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Why Looking Outside Your Company For Innovation Is A Huge Mistake

Incumbent companies protect their products, focus on the present, and avoid risk. But those conservative strategies are the riskiest of all. A case study of HP shows that standing still is really the most dangerous move.

On November 20th, HP announced a write down of $8.8 billion of Autonomy, which it had acquired for about $10 billion only 15 months earlier. In effect, HP admitted that 87% of this huge investment was vacuous and wasted. In its announcement, HP blamed the error on deceptive and improper valuation by the previous owners, accountants, and auditors of Autonomy. True or not, HP’s real error was strategic: pursuing acquisitions over innovation, failing to commercialize innovations of its own labs, and forsaking its core business, computers and laptops.

Consider this: In the last three years, HP’s market cap has declined steadily and steeply. The rot began in April 2010. What did HP do wrong in that month? Nothing. And by doing nothing, HP failed to preempt an important innovation that would spell HP’s decline: the iPad.

The iPad was a runaway success, reaching 15 million units in its first year and opening up the mass market for tablets. Indeed, no sooner had the iPad arrived than computer sales began to decline. This was true in developed markets. It was true in emerging markets too, where consumers strongly prefer less powerful but cheaper, compact products such as mobile phones and tablets over laptops and computers. In a heartbeat, HP’s core products of computers and laptops had become virtually obsolete.

The irony is that HP had the technology for the tablet even before Apple considered tablets. As far back as 2005, HP had a working model of an e-book, the precursor to today’s tablets. It was similarly sized, light, easy-to-use, with a touch screen. It was well-suited to read electronic books, magazines, and newspapers. It even had a touch feature to turn the page. However, HP never commercialized the innovation. Why?

The reason is that HP suffered from the incumbent’s curse. A recent coauthored study of mine indicates that incumbents suffer from three cultural biases that give rise to this curse: First, incumbents protect their successful current products. At that time, computers and laptops constituted a high percentage of HP’s sales and a considerable percentage of its profits. Tablets seemed inconsequential. Consider that in even a $1 billion new product would have amounted to a mere 1% of HPs sales. Second, incumbents focus on the present, especially the perennial crises that crop up in the lives of massive corporations such as HP. The future seemed distant. Innovations of the future seemed almost irrelevant. Third, incumbents are averse to risk. Radical innovations are highly risky. They can turn out to be big winners, such as the iPad. But most fail. These cultural biases led HP not to commercialize its e-reader of 2005. Had it done so, it would have had many years of experience to pre-empt the iPad.

Realizing its mistake, in July 2011, HP finally introduced a tablet, the TouchPad. The product was good but did not sell well at its high price. So HP stopped manufacture and dropped the price to $99 to clear inventory. When it sold out, HP manufactured another "final" batch to meet remaining customer demand. Such inconsistency and vacillation in a core market could only be described as tragic. Ironically, around the same time, HP made the reckless purchase of Autonomy at a precious $10 billion for a foothold in a non-core market: services.

My research with Abhishek Borah shows that even this strategy of HP is typical. Incumbent firms that fail to commercialize innovations in their core market recklessly invest in acquisitions to diversify into non-core markets. Despite ample evidence that the stock market repeatedly rewards innovation and penalizes acquisitions, firms seek remedies from the outside, when solutions sit on the shelf of their very own labs.

HP’s error was one of strategy, not valuation; was internal, not external; was rooted in culture, not in inadequate options. Instead of acquiring Autonomy, HP should have nurtured its own strengths by building a culture of unrelenting innovation.

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—Gerard J. Tellis is the Neely chair of American Enterprise, Director of the USC Marshall Center for Global Innovation, and professor of marketing, management and organization at USC Marshall. His forthcoming book is Unrelenting Innovation: How To Create a Culture for Market Dominance, published by Jossey-Bass.

[Image: Flickr user Holger H.]