Views on innovation in developing economies are evolving rapidly, yet they still do not capture the full significance of what is going on. Executives in the West are still prisoners of a mindset that equates innovation with technology and product innovation. This blinds them to significant alternative forms of innovation that can profoundly disrupt their businesses in the years ahead.
Early view of innovation
A decade ago, few Western executives were willing to recognize any potential for innovation in developing economies. From their perspective, the growth of developing economies could be fully explained by the availability of cheap "sweatshop" labor displacing unionized Western labor and the ability of agile Asian companies, freed from intellectual property constraints, to copy superior Western technology.
Fortune at the Bottom of the Pyramid
Six years ago, noted business analyst C. K. Prahalad wrote a book, The Fortune at the Bottom of the Pyramid, which began to change this view. In this book, Prahalad made a compelling case that companies were creating significant economic value by innovating the design of products and services to more effectively serve the unmet needs of the lowest income segments of the population in developing economies. He cited examples in fields as diverse as health care and agricultural products to drive home his point that there were significant economic opportunities associated with this new innovation focus.
While perceived as radical at the time, this perspective was still comforting to Western executives. Perhaps there were real product and service innovation opportunities in developing countries, but they were safely confined to those countries. After all, what might work for a peasant in rural India certainly would have little interest for a sophisticated urban consumer in the West. Western companies could choose to participate in these opportunities. In fact, these opportunities provided new platforms for growth to compensate for the lower growth offered by more developed markets. Yes, these Western companies would face growing competition from local entrepreneurs in these developing economies, but their core markets in developed economies were not really affected. This was much more of an opportunity than a challenge to existing business.
Even more recently, an important refinement to this perspective has emerged. Last October, two business school professors at Dartmouth, Vijay Govindarajan and Chris Trimble, teamed up with Jeffrey Immelt, chairman and chief executive officer of General Electric, to publish an article in Harvard Business Review that has attracted significant media attention. Entitled "How GE is Disrupting Itself", this article introduced the concept of "reverse innovation". Using the examples of portable ultrasound machines and small turboprop jet engines, it discussed how General Electric is using developing markets as seedbeds for product innovation to create much more efficient products and services.
In a new twist, the products discussed in this article were not simply designed to serve local developing economies. These products had the potential to become innovations that could be driven into world markets. They could challenge incumbents in these world markets and drive growth on a much large scale than ever imagined before. This perspective challenges the more conventional view of "glocalization" (a particularly horrible neologism) which argues that Western multinationals should develop products in their home markets and then tailor them to meet the more specific needs of local markets around the world. Instead, this new perspective "reverses" the innovation process, using developing economies as the platform for product innovation and then takes these innovations back into developed markets.
This is a significant advance over Prahalad’s earlier perspective that viewed innovation in developing economies largely as distinct and separate from innovation in developed economies. It now explicitly links product innovation across both domains and explores the potential for innovations in developing economies to drive "attacker" strategies against incumbents in developed economies.
And yet, this more refined perspective still under-estimates the full disruptive potential of innovation in developing economies. Reflecting Western biases, it still equates innovation with product innovation. It focuses on how products and services can be re-designed to offer more value at lower cost, making this form of innovation much more accessible to Western companies. They simply need to shift their innovation focus from developed economies to developing economies and significant growth opportunities will be available.
Immelt, Govindarajan and Trimble acknowledge that there are organizational challenges associated with this shift in innovation focus. As they caution, "zero-based innovation doesn’t happen without zero-based organizational design. GE’s organizational ‘software’ – its hiring practices, reporting structures, titles, job descriptions, norms for working relationships, and power balances between functions – all evolved to support glocalization. [Local growth teams] need to rewrite the software."
But note that the organizational changes described by these authors are all within the company. While these are still challenging to pull off, they do not call into question the basic mindset that Western executives have about the role of their companies. They do not call for a need to re-think at the most fundamental levels the institutional arrangements that define roles and relationships across companies.
These perspectives help to change our view of where innovation will occur – shifting our focus from the core developed economies to the geographic edges represented by developing economies like China and India. But they do little to alter our view of innovation itself. As a result, Western executives remain vulnerable to being blindsided in a much more fundamental way.
What if the most significant form of innovation is not product innovation or even technology innovation? What if a different form of innovation is emerging in developing economies that could prove far more disruptive, providing a platform for successful attacker strategies that would challenge Western companies on a global scale?
Five years ago, John Seely Brown and I wrote an article for the McKinsey Quarterly entitled "Innovation Blowback: Disruptive Management Practices from Asia." In that article, we described a series of innovations emerging in Asia that were much more fundamental than isolated product or service innovations. We drew attention to a different form of innovation – institutional innovation. In arenas as diverse as motorcycles, apparel, turbine engines and consumer electronics, we detected a much more disruptive form of innovation.
In these very diverse industries, we saw entrepreneurs re-thinking institutional arrangements across very large numbers of enterprises, offering all participants an opportunity to learn faster and innovate more effectively by working together. While Western companies were lured into various forms of financial leverage, these entrepreneurs were developing sophisticated approaches to capability leverage in scalable business networks that could generate not just one product innovation, but an accelerating stream of product and service innovations.
This is not a question of business model innovation or the management innovation that Gary Hamel talks about. Those forms of innovation are still contained within a single enterprise. Institutional innovation is different - it defines new ways of working together, ways that can scale much more effectively across large numbers of very diverse enterprises. It provides ways to flexibly reconfigure capability while at the same time building long-term trust based relationships that help participants to learn faster. That’s a key breakthrough – arrangements that support scalable trust building, flexibility and learning at the same time. Yet this breakthrough is occurring largely under the radar of most Western executives, prisoners of mindsets that prevent them from seeing these radical changes.
We highlighted the need for Western executives to question the most basic assumptions that they held regarding the institutions they managed. Without a profound shift in mindset, they would be increasingly vulnerable to innovation blowback – the prospect of institutional innovations in developing economies that would provide a platform for a growing stream of disruptive products and services to drive attacker strategies in developed economy.
In an earlier blog posting, I also contrasted different forms of institutional innovation emerging in India and China. Both forms of institutional innovation had significant potential to drive strategies to disrupt and gain share in global markets.
These institutional innovations will be far more difficult for Western companies to appropriate precisely because they challenge basic assumptions about roles and relationships across companies, not just the way individual companies are organized or managed. In our book The Only Sustainable Edge we argued that these institutional innovations would become the basis for a new form of strategic advantage – getting better faster by more effectively working together in larger and larger ecosystems of participants.
Institutional innovation has enormous power to disrupt and drive major new forms of economic value creation and capture. Much of its power stems from its ability to blindside incumbents who hold onto traditional mindsets. As I argued in the Shift Index, new digital infrastructures and related public policy shifts are increasingly rendering obsolete the assumptions that Western executives hold about what is required to create and capture economic value.
Until and unless Western executives begin to aggressively challenge these assumptions and awaken to the potential of institutional innovation, they will remain vulnerable to attack. They must begin to recognize that the most promising forms of innovation emerging in developing economies are not at the level of individual products or services but rather at a much deeper level – novel approaches to scalable peer learning shaped by institutional innovation.