As the year comes to a close, we're awash in bad news: bad earnings. Bad behavior. A stock market in free fall -- and the very real possibility that the market may go sideways for the remainder of the decade. Every executive has to be asking, What's next? And how do we move forward?
If there's one thing we need to understand about this bruised business environment, it's this: Yesterday's success has never mattered less. Today's success has never been more fragile. Tomorrow has never been more uncertain. And the courage to lead the kind of change that it takes to survive -- or, even more important, to win -- in this world has never been in such short supply.
Competing today comes down to a leadership gut check, where the first order of business is to admit that the boom-time 1990s were a once-a-century aberration. During the past decade, earnings and share prices were propelled deliriously upward by five manic forces: a huge run-up in capital spending and IT investment; a mountain of baby-boomer money that was force-fed into the stock market and in turn drove price-earnings ratios to nosebleed levels; round after round of cost cutting; a worldwide merger boom that pushed share prices ever higher; and a record number of share buybacks. To those five forces, you can also add a big dose of aspirational accounting.
While those forces may have buoyed the performance of your company in recent years, you must now confront a daunting fact: Things that can't go on forever don't go on forever. Those forces are spent. Going forward, your only weapon is systemic, radical innovation. In these suddenly sober times, the inescapable imperative for every organization must be to make innovation an all-the-time, everywhere capability.
The Case for Innovating Now
I hear it from executives all the time: "I understand that we need to innovate, but why now? I'm just trying to make it to the next quarter. This is the time to get back to basics." In theory, I don't object to getting back to basics. Every company has to grow revenue, raise prices (if it can), and cut costs. That simple arithmetic never changes.
But here is the dilemma: Most companies today can't grow revenue by flogging the same old stuff to the same old customers through the same old channels in the same old way. People may already be eating as many hamburgers as they are ever going to eat, drinking as much beer as they are ever going to drink, even buying as many plain vanilla personal computers as they are ever going to buy.
You just can't grow revenue significantly -- unless you bring jaw-dropping new products and services to customers. That's not easy, particularly if all of your energy is focused on retrenchment. But customers will always make room for something new, useful, and value packed. Consider DoCoMo, the Japanese company that developed an Internet-enabled mobile phone. Its i-mode service attracted 30 million customers in 30 months. Sure, you can grow today. But only if you bring something unexpected and exciting to your customers.
The same is true when it comes to raising prices. We're living in deflationary times. Most companies can only dream of increasing real prices. On the other hand, Starbucks can charge customers $3.50 for a latte! Starbucks came up with a mind-boggling array of alternatives to boring American coffee. It turned going to the corner coffee shop, hanging out, and drinking coffee into a powerful customer experience. It's not impossible to charge people a premium price for something they love -- but it takes a truly novel value proposition to reverse years of steady margin erosion.
Cutting costs may be the toughest challenge of all. Most companies are reaching a point of diminishing returns with traditional cost-reduction strategies. Few are cutting costs appreciably faster than their rivals. What we need here, like everywhere else, is radical thinking. The three companies that have weathered the current recession best are Dell, Southwest Airlines, and Wal-Mart. Each brought radical innovation to its industry's traditional cost structure. So let's be clear about it: The problem isn't that companies are wrong to worry about efficiency. The problem is that companies aren't imaginative in the ways that they worry about efficiency.
So fine, let's get back to basics. But if you want to outperform your lackluster peers, you're going to have to bring more than basic thinking to the basics. You're going to have to bring radical thinking to the basics.
The Acid Test for Corporate Radicals
Many executives choke on the word "radical." They equate "radical" with high-risk, ill-conceived, and highly speculative projects. But by my definition, radical means none of those things. Instead, a radical idea is one that meets one or more of the following three standards.
A radical idea has the power to change customer expectations. Not long ago, the PC was the ugliest thing in your home. Then Apple hired Jonathan Ive, a young British designer who turned that monstrosity into the first iMac -- a jazzy, fresh work of art that changed customer expectations. Apple is still just a footnote in the computer industry, but the one thing that has kept the company alive is its product innovation. Apple keeps raising the bar on what people expect to see in a PC. That's radical innovation at the product level.
A radical idea changes the basis for competition. In a world of increasing income bifurcation, conventional wisdom in retailing said that shoppers would go either to a Wal-Mart or to a Saks Fifth Avenue -- and that it would get ever tougher for companies in the middle to make money. Then Kohl's proved that conventional wisdom wrong. The company has half the number of stores as Sears and one-third the number of stores as J.C. Penney, and yet its market value is greater than that of either of its two century-old competitors.
The radical idea? To rethink what it means to be a department store. Kohl's created stores that are laid out in an attractive way. You don't feel as if you're wandering the soulless canyons of a warehouse when you're there. At the same time, the store's displays are arranged to get you in and out quickly. Says Kohl's CEO R. Lawrence Montgomery: "Our whole philosophy is to get shoppers to spend less time in our stores and buy more." If you've ever been in a Bloomingdale's or a Saks, you know their philosophy: How do we confuse customers with our layout and get them to spend as much time as possible walking in circles?
A radical idea is one that has the power to change industry economics. By adopting a point-to-point routing system, Southwest Airlines keeps its jets in the air for two or three hours longer than most of the other airlines (which use the hub-and-spoke model), thereby using its capital more efficiently. The result: Southwest, which is barely a generation old, now has a market value that is greater than the next five airlines combined. (Of course, Southwest has to be on the lookout for JetBlue Airways, which offers rock-bottom pricing with better than rock-bottom service.)
Does the word "radical" still make you uncomfortable? Get over it. Today's world is a tough place. It's going to remain a tough place for the foreseeable future. You can wallow in timidity, or you can realize that the case for radical innovation is stronger than it has ever been, because there are fewer options than there have ever been. My question to anybody who's still skeptical is this: What other choice do you have? What's your Plan B?
Innovation or Perpetuation?
Recently, I had the honor of sitting next to Nobuyuki Idei, the chairman of Sony, during a long dinner. One of the things he commented on was the enormous success of PlayStation, by far Sony's single most profitable business. While Mr. Idei was talking, I couldn't help but think back to an interview I had done two years earlier with Ken Kutaragi, who invented PlayStation.
When Ken started dreaming about the video-game business as an opportunity for Sony, he found little support inside the company. Sony was so hostile to the video-game business that, at one point, Ken moved his office to a distant facility on the outskirts of Tokyo. Despite the internal resistance, Ken managed to strike a deal to sell a Sony sound chip to Nintendo for use in a game console (his way of getting close to Nintendo and learning more about the business). Eventually, he won a senior-executive sponsor for PlayStation: the head of Sony Music in Japan, who hoped that the CD-based PlayStation might be another device on which consumers would play Sony music CDs.
Here's the point of the story: When I talked to Ken about PlayStation, he said that his success had come despite the system , not because of it. And he's not the only one. Most people who succeed at radical innovation inside large companies will tell you that they did it despite the system. What I find remarkable and disturbing is that so few senior executives seem to find that state of affairs to be remarkable and disturbing. Apparently, they're willing to accept the fact that their organizations are built for perpetuation rather for than innovation. I'm not. Now, there's nothing wrong with perpetuation. Control, hierarchy, diligence, efficiency, replication, quality -- we inherited those virtues from the industrial age, and virtues they will always be. But in a discontinuous world, we need to turn down the dial a bit on perpetuation and turn up the dial a bit on innovation.
In too many companies, real business innovation is an exception. Innovation lives in a ghetto, safely corralled in R&D or new-product development, where it can't infect the rest of the organization. And yet we know that to lock up innovation in a corner of the company is to limit that group's potential to create the future. The most important business issue of our time is finding a way to build companies where innovation is both radical and systemic.
The first step toward making innovation systemic is to realize that many organizations are systemically hostile to innovation. It's not that they're filled with reactionary, backward-looking people (okay, there may be a few exceptions). The real reason that they're hostile is that they're captive to a set of beliefs that make organizations unwittingly antagonistic toward innovation.
One belief that these companies have is that variety is bad. In most companies, a variance from a production standard, quality standard, or budget standard will almost always get you into hot water. Big companies want things to go according to plan. These days, you hear a lot of C-level executives talk about the virtues of alignment. Of course, we need alignment: We need to know what our strategy is and how we're measuring it and how we deliver value. But perfect alignment is death. Variety is the key to evolution. Mutation and sexual recombination allow a species to thrive in an unpredictable world. So it goes with innovation, which requires experimentation, trial and error, doing new things, and breaking old rules. An unhealthy adherence to conformity and alignment will drive out innovation -- and innovative people.
A second systemic belief that creates hostility toward innovation is the notion that change starts at the top. I often ask CEOs, "Who in your company is responsible for fundamental shifts in strategic direction?" Nine times out of 10, the answer comes back, "It's me" or "It's the board." But in my experience, the bottleneck that throttles innovation is almost always located at the top of the bottle. An organization that is trained to look to the top for clues about where it's going next is an organization where the vast majority of people have ceded responsibility for business innovation. When the power to set strategy and direction is narrowly held, corporate renewal inevitably falters. New voices are essential for new thinking.
A third belief that is toxic to innovation is the idea that the company is the business model. When your people no longer positively challenge the day-to-day definition of your business model, you are in a state of decline. Coca-Cola, for instance, has been late to some of the most important beverage trends of the past 20 years. They were late going into fruit-flavored teas (Snapple got there first). They were late going into sports drinks (Gatorade pioneered that category). They were late going into designer water (Nestlé is number one in the world in that business). And they were late going into New Age beverages (they are still trying to catch up to novelty-drink companies such as Red Bull). How could a company that competes for share of throat miss those things?
Like so many companies -- from Compaq to Xerox to United Airlines to the big television networks -- Coke was a prisoner of its business model, which was all about brown, fizzy water. Here's the point: Orthodoxy is the enemy of renewal. The future gets created by heretics. And every organization must continuously work to redefine itself in ways that ensure that it does not get held hostage to its own moribund business model.
A New Way of Seeing the World
The challenge of systemic, radical innovation leads to two fundamental questions: How do you generate breakthrough ideas? And how do you manage that process?
To answer the first question, my colleagues and I have studied hundreds of examples of business innovation during the past couple of decades. Again and again, we have asked ourselves, "Why is it that some people see opportunities and others don't? How do the radical innovators look at the world?" The answers that we have found can be summed up by Alan Kay's famous aphorism that perspective is worth 80 IQ points. An innovative insight is not the product of an individual's brilliance. It's not as if innovators' heads are wired in different ways. Innovation typically comes from looking at the world through a slightly different lens. In talking with innovators, four perspectives -- four lenses -- seemed to dominate.
Radical innovators challenge the dogmas and the orthodoxies of the incumbents. Whether it's Dell questioning the need for dealers to sell its PCs, Southwest questioning the need for a hub-and-spoke routing system, the Body Shop questioning the need for pictures of impossibly thin supermodels to sell its products, or Charles Schwab questioning the need for high-commissioned brokers to trade equities -- all of those companies challenged beliefs that everyone else took for granted.
When most people think about the future, they typically take 98% of the industry orthodoxy as a given. That means that before they start, they've already limited their potential for innovation to about 2% of the available "space." To innovate, you need to spot the absurdities that no one else has spotted, to ask the stupid question that no one else has asked, to take some existing performance parameter and push it so far that suddenly you have illuminated a new possibility.
A good place to start is by looking for trade-offs, situations where a competitor is telling itself or its customers, "You can have one or the other." Twenty years ago, the U.S. auto industry said that you could have either quality or low cost. Toyota offered both. The U.S. airline industry said that you could have the lowest fares or the highest customer satisfaction. Southwest managed to deliver both. When you hear "or," it's an invitation to innovation.
Radical innovators spot the trends that are already changing but have gone unnoticed. I'm not a big fan of forecasting or scenario planning, because I don't believe that you can predict the future. What you can do is ask, "What are the things that are already changing that most people (especially my competitors) haven't noticed yet?" The way to find new answers is to look where your competitors aren't.
Most executives will not have heard of a woman who goes by the name of Chyna. She had a book on the New York Times Best-Seller List, so you would expect that to have brought her some notoriety. But I'll bet that less than 5% of the country's CEOs know that Chyna, a glamorous amazon taken to wearing star-spangled bikinis, happens to be one of the divas of World Wrestling Entertainment (formerly known as the World Wrestling Federation). In the fall of 2000, Monday Night Raw , the wrestling group's premier television show, outdrew Monday Night Football by 47% among young American males. If I'm leading a company that's trying to sell something to adolescent males, and I've never heard of Chyna, then I don't understand my own customers, and I can't out-innovate my competitors. Every CEO needs to spend some time on the fringe -- the fringe of technology, entertainment, fashion, and politics. It is on the fringe where new possibilities first present themselves.
Radical innovators learn to live inside the customer's skin. This is not another plea to be customer focused. Getting "close to the customer" rarely provokes fundamental innovation, because you're talking to the kinds of customers that you already serve, and you're listening to what they're saying -- not paying attention to what they're feeling . Innovation almost never comes from an articulated need; it comes from an insight into an unarticulated need. We never asked for eBay, Starbucks, or downloadable music, but somehow, we got all of those things. Radical innovators have a boundless empathy with human frustration that allows them to see beyond articulated needs to the deeper, unexpressed need.
In order to get to that need, you must begin by developing an experiential sense of what it means to be a customer. My company recently worked with a major hospital that was trying to create a more customer-centric experience. We took a slice of the hospital's employee base -- a dozen or so people from senior medical personnel down to admitting clerks -- and we asked them to list the 10-best service experiences that they ever had. Maybe it was a day at Walt Disney World or a first-class flight to London on Virgin Atlantic. Then we asked the employees to take cameras and notepads and go enjoy some of those experiences. Any time something they experienced evoked a great feeling -- any time they felt respected or that their expectations were exceeded -- we asked them to take a picture, make a note, and tell us exactly what happened.
Next, we asked the same team to live through the experience of being patients in their own hospital, to lie in bed for a day with an IV, to use a bedpan, to traipse around in one of those gowns that flap open in the back, to put up with a procession of medical personnel poking and prodding them. Not surprisingly, the inpatient experience teased out some not-so-great feelings. You have to do two things to get at deep, unvoiced needs: Get an experiential insight into what it feels like to be your own customer, and assemble an inventory of first-person analogies (like the Disney World or the Virgin experience) from which you can draw out potential solutions.
When it comes to innovation, the key point is this: People get the courage to try new things not because they are convinced to do so by a wealth of analytical evidence but because they feel something viscerally . It's not that the analytics aren't important. It's just that until you feel something in your gut, until you've experienced it and know it to be true, you simply won't have the courage to act.
Radical innovators think of their companies as portfolios of assets and competencies. The real foundation for growth and innovation consists of a company's assets (its brand, its customer relationships, its subscriber database) and its competencies (its skills and the ideas that are locked in people's heads). One of the tricks that you can use is to think of the world as a Lego kit of different competencies and assets, owned by different companies, that you can put together with the skills and assets that already exist in your company. One company that has done just that is Swatch.
When Swatch was getting beaten up by its Japanese competitors, it realized that it couldn't win by trying to be more Seiko than Seiko. It had to do something different. Nicholas G. Hayek, an ex-consultant who pioneered the Swatch concept, married Swiss watchmaking skills with Italian fashion design and then borrowed plastic-engineering skills from Lego to produce watches that were dramatically different from the feature-laden gizmos produced by Casio, Citizen, and Seiko.
To escape the myopia of your current business model, stop thinking of your company as a business, and start thinking of it as a collection of tangible and intangible assets. Then look beyond your company's boundaries and ask yourself, "What are the possibilities that might produce a radical adjustment to a tired old business model?" At the end of the day, the essence of a company is not what you do -- it's what you know.
The Wisdom of Markets
Let's say that you and your colleagues have learned to see the world through a new lens, and you're starting to generate a cornucopia of rule-busting ideas in hopes of finding the handful of new ideas that will turbo-charge growth and pump up margins. Here's the next problem: Most companies aren't set up to manage all of those ideas.
Most companies are organized like the old Soviet Union: There's a hierarchy that is cleverly disguised as a perfectly sensible "resource allocation" process. An idea fights its way up through various levels of skepticism until someone near the top decides whether or not to invest in it. In most companies, the only person who can buy an idea is your boss or your boss's boss. And the typical criterion that they use for judging an idea is that it must have a 90% chance of being profitable in the next year or so. The problem is, how many new ideas -- including those with enormous upsides -- start out as a 90%-sure thing?
Silicon Valley is a market -- for ideas, talent, and cash. There's no one person who can kill a new idea. Indeed, Hotmail was turned down by a slew of VCs before Draper Fisher Jurvetson latched onto it and helped make it one of the Internet's first killer apps. Drawing on that analogy, there's a better way to get talent and cash behind promising new ideas: Adopt a market-based system that uses peer review and alternate sources of funding.
One company that has been working on that approach -- creating a chance for people inside the organization to make a case for their game-changing initiatives -- is Royal Dutch/Shell. In fact, the process is called Game Changer.
Game Changer began within the E&P (exploration and production) division at Shell. The head of R&D wanted to devote 10% of his budget to projects with game-changing potential. The problem: how to find such projects and get them funded in a famously conservative culture. To get started, Shell brought together a small group of mid-level individuals -- an eclectic team that came to be the Game Changer panel -- who were known to be creative and who could also draw on other technical resources across the company to evaluate ideas.
The Game Changers did the first round of peer review on potential projects. Ideas that made it through that first stage were sent to an "innovation lab" where teams of peers helped one another improve and elaborate on their game-changing ideas. The projects that survived the innovation lab moved to an advanced stage called the "action lab." The goal here was not to test the idea itself but to begin designing an experiment that would let Shell explore the idea in a risk-controlled, real-world setting. The questions became more focused: What kind of technical support would the idea need? How could Shell build a low-cost prototype in a low-cost way? A typical first-round project was funded at a $10,000-to-$50,000 level. As the idea advanced, it would get more funding.
Game Changer started in one division. Today, it has spread across all of Shell. There's a Game Changer team in corporate that handles some of the ideas that fall outside the boundaries of existing businesses. And each division also has its own Game Changer process.
Today, when a would-be innovator petitions the Game Changer panel for an initial dollop of funding, he or she is promised an answer within five days. Perhaps more important, most of the ideas that emerge are not for new, far-fetched businesses but for ways of breaking the rules in Shell's existing businesses.
Shell's insight is that the essential challenge for systemic innovation is to create a process where new ideas can be validated by peers -- not by the hierarchy -- and where there is more than one source of funding for unconventional ideas. The goal is to build systems that mimic the marketplace, where ideas, talent, and capital can find one another quickly.
It's almost a new year -- a year when, I'm convinced, CEOs will start to understand that without radical innovation, decline is inevitable. A year when we'll all start to take innovation more seriously.
Still, it's easy to lose hope: Barriers to innovation seem to be everywhere. But what sustains me -- and what I hope sustains everyone who wants to build an organization that is consistently innovative and that allows us to bring the full measure of our human creativity to work -- is this: There was no such thing as a large industrial corporation 150 years ago. There was no AT&T, GE, GM, or Sony, no long list of giant corporations. The large industrial company is a product of human imagination. Nothing ordained it. We invented it.
We invented these organizations -- and we can reinvent them. There's no law of nature or act of God that keeps us laboring away in organizations that treat human beings as mere factors of production.
Let's respect the fact that the large industrial organization is the most important human invention of the past 100 years. It has brought us unmatched material prosperity. If you have two cars in your garage, three televisions in your house, and can afford a couple of PCs, you have industrialization to thank for that. Thank the fact that we have built companies that can efficiently churn out products and services by the zillions. But in building those companies and in reaping those efficiency gains, we have also made a burden for our own backs to bear.
We've produced organizations that aren't much fun to work in. We've produced organizations that too often fail. And as they fail, so do the aspirations of the people who have devoted their lives to building them. Looking ahead, the challenge is to recognize that what we invented can be reinvented . We should take revolutionary steps to achieve evolutionary goals.
We're not going to build companies that are capable of systemic, radical innovation in one gigantic leap. We'll get there the same way we have gotten to total quality, the same way we have gotten to real customer service: through a series of steps where we build the new skills, metrics, processes, and values that turn rhetoric into reality.
The challenge is to know where you're headed, so that those steps can lead you in a whole new direction. And then, one day, you'll find yourself in territory where no one has gone before.
Sidebar: Is It an Acorn or a Rabbit Turd?
If you want to build an organization that's capable of systemic, radical innovation, you have to start by realizing that almost every company today is built for optimization. Short-term efficiency overrules almost every other economic decision. But by definition, innovation is wasteful in the short term: It takes a lot of acorns to grow an oak tree. Whether you're trying to innovate in the music business, the pharmaceutical business, or the fashion business, you're going to be confronted with an inescapable math problem: You need 1,000 crazy ideas to find 100 plans that are worth funding experimentally so that you can then identify 10 projects that are worth pursuing seriously in hopes of coming up with one or two strategies that have true transformative power.
Every CEO would love to be able to walk through the forest and know which acorn will germinate. But it can't be done. There's simply no way to know in advance -- not when there are so many variables and there is so little actual control. We can't know where the rains are going to fall, which acorn will get washed into better soil, and which one will end up in a rocky streambed. But that doesn't make the CEO powerless and subject to whim. When you walk through the forest, you can tell the difference between an acorn and a rabbit turd. And when it comes to innovation, the rule is simple: Don't waste time on rabbit turds. You don't have to tolerate stupidity. As you begin to sift through your organization's ideas, you can generally tell the difference between the ones that are simply crazy and the ones that at least have the potential to change customer expectations, the basis of competition, or industry economics in ways that are profitable.
Too many CEOs are concerned that provoking 1,000 or 2,000 unconventional ideas will incite their people to waste time going off in thousands of crazy directions. That's not the problem. People have been beaten down, boxed in, and brainwashed for so long that the challenge is not to rein in their far-fetched and absurd fantasies. The challenge is to get them to expand their thinking.
Gary Hamel (email@example.com) is founding director and chairman of Strategos (www.strategos.com), a Palo Alto - based company dedicated to helping its clients develop breakthrough strategies. He is also the author of Leading the Revolution: How to Thrive in Turbulent Times by Making Innovation a Way of Life (Harvard Business School Press, 2000).