Executives spend a lot of time these days worrying about innovation. Innovation is a key engine for growth and profitability yet few companies do it well and consistently. Even more fundamentally, few companies think broadly enough about innovation.
Mention innovation and most executives immediately focus on product innovation. Some will expand the scope to include process innovation. But few venture beyond to explore other levels of innovation.
Seeking More Robust Forms of Innovation
Here’s the rub. Product and process innovation tend to be event driven – someone comes up with a great new idea, applies it and reaps the rewards. But the rewards offer diminishing returns. We all know that product life cycles are steadily compressing and markets are fragmenting into a long tail of endless niches. Early growth from new product introductions rapidly peters out and then revenue begins to slide precipitously towards the inevitable (and increasingly near-term) product retirement.
Process innovation can yield longer-term returns. Yet, even here, process life cycles are also compressing in the face of rapidly changing business environments. In a much more connected world, processes can also be more readily copied. The ability to generate more value through process learning soon runs into the diminishing returns reality of the well-known experience curve - greater and greater effort must be invested to yield the same degree of performance improvement.
In a world where profitable growth is the key to value creation, companies need to find ways to sustain and amplify the rewards of innovation. To do this, executives will need to expand the scope of innovation well beyond product and process to a much broader terrain – institutional innovation.
What do I mean by institutional innovation? It redefines roles and relationships across independent entities to accelerate and amplify learning and reduce risks. The next generation of institutional innovation will seek more productive ways to connect with talent wherever it resides and build relationships that foster and focus learning rather than taking the walls of the enterprise as a given.
Institutional innovation in the twentieth century focused on creating scalable institutions through standardized product design and design of business processes to cost-effectively serve mass markets. In the twenty first century, the focus of institutional innovation will shift to foster scalable learning across institutions.
This is much broader than the current fad of open innovation. Open innovation focuses narrowly on accessing third party resources to support product innovation initiatives. The institutional innovation perspective expands the horizon to include all core operating processes of the enterprise – supply chain management, product innovation and customer relationship management. Most of the prominent examples of open innovation tend to highlight transactional approaches to accessing existing third party resources, especially knowledge that can be codified. The institutional innovation perspective focuses on approaches to build scalable, long-term trust based relationships that can accelerate learning on all sides by more effectively accessing tacit knowledge.
This is also quite different from the concept of “management innovation” that Gary Hamel first outlined in his Harvard Business Review article "The What, Why, and How of Management Innnovation" (see my review here) and more fully develops in his recently released book The Future of Management. For Hamel, the primary focus of innovation remains within the walls of existing institutions – he rightly points out that significant value can be created by re-thinking the management processes that drive these institutions but, as the examples he uses in his article and book demonstrate, he is largely concerned with different approaches to managing the resources within institutions rather than across large numbers of institutions.
The companies that excel at institutional innovation will lead the next wave of wealth creation. We are only at the earliest stages of this kind of institutional innovation, so there is both a lot of opportunity and a lot of uncertainty regarding the approaches with the most promise. JSB and I have offered some early perspectives on this in our writing on The Only Sustainable Edge, Creation Nets and From Push to Pull.
Institutional Design Principles
In thinking about institutional innovation, it is useful to highlight promising design principles that offer the potential to accelerate learning:
Diversity. As Scott Page and others have persuasively suggested, new insight and learning tends to increase with cognitive diversity. This principle highlights the importance of designing institutional arrangements that extend well beyond a single institution, with particular attention to the opportunity to connect to diverse pools of expertise and experience. Diversity can often be enhanced by connecting into spikes – geographic concentrations of talent – and by targeting “brokers” within social networks, creating a multiplier effect in terms of the number of participants that are potentially accessible.
Relationships. It is not enough to have cognitive diversity. By itself, cognitive diversity often breeds misunderstanding and mistrust, seriously limiting the opportunity for people and institutions to learn from each other. Long-term trust based relationships, on the other hand, make it easier to engage in productive friction – the clash of diverse perspectives in ways that produces deep new insight and learning. The challenge is that these kinds of relationships often take a long time to develop and are hard to scale. Innovative institutional arrangements can help to accelerate and scale the formation of these kinds of relationships.
Modularity. When activities are tightly specified and hard-wired together, the opportunities for experimentation and tinkering are very limited. Segmenting people and activities into discrete modules with well-defined interfaces can help to create much more space and opportunity for distributed innovation and learning.
Federated decision-making. To encourage distributed innovation and learning, it is helpful to distribute decision-making into self-governing units while at the same clarifying dispute resolution and escalation protocols to ensure that prompt action can be taken across business units when required. If structured appropriately, these dispute resolution mechanisms can become fertile grounds for productive friction that in itself drives learning.
Reputation mechanisms. As relationships scale, it becomes harder to develop a clear view of the full range of experience and expertise available to address challenging problems. Reputation mechanisms can play a vital role in enhancing findability but also help to reinforce incentives to participate and contribute.
Feedback loops. More broadly, there is enormous value to investing in performance measurement systems and structuring performance feedback loops so that participants can reflect on their practices and focus their efforts to improve performance. This task becomes much more challenging when activities and participants are scattered across a large number of institutions and geographies, but the rewards in terms of learning are far greater given the opportunity to compare and contrast performance across a larger number of participants.
Incentive structures. Focusing narrowly on near-term cash incentives undermines the ability to build trust and foster learning. By expanding incentives to include talent development and capability building, institutional innovators have the potential to turn zero sum games into positive sum games, where the prospects of expanding rewards encourage participants to adopt longer time horizons and invest more in collaborative undertakings.
There’s a massive opportunity for institutional innovation building upon these design principles. One of the key pitfalls, though, is the temptation to map out detailed blueprints of new institutional arrangements before deploying any changes. In the highly specified, hardwired institutions of the twentieth century, this level of advance analysis and planning was critical. These new design principles, however, make it possible to pursue a much more incremental approach to institutional innovation. New institutional arrangements consistent with the design principles above can be deployed in stages to facilitate learning and refinement.
As executives start to focus on the opportunity for institutional innovation, they could begin by asking the following questions:
- What are the top one hundred companies with world-class capabilities that are complementary to our own?
- What, if any, relationships have we built with these one hundred companies?
- How could we re-design these relationships along the lines of the principles presented earlier to enhance the potential for learning on both sides?
- What relationship networks are these one hundred companies participating in and how could we begin to participate in relevant networks to further expand our opportunities for learning?
In thinking about innovation, executives would be well served not to focus exclusively on finding talented product design maestros or even process design experts, but rather creative institutional designers who can challenge and re-think their existing institutional arrangements from the ground up.
These institutional designers will unlock a steady flow of product and process innovations. Without their help, executives will continue to struggle with isolated innovation initiatives that show great promise at the outset, but rarely deliver on their full potential. Even when the full potential of these initiatives is realized, this potential is inherently limited. Far better to re-think the innovation opportunity at a much more fundamental level – a level that keeps on giving.
For those who doubt the power of institutional innovation, reflect on what has been the single most wealth creating innovation over the past several centuries. The steam engine? The telephone? Ford’s assembly line approach to manufacturing? Fuhgeddaboutit. It was the development of the limited liability joint stock company – a profound institutional innovation.