March 27, 2006

Building Your Company's Innovation Portfolio

Innovation is back in style. Many companies that had been cautious over the past several years and primarily focused on cost reductions are now turning their focus to innovation. There is ample evidence of this orientation. For example, 87% of senior executives in a 2005 survey said that generating organic growth through innovation is necessary for success in their industries, and 74% planned to increase spending on innovation in 2005.1

Yet the mere desire for more innovation won't make it happen, and many organizations have poorly-managed approaches to innovation. In particular, they have too narrow a focus on innovation, and address only the product innovation domain. They do not manage an innovation portfolio in terms of how they source, fund, monitor, and assign responsibility for innovation. As a result, they will continue to have weak innovation results. In the 2005 study mentioned above, only 49% of the surveyed executives were satisfied with the financial returns on investments in innovation. In another 2005 analysis, there was no correlation between spending on innovation and the overall financial performance of organizations.2

In order to construct and manage an innovation portfolio, an organization must identify the types of innovation that are important to it, the key steps in the innovation process, and the primary responsibilities for managing it. Then it can begin to create a more formal approach for managing a broader, more comprehensive innovation portfolio. I'll describe each of the elements of such a portfolio.

Types of Innovation
What are the possible types of innovation that organizations can and should pursue? Unfortunately, most organizations focus only upon product innovation. In a 2003 study of companies' innovation sourcing strategies, two other researchers and I discovered that product innovation was far more likely to be addressed than any other type. 70% of the executives surveyed in the study said their organizations pursued product innovation, whereas the next most common responses (service and process innovation) were being pursued by only 20% of respondents.

Product innovation is certainly important, and in some ways it offers the clearest economic payoff for innovation. Companies create products, take them to market, and sell them to customers. Yet there are important arguments for going beyond product innovation alone. First of all, an increasing proportion of sophisticated economies are based on services—over 70% in the United States, for example3. Secondly, even in product markets, customers often buy products not just on the basis of the product's characteristics, but on the business model and processes by which the product is sold, and the services offered after the sale. Finally, companies are much more likely to produce effective and economically valuable products and services if they have innovative and high-quality management approaches.

IBM illustrates both the predominance of product innovation, and the emerging rise of other innovation domains. For several decades the company has vigorously pursued product and component research at its corporate laboratories such as Watson and Almaden. Despite the fact that half of its revenues derive from services, only in the last year has the company officially recognized services innovation as part of its innovation portfolio, creating the Services Research group at its Almaden Labs.

What does service innovation mean? For companies such as IBM offering business services, it means the development and testing of new ways to deliver services such as e-commerce, and new ways to help organizations change their cultures and processes. For organizations such as Bank of America that serve consumers, service innovation can mean identifying and testing new approaches to serve customers at the branch or point of sale.4 For a company that performs detailed building services such as ServiceMaster, service innovation might take the form of industrial engineering-like attempts to streamline movements and reduce wear and tear on workers and equipment. Of course, just as product innovation takes a somewhat different form in each company, so will service innovation.

Organizations are increasingly prospering from a combination of product and service innovation. Apple's iPod, for example, would not have been nearly as successful without the availability of the iTunes content downloading service. When IT companies such as IBM and Hewlett-Packard announce new products, there is often a need for services to install, implement, maintain, or extract value from them.

Process innovation can take place in product or service firms. It usually involves either internal business processes, or those involved in delivering products and services to customers. Process innovation can involve revolutionary or breakthough improvement in broad, cross-functional processes (sometimes called business process reengineering),5 or can also entail continuous or one-time improvement in smaller processes, as in Total Quality Management or Six Sigma initiatives. Some companies focus their process innovation efforts in some areas more than others. Dell Computer, for example, is more oriented to manufacturing and supply chain processes than to any other type. Others, such as Raytheon, have a broad corporate program that addresses all processes with one approach (Six Sigma in Raytheon’s case). Most organizations should have a portfolio of process innovation initiatives underway at any given time, including both breakthrough and incremental innovations where necessary.

Managerial innovation involves the exploration and adoption of new approaches for managing people, technology, and other strategic business resources. There have been hundreds of new management ideas over the past several decades, yet most organizations are woefully haphazard or faddish in how they adopt and embrace particular ideas. Just as product innovation usually involves researchers and engineers, and process improvement has specialists such as Six Sigma "black belts," managerial innovation is usually driven by a type of individual called an "idea practitioner"—someone who identifies appropriate new management ideas and shepherds them through implementation.6

Business model innovation may be the least well known of all the innovation domains. Business models are an organization's fundamental logic for going to market and making money. Business model innovation is critical because it is directly tied to an organization's economic fortunes. The concept became popular at the height of the e-commerce explosion, when many companies explored online business models for the first time. But e-commerce isn't the only form of business model innovation that companies can explore. Any company offering an expensive product for sale, for example, could explore the possibility of selling the same capability as an on-demand service (as many computer firms, including IBM and Hewlett-Packard) are currently doing.

Clearly there are other potential innovation types in addition to these, such as store design, architectural, and packaging innovation. Not all of these will be appropriate for all organizations at all times. Clearly some forms of innovation are going to be more important to a particular firm than others. However, a broad portfolio of innovation domains is desirable.

Additional Information:
1 Boston Consulting Group, "Innovation 2005," online at www.bcg.com
2 Barry Jaruzelski et al, "Money Isn't Everything," Strategy + Business 41, Winter 2005, p. 57.
3 James Brian Quinn, Intelligent Enterprise: A Knowledge and Service-Based Paradigm for Industry. (Free Press, 1992)
4 Stefan Thomke, "R&D Comes to Services: Bank of America's Pathbreaking Experiments," Harvard Business Review, April 2003.
5 Thomas H. Davenport, Process Innovation: Rengineering Work though Information Technology (Harvard Business School Press, 1993).
6 Thomas H. Davenport and Lawrence Prusak, What's the Big Idea? Creating and Capitalizing on the Best Management Thinking (Harvard Business School Press, 2003).

Posted by Tom Davenport at 11:38 AM | Permalink | Comments (3) | TrackBacks (3)

February 04, 2006

You Know You Compete on Analytics When...

1. You apply sophisticated information systems and rigorous analysis not only to your core capability but also to a range of functions as varied as marketing and human resources.

2. Your senior executive team not only recognizes the importance of analytics capabilities but also makes their development and maintenance a primary focus.

3. You treat fact-based decision making not only as a best practice but also as a part of the culture that’s constantly emphasized and communicated by senior executives.

4. You hire not only people with analytical skills but a lot of people with the very best analytical skills—and consider them a key to your success.

5. You not only employ analytics in almost every function and department but also consider it so strategically important that you manage it at the enterprise level.

6. You not only are expert at number crunching but also invent proprietary metrics for use in key business processes.

7. You not only use copious data and in-house analysis but also share them with customers and suppliers.

8. You not only avidly consume data but also seize every opportunity to generate information, creating a “test and learn” culture based on numerous small experiments.

9. You not only have committed to competing on analytics but also have been building your capabilities for several years.

10. You not only emphasize the importance of analytics internally but also make quantitative capabilities part of your company’s story, to be shared in the annual report and in discussions with financial analysts.

These points are from my January 2006 HBR article- "Competing on Analytics."

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November 30, 2005

The High Cost of Missing Knowledge: One Example

Last Thursday, a house exploded in Lexington, Massachusetts, where I live. TV news showed the smoldering ruins and told about the people who had come out to rake leaves just before their home blew up.

You hear similar stories from time to time: a gas leak, a spark, boom—no more house. This was different. Turns out that workers from the gas company, following an order they’d received, connected a high-pressure gas pipe to a low-pressure one, creating a pressure spike throughout the system. That caused leaks and equipment damage throughout the town, and the explosion. It has meant 1,800 homes without heat for the better part of a week, restaurants closed in the center of town, and literally hundreds of gas company employees working 24 hours a day, digging up dozens of streets to replace damaged parts of the system and checking gas lines in every one of those 1,800 homes. One evening, I counted 31 company trucks on Massachusetts Avenue. Lawsuits are likely.

You can bet this error will cost the gas company many millions of dollars. I don’t know how it happened, but I imagine there must have been opportunities to avoid it. This was no subtle mistake; they connected a 60 pounds-per-square-inch line to a 2 pounds-per-square-inch line. The manager who gave the order could have caught his own error, perhaps someone who transmitted it could have noticed, the supervisor of the work crew could have seen it, the workers themselves might have said, “Wait a minute; this isn’t right.” You’d think those high- and low-pressure lines would look different (but apparently they don’t).

This episode suggests a couple of points. One is that a lack of knowledge or a failure to apply knowledge at a critical moment (“this is wrong!”) can be expensive and dangerous. Another is that avoiding such problem requires experienced people who can recognize errors, a culture that encourages people to speak up when they see a problem, and systems that incorporate and provide essential information (for instance, color-coded gas pipes, in this case, or drug-interaction databases in hospitals).

I had a conversation with Dorothy Leonard this morning, she mentioned that one of the problems with trying to measure the value of knowledge management is that much of it helps avoid problems, and how do you measure something that doesn’t happen? True, but when it does happen, the cost of missing knowledge is clear.

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