partnersout there. One of the big challengesalways in managing open innovation, withlots and lots of partners, both providingideas and helping you to commercializethem, is who gets to keep the intellectualproperty and monetize that?

Provoost: Well you know, through the

acquisitions that we made, we made surethat we have a very good intellectualproperty platform [laughs].

Day: Thats definitely one way to do that.[Laughs]

Provoost: We have quite a lot ofintellectual property there, but if you reallywant to and have to partner, then youhave to make sure its a win/win. So, Iguess in the way we structure

partnerships, in whatever shapes orformsfrom joint ventures to alliancesyou need to make sure that its a mutuarewarding partnership. Its not only abouthe IP, but the IP of course is an elemenIt can be an enabler, or it can simply be control point; or it can be a sharedinterest. And so, I would say that weshould be open to any business modeland just pick the one that creates the

most value.

Day: Weve talked about two of what Ithink are the four main levers that you aworking with. One is leadership and youare exercising that and you have a visioThe second of course would be thestructure that you put in place, includingall of the people. The third, which is theone that I want to turn to now, is themotivation part of it, the incentives andthe metrics. Do you see the need for nemetrics and new kinds of incentives?

Provoost: Yes, but you need all threeI call it the Triple As. One, the leaderhas to be an advocatehe has to be anactivist almost for innovation. The seconA is accountability. I dont like the wordstructure too much. For me its aboutaccountability, its not about org chartsand re-drawing the reporting lines. Itsreally about accountabilitymake sureyou have owners with a face and a namand then connect the right peopletogether. So, the informal network, so tospeakthat is very critical.

The third A for me is you need amplifierNow, one amplifier is the reward schemthat you use. And there, its always abothe trade-off between incentive schemethat stimulate the feeling of belongingand the joining forces behavior versus tincentives that reward individual or teamaccomplishments. Now, weve made avery deliberate choice to actually go forthe incentive scheme that stimulates thekind of one lighting, joined forces, all-hands approach.

This is because if you want to win in thefuture, particularly in the context ofPhilips Lighting today, you need to maksure that all of the business groups, all othe units, all of the acquired companiesas well as the existing teamsyou needto make sure that these teams areworking together. I mean, if you just letLamps do what they think is the best folamps, or Lighting Electronics do what ibest for lighting electronics or theLuminaires Group do just what is best



for luminaireswe will end up with asuboptimal situation.

For me, the innovation agenda is actuallypart of a larger growth agenda and I wantto make sure that everybody feels part ofthat same growth objective and signs upfor the same bottom line. This will makeresource allocation, reprioritization orsharing of competencies and capabilities

much easier. So, that is the way we aregoing to deal with it.

Day: This goes hand in hand with apartnering orientation, or a share-to-gainmindset.

Provoost:Absolutely.

Day: I have one final question, whichis really looking at innovation in largeorganizations, at a time of recession. Forthe last five years, we have had a robusteconomy, notably in North America,

Europe and in Asia. Innovation is at thetop of most CEOs agendas as it is inyours. Now, looking at your experienceand thinking about your competitors andcompanies that you know, what do youthink is going to happen in recession?What will happen to innovation, theenthusiasm for it, the willingness tosupport it and make the long-terminvestments that are necessary?

Provoost: Well, I cannot answer for theworld or for other companies. Butcertainly from a Philips Lighting

perspective, in times of recession, thelast thing you want to do is cut off theoxygen. In times of recession, you needto work harder, run faster and so youneed a lot of oxygen and for meinnovation is about oxygen. So, we arenot going to cut the oxygen and were notgoing to cut the lifelinebecause nolifeline means no survival.

Of course, recession will probably forceus to make choices. So, its not aboutdoing less, its about picking the right

battles. And I think that in times ofrecession, actually, its a bit of a paradox.Value becomes more valuable. At the endof the day, consumers have to makechoices too. And so, its about share ofwallet and the choices they are going tomake. Are they going to buy PhilipsLighting or something else?

Now, if the value proposition is attractiveenoughand it can only be attractive ifthere is a real innovative component to it.

And, that could be a real energy efficientlighting solution, which helps in time ofrecession to keep the costs down. Then,we should be the most attractive offer forthat consumer. I dont think the answershould be or could be to cut budgets.But, as consumers need to makechoices, we have to maybe makechoices. And that is, for me, the way thatwe will deal with it. So, in that sense, I am

very optimistic.

For me innovation is a little bit likeacupuncture: You need to put the needleswhere the energy points are. This is true

in general, but in times of recession,thats probably even truer. And so, I hopethat we can manage it in the proper waygoing forward. Again, I am optimistic,even in times of possible recession.

Day: Some years ago, there was a veryinteresting study which looked at acouple of recessions and looked at thechanges in industry structure, both beforeand after the recession. And it turned outthat was when market shares shiftedbecause there were some competitorswho were forced, or who chose to

maximize current earningscut back onmarketing, cut back on innovation, not tomention executive education and all ofthose other thingsand they invariablylost a lot of ground.... And that is whenyou can pile on and gain share.

Provoost: We referred to Darwinearlier and this is again Darwin at work; itis survival of the fittest. A recession canindeed trigger shake-outs and the onethat prevails is the one that was the most

flexible and responsive to changeandthe one that speaks to the hearts andminds of the consumer.

Knowledge@Wharton: I have acouple of questions. Whose job is it toinnovate in your company?

Provoost: There are probably twoanswers to that. One, it is everybodys j

because innovation is not only aboutproduct innovation or service innovatioIn essence, you can innovate everythinevery day, in every process. I think thenotion of innovation, in my opinion,

should be a very inclusive notion. This i

so everybody can ask themselves, evermorning: What can I do differently? Andthat goes from taking out unrewardedcomplexity in the spirit of Philips Sensand Simplicity to just challenging thestatus quoand I think that that iseverybodys job.

Now, at the end of the day, if you reallywant to push the envelope, and you donot want to limit yourself to the small i(incremental innovation) but you alsowant to hit the big Is (breakthroughinnovation), you will need to have the bboss to have skin in the game, too. Andso, I think that its very important that thleader is the chief activist, so to speak,and leads by example.

Knowledge@Wharton: You referreto the sort of disruption that innovationcauses. Innovation is inherently asomewhat messy process. How do youmanage the balance between creativityand organization in managing innovatio

Its not about being

the strongest, but

its about being the

most responsive

and agile when it

comes to change.

Rudy Provoost,

CEO, Philips Lighting



Provoost: I dont think that theprocess should be messy. I think that theprocess should be very structured anddisciplined. But what you put into theprocessand what comes out of itandthe cycles of, I would say, diverging andconverging solutions and elements ofinnovationthat could be a very creativeprocess. But, the best creative process isthe one that is well structured at the end.

You look to the benchmarks, from theideas of this world, to some companiesthat are very well known for their success.I mean, they all have a very structuredand disciplined way of dealing withinnovation, but within the boundaries,their bandwidths, they allow a lot ofcreativity. And, I guess that is the way tohandle it and to manage it.

Knowledge@Wharton: How do youmeasure the returns that you earn on yourinvestment in innovation?

Provoost: I think it is extremelyimportant that with whatever point ofmeasurement you take, whether its whatyou put into the innovation process, likeR&D resources, or the process itself, theeffectiveness of the innovation, or the

output of itthat there is always thenotion of profitability. So, in one way oranother, if you think about outcomes,things like R&D as a percentage of sales,I dont believe in. R&D in relation toEBITDA, I believe in.

Every innovation project should have areturn on investment, an internal rate ofreturn, a net present value. And, you need

to hardwire it and keep yourself honest,because at the end of the day, its abougenerating returns. The top line isinteresting, but the bottom line is whatmatters. You need that bottom line inorder to continue to generate resourcesand to continue to invest in innovation.And so, that for me is a very importantelementthe most important element.

And of course, there are many laggingindicators, like new products that werebrought to the market in the last twoyears or three years. That is for me alagging indicator. Id rather have leadingindicators like: What do we have in thepipeline? And, there again, that shouldstimulate that culture of innovation, ofnot just trying to be satisfied with simplemeasures that do not mean a lot.


12/19

During a recession with fast-growing unemployment, looking for ways to incentivize

entrepreneurial activity and enhance corporate liquidity has become a strategic focal point

for Spanish companies. Ignacio de la Vega, director of the IE Business Schools Center forEntrepreneurial Management and president of the Global Entrepreneurship Monitor

(GEM), which analyzes entrepreneurial conditions in 43 countries, spoke with Universia

Knowledge@Wharton about the current economic crisis and its impact on entrepreneurshi

The GEM 2008 Global Report is sponsored by the Ministry of Industrys small and midsiz

business division and the Banesto Foundation for Society and Technology.


Universia Knowledge@Wharton:

What has been the impact of the global

economic crisis on entrepreneurial activityin Spain? What differences are therecompared with previous crises? In whatways will entrepreneurial activity evolve?

Ignacio de la Vega: Starting from2000, we have measured the macro-climate and environment in Spain verycarefully at our organization. We beganwith an entrepreneurial activity rate of4.55% that year, and we see an extremelyimportant turning point between 2000and 2001, when the rate climbed to

7.78%. If we think about what washappening at that time in the market, we

see that it was a period of boom, whenthe Internet bubble in Spain was at itsdecisive moment. There were lots ofopportunities to start companies and,unlike the current situation, whenentrepreneurial activity did not bear fruit itwas not because of a shortage of workopportunities but purely because of theparticular opportunity. In 2002, wepractically returned to the levels of 2000,with a 24% drop in the rate ofentrepreneurial activity, which is anaccurate reflection of the overall

economic climate. Then the Internetbubble burst, and there was a serious

crisis in the technology sectora sectorcrisis, not a systemic crisis like todayanthere were the attacks of September 11 and finally, optimism declined along witthe rate of entrepreneurial activity.

Ever since then, weve been experiencinrising economic activity, until this yearwith some isolated declines, but thatreflects the growth of our economy sinc2000. Analysts began to notice the crisiin July 2007, but at that time it was acrisis in financial markets that had yet to

Innovation Out of Necessity:Entrepreneurship during a Downturn



spread into the real economy. In July2008, at the time of our annual study, thefinancial crisis already had a veryimportant impact on the real economyand we were expecting successivedeclines in the rate of economic activity incoming years. Given todays challengingconditions, including the climate ofpessimism, scarcity of financing and soforth, the rate [of entrepreneurial activity]

will continue to drop. Nevertheless, wehave been living through a new era eversince 2000, and an amazing drop-off injob opportunitiesthe unemploymentrate is over 15%. Obviously,entrepreneurial projects are a veryimportant source of development thattakes place out of necessity. For thesame reason, the decline will not be assteep as in the 2000-2002 periodbecause, since there are fewer jobopportunities today, many unemployedpeople will have to look for refuge in self-

employment.

UK@W: What barriers are todaysentrepreneurs facing?

I.D.V.: There are three fundamentalbarriers at the moment. The first ispsychological. Given the problems in themarket, starting a business appears to bevery risky, especially in a country like ours,which has a culture where there is a clearfear of failure and risk. We find ourselves ina tense position, halfway between theneed to find means for income and

professional activity, and the psychologicalfear of failure and risk. In my view, theneed [for income] will win out.

Once that barrier has been overcome, thesecond big barrier is [a shortage of]financial resources. Fewer financialresources are coming from the twoprincipal sources for financingentrepreneurial activity: First, debt, whichyou get from financial institutions, andpublic support is not functioning at thistime. Second, its not coming frominformal investors, either; especially whenit comes to the smaller companies weretalking about, where [entrepreneurial]activity has fallen by 13%. The figure ofthe business angel was already weak inSpain [before the crisis], and in thecurrent situation, those people who areliquid expect to make money [on theirinvestments], and those who have alreadyinvested [their funds] dont have any morecash to invest. Our 2008 report alreadyreflects this situation; it shows there has

been a significant increase in the numberof entrepreneurs who develop a businessproject and contribute 100% of thefinancing. Nowadays, given the rate ofunemployment, a normative change isgoing to permit people to capitalize up to60% of their unemployment subsidiesand dedicate it to entrepreneurial activity.This will add some fuel to the system.

The third barrier is real demand. Demandhas shrunk a great deal, and it is veryhard to find [business] opportunities inmany sectors. Competition betweencompanies is already well establishedand, in an attempt to survive and grow,many companies are becoming moreaggressive. That occasionally meanslowering their prices, and takingcompetitive positions in the marketplacethat make it hard for someone who doesnot have these competitive advantages toenter the market.

UK@W: How are people dealing withthose obstacles? What concretemeasures are they implementing, andwhats your assessment of them?

I.D.V: The solutions involve laying outpublic policies that are more efficient thanthose we have today; that includesmaking it a clear responsibility of financialinstitutions to get more involved in thesystem, and really bring to the marketsome of the rescue measures for smallcompanies that have already begun as

commitments by the communicationsmedia to develop some optimism withinthe system. As long as we do not see thelight [at the end of the tunnel], we wontbe spending. When demand contracts inthe ugly way it is contracting today,entrepreneurial activity becomesparalyzed. Companies leave the market,and it is very hard for others to enter it.

The Spanish government has limitedresources. For example, its monetarypolicy is determined by the EU. However,there are some things it can do. It has

tried to inject confidence in the marketwith its bank rescue plan, but it has hadsome mediocre results because manybanks are not participating or are doingso only by dribs and drabs; that way,banks are not required to provide liquidityto the market. The problem is if the smallcompanies dont get any liquidity, andthey turn off the flow of credit, and theneven if they sell less and many of themdont get paid when they do sell, theywind up not being able to take care of

their [debt] obligationsnot makingnominal payments, payments tosuppliers, and so forth. The vicious circtightens, and it is very harmful. To remethis situation, you create a rescue plan fsmall companies that basically consistsof providing them with some 10 billioneuros, but there is the problem ofcommunication here. Financial aid isavailable through the ICO [the Ministry o

Economics Official Credit Institute], butthe catch is that this operates throughfinancial institutions that have a maximulevel of requirements when it comes to[providing] guarantees. As a result, smacompanies continue to lack access tothat financing.

There is a need for more aggressivesolutions such as if the government werto strongly guarantee help through theICO for small companies that have acertain degree of insolvency. There are

3.5 million small companies, of which80% have financing problems. On theother hand, you could jointly create apublic bank to develop projects aimed asmaller companies, although that is alsodifficult to communicate given todayscommunity norms. The solution definiteinvolves injecting liquidity and confidencinto the system. Some banks do that, bwith complex criteria and in sectors ofactivity that are not subject to so muchrisk. In addition, the criteria for solvencyare especially high, leaving out strongcompanies that could survive and that,

best, have a cash flow problem.

Starting from there, there are lots of othmeasures: A fiscal agreement for theserious reduction of taxes so that smallcompanies can delay some taxpaymentsso that they can spread outpayments of VAT [Value Added Taxes];and for social security liquidations,something that they can do now butwhich will have an extremely high costwhen there is a bank guarantee.

UK@W: Experts talk a lot aboutinnovation and exports as two good toofor getting around the crisis. Do youbelieve that the right policies foraddressing those subjects are getting othe ground today?

I.D.V: Innovation is not just aboutdeveloping innovative R&D in technologThat is just one sort of innovation that ispossible for a very specific sort ofcompany. Many small companies dontin that category. The sort of innovation



within reach of small companies ofteninvolves some technology but, especially,it involves an innovative business model.For example, a neighborhoodsupermarket faces a very trying situationsuch as declining revenues, higher costsfor all sorts of things including logistics,and so forth. For this sort of entrepreneur,innovation could mean trying to generateadditional value for customers with

classic solutions such as discounting, orit could mean looking for more innovativeproducts, since competing simply on thebasis of price has become so difficult.

You have to invest in R&D and have apublic policy [to support that], but peopleneed to know this is about long-terminvestment. It doesnt make sense to saythat [R&D] is a [short-term] solution to thecrisis. If we begin to invest seriously nowand, for example, create a Ministry ofInnovation, perhaps we can diversify thebusiness model of the country in ten

years. The reality is that the governmentsR&D funding has been squandered; onoccasion, it was used for buying newmachinery and other initiatives that arenot really R&D.

As for exports, diversified companies aremore sustainable, according to thetextbooks. But we are talking about smallcompanies exporting and, at times, thatis an oxymoron, a contradiction in terms.Ultimately, it is a problem ofcompetitiveness. In order to export, you

need to be competitive, and in thiscountry we have a very troubling situationin that regard. At times, the origins of thatproblem are in public policy; we havetrouble exporting because we haveexhausted our options for exporting inmany sectors. In addition, we start withan unfavorable scenario in many low-costmarkets in that salaries in those countriesare up to eight or 10 times lower than inSpain; absenteeism is practically zerothere; quality control requirements are

very lax, with no controls, etc. Things thatwe do not require of companies of [non-European] origin [such as China] arerequirements for our companies [in theEU], and this makes our competitivenessdeficit even a bit deeper. You have tostart from the root of the problem: Weneed to educate our companies, providethem with resources so that they can bemore competitive. And we all need to

play with the same rules.

UK@W: The database for your reportincludes 50 countries. What is the profile

of the typical Spanish entrepreneur? Hasit changed a great deal in recent times? Ifso, why? How does it differ from that ofneighboring countries?

I.D.V.: Our rate of entrepreneurial activityis a bit lower than in English-speakingcountries, but higher than in the countriessurrounding us. The profile of the

entrepreneur is becoming more uniform,but the interesting thing is the changethat has occurred in the last two or threeyears; the typical entrepreneur ismaturing and aging. The average age hasgone up by almost four years, and it isapproaching forty [years of age]. Thesedays, an entrepreneur coming into themarket needs more professionalbaggagemore knowledge of the sectorand so forth. This is very common amongentrepreneurs older than fifty. This isrelated to the concept of becoming an

entrepreneur out of necessitystartingat that age because your professionalcareer in Spain has come to an end eventhough that shouldnt be the case. Inaddition, todays entrepreneur has ahigher level of training, and educationnow provides an additional competitiveadvantage. Todays entrepreneur alsoinvests more [in his or her business], andthe average cost of an initial investmentin a project has gone up. Theentrepreneur contributes part of the

funding from his own pocket, whichmeans that there are fewer and fewer[external] sources of funding.

In times of crisis, the ratio between maleand female entrepreneurs evens out. Thisis something positive, and it obscures areality of our environment. In families whethere are not workers, the woman oftendevelops her entrepreneurial project on h

own. This can even happen, at times, intraditionally masculine business sectors.Declining activity in sectors such as realestate, construction and automobiles

means that male entrepreneurs aredisappearing and female entrepreneursare being created in the service sector.Traditionally, Spaniards invest in the servisector because it is more welcoming, andit has minimal risk. However, we alsoobserve that over the past twelve monthsthere has been a significant increase in thindustrial sector of renewable energy.

UK@W: Do you believe that the crisis wchange business habits in Spain?

I.D.V.: For some years, youve alreadybeen seeing a certain change, but this ia little like R&D in that it is a long-termprocess. Nowadays, few Spanish collegstudents want to become entrepreneursWe need a profound change that beginswith training, a change in values andsociety. So long as the communicationsmedia do not recognize the entrepreneurather than the speculator, as the persowho generates value, things will go poofor us. This change was beginning tooccur before the crisis, building on theboom. Now we are moving in the rightdirection. In addition, the government isvery interested because small andmidsize companies generate more than80% of all new jobs. The responsibilitybelongs to all of usthe people, thegovernment, the business schools, theuniversities and so forth. What kind ofcountry do we want to be in the future?

Small and midsize companiesgenerate more than 80% of allnew jobs.

Ignacio de la Vega, Director, Center forEntrepreneurial Management, IE Business School



But innovating has become a lot tougher

lately, according to a panel of technology

experts who recently spoke at the

University of Pennsylvanias Executive

Masters in Technology Management

program. With R&D budgets shrinking

and markets retrenching in a worldwide

economic crisis, the panelists noted,

technologists will need more than lab

expertise to convince their employers to

keep the research funding spigots open.

Indeed, the ability to communicate well

and other soft skills are just as

important as technological expertise when

it comes to selling new ideas to investors

or senior management, suggested several

members of the panel, which was titled

Street-Smart Innovation to Align

Emerging Technology and Business. In

addition, future scientists, researchers

and program managers should focus on

aligning innovative projects with compan

goals. As panelist Nicholas D. Evans, vic

president of the innovation division at

Unisys, pointed out, its much easier to

justify budgets for speculative projects

that show an obvious commercial benef

to the parent company.That lesson became painfully obvious th

past summer to employees of the storie

Bell Labs research group, based in

northern New Jersey. Alcatel-Lucent,

owner of Bell Labs, all but gutted much

the non-commercial basic research

performed by the lab. The product of a

rocky 2006 merger, struggling Alcatel-

Lucent sought to align Bell Labs

operations more closely with the parent

Innovations typically involve trial, error and outrightfailure before turning into successful products orservices. Thomas Edison, for example, conductedapproximately 10,000 failed experiments beforeperfecting the incandescent light bulb. For decades,leading businesses have willingly shouldered theexpense and the risk of innovating as the price of

staying ahead of competitors.

Finding Money for Innovation:Develop Those People Skills


16/19

commercial interests in wireless, optics,networking and computer science.

So, how do organizational entrepreneurskeep innovation alive in companieslooking to slash costs? And how do start-ups and growth companies attractinvestors when the rest of the economy ismelting? Thats another place wherethose soft skills come in handy. Several of

the panelists suggested that whiletechnical people are generally not knownfor soft skills, those individuals whodesire funding to continue their workwould do well to acquire them.

Anthony P. Green, a vice president withfirst-round funding group Ben FranklinTechnology Partners, said he frequentlysees entrepreneurs stumble because theylack such skills. All too often, entrepreneurscome across as rude, dismissive and dis-respectful to audiences of potentialinvestors, thereby infuriating the

investment community. Panelist Eric F.Bernstein, a laser surgeon, dermatologistand technology entrepreneur, echoed thatpoint. Business is all about relationships.They need to like your idea, but they alsoneed to like you.

Suzanne Taylor, portfolio director ofcorporate operations for Unisys, pointedout that budget handlers are also moreinclined to favor innovation if it can beshown to cut costs. Innovation departmentheads must become adept at making the

case for maximizing productivity andreducing waste, Taylor said. This requiresexcellent communication skills, she added,including the fine art of schmoozing. Andthe higher up the case is made, the betterfor the innovator, added Sanjoy Ray,director of global application engineeringfor pharmaceutical giant Merck. Executivesponsorship is very powerful. It providesair cover.

From Nanotech to Alternative Energy

The panelists agreed that amid the ruins

of the current economy lie vastopportunities. The question is: Where?

Bernstein, who is involved as an investorin four companies, said a hugeopportunity exists in digitizing andnetworking medical information. Medicineis a final frontier for informationtechnology as paper records contributeto the escalating costs and delays ofhealthcare. Green also sees possibilities

in nanotechnology, which involvesengineering at the atomic level. Someproducts have already come to market,but the technology has yet to reach itscommercial promise. Bioethicists havenoted that nanotech presents a host ofas-yet unanswered questions, includingthe issue of what it will mean to behuman if, as predicted, nanobots aredeveloped to attack disease and enhance

performance. If [nanotechnology] isreally as disruptive as biotech was, it willmake a big difference, said Green, a self-described veteran of the biotech wars.

Alternative energy, which had beengaining steam in 2008, has beenundermined as an investment becausethe global slowdown has resulted in lowerprices for traditional fossil fuels, thepanelists said. That makes alternativeenergy projects tougher to justify to jitterylenders, who bank on the projects being

cost competitive with fuels such as oiland natural gas. The ills of Westernbanks mean, inevitably, that the supply ofdebt finance for wind farms, solar parks,biofuel plants and the like will be lessplentiful, and more expensive, in themonths ahead than it has been in the lasttwo years, notes a recent report by NewEnergy Finance, a research firm thatcovers the deal-making environment forrenewable energy projects. On the otherhand, President Barack Obama haspledged to devote much of his economicstimulus plan to investments in green

technologies.

But in times like these, is there anymoney for enterprising business peoplewith superb ideas in these fields? Areangels and venture capitalists still in thegame? Green conceded that its brutalfor those seeking early-stage, non-seedfunding. No one is funding at the $1million level, he said. The problemsurfacing right now is that full-blownventure capital groups want to deal onlywith requests in the $6 million to $8

million range. Not everybody needs orwants that amount to get a business tothe next stage, he said.

Where the Toys Are

Jim Senior, a speechwriter for Unisys whowas the panel moderator, noted thatcost-conscious executives might want tocarefully consider any cuts they make toinnovation departments if they are

interested in retaining top talent. Manybrilliant and highly marketabletechnologists will remain in an otherwisunremarkable place if the company hasthe financial muscle to invest capital inlabs and equipment. Senior recountedthe story of one researcher who wasasked why he stayed at a largebureaucratic company. His response:Because you have all the toys.

According to Wharton marketingprofessor George S. Day, many well-known companies remain committed toinnovation in spite of downturns andearnings myopia. There are somecompanies that see beyond that andcontinuously invest in innovation andgrowth, said Day, co-director ofWhartons Mack Center for TechnologicInnovation. The best known ones areSamsung, American Express, Nokia.These companies are not cutting back o

innovation. Were not just talking aboutproducts and services, but aboutcustomer experience. For example,American Express last year invested $5million in its Chairmans InnovationFund, money that is reserved forfinancing employee ideas to improve thbusiness long-term.

Since true innovation entails uncertaintas opposed to quantifiable risk, there walways be an element of vision,entrepreneurship and faith involved,noted Mack Center research director Pa

J. H. Schoemaker. The C-suiterecognizes that business is about takingrisks and that not everything can beanalytically proved or supported whenventuring into the unknown. Too often,companies focus on incrementalinnovationsince it is more predictableand less disruptive.

Whats more, Schoemaker said, a difficueconomic climate is an ideal time todiagnose defects that may have goneunnoticed when the economy wasstronger. Tough times present anopportunity to assess systemic weaknein ones industry, company andleadership team, said Schoemaker, whis also an adjunct professor of marketinat Wharton. Just think of a sport like goor tennis. When conditions are tough, thweaknesses in your game will show moclearly. His advice: Use the bad timesconduct a deep self-audit.




While globalization haswitnessed the decline ofU.S. dominance inmanufacturing, energy andeven finance, one thing hadlong been presumedunassailable: good old

American ingenuity.Now it appears thats not safe, either.China, whose industries have been enviedin the West more for their tenacity than theiringenuity, has established a multi-yearframework to become more innovative and,therefore, competitive. So has Singapore.Finland is merging its top business school,design school and technology school tocreate a multi-disciplinary university ofinnovation.

Council members of the NationalAcademy of Sciences and the NationalAcademy of Engineering have expressedconcern that a weakening of science andtechnology in the United States wouldinevitably degrade its social andeconomic conditions and in particularerode the ability of its citizens to competefor high-quality jobs, according to a 600-page report from the National Academiespublished in 2007 and titled Rising

Above the Gathering Storm.

The wild card these days is what willhappen to innovationthe advance ofprogressive ideas in science, technologyand businessnow that the worldeconomy is in a tailspin. The conventionalwisdom might suggest that business,government and academia will be lesswilling to embrace the risk-taking andshort-term costs that come with theterritory of innovating.

Yet Paul J. H. Schoemaker, researchdirector for the Mack Center forTechnological Innovation, suggests thatfor some companies, the economic criscan actually provide an innovationplatform. The crisis has multipleimpacts, Schoemaker says. Loss ofrevenue and profit will at first instill acost-cutting mentality, which is not goofor innovation. But if the patient isbleeding you need to stop that first. The

however, a phase starts where leadersask which parts of their business modeare weak (and perhaps unsustainable)and that, in turn, can lead to restructurinand reinvention.

He also cautions against too muchcautionover-reliance on incrementalinnovation versus transformative, ordisruptive, innovation. In innovationcircles, the two have come to bedifferentiated as small i and Big I

Why an Economic Crisis Could Bethe Right Time for Companies toEngage in Disruptive Innovation


18/19

innovation. The largest gains in businesscome from more daring innovations thatchallenge the paradigm and theorganization, Schoemaker says.

The Business of Being Disruptive

While disruptive innovation has enjoyedoffice buzz-phrase status for only about adecade, the idea is quite old: Austrianeconomist Joseph Schumpeter had it in

mind when he borrowed the phrasecreative destruction to describe histheories of how entrepreneurs sustain thecapitalist system.

So just how does an entrepreneur orbusiness go about being disruptive?How does one convince investors or topbrass of a radical ideas worth?

One person who knows something aboutbringing disruptive innovations to marketis Jeong Kim, president of Bell Labs atAlcatel-Lucent and a successful techentrepreneur. He offered somesuggestions in a recent presentationtitled Paving the Way for DisruptiveInnovation that was part of the ExecutiveMasters in Technology Managementprograms ongoing lecture series: AligningEmerging Technology and Business.

Among the most critical assets one canpossess, he says, is company-widerecognition that disruptive innovation isactually important. In a company thatsalready successfulor one with layers of

bureaucracy that hinder new ideasthiscan prove difficult. The firm also mustcommit itself to research. Disruptiveresearch is absolutely critical, especiallyin the technology space.

Furthermore, it is not enough to simplyhave brilliant engineers. Without competentmanagement on the business side, themost elegant technology can wind up onthe scrap heap of business history, or evenworse, usurped by a competitor:Disruptive innovation is not sufficient,says Kim. You can [cite] numerous

examples of companies that came up with[new] technology but eventually weredisplaced by somebody else.

In the innovators lingo, these somebodyelses are known as fast followersthatis, companies with better funding orsharper management who were able toexploit a technology more quickly andeffectively in the marketplace than theoriginal creator. You like to be the first todevelop technologies, Kim says. But

the more flexible, the more innovativein terms of business model that thecompany is, the longer you can maintainadvantage.

That point gives rise to the question:What is the best business model forfostering innovation? As it turns out,numerous decision-making tools exist tohelp firms systematically manage an

innovation program, says Schoemaker,co-author of a book titled Wharton onManaging Emerging Technologies.

According to Schoemaker, when it comesto innovating, the analogy is to firing ashotgun, not a rifle. Given the high failurerate of innovative projects, companies aresmart to develop an array of possiblesituations and contingencies, rather thanpin all their hopes on one plan. Stickingto our knitting might appear to be asound business clichit worked for a lotof companies that survived the dot.com

era. But Schoemaker and otherinnovation gurus advocate looking atareas adjacent to ones main business asfertile soil for innovative breakthroughs.Old-fashioned, linear approaches that relyon standard measurement schemes areoften outdated if relied upon solely. Byexamining a companys growth gap,developing scenarios, exploringadjacencies and venturing more into blueoceans, companies can reap greaterbenefits, Schoemaker says. (Blueocean is innovator-speak for unrealized,

and therefore uncontested, markets.)The investment approach, however, hasto emphasize more of an options andportfolio strategy rather than static NPV[Net Present Value valuation method].

Wharton management professor MaryBenner sees the stick to our knittingsyndrome as impinging on largecompanies ability to react to competitivethreats. I find that firms innovation intoradically new technologies or new marketscan seem to shareholders and securitiesanalysts like too great a departure fromtheir expectations for these firms. Investorsand analysts often prefer that firmsmaximize shareholder value by sticking totheir knitting. The result is that large firms,particularly those expected to have stable,predictable earnings and dividendpaymentsi.e., income stocksare notlikely to be rewarded by the stock marketfor entering new technologies orundertaking radical innovation, and insteadmay be punished by reductions in stockprice and market value.

A prime example she has found inher own research, she noted, isVerizon Communications, the gianttelecommunications firm. Stock analystquestioned Verizons large capital outlayon FiOS, a high-volume fiber-opticnetwork intended to counter a triple-play threat to its business posed byComcasts cable television, high-speedInternet and voice-over-Internet phone

service.

Recent research suggests the stockmarket is not good at valuing intangibleuncertain innovation or technologicalchange, Benner says. What this meanfor large, publicly traded firms is that thmay face a disadvantage in engaging inradical innovation, and this innovationmay instead take place in venturecapitalfunded start-ups.

Indeed, outsourcing of innovation itselfcould turn out to be the wave of the not

so-distant future. Particularly in thepharmaceutical area, there has been afocus on how firms acquire innovationthat has been undertaken by small,privately funded firms such as biotechstart-ups, Benner says. It may be thatthe locus of much really radicalinnovation is shifting outside of the largorganizations to small start-ups.

That points to a big trend emerging inproduct development, so-called OpenInnovation, according to Wharton

marketing professor George S. Day, co-director of the Mack Center forTechnological Innovation and co-authorof Wharton on Managing EmergingTechnologies. Open Innovation, alsoknown as crowdsourcing, entailscollaborating with partners to solvebusiness problems.

The archetype of that model is WalthamMass.based InnoCentive. It matchescorporate seekers who have science,engineering and business problems witamateur solvers worldwide. The

solvers then competefor braggingrights and often token rewardstoprovide the best answers to the corporaproblems. Most companies are notlooking for a big innovation they canknock out of the ballpark, Day says.Rather, they want a relatively quick fix foa specific piece of a larger puzzle.

For firms that want the secret sauce toalways come from in-house, previoussuccess can present a huge roadblock t



19/19

innovation, according to Kim. Theproblem is that success creates a virtualconstruct, a paradigm of How to DoThings, inside of which new thinkingcannot flourish. Kim calls it The Curse ofKnowledge. Cross-discipline teaming isone way of breaking the Curse ofKnowledge, he says. Another isexperience pairing, or matching a senioremployee with an individual who has

considerably less experience, but a freshperspective on how to solve problems.

An incredible opportunity to innovatedisruptively lies in the problem ofinformation overload, says Kim.Knowledge is being created at a far fasterrate than any one human can ever hopeto assimilate. The flip side is that weconstantly filter out vast stores of databecause we are bombarded withinformation as never before in history.

To prove his point, Kim showed audience

members a movie clip that repeated anold psychology experiment. Two teams,one dressed in white, the other in black,dribbled basketballs and passed themback and forth. Audience members weretold to count the number of passes madeby the black-shirted players. A few of thestudents missed the person in the gorillasuit who nonchalantly walked through themiddle of the scene, because they werenot looking for it. I can assure you thatall of you saw the gorilla. But somepeople processed it, stored it, some

people missed it. You were looking for aparticular thing.

Seven Hours of Whitewater Rafting

The term disruptive technology wentviral in the late 1990s after the release ofHarvard Business School professorClayton Christensens book, TheInnovators Dilemma. But in practice, BellLaboratories has served as an incubator ofparadigm-shifting, disruptive innovationssince its creation in 1925 as a joint ventureof AT&T and Western Electric.

Researchers at northern New Jerseybased Bell Labs have won six NobelPrizes and take credit for an inventory ofinnovations: The photovoltaic cell, thesilicon-based transistor, statisticalprocess control, the UNIX operatingsystem, the C programming language,digital cell phone technology and wirelesslocal area networks are just a few of thebetter-recognized innovations that havetaken shape there.

Today, Kim said, Bell Labs researchersare working on similarly ground-breakingtechnologies. They are developing, forinstance, a liquid sensor that can betransformed to any shape by applyingvoltageKim envisions it being used as azoomable lens. The division is also usingnanotechnology to create 3-D images. Youhave seen, in science fiction movies, 3-Dholographic movie images? It can be done.

It can be done using these technologiestoday. Its just not very cost effective.

Kim offered a case study from Alcatel-LucentLucent Technologies at the

timeon how to inject a spirit ofdisruptive innovation into an existing andstagnant culture. Lucents opticalnetworking division was severelyunderperforming, and the company firedthe units top managers. I was reallyconvinced that the reason I was put inthere was that nobody else would do it,and they needed somebody to blame,says Kim.

The division was moribund: Financialresults were disappointing and moralewas low. Kim shook up the managementteam and took the survivors to an off-siteretreat that featured whitewater rafting.First thing they do is say, Why are wedoing this ...? After a while, they getreally bored. The exercise, intended tofoster teamwork and cooperation, wasdesigned with the help of a psychologist.

Instead of cooperating, the managersbegan splashing one another with theiroars, like little kids.

But the exercise-psychology experimenwasnt over at the end of the rafting runAfter six or seven hours of whitewaterrafting like this, they were tired. Thatevening over dinner, people let their at-work guardedness down and spent tim

learning about one another.

The next day included all the off-sitestrategizing and white board sessionsone might expect, but Kim says theinteraction was more genuine andproductive than if they had met as theywere previously, a grouping of near-strangers. In the first quarter followingthat meeting, he says, the group postedrevenues of $510 million, $560 millionthe next quarter, then $730 million, then$970 million. The point, he adds, is thatteamwork is so critical for the success

of a company.

Kims advice for jumpstarting disruptiveinnovation is not exactly revolutionary,though it can seem exceedingly rarewhen many companies still think quarteto-quarter and employees take a similarshort-ranged view.

Not even storied Bell Labs, it seems, isimmune from the pressure to producequickly exploitable technology. In a shocto the science world, Alcatel-Lucent allbut shuttered its funding for the Labsbasic physics research. Company officiasaid the move was done to align the Labmore closely with the parent companyscommercial pursuits in wireless, optics,networking and computer science. Or, aAlcatel-Lucent spokesman Peter Benedtold Wired Magazine in August, In thenew innovation model, research needsto keep addressing the needs of themother company.

Basic research investigates the mostfundamental of scientific questions and

has no direct commercial application. Athe same time, it has laid the groundwofor most of the modern technologicalconveniences we enjoy today, includingcommercial aviation, the GPS systemand lasers.

You have to make an investment incapital, human knowledge andnetworking, says Kim. Thats theway to get ahead.

The largest gainsin business comefrom more daring

innovations thatchallenge theparadigm and theorganization.

Paul J. H. Schoemaker,

Research Director, The Mack

Center for Technological

Innovation, The Wharton

School

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