Innovation and the Path to Growth, Profitability, and Competitiveness

by John Milton-Smith

Executive Summary
Disciplined managerial leadership and teamwork are keys to innovation. Innovation should be driven by the end customer, not by R&D. Aim to create unique market space and make competition irrelevant. The 7Es innovation framework identifies seven essential stages in the innovation process. The Cochlear case provides an instructive example of a structured innovation process. Organic growth based on innovation is the surest path to sustainable growth and profitability. Mergers and acquisitions (M&A) are a high-risk substitute for innovation strategy. Innovation should be managed as an open process involving a variety of partners.

Introduction
As management guru Peter Drucker pointed out, entrepreneurial management and innovation were the drivers of the exceptional employment and profit growth in the United States during the 1970s and 1980s. Drawing on insights from this period, Drucker argued that innovation is due more to purposeful, systematic hard work rather than simply a flash of genius. It is, therefore, important to distinguish innovation from invention. Whereas creative ideas and discovery are at the heart of invention, innovation involves the creative management and application of invention. As companies such as 3M and IBM have demonstrated, innovation should be treated as a standard organizational function responsible for finding new sources of customer value.
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There are three major categories of innovation. According to Christensen, two of the categoriessustaining innovation and disruptive innovationare complementary, but significantly different. Sustaining innovation is incremental, and reflected in continuous improvements to the safety and efficacy of pharmaceutical drugs, whereas disruptive innovation includes major breakthroughs, such as the automobile and digital photography. Some of the most successful disruptive innovations are products, services, processes, and experiences that apply or combine existing elements in different ways to produce radically new customer benefits and experiences. Examples include Apple iPod, YouTube, Star Alliance, and Starbucks. The third category is business concept innovation. Because of the intensity of competition and turbulence in the market environment, Hamel argues that companies must adopt a radical new innovation agenda, and apply systematic innovation design rules. This view is endorsed by Bill Gates, who, warning of the risks confronting complacent incumbents, has claimed that Microsoft is always two years away from failure.
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Neither the iPod nor YouTube rely on disruptive technology, yet both have created new global markets. Whereas the iPod offers a unique experience through the quality of its design, customer interface, and product extensions, YouTube has invited millions of people worldwide to become amateur broadcasters by creating and sharing original videos. In the case of Star Alliance, a group of otherwise competing airlines collaborates to provide passengers with seamless global routing options, ticketing arrangements, and loyalty benefits. Starbucks, on the other hand, reinvented the traditional Italian coffee shop to create a global coffee culture and experience, based on market development, line extension, and mass customization. Once the focus is on the end-customer, every element in the design and delivery of the value chain becomes a potential opportunity for innovation. As in the examples given above, radical innovation lies in the bundling and branding of multiple value-adding elements, rather than in any single element.
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Service and experience innovationeasily the biggest generators of wealth-producing added valueare the areas most neglected by R&D communities and the innovation industry. Kim and Mauborgne (2005) use Cirque du Soleil as an example of a company which has created the blue ocean of new market space,
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and made competition irrelevant. In achieving both differentiation and low cost by reconstructing elements across industry boundaries, Cirque du Soleil invented a unique, live entertainment experience, involving elements of circus, theater, opera, and ballet. It is different from traditional circuses. There are no animals or star performers, and the target audience is sophisticated adults rather than children. New shows tour the world regularly, partly financed by regional sponsors and a loyal customer base.
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The 7Es Innovation Framework

Innovation is complex, involves risk, and cannot be reduced to simple templates. However, a systematic and disciplined innovation strategy has a number of common elements. Under the direction of a CEO who is strongly committed to organic growth and innovation, there should be an open market for ideas, capital, and talent. Innovation project team leaders should be given responsibility for critical functions and processes, including the following, which, the sake of convenience, could be designated the 7Es: Explore by generating and vetting ideas from a wide variety of internal and external sources; Evaluate by assessing and prioritizing options, making a selection and giving feedback; Extend by involving and co-opting partners and opinion leaders, and progressively demonstrating small wins; Experiment by designing, testing, demonstrating, and reviewing a prototype or pilot study; Engage by winning the managements support for a proposed business model; Evangelize by publicizing, showcasing, celebrating, and involving all stakeholders; Execute by implementing the business model, including launch and marketing strategies.
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Case Study
Cochlear: The Triumph of Organic Growth Strategy
Cochlear Limited provides an excellent demonstration of the innovation processes listed above. Cochlear is a Sydney-based medical technology business with a long-standing mission to help the hearing-impaired. Despite humble beginnings, Cochlear produces the worlds best-selling hearing implant. By early 2009, it had a global market share of 70%, and approximately 2,000 employees in more than 20 countries. Cochlear was built on the entrepreneurial drive and single-minded passion of Professor Graeme Clark. Even as a young ear, nose, and throat specialist in Melbourne in the 1960s, his fathers deafness drove him to explore new ways of overcoming hearing impairment. In order to win over skeptics, Clark was extremely careful to evaluate his experiments with the utmost rigor. In fact, the early tests were unsuccessful. Finally, he concluded that an implant with single-channel stimulation of the inner-ear auditory nerves would not lead to speech understanding in deaf people. The bionic ear concept emerged gradually, and involved the integration of research from numerous disciplines. Clark consolidated and extended his research while undertaking a doctorate, and after becoming chair of a new department at the University of Melbourne. During this time, Clark partnered with a leading expert in sound quality and a small local company experimenting with heart pacemakers. Finally, he confirmed that multi-channel stimulation was a feasible option, and began to pursue it with vigor. Clarks major experimental phase began in the 1970s. The lengthy delay was due largely to the indifference of the medical community, and the lack of financial support. Fundraising continued to be a major obstacle, and the leading Australian research bodies repeatedly rejected Clarks applications for research grants. Forced to operate outside the normal research channels, and adopt a direct crusading approach, Clark became a full-time evangelist, undertaking a hectic round of fundraising lunches and meetings. After more than seven years of struggle, Clarks first major breakthrough came in 1974, when he persuaded the proprietor of a new television channel to conduct a telethon to finance the first prototype. When the telethon money ran out, Clark persuaded Prime Minister Malcolm Fraser to help. However, it was not until 1982 that Cochlear Limited finally floated on the stock exchange, and the systematic execution of Clarks vision began.
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Because of the strict regulation of medical technology, and notwithstanding the enormous credibility which Cochlear has earned, there is no respite for top management. They will always need to be evangelists. In recent years, 13 new territory outreach specialists have been added to the US field force to help educate hearing-aid professionals, a training and education center has been established in Beijing, and a Cochlear Awareness Network has been created so that volunteers can be enlisted to provide information to potential implant recipients. Most of Cochlears growth took place during 20032008.This period was marked by consistent annual growth in sales, revenue, and net profit, while gross margin increased to 72%.Whereas in April 2002, there were 35,000 cochlear implant users worldwide, by 2008 this figure had more than tripled to more than 120,000. Since 2003, the company has been reinvesting 1213% of revenue into continuing R&D activities, and set up partnerships with more than 80 universities worldwide. According to Cochlears half-yearly results, reported on February 11, 2009, the growth trajectory has been maintained, despite the global financial crisis, with a further net profit increase of 22%.
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Even as a relatively small SME, Cochlear continued to pursue a global strategy based on organic growth and strong branding. Despite the general preference for growth by M&A, Cochlear remains committed to the philosophy that you get bigger by being better. There is still a huge unserved market. According to its latest annual report, Cochlear estimates that there are about 278 million people with moderate to profound hearing loss in both ears, and this figure will rise as the population ages and life expectancy increases. Apart from upgrades and repairs, Cochlear is also developing specialized products for different types and degrees of hearing loss.
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The Critical Link between Innovation, Growth, and Competitiveness

The synergistic relationship across innovation, growth, and competitiveness demonstrated in the Cochlear case is well documented. For example, there is a significant body of research confirming that a record of ambitious organic growth is the main determinant of a companys stock-market value. Investors regard strong organic growth as a reliable indicator of a sound business model. Furthermore, commitment to the discipline of organic growth is evidence that managers think strategically about the future, believe that innovation is the key to competitive advantage, and stay focused on creating value for customers.
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The sustained growth and market capitalization performance of companies such as GE, Google, Samsung, Dell, and Procter & Gamble (P&G) further underline the importance of innovation-driven organic growth. For example, between 2004 and 2006, soon after adopting a radical connect and develop open innovation model, more than 100 of P&Gs new products had elements which originated outside the company. More recently, in 2008, A. G. Lafley, P&Gs CEO confirmed the transformation, stating that, P&G has delivered, on average, 6% organic sales growth since the beginning of the decade, virtually all of it driven by innovation.
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In a comprehensive study of corporate growth conducted over a ten-year period, Hess found that the companies most committed to organic growth outperformed the S&P 500 by a factor of 10. He concluded that, in the long term, the companies that succeeded to a greater degree than their peers were found to follow an organic growth strategy. By contrast, attempts to generate growth through M&A failed to achieve their objective, indicating that M&A is opportunism rather than strategy and frequently involves a quick fix approach to expansion and market share.
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Strategic Partnerships Facilitate Innovation and Growth

As opposed to M&A, strategic alliances and partnerships are increasingly successful organic growth options, as the Cochlear case demonstrates. Open innovation, working closely with customers, suppliers, service providers, and other firms, is generally the most cost-effective method for identifying value-creating opportunities, sharing knowledge, expanding into new markets, and lifting competitiveness.

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According to Lendrum (2003), the benefits of partnerships relate not only to increased growth and profits for shareholders and other stakeholders, but also include improvements in leadership effectiveness, workplace relations, and innovation capability. Based upon his extensive research, Lendrum concludes that innovation is a key factor in the evolution and revolution of partnering/alliance relationships, and the driving force behind the process.
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The link between partnerships and innovation is critical. Indeed, the more radical the innovation, the more deeply and broadly must other players, especially customers, be involved. Market leaders such as Philips, IBM, and Toyota have hundreds of inter-firm partnerships, which have played a major role in their growth and competitiveness. Groupings such as science parks and clusters (geographic concentrations of interconnected companies) offer the same potential partnership benefits to SMEs, which tend to be nimbler and more innovative than their larger counterparts. Successful replications of the so-called Silicon Valley Effect can now be found in most parts of the world, including Tromso in Norway, Cambridge in England, the Emilia-Romagna region of Italy, Malaysias Cyberjaya, and Dohas Education City.
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Making It Happen
The practical action steps for implementing an innovation-based organic growth strategy are as follows: Top management focuses on mission-driven organic growth, treats M&A with great caution, and aims to create strongly branded, unique market space. The CEO becomes a highly visible innovation leader and champion, stimulates the discussion of new ideas, and encourages information sharing and learning. Innovation is at the center of the mission statement, strategic goals, job descriptions, performance targets, etc. The CEO provides innovation leadership, and, with a top-level team, approves and supports major innovation projects. Cross-boundary innovation project teams operate throughout the organization. All innovation projects demonstrate how they will contribute added value in providing a unique experience to the end-customer. The initial criterion for an innovation project is possibility, not probability but projects that fail an initial feasibility study are killed off quickly. The operating protocols for all innovation project teams specify criteria for an open process, including suppliers, customers, and other partners.

More Info
Books:
Hess, E. The Road to Organic Growth: How Great Companies Consistently Grow Market Share from Within. New York: McGraw-Hill, 2007. Kim, C., and R. Mauborgne. Blue Ocean Strategy. How to Create Uncontested Market Space and Make the Competition Irrelevant. Boston, MA: Harvard Business School Press, 2005. Lendrum, T. The Strategic Partnering Handbook. New York: McGraw-Hill, 2003.

Article:
The McKinsey Quarterly. How companies approach innovation: A McKinsey global survey. October 2007. Online at: www.mckinseyquarterly.com/ How_companies_approach_innovation_A_McKinsey_Global_Survey_2069

Websites:
Asian Productivity Organization: www.apo-tokyo.org Cambridge MIT Institute: www.cambridge-mit.org The Conference Board: www.conference-board.org Hay Group: Your Challenges: www.haygroup.com/ww/challenges
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Innovation and the Path to Growth, Profitability, and Competitiveness

Knowledge@Wharton Innovation and Entrepreneurship: knowledge.wharton.upenn.edu/category.cfm? cid=12 PricewaterhouseCoopers Center for Technology and Innovation: www.pwc.com/extweb/service.nsf/ docid/D9A4C1B3A70E44F885256F8800743B91

Notes
1 Drucker, P. F. Innovation and Entrepreneurship. New York: Harper Business, 1993, pp. 3036, 138, 150. 2 OConnor, G. C., R. Leifer, A. C. Paulson, and L. L. Peters. Grabbing Lightning: Building a Capability for Breakthrough Innovation. Hoboken, NJ: Wiley, 2008, pp. 169170, 202203, 259. 3 Christensen, C. M. The Innovators Dilemma. New York: Harper Business, 2000, pp. xv, 1019. 4 Hamel, G. Leading the Revolution. Boston, MA: Harvard Business School Press, 2002, pp. 59118, 251 282. 5 Hamel, G. The challenge today: Changing the rules of the game. In Leibold, M., G. J. B. Probst, and M. Gibbert (eds). Strategic Management in the Knowledge Economy. New York: Wiley-VCH, 2005, p. 119. 6 Winter, S. G. Appropriating the gains from innovation. In Day, G. S., and P. J. H. Shoemaker (eds). Wharton on Managing Emerging Technologies. New York: Wiley, 2000, pp. 245, 256. 7 Ibid. 8 Kim, W.C., and R. Mauborgne. (2005), p. 18. 9 Lord, M. D., D. deBethizy, and J. Wager. Innovation that Fits. Upper Saddle River, NJ: Prentice Hall, 2005, pp. 18, 134, 230. 10 Hamel. 2002, op. cit, 299302. 11 Cochlear Limited, Annual Report 2008, Sydney: 820. 12 Ooi, T. Dollars decline boosts Cochlear hopes. The Australian Business (February 11, 2009): 1. 13 Cochlear Limited. op. cit. See also World Health Organization. Deafness and Hearing Impairment. Fact Sheet No. 300. New York: March, 2006: 1. 14 Day, G. S. 2006. Closing the growth gap: Balancing big I and small I innovation. Knowledge@Wharton,February 1, 2006: 1. Online at: knowledge.wharton.upenn.edu/papers/1333.pdf 15 Huston, L. and N. Sakkab. Connect and develop: Inside Procter and Gambles new model for innovation. Harvard Business Review (March 2006): 13. 16 Lafley, A. G. P&Gs innovation culture. Strategy+Business Enews (August 28, 2008): 210. 17 Hess, E. D. (2006), 13, 27. 18 Lendrum, T. (2003), pp. 5, 39, 155156. 19 Moore, J. F. The Death of Competition. Leadership and Strategy in the Age of Business Ecosystems. Chichester, UK: Wiley, 1996, p. 61.

See Also
Thinkers Michael Eugene Porter Finance Library Reengineering the Corporation: A Manifesto for Business Revolution

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