The Innovation Value Chain

1. The Innovation Value Chain Prof. Morten Hansen Managing in Information Intensive Companies September 3 2010

2. Does innovation matter? It is one strategy for success One piece of evidence: Winners among sample of 160 companies pursued innovation more 87% of executives said That organic growth through innovation had become essential to success in their industry (2005 BCG innovation survey of 940 managers) Disruptive = introduce disruptive technologies and business models; exploit = exploit new and old technologies to design products and enhance operations; cannibalize = don’t hesitate to cannibalize existing products Source: “What Really Works,” by Joyce, Nohria and Roberson, 2003, page 221.

3. What is required to create an innovative organization? From a few individuals….to an innovative organization Creative people with good ideas Process for generating good ideas A few “intrapreneurs” Mechanisms for selecting and developing projects A few champions Roll-out and exploitation strategies Not about innovative people, but about innovative processes

4. The Innovation Value Chain: A Systematic Way of Improving the Innovation Process IDEA GENERATION CONVERSION DIFFUSION Source: The Innovation Value Chain. By Morten Hansen and Julian Birkinshaw. Harvard Business Review, July 2007.

5. Survey of 121 companies show that all parts of the chain are difficult Average across the chain (2.6 on a 5-point scale) is very low. All 6 items in the chain are also low. Diffusion is a bigger problem than idea generation. IDEA GENERATION CONVERSION DIFFUSION Source: Benchmark survey of 121 companies, August 2007. By Hansen and Birkinshaw.

6. Example: Survey at InsCo suggests it is above average across the IVC Strongest link is idea-generation inside. No particular weakest link. IDEA GENERATION CONVERSION DIFFUSION InsCo Overall Benchmark Source: Benchmark survey of 121 companies, August 2007. By Hansen and Birkinshaw and InsCo survey (n=22)

7. Although good scores for InsCo, gap to the best- Work required to become top 10% innovator InsCo overall

8. Idea Generation IDEA GENERATION CONVERSION DIFFUSION • IN-HOUSE

9. In-house IDEO: Using culture to promote innovation IDEO is an award-winning product design firm. They have developed a culture that has allowed them to be “routinely innovative.” How have they been able to do this? What specific mechanisms do they use to promote creativity and implementation? Can you “steal” any of these?

10. In-house “Routinely Innovate”: How do they do it? • Creativity • Ideas come from anywhere • Egalitarian • Brainstorming • One idea at a time • Listen actively • Build on other’s ideas • No criticism • No punishment for failure • Initiative is expected • Data driven • Ask “experts” and “customers” • Diverse groups • Fun, playful • Passion and energy • Implementation • Clear direction • Action oriented • Fail early, fail often • Rapid prototyping • Role of leadership • Focus • Use of deadlines • Not “experts” • Process for deciding • Voting • Involvement • Sub-groups • Adult supervision

11. In-house Research shows that four company values promote innovation • Creativity • 1) Support for risk taking • Rewards for innovation • Management role • models • Challenge the status • quo • 2) Tolerance of mistakes • Mistakes are normal • Being “safe” isn’t OK • Implementation • 3) Teamwork • Share common goals • Open information • 4) Sense of Urgency • Fast decision making • No red tape • Once decided, full • commitment Source: “The determinants of team-based innovation in organizations.” Small group Research, vol. 34, 2003

12. Large European Media Company example:Survey shows mediocre on all four values Median On scale Creativity Implementation Min and Max

13. Support for risk taking Not monetary rewards Recognition from managers Trophies, individual plaques “Exalted order of the extended neck” (Hershey Foods) Do not over-analyze Resources given to experiments/prototyping Defer judgment Tolerate mistakes Award at Intuit: “The failure we learned the most from” J&J, “Failure is our most important product” J&J: Reasonable mistakes Analysis, foster learning, modest in impact Promote people who failed reasonably In-house Leaders need developtolerance for risk-taking and mistakes Source: Winning through Innovation, by Tushman and O’Reilly.

14. Intel: Risk-taking as a value, and holding people accountable for living that value Articulation of values Behaviors Organizational mechanisms Six core values Each value translated into behaviors Performance review example • Discipline • make and meet commitments • pay attention to detail • Results orientation • confront and solve problems • Risk taking • listen to all ideas and viewpoints • Great place to work • be open and direct • Customer orientation • Quality • Example: risk taking • Publicly discusses • failures to learn • Acknowledges failures • Promotes ideas that • may not be popular • Allows others to • express divergent • opinions • Takes no personal • risks; creates an • environment of fear Example: risk taking Managers assess behavior of direct reports against behaviors (not vague values) “Ralph needs to learn to make initial decisions much more rapidly… he needs to be willing to take more risks here” performance review

15. Idea Generation IDEA GENERATION CONVERSION DIFFUSION • CROSS POLLINATION (COLLABORATION)

16. Collaboration Procter & Gamble master at innovation through collaboration $ 34.99 bleach expertise novel film technology teeth whitening expertise Technologies Fabric & Home Division Oral Care Division Corp. R&D Organization Units

17. Collaboration Re-combining to sell solutions:Example: Jardine Pacific, Hong Kong Recombination of four areas into a new high-rise services business Sell a service, not individual products Real estate Clean- ing Air conditioning Elevator Facility management business (comprehensive service management)

18. Collaboration Ex: InsCo survey indicates InsCo is quite far from top ranking in cross-pollination* Cross-pollination survey scale 5=best 1= worst Benchmark study *) from different country units and divisions in InsCo

19. Collaboration Large opportunities for cross-unit innovationacross divisions Current and Gap for Collaboration across divisions Large Gaps Gap Current Cross-unit product innovation Packaging and bundling Developing New business

20. Idea Generation IDEA GENERATION CONVERSION DIFFUSION • EXTERNAL

21. External What makes you believe that you have more and better ideas inside? “We have 8000 people in R&D [in P&G] but there are about 1.6m scientists and engineers outside P&G who can help us. That’s a 1:200 ratio. We’re now looking at our organization as the 8000 and the 1.6 million.” Larry Huston, Procter & Gamble Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

22. External Procter & Gamble’s move to open innovation Before Year 20000 Year 2000 New Goals 1) To grow top line 5 – 7 % per year (=$ 4bn per year) 2) External ideas count for 50% from existing 10% “We want P&G to be known as the Company that collaborates – inside and out – better than any other company in the world” A.G. Lafley, CEO P&G Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006; CRSP data analysis.

23. External What they did 2000-05:“Connect & Develop” Strategy 1) Partnered with, and invested in, IT networks aimed at sourcing solutions • www.innocentive.com • www.Yet2com.com • www.ninesigma.com yet2.com is a website that functions as a global online marketplace for technology that is for sale or for license. Companies who have signed up with yet2.com to list their technologies represent about a quarter of the world's R&D budget.yet2.com also assists companies with marketing their ideas, inventions, and patents through websites like this one which are customized for each customer. Source: www.pgconnectdevelop.com

24. External What they did 2000-05:“Connect & Develop” Strategy 2) Internally hired 75 technology entrepreneurs - liaison with partners, scouters, building relationships etc. - sr. research people - rotating to and from position 1-4 years 3) Organized offices –nodes– with particular focus - China: low-cost innovations - Japan: hot items on their shelves - Italy: coffee trends - France: fragrance Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

25. Example: Pringles

26. External How it works: Directed search - Example: Pringles “How about trivia questions printed on Pringles?” Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

27. External How it works: Directed search - Example: Pringles “How about trivia questions printed on Pringles”? Brief: how to print volume with edible materials, using inkjets Brief goes out throughout network Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

28. External How it works: Directed search - Example: Pringles “How about trivia questions printed on Pringles”? Brief: how to print volume with edible materials, using inkjets Professor in Bologna, Owns a bakery, does food-edible dyes to print with inkjet on cookies Technology Entrepreneur In Italy Brief goes out throughout network Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

29. External How it works: Directed search - Example: Pringles Printed Pringles “How about trivia questions printed on Pringles”? 8 months development Brief: how to print volume with edible materials, using inkjets Professor in Bologna, Owns a bakery, does food-edible dyes to print with inkjet on cookies Technology Entrepreneur In Italy Brief goes out throughout network Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006

30. External P&G: Strong results 2001-05 Open innovation success 2005 1) External ideas 10% -> 35% 2) 60% increase sales/R&D employee 3) R&D expense per product drastically down Source: Morten Hansen and Julian Birkinshaw interview Jan 20 2006; CRSP data analysis.

31. Intuit very good at external innovation- “Follow-me-home” program • Problem: > 50% of U.S. small business keeps their books with simple spreadsheets or pencil & paper. Get them to use QuickBooks. • 2003 initiative • 10 employees, 40 follow-me-homes. Live with the customer for a day to systematically observe • “I don’t need no stinkin’ accounting” • Simplified, tracking money in and out • “Accounts payable” and “accounts receivable” focus • 1st prototype required 125 setup screens • Now, “money in”, “money out”, 3 setup screens • Took 6 times of follow-me-homes and prototyping • “QuickBooks Simple Start” outsold most accounting software in the U.S. Source: Fortune, Dec 12, 2005

32. External 2003 initiative targeting non-users Others 2m 6m Users Intuit 11m QuickBooks Simple Non-users 19m Small Businesses Source: Steve Bennett, intuit 2005 Shareholder meeting

33. External Result of this innovation approach: continuous rapid organic growth QuickBooks segment results Source: Steve Bennett, intuit 2005 Shareholder meeting

34. External Intuit’s core competency: Open Customer-centric innovation process “Customer-driven innovation that solves important customer problems simply and delivers delight” CEO Steve Bennett Living with customers - ”Follow-me-home” corner- stone of achieving this Source: CEO Steve Bennett, 2005 Shareholder Meeting

35. External InsCo pretty good at external idea generation- reasonable understanding of customer needs External idea generation survey scale 5=best 1=worst Benchmark study (external idea generation scale) External idea generation scale Understanding customer needs. “People in our unit do have a clear understanding of our customers’ needs (end client as well as business partner).”

36. Conversion IDEA GENERATION CONVERSION DIFFUSION • SELECTION • DEVELOPMENT

37. Selection Is there a better approach than traditional selection methods? “The last bastion of Soviet-style central planning can be found in Fortune 500 Companies—it’s called resource allocation. The guys at the top decide where the money goes. Unconventional ideas are forced to make a tortuous climb up the corporate pyramid. If an idea manages to survive the gauntlet of skeptical vice presidents, senior vice presidents, and executive vice presidents, some distant CEO or chairman finally decides whether or not to invest. You wanna try something new, out of bounds, something that challenges the status quo? Good luck.” Gary Hamel Harvard Business Review, Sep-Oct 1999

38. Selection Connecting the market for ideas and capital:Two fundamental options

39. An alternative funding mechanism: Shell’s Gamechanger • 25-person virtual team of mid-senior managers, $40m investment budget • People have full-time job, “Gamechanger” on their business card • Decision panels consist of 2-4 managers + domain experts • Individuals from anywhere encouraged to submit their ideas: • Initial submission online • Screening meeting within 2 weeks • Promising cases given some time to put full proposal together • Within 6 months case gets reviewed, and if successful, seed funding (typically $500,000) is provided • 40% of projects in E&P division came out of Gamechanger • Key points: • Ideas are experiments: small amounts initially to test them out • Internal VCs act as alternative source of funds: everyone can try it.

40. Gamechanger works like a Venture Capital Fund inside a company BUs invest further Close-out meeting: Terminate or refer $ Commit- ments 2nd panel meeting: more seed money (~$300-500K) 1st panel meeting: seed money (~ 3 weeks pay) Employee submits idea on web-site Time # ideas: 100 50 22-24 11-12 referred 5-6 success • “Ideas that nobody wants to fund” • Doesn’t fit core, not in budgets • More radical

41. Selection Gamechanger numbers are pretty good- 9-year track-record • $40m investment budget per year • Total of 1600 ideas over 9 years • In 2005, 175 submissions • Continues to get same number of ideas per year • Estimated $2bn worth of portfolio • Approx. 5-7x return on investment

42. Development Typical Problems An alternative development mechanism:Internal venture units (“incubators”) • Most venture units fail to create significant new businesses • Entrepreneurship likely to be suppressed elsewhere • Very hard to integrate corporate ventures back into mainstream

43. Conversion Example: InsCo ok in conversion but gap to top 10% In-house idea generation survey scale Conversion survey scale 5=best 1= worst Selection Benchmark study Development

44. Diffusion IDEA GENERATION CONVERSION DIFFUSION • DIFFUSION

45. Exploit Does it pay to be the most innovative? Patenting by Two largest Biotech Firms

46. Exploit Pay to be most innovative? Not in this case Source: CRSP.

47. Exploit Amgen pushed two key drugs

48. Exploit Amgen emphasizing exploitation (1)New incremental treatments for Epogen “We spend 45% of our R&D budget on new indications for existing drugs” Binder, President of Amgen

49. Exploit Amgen emphasizing exploitation (2)New incremental treatments for Neupogen “We spend 45% of our R&D budget on new indications for existing drugs” Binder, President of Amgen

50. Diffusion Diffusion and Exploitation powerful- Example: Medical Device Industry The Exploiter (Stryker) beat the Radical Innovator (U.S. Surgical Corp.) • Incremental innovations (Stryker Corp.) • “We like to stay one fad behind” (CEO) • Tweak products + acquire new products • Pump these through sales channel • example: removable headrest on hospital bed • for better eye surgery • Very innovative (U.S. Surgical Corp.) • Industry-defining innovations • Creation of new markets and categories • example: surgical stapling • example: endoscopy instruments