Innovation in Stage 2 Companies

7 September 2009
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My favorite assessment to give leaders is the Perth Leadership Institute’s Financial Outcome Assessment, which tells a person’s intrinsic profitability. In other words, it can identify and predict a person’s ability to create profit (or loss) over time, which is powerful and practical information for someone with P&L responsibility.

Ted Prince is the founder and head of the institute, and he recently published an article about innovation during a recession. It adds to another interesting white paper that Perth published in January 2007. I think it brings up some interesting points, and also highlights some issues at play in how Stage 2 companies manage innovation.

Article Summaries

Although the whole article is worth reading, there are a few highlights. Most importantly, Prince highlights some surprise realities about innovation, including:

· Innovation is not creativity. As Perth defines it, innovation is a new offering in the market that consumers find novel and are willing to pay a premium for. Ted cites Bill Gates as an innovator who is not creative.

· Most innovators lose money. The article says, “Millions of innovative companies have gone out of business precisely because they focused on innovation rather than profitability.” [I’ll comment on this below.]

· Having an advanced degree does not make someone innovative. In fact, the people with the least knowledge of a market space often come up with the best innovation.

· Innovation needs innovators. Having a process or an organization focused on innovation will not generate results if you don’t have the right kind of people working on innovation.

In the January 2007 white paper, Ted makes some additional points:

· People fall into 3 broad innovation categories – Current (low innovation as Perth defines it), Moderate, and Breakthrough (high innovation).

· Of those who are innovative, there are 3 types, which Perth calls “High Leverage”, “Contribution”, and “Intensive.” Those three categories map generally to the amount of resources an innovator uses, with high leverage spending the least, and intensive spending the most.

· Companies usually have a culture that aligns with one of the innovation types Perth identified, and that culture often goes through “style drift” as it matures (generally, spending more as time goes on).

Innovation in Stage 2 Companies

My experience with Stage 2 companies is that they are usually started by a strong innovator. That innovator usually hires people who are also good at innovation, and this core team is what gets the company through Stage 1 successfully. (Or, to Prince’s point above, fails – most likely because they were innovative without being commercially compelling.)

At that point, though, the company finds that what’s needed to succeed in Stage 2 is different than Stage 1. Simply, more things need to get done, and more people and products and customers need to be managed. This is a tricky time for a Stage 2 company.

First, the Stage 1 team must hire people who are less innovative. Because Stage 1 leaders are often good innovators and inexperienced managers, they usually do not have good “pattern recognition” skills to select the right hires for the company’s new management needs.

Second, the Stage 1 team now adjusts to a new reality, that sounds like a dream to most Stage 1 teams but is a continual bane for many Stage 2 companies – namely, the company can fund its own R&D, rather than relying on customer funding. This possibility is usually greeted with excitement, as the innovative Stage 1 team now has resources to pursue its (many) own ideas. But, what those teams often don’t realize is that that freedom comes with a price – they can no longer rely on the market to regulate their R&D investments (“We can only work on R&D that our customers pay for, because otherwise we won’t stay in business”), and they must now put in place their own systems to regulate their investments.

This evolution is very challenging for most Stage 2 companies I work with. First, R&D has often been the lifeline of the business, and an area that the founding team has a particular passion for. Second, as technical innovators, the founding team is often not a particularly good investment team. And third, many founders left organizations that imposed too much structure on R&D – structure that slowed the organization and created the market opportunity the founder left to pursue – and the founders do not want to recreate the rigid environments they left. Whereas Stage 1 teams usually embrace increased discipline in the areas of production and customer delivery, because the pain of unhappy customers and lost work is obvious, they are usually slow to recognize the problems with their R&D management, and even slower to correct them.

But managing innovation is critical to Stage 2 success. Most of my clients have reinvested millions of dollars of their profits into R&D, and their results are usually modest at best.

Prince notes that innovation without regard to profitability usually leads to failure. The Stage 2 leaders who disagree with that statement are the ones who have the hardest time developing a system to manage innovation. They claim that their company succeeded because they put innovation, rather than profitability, first, and “it will be the death of this company if we start managing based on profit and the almighty dollar.” This point highlights a particular blind spot that Stage 1 leaders often have when their companies move to Stage 2 – not developing organizational capabilities that replicate and expand their own personal ones. Leaders who successfully put innovation ahead of profitability are probably blessed with an intrinsic understanding of commercial value, that was at play even though they didn’t realize it (they are probably Breakthrough innovators, in Perth’s terminology). Companies with leaders who do not have that natural ability fail – and organizations that do not have systems to replicate that ability in Stage 2 struggle.

This year, as the need to manage expenses rises, I am working with several of my clients to develop and manage innovation processes that bring together the 2 aspects of innovation that Prince discusses in his article – novelty and commercial value. These processes are strategically important, because the forces of creative destruction will continue to reward companies who can generate high ROI, and can innovate within whatever market constraints exist – including tightened budgets.