As Published In February 2007

Creating a Culture of Innovation
By Molly Rose Teuke

Q&A with James P. Andrew, who leads The Boston Consulting Group's global innovation practice. Andrew works with leading companies around the world on their innovation strategies and regularly counsels senior executives on issues of innovation culture, performance and leadership.

How do you define innovation? Ask 100 people, you'll get 105 different answers. I define innovation as a process that uses new knowledge to generate payback. Innovation is a process, not an event. And without payback, it's just an invention, just an idea.

Are there different types of innovation? There are three types of innovation. Incremental innovation allows you to maintain your market position. Expansionary innovation involves making a meaningful move in your business or industry by creating a new product or business model that significantly boosts your market share. Breakthrough innovation allows you to enter a new business or market, or to dramatically expand the number of customers that buy your products and services. They're all important and most companies do all three at some point in time.

How do you fit innovation within an existing business strategy, given that innovation is about pursuing something new? The real question is how to use innovation to enhance and improve your business and competitive position. It should not be something that is disconnected from your business strategy.

People often confuse innovation with wild creativity or "big ideas," but context is essential. Because a company's innovation strategy must support its business strategy, the definition of innovation has to be tied to 'What am I trying to do in my business?' The most successful companies anchor innovation in where they want to take their organization, how to create competitive advantage, and how to best serve customers. And the last point is essential because true innovation needs to generate a payback, and someone needs to think it is valuable and be willing to shell out some cold hard cash—or whatever it is may be a great invention but it really is not innovative.

You've said the choice of an innovation business model is important. Can you elaborate on that? Very simply, a business model defines what activities a company will undertake to turn an idea into cash, what activities it will turn over to somebody else, and how it is going to get paid. It can be a whole lot more complicated than that, but those three items really define the business model for a given situation.

There are three innovation business models a company can use to generate a return from an idea. Companies need to ask themselves when looking at an opportunity— Will my organization be an integrator, doing everything itself and taking on the greatest risk but also getting the greatest payback? Or an orchestrator, sharing both the risk and the payback with one or more outside parties? Or a licensor that turns over its idea (and most of the payback) to a third party who assumes much of the risk and handles commercialization?

Every company is most comfortable with one of the business models, and usually will default to it if they don't systematically think through the alternatives. But the default option may not be the best choice given the situation. The business model you choose has real implications for the probability of generating payback, as well as allocating risk and payback between different participants. Companies should very strategically think through each of the three options before selecting one.

How do you measure payback? It's critical to measure the payback your innovation efforts deliver, but it is not always easy and therefore many companies don't. And, there is no silver bullet, no single number that will tell you how successful your innovation activities are—innovation is simply too holistic to be able to fully understand how you are doing with one metric. It's important to develop a robust set of metrics that provides you with a clear picture not only of the outputs of innovation—cash payback and indirect benefits—but also the inputs, such as time and money, and the overall effectiveness of the innovation process.

For outputs, you need to measure not just cash payback, but also the indirect benefits of innovation: knowledge acquisition, brand enhancement, ecosystem strength (the marketplace system you are a part of), and organizational vitality. But even these benefits must generate cash to be of value to your company and your shareholders. For inputs, you need to track the financial resources you're committing to innovation, which most companies at least try to capture, and also the number of people you're committing to it, especially your key people. For process metrics, you can look at how many ideas move from one stage to the next in your innovation process, and how many get bogged down. You can even look at how many ideas you're generating as a company. And for those that make it to fruition, look at the difference between expected and actual end value. There are many options for each of the three categories. But the specific metrics you use are less important than the fact that you use them—and that you don't use too many or too few. We've found the right number is between 8 and 12. Less and you're not getting enough information on inputs, outputs and process. More and you get bogged down in data.

In BCG's 2006 survey on innovation, you reported that 90percent of executives see innovation as one of their company's top three strategic priorities, compared to only 67percent of nonexecutives. What's going on? We've seen that same gap every year. It's persistent and it's one of the things that differentiates companies that are highly innovative from companies that are not. If you're serious about innovation, you have to align your organization around it, but many executives get frustrated by what that requires, how long it takes, and how consistently they have to stay on message to move their organizations. Or they don't see it as a priority and delegate all that innovation stuff to somebody else. That doesn't work because the organization quickly realizes that executive leadership isn't totally committed to innovation. Innovative companies have leaders who successfully convey the value of new ideas and risk-taking to absolutely everyone in the organization.

How can managers do a better job at driving innovation through the organization? The first role of leadership is convincing the organization that innovation really matters. That sounds obvious, but it's not. Everyone needs to know where innovation fits in your business strategy—how will you win in the marketplace? The second is allocating resources. If the first thing you do every time there's a budget shortfall is chop all the resources for innovation, you're sending a pretty clear message. Breaking down organizational boundaries and assigning the right people to the right projects is important, too. Good people are always in demand, so the leader must get involved to make that happen.

And let me come back to measuring again for a minute. Because measures exist for a reason—they are not an end in-and-of-themselves. Many companies try to measure the results of their innovation efforts with piles of spreadsheets. It's not about spreadsheets. It's about making decisions and managing things holistically. A spreadsheet is a great way to run a set of financial calculations, but it's not a very useful tool for engendering the kinds of conversations you need to have about the inevitable trade-offs that come from taking that idea and turning it into a profit stream for the company. We've created something called the cash curve [see inset], a tool that provides a basis for the conversations that need to happen—conversations about whether you're taking too much risk or not enough, whether it's time to kill an effort, invest more, delay or speed up the launch, and so forth. If, for example, we make some different choices around the innovation business model, that curve will look different, with a different set of management challenges and a different set of trade-offs. To me, the biggest mistake that companies make with regard to innovation is not managing their innovation process with the same rigor and high performance standards (and support) as they manage everything else. And making sure that this happens is a significant opportunity for leaders who want to make a difference.

What about failure? One of the big differences between companies that are innovative and those that aren't is their attitude toward failure, whether people in the organization understand that at times, and in the right way, it's actually okay to fail. This ties into what we were just talking about, encouraging and modeling risk-taking.

One of the biggest laments I hear from CEOs is they don't believe their innovation portfolio has enough risk in it. What they mean is that they are very willing to take on more risk than they are having the opportunity to see, if it might lead to more growth. And I think that is because there is a dichotomy in risk tolerance between the top and the rest of the organization. The top is willing to manage their portfolios like a venture capitalist does, with a range of likely outcomes. Out of 10 projects, for instance, the venture capitalist needs just 2 to do very well. Of the other eight, one or two need to do okay and the others shouldn't use up too much money. But usually the people lower in the ranks usually see life with regards to innovation as a portfolio of one project—theirs. And that's because they believe that top management sees things that way and failures are punished.

The problem is when you haven't created a culture that's supportive of innovation, but instead have one where people have good ideas but think, 'If it doesn't work, my career is threatened or at a minimum I'm going to be off the fast track'. When people can point to top executives who have made mistakes and still survived and thrived—when they can point to colleagues whose innovation efforts failed but their careers are fine—that sends a very powerful message. Some companies actually have parties where they celebrate failures and the lessons they learned. It takes a lot of work to learn from mistakes and failures, but it's one of the things truly innovative companies do.

James P. Andrew is head of The Boston Consulting Group's worldwide innovation practice and coauthor (with Harold L. Sirkin) of Payback: Reaping the Rewards of Innovation, Harvard Business School Press.