Updated chapter13.txt

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# Section 13: Innovation

_Innovation is the process of solving large-scale organizational problems or developing new technologies and processes to more effectively pursue goals. What can we learn from past examples of innovation? What types of organizational policies and processes inhibit innovation? What are characteristics and leadership practices in organizations that have been innovative?_

## The Anatomy of Innovation

Bornstein, D. (2007). How to change the world: Social entrepreneurs and the power of new ideas. Oxford University Press. CH3 – Fabio Rosa: Rural Electrification. Author: Gobbo, Andre Francis; Editor: Rodriguez Ranf, Daniela

*The Light in My Head Went On*

Fabio Rosa was a recent graduate in agronomic engineering in Brazil and wanted to help bring electricity to rural areas of the country. One day he received a phone call from a university classmate who invited him to Palmares, which was a rural, depressed area inside of a wealthier state. The town could be described as “...reminiscent of the Mississippi Delta”, and had zero infrastructure to work with. Rosa found out that the father of his friend who invited him there was the mayor of the municipality. After a few conversations, Rosa was hired as the secretary of agriculture.

After starting the job, Rosa quickly found that there was a disconnect between what the politicians wanted (to build roads) and what the farmers wanted (for their kids to escape poverty and to maintain ownership of their farms). About 90% of the land was used solely for producing rice. In order to produce rice, the farmers needed water, which was controlled by wealthy landowners who set a high price for access to the irrigation channels and dams. Rosa had an idea to create artesian wells in order to increase access to water; however, he needed electricity in order to make this happen. Unlike the U.S., Brazil had no government work programs that brought electricity out to rural farms. As a result, about 70% of people in Palmares had no electricity.

During his research, Rosa stumbled upon an interview with Ennio Amaral, who was a professor at the Federal Technical School in a nearby rural municipality. In this interview Amaral mentioned how he brought electricity to his rural area. Instead of a conventional power distribution system involving three wires that provided more electricity than farmers needed and was subsequently too expensive, he put together a high-tension “monophase” current system that was more suitable for modest energy consumption. This monophase system had one wire, carried the current through a transformer to the house, and grounded the system in nearby soil. His plan also substituted cheaper materials than the conventional system (e.g. wood for cement, steel instead of copper, etc).

Upon further research, Rosa found that there was enough water of appropriate quality for him to implement his idea of building wells. However, the system taht Amaral developed at his community, that Rosa wanted to implement at Palmares was technically considered illegal by the state electrical companies who determined what technical standards were considered “appropriate.” If the system didn't comply with the Norm determined by the companies, then the power wouldn't get turned on. Because of this, Rosa went to the town's mayor, who eventually opened the political doors necessary for Rosa to experiment.

One of Rosa's main challenges wasto convince the farmers that his means of bringing electricity would actually work and be implemented, unlike promises that were made before Rosa arrived. Fortunately Rosa was able to collaborate with the farmers by using their materials and his ideas to create a type of well that didn't need the conventional type of power distribution. By creating this workaround, Rosa had solved one of the most serious problems with providing low-cost irrigation to farmers.

However, there was still an issue with “red” rice. Red rice is basically a weed that grows when land is continually cultivated. Because of this, farmers in Palmares only cultivated ¼ of their land at a time. Rosa had the idea of flooding the fields before planting the rise, which would prevent the red rice from growing due to a lack of oxygen. Farmers could then pregerminate the proper rice seeds and then transplant them underwater, allowing for only the proper type of rice to grow. This strategy had previously been unvailable to the farmers due to the high cost of water. However, thanks to low-cost irrigation system Rosa had created, each farmer could multiply the productivity of their land by a factor of four. Rosa had created a new equation allowing this to happen:

- **Inexpensive electricity** + **shallow artesian wells** + **monophase pumps** = **cheap irrigation **
- **Cheap irrigation** + **water seedling** = **more efficient land use, increased income, and a future for rural communities **

In Brazil, people in rural areas were leaving in order to find work in the cities. As a result, people were forced to live in shantytowns, unemployment was driven up, and crime rates were increasing. Rosa's equation struck at the root of this problem by giving people in rural communities the access to create their own sustainable wages.

Rosa took this idea to the federal agency that was involved with long-term national development funding, who pounced at the idea. However, there was a substantial obstacle due to political opposition from the state electric company, Companhia Estadual de Energia Eléctrica (CEEE), and from cement and aluminum cartels. As such, Rosa had to muster up political support for his cause for the ensuing battle.

During this time, Rosa had found a means to cheapen the costs of implementing his strategy. He contracted with two state companies in order to build five kilowatt-amp transformers that were necessary for his system. The farmers supplied trees from their properties for electric poles, which Rosa had managed to configure such that he could use fewer than what was required by the government. Rosa even found a way to extended the life cycle of the poles by dunking them in a chemical solution called creosote.

As this was going on, CEEE withdrew Rosa's permission to engage in his project. Because Rosa's model was threatening that of CEEE's, CEEE held a meeting where they tried to cut a deal. CEEE would provide electricity to Palmeras through the proper grid if Rosa's idea was completely abandoned. However, Rosa countered by saying that his solution could be implemented throughout the entire country, whereas the preexisting electric grid couldn't. Fortunately the national development bank got involved and managed to get the state electric company to stand down.

As a direct result of Rosa's work, 400 families were provided with electricity at a cost of $400 per family, which is significantly cheaper than the government's cost of $7000 per family. Those farmers that switched to the water seedling approach saw their incomes jump from $50-$80 per month to $200-$300 per month. Almost a third of the houses (130 of 400) were people who returned to the rural town from the city because of the project.

Due to the popularity and success of the project, CEEE got involved again because they didn't want a major challenge to their distribution norm. They claimed that the results from Rosa's system were inconclusive and couldn't be recreated anywhere else. It took another year before the CEEE caved and turned Rosa's system into a norm, called the 025 Norm. This meant that Rosa's system was no longer breaking any laws.

Shortly after these successes, the mayor of Palmares was forced out due to term limits, and the new mayor completely halted Rosa's project. Fortunately Rosa's work had taken root in various parts of the municipality, and had positively affected the lives of many. However, Rosa was now out of a job.

Fortunately, the national development bank put Rosa in a different municipality. From there Rosa continued to promote rural electrification, and was leased land to experiment with rice planting techniques. He eventually started another project to bring electricity to 25,000 low-income rural dwellers. Through this project he discovered that the technique of delivering electricity he developed in Palmares could be applied widely to other forms of farming. Rosa and a colleague at the national development bank partnered with the best electrical engineering university program in the country to establish a resource center that utilized the newly established 025 Norm as the central standard. This had ended any and all conflict that the could only work in one place. A credit line was even established with this as the Norm, however economic issues eventually forced the credit line to get slashed.

Due to these political constraints that Rosa kept encountering, he gave up on working with the government and decided to establish a private company. Through this company he started to spread photovoltaic solar cells around the country. However in order to offset such high costs of implementation he had to package the solar cells with something else. He eventually discovered that if he sold solar energy as a package with electric fences he could bring down the prices of fences by about 85%. This meant farmers could receive electricity, increase farm production, and improve land management all at once. Over the course of 5 years he established 700 solar electric and fencing systems in 16 different Brazilian states.

As this was happening, different states had continued to consult with Rosa about the 025 Norm in order to pursue rural electrification. One state launched a $34 million plan to bring electricity to 160,000 people, while another state launched a $240 million project to bring electricity to 800,000 people. However both of these projects eventually fell short of their goals due to a lack of motivation and follow through.

In the mid-1990s a political movement started by farmers who could no longer subsist on their land began to gain traction. As a result of this, the government sought a short-term solution by placing these people on certain tracts of land, but without any electricity. The lands they were put on were grass lands, which were best for grazing instead of farming. This resulted in farming practices that caused environmental degradation and the perpetuation of poverty. A quarter of people who received land had abandoned it in 2 years, while some regions saw almost half of their land get deserted. Rosa saw this problem, and sought to find a solution.

Rosa found it in a book by Andre Voisin published in 1957, who developed the idea of rational or managed grazing. This technique was designed to avoid overgrazing, and was implemented successfully in parts of France, New Zealand, Canad, and the U.S. It was originally introduced to Brazil in the 1970s, however it was met with disappointing results and was ultimately scrapped.

Rosa found that the system only worked if there were several small paddocks created a low cost. He eventually found that small paddocks could be created with the use of electric fencing and appropriate technology. By adjusting the original formula from the 1970s to account for things like fences being drained of their currents by tall plants and other region-specific issues, he was able to develop a system that maintained an effective current throughout the fence. This led Rosa to creating another equation:

- **Solar energy** + **polywire** + **fiberglass posts** = **inexpensive fencing**
- **Inexpensive fencing** + **Voisin managed grazing** = **higher yields, sustainable land use, and a future for even more rural communities **

As a result, he saw that most farmers' yields doubled or tripled. Unlike his previous innovations, this time he didn't have to worry about government involvement because the system was being propagated through market demand.

Eventually Rosa stepped down from his business in order to build up a nonprofit that he had started a few years prior to spreading solar cells and electric fences. He sought to use this nonprofit to apply the models he developed in his private business to those poorer areas where the for-profit model didn't quite fit. He started by focusing his efforts in southern half of Rio Grande do Sul, where 250,000 people lacked electricity, and then targeted 13,000 poor families.

Rosa conducted a market study and found that more than half of families were spending $13 each month on diesel fuel, kerosene, and batteries. He correctly thought that people could instead spend this money on monthly payments for a renewable energy supply, equipment, and service. Farmers could rent systems or slowly pay them off at a rate close to $13. Poorer people could also afford this, but they needed more help. So in order to reach the entire market, Rosa designed two projects: one nonprofit, and one for-profit.

The nonprofit was called the Quiron Project, which was a venture designed to boost the incomes of 7,000 poor families through a combination of solar energy, organic animal production, managed grazing, and other means of resource conservation. The for-profit was called the Sun Shines for All project, which sought to provide solar energy to 6,100 families that had no electricity but could afford rates of solar panels through renting. His company would break even between 42 and 48 months, and provide 20-30% return for investors in addition to social and environmental benefits.

As a result of all of this work, Rosa was recognized as one of the first 40 people to be honored by the Schwab Foundation for Social Entrepreneurship. He also won a $50,000 award from the Tech Museum of Innovation associated with the San Jose Tech Museum for applying technology to benefit humanity. He was one of 5 winners that were chose from 400 nominees hailing from 50 countries. The good news kept coming, as the Solar Development Group, a company based in Washington, DC, agreed to invest in The Sun Shines for All project in 2002. He also received funding fro the Quiron Project from a wide variety of other wealth funders. Thanks to Rosa's tireless work, he helped bring about a fundamental change that institutions can establish reliable, long-term credit relationships with poor people across the world.

## Origins of Innovation

Gladwell, M. “The Creation Myth: Xerox PARC, Apple, and the Truth about Innovation.” The New Yorker, May 16, 2011. Author: Boucher, Timothy M.; Editor: Berkley, Njeri N

This article describes the struggle that exists between the innovators and the management that oversees them in a business structure. The article uses as its primary case study the Xerox Palo Alto Research Center (Xerox PARC) to describe the inevitable clash that frequently exists in in an organization where innovators are relied upon to generate new product ideas (or reforms) but also reeled in by management that is fearful of wasting precious resources on potentially unprofitable ideas.

The article starts with a discussion of how Steve Jobs visited Xerox PARC’s facilities in Palo Alto, California in 1970. He had worked out an agreement with Xerox wherein he would allow them to buy 100,000 shares of his company for $1,000,000 and in exchange PARC would “‘open its kimono’” so that Jobs could see what they were working on. It was during this open door adventure that Jobs got to see the prized PARC personal computer, called the Xerox Alto. Jobs saw how someone operating the Alto could command the computer to do things using a “mouse,” a concept that up until that point was unheard of. Jobs also saw how the mouse could be used to seamlessly move from task to task on the computer, an idea that fascinated him.

Jobs would later take the innovations he saw and PARC and work with others at his company to hone, refine, and to a certain degree re-invent them into a marketable product that would ultimately become the first Macintosh. Jobs later commented that “‘If Xerox had known what it had and had taken advantage of its real opportunities, it could have been as big as I.B.M. plus Microsoft plus Xerox combined – and the largest high-technology company in the world.’” Jobs’ guiding principle, it appears, was to have the PARC ideas become manufacturable for a fraction of the cost and that would last the consumer a considerable amount of time before breaking. However, he made explicit to his designers that he did NOT want them to reproduce the concepts at PARC, but rather he wanted them to simply build off the ideas from PARC and make them better. Xerox’s principles, on the other hand, appeared to be more driven by analytics to determine what research and innovation had the best marketability.

The rest of the article cites numerous other instances in which creative types take the ideas of others and hone, refine, and improve them in order to develop the modern marvels that we have all come to see in the marketplace. For instance, the article references the development and use of Revolution in Military Affairs (R.M.A.). This concept, which is “the way armies have transformed themselves with the tools of the digital age – such as [using] precision-guided missiles, surveillance drones, [etc.]” was first pioneered by the Soviet Union. However, the Soviet Union’s “centralized military bureaucracy, with a long tradition of theoretical analysis” was not equipped to turn the concept of R.M.A into workable technologies that it could utilize. It took the entrepreneurial culture of the U.S., which was “orient[ed] toward technological solutions” to develop a technology (here next-gen command and control systems). But the U.S. didn’t really “need” those technologies at the time, and it took a country like Israel, who was “resource constrain[ed]” and under “constant threat” to take the technology developed by the U.S. and put it into practice during their conflict with the Syrian Air Force.

The above serve to show that innovation does not necessarily take the stereotypical form of in-house research and design (R&D) by one company and that company then suddenly creates the latest and greatest technology. Instead, many of the world’s most useful and creative innovations have come from collaboration that crosses typical competitive boundaries between businesses, and even countries. Similarly, the article informs innovators that they should not be discouraged by corporations refusing to take to market every one of their ideas. The article notes that genius is the idea that one pushes out thousands of ideas for the hopes of getting just one published, put to market, or further developed. Because businesses have to make money, they cannot possibly produce every idea that an innovator comes up with, and instead have to pick and choose (usually based on analytics) how they will proceed. It may be that a given idea would have made a fortune, but companies cannot always know that. Instead they have to take gambles on certain innovations while leaving others behind. This is the struggle that resulted in Xerox not pursuing the personal computer market, and leaving open a void for Apple to fill.

Heath, C., & Heath, D. (2013). Decisive: How to make better choices in life and work. Random House. CH 4: Find Someone Who Has Solved Your Problem.

Heath, C., & Heath, D. (2013). Decisive: How to make better choices in life and work. Random House. CH 3: Multi-Track.

## Experimentation and Risk Management

Collins, J., & Hansen, M. T. (2011). Great by Choice: Uncertainty, Chaos and Luck-Why some thrive despite them all. Random House, CH4 – Fire Bullets, Then Cannonballs. Author: Lancto, Katelyn N; Editor: Legnetto, Deanna Marguerite

**Great by Choice: Uncertainty, Chaos, and Luck – Why Some Thrive Despite Them All
Chapter 4: Fire Bullets, Then Cannonballs**
Jim Collins and Morten Hansen

This reading looks at what makes a company successful when compared against lower performing companies in the same field. When the authors began their research, they believed that innovation might be one of the primary distinguishing factors for success in industries characterized by rapid change. However, their research ended up showing that the most successful companies are not necessarily the most innovative.

The authors begin by looking at two airline companies, PSA and Southwest Airlines. In the early 1970s, PSA was widely successful in a California market, providing a fun environment, consistently on-time flights and low fares for their customers. Southwest decided to copy their model down to the smallest detail in the Texas market without innovating much, if anything. This case study is interesting because today, PSA no longer exists despite having one of the most successful airline business models of the 20th century.

In the biotechnology industry, you might expect the correlation between innovation and success to be 100%, different from the airline industry. Looking at two particular companies, Genetech and Amgen, the authors found that Genetech far outpaced Amgen in patent productivity (innovation), while Amgen far outpaced Genetech in the area of financial performance (success). Even though Genetech was known throughout the industry for having an “unparalleled record in the industry at creating major new breakthroughs” Amgen was the company that consistently saw profits.

The evidence indicates that 10X companies (companies that outperform others in their industry by a factor of 10) are not necessarily more innovative. In some surprising cases, such as Southwest versus PSA and Amgen versus Genetech, the 10X companies were in fact less innovating than the comparisons.

A study done by Gerard J. Tellis and Peter N. Golder in Will and Vision discovered that only 9% of pioneers ended up as the “winners” in a market. In fact, 64% of pioneering companies failed outright. What this really showed is that pioneering innovation is good for society, but statistically “lethal” for the pioneer.

However, the study did not find that innovation is unimportant. Every company in the study participated in innovation. 10X companies innovated less than would be expected relative to their industries and their size. They were just innovating enough to be successful, but they are not generally the most innovative in a given field. Therefore, the authors of this reading concluded that there is a level of “threshold innovation” in any industry that you need to meet in order to be a contender in the game. If you don’t meet that threshold level of innovation, you cannot win. But once you’ve met that threshold, being more innovative doesn’t end up mattering much.

What really matters is a combination of creativity and discipline. “The great task, rarely achieved, is to blend creative intensity with relentless discipline so as to amplify the creativity rather than destroy it. When you marry operating excellence with innovation, you multiply the value of your creativity.” (Collins, page 78). For example, in the early 1970s, Intel introduced a 1103 memory chip into the market months behind the completion, but they passed and utterly crushed the competition with a simple model, “Intel Delivers.” Intel obsessed over manufacturing, delivery and scale, which ended up leading to great success. The core value of Intel is discipline, and this paired with creativity and innovation leads to success.

One of the most useful tools to succeed in this combination is to fire bullets, then cannonballs. Imagine you are stranded on a ship at sea with a hostile ship approaching, and you have two options; you can use all your gunpowder for a single cannonball that would destroy the ship if it hits, but you run the risk of missing completely. Or, you could fire some bullets until you are able to hit the ship, calibrating the distance, ensuring that your cannon could hit when you do fire it. That is how successful companies approach innovation.

Take Amgen, for example. In 1980 they began working on a small company with a simple idea; get the best people, fund them to throw the latest recombinant-DNA technology at a bunch of different ideas until they hit something that would work, then create the product and build a successful company. They tried the technology on virtually everything, firing bullets until they landed on a success with erythropoietin (treats anemia). Then they fired a cannonball by building their company around this success and EPO became the first super-blockbuster bioengineered product in history. You start by firing bullets to see what works. Once you have empirical confidence, you concentrate your resources and fire a cannonball. Then you focus on production to make the most of your success.

A bullet essentially is an empirical test aim at learning what works and it mist meet three criterial; (1) it must be low cost; (2) it must be low risk, meaning that there is minimal consequence if the bullet hits nothing; and (3) it must be low distraction for the enterprise overall.

10X companies were much more likely to fire calibrated cannonballs, versus comparison companies that were more likely to fire uncalibrated cannonballs before ever firing a bullet. The study found that whether fired from a 10X company or a comparison company, calibrated cannonballs had a 4 times higher rate of success than uncalibrated cannonballs (88% to 23%).

Returning back to the demise of PSA, in 1968 PSA launched the “Fly-Drive-Sleep” initiative, pairing airfare, hotel and car rentals all in one company. They leased hotels and bought car companies on a large scale. However, this initiative led to consistent losses every single year. Even further, in the 1970s PSA bought five L1011 super-wide-body jumbo jets at a high price. It required substantial upfront investment, they made modifications that would make resale difficult, and the oil embargo led to increased gas prices. These were uncalibrated cannons. PSA never returned to its prior greatness and continued firing uncalibrated cannons until they were forced into a buyout. “If an enterprise gets slammed by a series of shocks just as its uncalibrated cannonballs go crashing off into space, it’s more likely to have a catastrophic outcome.” (Collins, Page 85).

Another key difference between 10Xers and comparison companies is that 10Xers learn from their follies. When a 10Xer fires an uncalibrated cannon, they quickly recover and learn from their mistakes, returning to the bullet-then-cannonball approach. Look at Progressive, for example. This insurance company had a policy of limiting new business to 5% of total corporate revenue until it can be fine-tuned for sustained profitability. In other words, they fired bullets, then cannonballs. But they mad a mistake in the mid-80s by firing an uncalibrated cannonball by taking on the trucking industry, which led to heavy losses. Progressive vowed never to make the uncalibrated cannonball mistake again and applied the lesson to its move into standard auto insurance. Progressive used bullets to test out the standard insurance industry in states where it was familiar before expanding. By 2002, Progressive was the #4 auto insurer in the country.

What’s more, Progressive used the same model with home owner’s insurance, which helped it avoid losses. They decided to fire bullets in the home owner’s market by testing in a handful of states, but these bullets hit nothing. Progressive decided to pull the plug and did not fire a cannonball. “In the face of instability, uncertainty, and rapid change, relying upon pure analysis will likely not work, and just might get you killed. Analytic skills still matter, but empirical validation matters much more.” (Collins, page 88). You don’t even need to be the one firing the bullets if there is empirical experience available from others (such as with Southwest copying the previously successful PSA model).

The importance of empirical validation cannot be understated. It’s not that 10X companies were predictive geniuses, but they are skilled at the fire-bullets-then-cannonballs approach. Bill Gates and Steve Jobs are thought to be technological visionaries, but even they cannot perfectly predict. In 1987, Bill Gates needed to decide between the DOS/Windows operating system or OS/2. He chose OS/2, but at the exact same time, he hedged his bets by continuing Windows development, just in case. It was this productive paranoia that made him successful. “Gates was smart enough to know that he wasn’t smart enough to predict with certainty what would actually happen to OS/2.” (Collins, page 89). In 1989, Windows was winning and Gates was able to switch gears and bet on Windows. By 1992, Windows was selling more than a million copies per month.

Fast-forward to when Steve Jobs decided to move Apple into retail stores in the early 2000s, he hired Mickey Drexler, CEO of the Gap, to share his empirical experience. He suggested that instead of a big launch with 30 or 40 stores, that they start by building a prototype and adjusting until they got it right before any big launch. Jobs followed that advice and it paid off. This was a prime example of firing a small bullet before unleashing a large cannonball.

Steve Jobs ultimately left Apple in the 1980’s because of differences with the ten-CEO. He watched the company flounder and stagnate before his return in 1997. After his return, he did not focus on rapid innovation, but rather, discipline. Without discipline, there was no chance for creativity. He started by cutting perks and cutting the fat that was slowing the company down. Instead of looking for the “Next Big Thing,” they focused on building the success they already had, namely, the Macintosh personal computer. While furthering computer innovation, Apple pursued additional emerging technologies in the market.

Apple was not the first company to introduce music file sharing and MP3 players. Jobs felt that they were behind when that technology surfaced. Apple pulled together an MP3 player along with supporting software for macs, but they didn’t see this as a cannonball, more of a bullet. It was an expansion of what they already had. They were increasing empirical validation. They took a step by launching an online music store where people could buy music instead of stealing it. This only added to their empirical validation. Then, the big cannonball; they made iTunes and iPods for non-mac computers.

In the end, it is not rapid innovation that predicts success. What is important is discipline, combined with innovation and expansion based on empirical validation. Creativity and discipline are the brick and mortor of some of the greatest success stories from Southwest Airlines to Amgen to Apple.

Heath, C., & Heath, D. (2013). Decisive: How to make better choices in life and work. Random House. CH 7: Ooch.

## The Financial Architecture of Innovation

Lerner, J. (2012). The architecture of innovation: The economics of creative organizations. Harvard Business Press. CH1 – The Search for Innovation and Growth. Author: McCully, James I; Editor: Legnetto, Deanna Marguerite

The article begins by detailing two business acquisitions, starting with Google’s acquisition of Motorola in August 2011. The author details the manner that Motorola focused on incentivizing innovation despite the company not being known for a while, to be particularly innovative. Motorola had focused on filing patents and any employee that was successful in doing so was rewarded with a bonus worth several thousand dollars. Researchers who made at least ten patent filings were given gold-colored employee badges, twenty-five filings awarded a platinum-hued one, and all these plateaus came with additional financial bonuses. This incentivized getting as many patents filed as possible but Motorola failed to pursue the innovations that led to fundamental changes in their key markets. Between 2006 to 2010, Motorola fell from number one to number eight in U.S. shipments of mobile handsets; they were not being innovative in the right areas. In contrast, eBay’s purchase of Skype began with the failure of Kazaa, a peer-to-peer sharing network that was enormously successful but was brought down by the music industry over illegal sharing of music files. However, after this initial demise, the idea of using a peer-to-peer network was revamped for making phone calls without any costs. With the support of venture-backer, Howard Hartenbaum, this idea was refined and together with other early investors nurtured the company and the rough idea blossomed into the production juggernaut we have today. It was eventually purchased by eBay for $2.6 billion. Therefore, the author askes how do we distinguish the two situations and how do we innovate in the right manner to be successful?

“The Architecture of Innovation” looks into the importance of innovation and the process to accomplish it successfully. Many feel it is a random process where a few get lucky and many fail without any concise logic or system to abide by. However, the author focuses on the power of incentives in shaping the behavior of those who design and commercialize innovations. Appropriate rewards are required, if not many good ideas languish unused, and researchers end up pursuing useless ideas instead. But creating incentives for innovations is not simply a matter of “more is better” as too-strong and too-short-term incentives can actually be counterproductive in boosting innovation.

Using the two examples given earlier regarding Motorola and Skype, the author proposes a hybrid model that combines the best features of the corporate research laboratory and the venture-backed start-up. Through this method, the powerful motivations and focused goals associated with venture capital can be preserved, while the limitations that circumscribe the effectiveness of this intermediary can be overcome. However, this is more easily conceptualized than implemented, with corporations launching a variety of initiatives to foster “open innovation,” or the development of ideas from outside the corporate walls have generally failed. Failure can be pointed at corporations’ unwillingness to offer significant rewards or to relinquish control. Therefore, an examination into the experiences of corporate venturing programs can illustrate these issues since in theory the resources and long time perspectives of a large firm should make these programs particularly effective.

An example given by the author is from the Xerox Palo Alto Research Center (PARC) failure and the resulting birth of Xerox Technology Ventures (XTV). PARC was remarkably successful in developing ingenious products that fundamentally altered the nature of computing, such as the Ethernet, the graphical user interface (the basis of Apple Computer’s and Microsoft’s Windows software), the “mouse”, and the laser printer. The culmination of all these innovations came in the form of the Alto, a very early personal computer. The Alto’s prototype was placed in the White House, Congress, and various companies and universities. Despite the early success, the Alto project was terminated due to internal differences and discouraged employees leaving to form their own companies in search of more recognition and financial rewards. Eventually, the value of these companies would be worth ten times more than Xerox. The XTV was established as a result of these previous failures. As Xerox chairman, David Kearns stated at the time, “XTV is a hedge against repeating missteps of the past.” Therefore, the modeling of XTV was unique since it was a corporate division and not an independent partnership like most venture organizations. The XTV partners crafted an agreement with Xerox that resembled typical agreements between limited and general partners in venture funds. The spinout process was laid out so that there was no ambiguity, great flexibility to respond to investment opportunities and full autonomy when it came to monitoring, exiting, or liquidating companies. The partners were allowed to spend up to $2 million dollars at any one time without getting permission from the corporation. Additionally, the level of compensation and time frame for partnerships were analogous to independent venture organizations. This structure was also extended to companies in which XTV invested in, as they were structured as separate legal entities with their own boards and officers. XTV also insisted, against the objections of their lawyers, that the employees would receive options to buy real shares in the venture-backed companies, in line with traditional Silicon Valley practices. This independence of management was also extended to technological decision making in these companies as the traditional Xerox products was designed so that it could be operated and serviced in almost any country in the world. No such restrictions were made for XTV ventures since they could produce products for “leading edge” users, who emphasized technological performance over extensive documentation. Under this system, XTV was able to successfully commercialize technology that was lying fallow in the organization but also generated attractive financial returns as well.

One example of the successes of XTV in the commercialization of technological discoveries was Documentum, which marketed an object-orientated document management system. Xerox had previously undertaken a large number of projects in this area for over a decade but had not shipped a product. By recruiting two specialists, they were able to assess the market and Xerox’s knowledge in the area, in turn creating a marketable product. Documentum went public with a market capitalization of $351 million, a conservative calculation indicates that the $30 million invested by Xerox generated capital gains of at least $175 million. Additionally, the same assumptions suggest a net internal rate of return (IRR) for Xerox of at least 56 percent, which compares very favorably to independent venture capital funds IRR of 14.9 percent. This does not include the ancillary benefits generated by this program. Since it is possible that other high expected value projects might not have been funded due to high risk but were because of fear that it might have been funded by XTV and be successful.

Despite this success, Xerox terminated XTV and replaced it with Xerox New Enterprises (XNE) that sharply cut the autonomy that was a large reason for XTV's success. A reason behind the change was that the program was only rewarding those working on marginal technologies that distracted researchers from their critical job of designing better copiers and printers. Another reason was that corporate leaders felt the financial compensation for successful venture teams was too high and that having midlevel functionaries in an obscure initiative being the highest-paid executives in the corporation did not create great enthusiasm for those in control. Regardless, XTV as a hybrid program did show that this system is not impossible to pull off and is not part of any random outcome, but rather came together with careful thought and planning.

The author states that this type of hybrid model is very different from the usual “pipeline model” where innovation results inevitably from spending more on basic research. Furthermore, these "pipeline model" initiatives have had miserable results, citing to Jimmy Carter’s creation of U.S. Synthetic Fuels Corporation to stimulate advanced energy research as one of those failures. The author believes that it is necessary to predict the future for innovation but it is not the complete solution. Innovation is complex and multifaceted; evidence shows that greater attention to the ways in which organizations and incentives can shape the innovation process, can produce significantly better results. Given the importance of innovation to both developed and developing countries' economies, the proposed solution of using a hybrid model for better and greater innovation is necessary.

## The Organizational Architecture of Innovation

Christensen, C. (1997). The innovator's dilemma: when new technologies cause great firms to fail. Harvard Business Review Press. CH5 – Give Responsibility for Disruptive Technologies to Organizations Whose Customers Need Them. Author: Rodriguez Ranf, Daniela; Editor: Swartwood, Hilary Ann

_Clayton M. Christensen_

**Chapter 5: Give Responsibility for Disruptive Technologies to Organizations Whose Customers Need Them**

In this chapter Christensen elaborates on the idea that in practice, it is a company’s **_customers_** who effectively control what it can and cannot do. He also explains the **resource dependence theory**, a controversial theory supported by a minority of management scholars that suggests that a company’s freedom of action is limited to satisfying the needs of those entities outside the company (customers and investors, among others) that provide the resources it needs to survive. The theory further posits that organizations will survive and prosper only if their staff and systems serve the needs of customers and investors by providing them with the products, services, and profit they require; and that organizations that don’t structure themselves in this way, will ultimately die off. The controversial aspect of this theory is that it stipulates that managers are powerless to change the direction of the companies against the desires of their customers: “it is forces outside the organization, rather than the managers within it, that dictate the company’s course.” According to resource dependence theory then, the real role of managers is only symbolic in companies whose staff and systems are ‘well adapted to survival’. This is a disturbing idea for anyone who has managed companies and people, particularly those who see their role as change-makers. However, Christensen explains that based on findings reported in this book provide support to the resource dependence theory, p. Particularly, the point about how customer-focused resource allocation and decision-making processes of successful companies are far more powerful in directing investments than decisions from executives.

The question then is, if customers employ vast power in influencing and directing a company’s investments, **what should managers do when faced with disruptive technology that the company’s customers do not want?** Christensen proposes two options: 1) to convince everyone in the company that they should pursue it anyway by explaining the long-term strategic importance, despite rejection from customers who provide revenue and despite lower profitability than the upmarket alternatives; or 2) to create an independent organization and embed it among emerging customers that _**do**_ need the technology. Cases presented in this chapter serve as evidence for why the second option offers higher probabilities of success than the first.


The mechanism by which customers control the investments of a company is through the resource allocation process: the process that determines which initiatives get staff and money, and which do not get resources. Resources determine whether a project will survive or fail. As Christensen describes it, “only those new product development projects that get adequate funding, staffing and management attention have a chance to succeed; those that are starved of resources will languish.” Resource allocation and innovation are then two sides of the same coin and patterns of innovation in a company will mirror the patterns of where resources are allocated in a company. A good resource allocation process includes a vetting process to filter out proposals that customers don’t want. According to Christensen, if this process works well, products that customers want will get funds and products that customers don’t want should not, and that t. This is how companies must work and that the better companies follow this approach the more successful they will be. From an internal process and company dynamics perspective, Christensen explains that non-executive participants make their resource allocation decisions by 1) deciding which projects to propose and give priority to senior management based on an understanding of what types of customers and products are most profitable; and 2) by how their involvement or sponsorship of a potentially profitable innovation project/program could impact their career trajectory. Christensen says iIt is through the combination of seeking company profits and personal success that customers wield a profound influence on resource allocation.

Christensen breaks down the system of customer control through three cases from the history of the disk drive industry to demonstrate how managers can develop strong market positions in a disruptive technology. In two cases for Quantum and Plus Development, as well as for the Control Data Corporation in Oklahoma, managers spun out independent companies to commercialize the new disruptive technology, which allowed them to harness the forces of resource dependence. In the third case of Micropolis Corporation, the manager chose to fight the customer forces from within the mainstream company; t. The company survived the project through sales of a new product line, but not without enduring many losses that included walking away from all of their major customers, and survived due to sales of a new product line. . The manager of this last case concluded that the experience of transitioning was one of the most exhausting of his life.

Disruptive technologies have had a deadly impact in many industries beyond disk drives. Christensen presents three other examples of the effect of disruptive technologies in the following industries: computers, retailing and printers. These examples highlight how only companies in these industries where those that harnessed rather than fought the forces of resource dependence survived.

_**DEC, IBM, and the Personal Computer**_
The company that was most affect by disruptive technology is Digital Equipment Company (DEC), which failinged in just a few years as stand-alone workstations and networked desktop computers avoided most customer’s needs for minicomputers. It failed four times to build a profitable business model, four timesand to withdrawing from the personal computer market. Christensen argues that in trying to enter the desktop personal computing business from within its mainstream company, DEC was force to straddle two different cost structures based on two different value networks. In contrast, IBM had significant success in the first five years of the personal computing industry. The emergence of the minicomputer represented a disruptive technology to IBM, the industry’s first leader and its competitors. Customers didn’t yet have a use for it, and the market was initially significantly smaller, so as a result makers of mainframe computers ignored the minicomputer for years. Apple and IBM who were the leading desktop makers did not introduce portable computers until the portables’ performance trajectory intersected with the computing needs of their customers. Its success was due to IBM’s creation of an autonomous organization in Florida that was free to procure components from any source, to sell through its own channels, and develop a cost structure appropriate to technological competitive requirements of the personal computer market.

The conclusion is that it is very hard to manager two cost structures and two profit models within a single company, as the positon in one market will suffer unless two separate organizations, embedded within the appropriate value networks pursue their separate customers.

_**Kresge, Woolwoth, and Discount Retailing**_
Few industries have been impacted more severely by disruptive technology than in retailing, where discounter companies seized dominance from traditional department variety stores. It was disruptive because the quality and vast selection offered by discounters created a chaos in the traditional metrics for quality retailing and the cost structures were radically different to compare between their value networks. Just as in disk drivers, a few traditional retailers like S.S. Kresge (K-mart), F.W. Woolwoth, and Dayton Hudson (Target) saw the disruptive approach coming and invested early. None of the others (Sears, JC Penney, among others) made significant attempts to create business discount retailing. Kresge and Dayton Hudson both created focused discount retailing organizations that were independent from their traditional business and they succeed. By contrast F.W. Woolwoth (Woolco), tried to create it from within the traditional variety store company and failed. Woolwoth’s organizational strategy for succeeding in disruptive discount retailing was the same as DEC’s strategy fior launching the personal computer, and neither could achieve the cost structure and profit model required to succeed in the mainstream value network. Kresge achieved alignment by cutting off the customer base that historically had provided the company’s resources, thereby intensifying Kresge’s dependence on the new source of resources in discount retailing.

_**Survival by suicide: Hewlett-Packard's Laser Jet and Ink-jet Printers**_
Hewlett-Packard’s experience in the personal computer printer business illustrates how a company’s pursuit of a disruptive technology by spinning out an independent organization might entail killing another one of its business units. Ink-jet printing was a disruptive technology because it was slower than laser jet, the resolution was worse, and its cost per printed page was higher, but it was smaller and less expensive than the laser jet. Rather than attempting to commercialize both from the main HP printer division, it created a completely autonomous organizational unit in Vancouver, Washington responsible for making in-jet printers a success. HP then let the two compete with each other. Ultimately, the ink-jet printer was more successful and one of HP’s businesses may have killed the other, but. However, Christensen suggests that had HP not set up its ink-jet business separately, the ink-jet technology would probably have failed within their mainstream laser jet businesses.

Aside from creating organizational distance between mainstream enterprise and the organization charged with commercializing the disruptive technology, Christensen suggest there is a second dimension: the team should be structured to facilitate the cross-functional interaction that is characteristic of different types of projects. BThe best projects at this of an industry’s development are best managed by a tightly integrated teams. According to Christensen’s research says that, scholars have found that overtime, the patterns of interactions and communication between the individuals and groups within the organization will come to mirror the manner in which the components themselves interact within the product architecture. Christen emphasizes that “the organizational structure and the patterns of working together work well as long as the innovations are modular, meaning as long as the technological change is largely self-contained within each component and does not require that other components in the system be redesigned to accommodate the change.” He explains that when a new project involved a new architectural design, then the structure and patterns become barriers rather than facilitators. The same thing applies at the broader level when a product requires manufacturing, purchasing and marketing to coordinate their activities around different questions at different points than the norm, then a strong team is important.

It is important to note that no single model is appropriate for all types of products and technologies. Major development projects that involve significant architectural innovation, that require different patterns for working, but that are sustaining in character, can be managed by a strong team within the mainstream organization. However, disruptive projects, can only thrive within organizationally distinct units.