A couple of weeks ago I posted “How innovative is your organization” in order to discuss some fundamental aspects of innovation. In this post we will look at the impact of innovation. My personal observation is that most organizations see innovation as a very positive measure. Of course, being innovative sounds fine and offers a lot of benefits, e.g. to protect competitive advantages. But to tell the truth, this statement is a little bit too general. Hence let us look at some research results: There is no simple and direct interrelation between innovation and corporate success like “the higher the rate of innovation the more successful the company”. Indeed, 70 % of above average successful companies use a growth and innovation approach in their strategy. Hence it could be argued that innovation would be a generally appropriate instrument to increase corporate value. But results from two different research projects indicate that factors like market size and complexity can also have an impact on the success of an innovation.
Outcome of the PIMS-Research. In the early 60’s the PIMS-research project (Profit Impact of Market Strategy) was started by Fred Borch (GE). The project was managed by Sidney Schoeffler (Harvard Business School). Objective of the PIMS-project is to identify the “laws of the market place” by collecting and analyzing data from various industries. The next stage in analyzing data is to derivate those factors, which are essential for the corporate success. The result of this research project was the identification of 8 major success factors. Using these 8 factors it is possible to explain 70 – 80 % of the variation in success of a business unit. To measure success the ratios ROI (return on investment) and ROS (return on sales = net profit before tax and interest related to sales) will be calculated. The factors are: Investment intensity, productivity, and market share, degree of market growth, quality, degree of innovation; vertical integration, and customer profile.
The degree of innovation represents the percentage of sales of those products, which are not older than three years. But in terms of innovation impact it is essential to consider another factor, too. To gain a positive impact from an innovation on corporate results it is required to own a certain market share. If this is not achieved, costs of innovation are higher than the value added from innovation.
In summary it can be argued that – due to its costs – an innovation has a positive effect on the results in the case that the company has a sufficiently high market share. In the case of small market shares innovations can have a negative effect on corporate success.
Required skills. Innovations require a specific set of skills, e.g. creativity, risk taking, flexibility. A previous study from ADL highlights a specific dilemma: There are very innovative companies that only achieve low financial results or have faltering sales (e.g. Swiss CIBA) or that destroy corporate value (e.g. Airbus). On the other hand there are traditional companies without much innovation that are very successful (e.g. fertilizers maker K+S) (Von den Eichen et al, 2007).
What happened to the first group of highly innovative companies? In terms of strategy the core problem is the link between innovation and complexity. In the case of the first group innovation was combined was an increasing level of complexity. (e.g. a number of problems with the highly innovative Airbus A 380 was caused by the fact that this plane is an extremely complex product which relied on a complex network of suppliers). Lessons learned for corporate management: Managing innovation has to include management of complexity that might occur from innovation. Having this in mind we have identified an important issue for the strategic planning process (I will discuss the link between innovation and strategic planning in the future – hence keep in touch with Eddielogic!). Taking into account the possible impact of an innovation (to replace or to modify the business model of an industry) it can be understood why the complexity issue occurs. A very important activity or process will
- Be changed
- Be added
- Be adapted and exploited to enter a new business segment
Take for example the essential steps that a camera maker has to make to participate in the shift from traditional cameras to digital cameras. Traditional cameras combined mechanical components with digital components (e.g. to measure exposure) and did not have a full color LCD monitor on its back. Digital cameras have different components; hence camera makers had to find new suppliers and had to develop new competencies for running a different production process. Not all camera makers where able to keep up with the competition (e.g. Minolta left the camera business and sold its production to Sony a couple of years ago.)
It should also be considered that well-established competitors will not ignore the new business rules. This issue represents another factor that should be taken into account within the strategic planning process.
According to an ADL-study results it is essential that organizations bring innovation, complexity, and strategy into line. This is the most crucial aspect! Companies that manage this adjustment achieve a profit margin before interest and tax that is 6times higher than that of other companies. Further effects include a higher dividend yield and a 13 % higher sales growth.
So what should your organization consider when focusing on innovation?
- You organization should have an appropriate market share in order to cover costs of innovation.
- You organization should have “the” skills and competencies to manage the desired level of innovation. Often innovation means complexity – can you manage it?
- Innovation is only one part of the game. Strategy, innovation and complexity should be in line and represent a holistic, sound system. Do you have it?
In one of our next posts we will have a look at the barriers to innovation and how to integrate innovation into strategic planning. Therefore: Come back to Eddielogic!