Special Feature
Part of a ZDNet Special Feature: Innovation: How to be a World-Changer

Innovation through the looking glass

Most companies have to innovate continuously just to maintain their competitiveness. Disruptive innovation in search of new product categories requires extra effort and carries more risk, but can deliver greater rewards if managed properly.

Image: Shutterstock
Innovation is generally seen as a 'good thing', but history provides many examples of pioneers who failed to capitalise on their inventions -- and, conversely, of canny operators who exploited existing technology to great effect.

A classic example of the latter is Apple: despite having invented neither the portable music player nor the smartphone nor the tablet, and despite historically spending a relatively low percentage of its revenue on research and development, the Cupertino firm has become the world's most profitable technology company -- largely on the back of its iPod, iPhone and iPad sales. The company may well repeat the trick in the smartwatch market with the recently-released Apple Watch, although it's currently too early to call.

Clearly there are many routes to success, not all of which require heavy investment in R&D. Other important factors include the acuity with which a company analyses the market in order to determine which products to develop, the openness of company culture to new ideas, and the efficiency of its product-creation pipeline. After all, no amount of R&D investment will deliver results if the company's strategists and marketers are barking up the wrong tree, if creative thinking within the company is ignored, or if the operations department fails to get its act together.

Talking of Apple, the late Steve Jobs had plenty to say on the subject of innovation:

"Innovation has nothing to do with how many R&D dollars you have. When Apple came up with the Mac, IBM was spending at least 100 times more on R&D. It's not about money. It's about the people you have, how you're led, and how much you get it."

"You can't ask customers what they want and then try to give that to them. By the time you get it built, they'll want something new."

"Innovation comes from people meeting up in the hallways or calling each other at 10:30 at night with a new idea, or because they realized something that shoots holes in how we've been thinking about a problem."

R&D: statistics and theories

It's perhaps no surprise, then, that simple correlations between R&D spend and company performance are not easily found. As a recent McKinsey report put it: "repeated studies have shown no definite correlation between this R&D ratio [the proportion of revenue spent on R&D] and any measure of a company's success."

R&D obviously needs to be focused on the right areas and managed well in order to deliver tangible benefits to a company. This is something that McKinsey has recently attempted to address via a new formula that, it believes, "will be useful to any company that wants to establish and maintain a comprehensive and transparent overview of the R&D organisation's many platforms, hundreds of projects, and thousands of engineers, technicians, program managers, and lab workers."

McKinsey's formula looks simple enough:

innovation-mckinsey.jpg
Source: McKinsey

The input variable, 'Consumed R&D costs', is straightforward and widely measured. The output variables -- 'Total gross contribution' and 'Achieved product maturity' -- are harder. Total gross contribution represents "a product's economic value to customers, while keeping fixed costs out of the equation", and must either be estimated or calculated retrospectively. The other output, Achieved product maturity, represents "how close [the product] is to verifying and validating its technical and commercial requirements" at the time of its market introduction. Assuming that these metrics are available, the value of this model, says McKinsey, is that it sheds light on different aspects of productivity and "facilitates more confident managerial interventions to improve them".

Three different innovation models are identified by Strategy& (the consulting arm of PwC) in its Global Innovation 1000 (GI 1000) reports:

Need Seekers "make a point of using superior insights about customers to generate new ideas", the goal being "to find the unstated customer needs of the future and be the first to address them." According to Strategy&, around 25 percent of the 2014 GI 1000 are Need Seekers.

Market Readers "focus largely on creating products through incremental innovations to products already proven in the market. They use a variety of means to generate ideas; most involve closely monitoring their markets, customers, and competitors." According to Strategy&, around 40 percent of the 2014 GI 1000 are Market Readers.

Technology Drivers "depend heavily on their internal technological capabilities to develop new products and services. They leverage their R&D investments to drive both breakthrough innovation and incremental change." According to Strategy&, around 35 percent of the 2014 GI 1000 are Technology Drivers.

Although all three innovation models can be successful, Strategy& finds that the Need Seeker strategy is "inherently advantaged". Compared to Market Readers and Technology Drivers these companies: have an increased focus on tightly aligning their innovation and business models; report more often that they are better at innovation than they were 10 years previously; and more often indicate that they are financially outperforming their competitors.

Let's have a look at some examples of success and failure (either recent or past) in the innovation game, and see (very broadly) how they fit these various approaches.

Success and innovation

Samsung

Revenue (2014) $195.9 billion

R&D spend (2014)

$13.4 billion

R&D/Revenue (2014)

6.8%

US patents granted (2014)

4,952

GI 1000 category

Market Reader

Samsung is not traditionally seen as a great innovator, but you don't grow to be the world's largest technology company simply by imitating the inventions of others (although Samsung has, of course, been involved in some high-profile patent disputes, notably with Apple, in recent years).

As discussed in this Forbes article, Samsung's approach to innovation since the turn of the millennium has been extremely methodical, based on problem-solving and process-improvement tools such as TRIZ and Six Sigma and making extensive use of Russian scientific expertise. The aim, according to this circa-2003 Samsung document, was to transform the company from a 'fast follower' (a.k.a. Market Reader) to an 'innovative leader': "Instead of leading the industry by developing innovative products, we have followed fast what the leading companies had developed. Top management pointed out this and asked employee not to be a fast follower, but to be an innovative leader."

With R&D spend growing from $4.3 billion in 2005 to $13.5 billion in 2014 (see graph below), the number of US patents granted per year climbing steadily from 1,645 to 4,952 over the same period, and a 4th-place ranking on Strategy&'s latest Global Innovation 1000 report, Samsung would appear to be moving in the right direction -- although the 2014 GI 1000 report still classes the company as a Market Reader rather than, as Samsung evidently would prefer, a Technology Driver.

Check out Samsung's Strategy and Innovation Center for information on current projects in areas such as digital health, data centres, human-computer interfaces and the internet of things.

Apple

Revenue (2014) $182.8 billion

R&D spend (2014)

$6.04 billion

R&D/Revenue (2014)

3.3%

US patents granted (2014)

2,003

GI 1000 category

Need Seeker

We've already noted Apple's relatively parsimonious approach to R&D spending. Here are some more figures. Since breaking the $100 billion revenue barrier in 2011, Apple's R&D spend has averaged $4.1bn -- less than half that of Samsung, which has spent $8.5bn a year on R&D, on average, since passing the same revenue mark in 2008:

apple-samsung-r-d-spend.png
Data: company annual reports

Tempting though it is to pronounce Apple 'more efficient' at innovation than Samsung, it's worth looking at the number of US patents awarded to each company in relation to R&D spend. We plotted the number of patents awarded in year Y versus the R&D spend for year Y-3 for each company (using three years as an estimate of the average time lag between doing research and receiving a patent) to get the following graph:

apple-samsung-r-d-patents.jpg
Data: company annual reports and IFI Claims Patent Services

The fact that both companies appear to get a similar rate of patent return per dollar of R&D spend suggests similar levels of basic R&D competence: Samsung spends more than twice as much as Apple largely because it operates in a much wider variety of markets (including TVs, fridges and washing machines, printers, health and medical equipment, mobile devices, networking and telecoms equipment, processors and memory chips, and LEDs).

In its 2014 Global Innovation 1000 report, Strategy& classes Apple as a Need Seeker and ranks it the most innovative company in its survey.

Applying the aforementioned McKinsey model (very crudely) to Apple suggests that the company achieves high productivity by keeping R&D costs relatively low and releasing high-grossing, relatively mature products into a limited number of existing markets and updating them in a timely manner. This has been an impressive feat of management over the last decade or so, but it's hard to escape the feeling that Apple may have to do some genuinely 'disruptive' innovating (sensu Christensen, 1997) before long in order to maintain its current level of success.

Google

Revenue (2014) $66 billion

R&D spend (2014)

$9.8 billion

R&D/Revenue (2014)

14.9%

US patents granted (2014)

2,566

GI 1000 category

Technology Driver

Just as Apple did not invent its key revenue-generating product classes (smartphone, tablet), so Google was by no means the first internet search engine: WebCrawler, Lycos, Infoseek, Alta Vista, Magellan, Excite, Yahoo!, Inktomi and AskJeeves, among others, all predated Google's 1998 launch. However, at the time of writing, Google's share of the global search engine market stands at 62.3 percent, according to NetMarketShare. Advertising generates the majority of the company's revenue: 68.3% comes from Google websites and 21.2% from Google Network Members' websites (figures from Google's 2014 annual report).

Google needs to continue to attract users to its (mostly free) services in order to capture the preference data that allows precise ad targeting. That's why the company is well known as an innovator -- although for every Google Maps and Street View, there's a potential Google Wave waiting in the wings.

Google's commitment to innovation is reflected in its R&D spend relative to revenue, which averaged 12.6% between 2005 and 2014. Compare that to Apple (2.98% over the same period) and Samsung (5.8%):

apple-samsung-google-r-d-relative.png
Data: company annual reports

No wonder, then, that Strategy& classes Google as a Technology Driver in its 2014 GI 1000 report, ranking it as the second most innovative company (behind Apple).

The best-known innovation-related fact about Google is the one-day-a-week (20 percent time) that employees famously get (or got) to pursue personal projects, which spawned well-known services like Gmail and Google News. In 2013 reports emerged that this somewhat scattergun approach had been fine-tuned -- a development that followed the 2011 closure of Google Labs, where many 20-percent-time prototypes were given an airing. Google still does plenty of research, of course, much of it centred around the secretive Google X lab, which is home to 'moonshot' initiatives like Google Glass, self-driving cars and Project Loon (wireless internet access for rural areas via high-altitude ballons).

Although patents are an imperfect measure of innovation, it's interesting to add Google to the graph presented earlier comparing Apple and Samsung. This shows how Google sits between the two companies in terms of absolute R&D spend, and appears to be a slightly less efficient patent-generating operation:

apple-samsung-google-patents.jpg
Data: company annual reports and IFI Claims Patent Services

Google noted in its 2004 IPO Letter that "We will not shy away from high-risk, high-reward projects because we believe they are the key to our long-term success. We won't stop asking 'What if?' and then working hard to find the answer." In its 2014 annual report, the company adds: "We often release early-stage products. We then use data and user feedback to decide if and how to invest further in those products."

In terms of the McKinsey model, gross contribution and product maturity may initially be low compared to R&D costs for many Google projects, but the company relies on careful data-driven management to weed out the also-rans, allowing the potential big winners to grow and prosper.

Failure and innovation

Here are three classic business stories -- two done and dusted, one still in the making -- where for varying reasons a company found itself in trouble because of its innovation strategy.

Xerox
Revenue (2014) $19.5 billion

R&D spend (2014)

$577 million

R&D/Revenue (2014)

3.0%

US patents granted (2014)

967

Given that Xerox remains a successful enterprise (revenue of $19.5 billion, net income of $1.1bn in 2014), it's slightly unfair to list it in the 'failure' section. However, as far as innovation is concerned, that tag will probably always hang over the company thanks to the pioneering work undertaken at its PARC research lab in the 1970s.

Tasked with creating 'the office of the future', a world-class team of PARC academics and engineers did just that, inventing the following technologies: laser printing (1971); object-oriented programming (1972); the personal workstation (1973); Ethernet and distributed computing (1973); the first raster-based graphics program (Superpaint, 1973); WYSIWYG bitmap editing (including precursors of Microsoft's Word and Adobe's PostScript, 1974); solid-state lasers (1974); the first graphical user interface, or GUI (1975); VLSI circuit design (1977); worm programs (1978); natural-language processing (1979); and corporate ethnography (1979).

Xerox acquired the 'failure' tag because, laser printing aside, it failed to commercialise PARC's inventions, allowing Apple, Microsoft, Adobe and many others to profit hugely from its ground-breaking work. In his 2011 book Managing Technological Innovation, Frederick Betz sums up the aftermath: "In the late 1980s, Xerox turned its entire corporate attention to manufacturing copy machines, missing the evolving personal computer industry and the Internet revolution of the 1990s. By 2002, Xerox was deeply in debt and on the verge of bankruptcy."

innovation-xerox-shares-2.jpg
Xerox share price performance, 1978-2015. Source: Google Finance

Steve Jobs, characteristically, put Xerox's missed opportunity in more forthright terms in an interview for Robert X Cringley's documentary Triumph of the Nerds: The Rise of Accidental Empires: "They grabbed defeat from the greatest victory in the computer industry. Xerox could have owned the entire computer industry today...could have been the IBM of the nineties, could have been the Microsoft of the nineties."

All of which goes to show that innovation by itself is not enough. In McKinsey-formula terms, if there is no 'Achieved product maturity' then the company derives no value.

Interestingly, German software giant SAP has recently funded a PARC-like operation called the Communications Design Group, in conjunction with Viewpoints Research Institute -- whose co-founder and president is one of PARC's best-known alumni, Alan Kay (of object-oriented programming, GUI and Dynabook fame).

Kodak

Revenue (2014) $2.1 billion

R&D spend (2014)

$94 million

R&D/Revenue (2014)

4.5%

US patents granted (2014)

390

Kodak's decline from a dominant position in the film photography market for most of the 20th century to Chapter 11 bankruptcy protection in January 2012 is a classic business saga in which innovation plays a key role.

Ironically, Kodak invented the technology that eventually brought it to its knees: the first CCD-based digital camera (a 3.6kg, 0.01-megapixel prototype) was built by a Kodak engineer, Steven Sasson, in 1975. And in 1986, Kodak unveiled the first megapixel sensor small enough to fit in a handheld digital camera -- a key milestone in the technology's evolution.

Kodak even created its own 'writing on the wall', as this Forbes article documents: in 1981 the company commissioned a far-sighted study of the potential of digital photography, which concluded that its lucrative film-based business was indeed threatened by digital, but that it had around a decade to do something about it.

Clearly the appropriate action was never taken, as is demonstrated by Kodak's sorry share price history until trading ceased in January 2012:

innovation-kodak-shares-2.jpg
Kodak share price performance, 1978-2012. Source: Google Finance

Kodak subsequently returned to the NYSE in November 2013 after emerging from bankruptcy, a recovery partly funded by the February 2013 sale of its digital imaging patent portfolio for $527 million.

Kodak's mistakes included an unwillingness to consider a disruptive innovation created by its own R&D department, and an inability to adapt its established business model to changing market conditions.

BlackBerry

Revenue (2014) $6.81 billion

R&D spend (2014)

$1.29 billion

R&D/Revenue (2014)

18.9%

US patents granted (2014)

1,337

BlackBerry (formerly RIM) was dominant in enterprise mobility in the 1990s and early 2000s, and is currently attempting to revamp its business model, having failed to adapt to changes in the smartphone market that began with the launch of the iPhone in 2007. At the time, RIM's co-CEO Jim Balsillie commented that the iPhone was "kind of one more entrant into an already very busy space with lots of choice for consumers...But in terms of a sort of a sea-change for BlackBerry, I would think that's overstating it" (see this Business Insider article for more choice iPhone quotes from RIM's bosses).

RIM/BlackBerry did continue to prosper for several years after the advent of the iPhone, but the company's recent smartphone market share and share price figures are not pretty sights:

blackberry-mkt-share-price.jpg
BlackBerry smartphone market share 2007-2015 (top) and share price performance 2000-2014 (above). Sources: Statista and Google Finance

BlackBerry's problems started around 2010, according to a perceptive analysis by ex-Apple and Palm marketing executive Michael Mace, who detected signs of market saturation, suggested that the company had "lost the ability to create great products" and noted the existence of a hard-to-reverse 'platform death spiral' ("unless you're Steve Jobs and you get very lucky").

In June 2011 anonymous open letter from a senior employee to RIM's top brass confirmed that all was not well within the company. Here's a key passage (our italics): "Let's start an internal innovation revival with teams focused on what users will love instead of chasing 'feature parity' and feature differentiation for no good reason (Adobe Flash being a major example). When was the last time we pushed out a significant new experience or feature that wasn't already on other platforms?"

BlackBerry's current strategy is centred around devices (BB10 handsets), enterprise services (primarily MDM/EMM via its iOS-, Android- and Windows Phone-supporting BES12 platform), BlackBerry Technology Solutions, or BTS (QNX, Certicom, Paratek, BlackBerry IoT Platform and Intellectual Property & Patent Licensing) and messaging (BBM). The key question for BlackBerry is whether it can grow the business of managing smartphones running multiple OSs via BES12 fast enough to cover the declining revenues from its old business model -- which was selling and managing handsets based on its previous-generation BB7 OS.

Despite -- or perhaps because of -- its troubles, BlackBerry's spending on R&D as a proportion of its revenue has grown significantly in recent years, averaging 6.9 percent between 2005 and 2011 and 15.6 percent between 2012 and 2015. The R&D figure for fiscal 2015 (ending 28 Feb 2015) is $711 million out of $3.33 billion revenue -- a remarkable 21.3 percent. The comparison with Apple, Google and Samsung is striking:

blackberry-relative-r-d.jpg
Data: company annual reports

Whether BlackBerry's R&D department can pull a rabbit out of the hat remains to be seen, but the company's commitment to innovation is certainly impressive under the circumstances.

Outlook

Innovation is commonly divided into two broad classes: incremental, which mainly addresses existing customer requirements and delivers gradual improvements to current product lines; and disruptive, which generates brand-new product categories that cater for needs that customers have not yet articulated.

Many companies can live off incremental innovation, sometimes for long periods depending on the particular market -- just look at the hard disk industry, for example. However, there's always the risk of being blindsided by new technologies that render incumbent product lines obsolete.

Disruptive innovation offers greater potential rewards, but pioneering companies are by no means guaranteed success. Some, like Xerox, simply fail to recognise and exploit what their R&D departments have done; others, like Kodak and BlackBerry, struggle to modify their existing business model -- especially if it has been successful for a long time.

These ideas can be expressed in evolutionary terms, with genetic mutations representing incremental innovation and recombination via meiosis representing disruptive innovation. Companies in particularly competitive markets may recognise another evolutionary idea: the Red Queen Hypothesis, which says that species must continually evolve in order to avoid extinction. The hypothesis gets its name from Lewis Carroll's Through the Looking Glass, in which the Red Queen tells Alice:

"Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

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