how_to_manage_radical_innovatio.pdf

How To ManageRadical Innovation

Robert Stringer

Three of the people attending the meeting in a Chicago suburb were going broke.They had spent most of their money and all of their time for the past two yearstrying to commercialize a radical innovation called "Liquid Life," an all-naturalbeverage made 100% from pureed fruit. They had developed an attraaive plasticpackage, six good tasting flavors, and eye catching point-of-sale promotionalmaterials. Grocery stores had told them they loved the idea and would gladlycarry the product. However, consumers knew nothing about "Liquid Life" and itwould take millions of dollars to cormnercialize the innovation the way the threeentrepreneurs wanted to do it. Now, they had run out of money and time.

Four other people were at the meeting. Two were investment bankers, onea venture capitalist, and one a vice-president from Big Food, Inc., a Fortune 100food and beverage company. Three of these four tried, once again, to convincethe "Liquid Life" entrepreneurs to sell their ideas and technology to the foodcompany. Once again, this advice was met with an emotional refusal.

The argument was always the same: the food company loved the breakthroughtechnology and was desperate for a radical new idea that might pump life intoone of its existing product categories, but they could not pay much for anunproved innovation. The "Liquid Lifers" loved the idea of having a bigcompany's resources behind them, but they knew the food company would stran-gle their commercialization dreams and control the way they developed futureproducts. None of them wanted to join a largethough very successful^publiccompany. The investment bankers had brought the food company to the meetingand advised the "Liquid Lifers" to sell. The venture capitalist wasn't so sure.

This scene is played out every week. Entrepreneurs see opportunities tointroduce radical innovations and they act on this opportunity. Their analysismay not be complete, but they are committed to action and they learn by doing.Often, it is an expensive lesson. Large companies in traditional industries, on the

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How To Manage Radical Innovation

Other hand, may realize that their industries are suddenly changing and that thewinners in the new millennium will be those who adapt the quickest and inno-vate most effectively, but they do not know how to do this. They seem to be"genetically" incapable of commercializing radical innovation, and they cannotbring themselves to learn by doing.

Innovation Is a Strategic ImperativeNot surprisingly, history tells us that most large companies are not radical

innovators. They are good at making close-in changes to existing products ortechnologies, but they do not often commercialize breakthrough ideas. Accord-ing to Marketing Intelligence Service's Innovation Ratings, more than 25,000new consumer packaged goods were launched in 1998, most of them by largecompahies. Over 93 percent of these were judged to be "not significantlyinnovative."'

Corporate size is inversely correlated to growth through innovation. His-torically, the Small Business Administration estimates that small firms have pro-duced 2.4 times as many innovations per employee as large firms.^ A recentHarvard and Boston University study of 20 U.S. industries from 1965 to 1992discovered that small companies supported by venture capital produced sixtimes as many patents as a similar amount of traditional corporate R&D spend-ing.' Another recent study of the growth records of the Fortune 50 sponsored byHewlett-Packard and the Corporate Strategy Board concluded that the singlebiggest growth inhibitor for large companies was "mismanagement of the inno-vation process.""

The recent emergence of the e-business model places an even greaterpremium on the ability to quickly commercialize radical innovation. In the ageof the Internet, informationabout new technologies, new applications, newresearch results, product performance, customer experiences, and competitivereactions to new ideasis increasingly available to everyone. Not only is there anever-larger array of radical new value propositions for both buyers and sellers,the need for speed in finding, assessing, and commercializing innovative ideas isdramatically increased. In an e-world that runs on e-time, speed to market ismeasured in days and weeks. A conservative and deliberate company will find ithard to survive, much less prosper, in the world of e-business.

Though the world demands more innovative organizations and the largestU.S. companies want to be innovative, most are poorly equipped to implement agrowth strategy based on radical innovation because most large companies aregenetically programmed to preserve the status quo. They do not have the rightorganization, culture, leadership practices, or personnel to collect and success-fully commercialize radical new ideas. In addition, when they are exposed toentrepreneurs who have potentially profitable breakthrough innovations, theydo not seem to learn fast enough and well enough to take full advantage of theexposure and the innovations.

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Why Aren't Large Companies More Innovative?This genetic conservatism and learning deficiency underlie the four rea-

sons why large companies find it so hard to successfully embrace and commer-cialize radical innovations.

Industry Leaders Can't Afford to Embrace Radical InnovationPowerful economic and strategic barriers prevent many large companies

from being the "first movers" who introduce radical innovations to the market-place. Clayton Christensen, in his award-wirming The Innovator's Dilemma,explains the difference between "sustaining" and "disruptive" technologies andpoints out how poorly equipped industry leaders are to cope with radical or dis-ruptive innovation.' Sustaining technologies foster improved performance ofexisting products or services. Industry leaders must (and usually do) investheavily in sustaining technologies. When disruptive technologies emerge in anindustry, they may lead to worse product performance for mainstream customers,even though the radical innovation often embodies a new and improved valueproposition for rapidly growing segments of non-mainstream customers.

Industry leaders find it hard to embrace emerging, non-traditional tech-nologies because it costs them too much money. The larger their market share,the more they feel they have to lose. The economics of radical innovationimpairs their vision in two ways. First, leaders cannot "see" the long-term poten-tial of the new technology because the very basis of competition changes. Sec-ond, even if an industry leader recognizes the fundamental shift, it is difficult forthe company to reallocate resources fast enough to capitalize on the opportunity.This gives industry leaders mixed motives. They sense the world is changing, butthey have too much invested in the status quo to embrace the radical innova-tion. They prefer to focus on making incremental improvements to their coretechnologies.

Structures and Cultures DiscourageBringing Big Ideas to Market

Size and shape make a difference. Large scale, while often a powerfulsource of competitive advantage, leads to bureaucratic structures that discouragebringing breakthrough or radical innovations to market. The brand managementorganization in most consumer goods companies encourages short-term think-ing and incremental product improvements, not breakthrough ideas. Radicalinnovations often require dramatic shifts in production capabilities, distributionmechanisms, or customer relationships. These shifts threaten the status quo andupset the hierarchy and social systems that have contributed to the large com-pany's past successes. The cultures of most large companies act as powerful sta-bilizing influences. Exploiting and commercializing radical new ideas, especiallywhen they threaten to sweep away the old order of things, destabilizes the orga-nization. Inventions that are considered isolated "good ideas" will be tolerated.


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often encouraged, but rapid and widespread commercialization of an untestedand unproved new idea is another matter.

Relying Too Much on InternalRelying on ever-larger internal R&D budgets to keep abreast of all of the

potential breakthrough ideas has not worked in the past. There is no reason tobelieve it will work with all the new technologies and business models beingintroduced today. Internal R&D projects cannot possibly anticipate or support allof these emerging designs all the way to the marketplace. During times of rapidchange, industry leaders who want to stay leaders need to place multiple bets ona wide range of promising innovations. Furthermore, they need to see howthese new ideas work outside of the laboratory. The real worth of a radical inno-vation can only be calculated after real customers make real purchase and usedecisions over time. Most R&D departments have limited responsibility for thestart-to-finish commercialization process, so pouring more money into internalR&D is not the answer. To complicate the industry leaders' R&D dilemma evenmore, they must continue to invest in their existing technology. To stay on top,they must constantly develop their existing products and services, while at thesame time engaging in robust search and learning behaviors that allow them toquickly discover, influence, or respond to the emerging technology or businessmodel. These multiple demands on internal R&D inevitably put pressure on thebudget. Many large companies have responded to this pressure by decentralizingR&D. All this does is ensure that immediate sales and marketing needs will takeprecedence over longer-term investments in radical innovation. Even in a cen-tralized R&D function, industry leaders must be very careful about prematurelyassuming a new technology will be the best solution and committing the com-pany to it. Unless they "keep their powder dry" as long as possible before mak-ing a large investment in a radical innovation, they run the risk of being stuckwith a bad idea.

All of this is a tall order for any internal R&D department, no matter howwell funded, how well managed, or how well positioned in the strategic decisionmaking process of the corporation. Traditional methods of evaluation of theportfolio of internal R&D projects (e.g., discounted cash flow analysis) also serveto inhibit the comimercialization of radical innovations. The criteria used to judgeradically new ideas are generally subject to the same short-term biases and con-straints as other investments. The resulting pattern of innovation tends to sup-port close-in, incremental change, but it will not generate a significant flow offully developed breakthrough ideas.

A classic example of this problem was played out at IBM. If it had notbeen for Bernard Meyerson, one of IBM's research fellows, the development ofsilicon-germanium semiconductors would have been aborted back in the early1980s. According to all of IBM's sophisticated portfolio analyses, this project wasnever going to make sense. Meyerson kept it alive, largely by ignoring the math-ematical logic of this analysis. Often working on a shoestring budget, he fought


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for years for silicon germanium in the face of supposedly more feasible R&Dprojects in IBM's R&D portfolio. The internal battle for support for radical ideasmust have been fierce at IBM. Meyerson himself admits he was following theadvice of a former IBM president who, wise in the ways of corporate bureau-cracy, said: "If a senior executive hasn't screamed at you lately for grosslyexceeding your authority, you're probably not doing your job."*

There is a strong logic for saying that the evaluation and funding ofbreakthrough R&D should be separated from a large company's normal R&Ddecision-making processes. In order to avoid the trap of incremental thinking, allaspects of breakthrough innovation must be carved out; this includes identifyingpromising radical innovations, funding them, testing them, screening them, andcommercializing those that make sense. However, if you separate accountabilityfor introducing radical innovations, how do you maintain control? How doesthe large company know when a development project is to be considered break-through? These become sensitive political issues. How can a large company giveup control over even part of its investment in R&D? After all, that control is thewhole point of the internal R&D portfolio management process.

Large Companies Don't Attract or Retain Radical InnovatorsResearch shows that the motivational profile that is most likely to be

successful in a large corporate environment is one dominated by the need forpower, not the need for achievement.^ Social skillsincluding the ability toinfluence others, the patience to work across organizational boundaries, and themastery of the political aspects of organizational lifecount for more than hav-ing an aggressive competitive spirit. Innovators tend to be high achievers, andthey are attracted to working environments where they can "call the shots" andbe individually responsible for results. Smaller companies offer far more oppor-tunity for innovators to satisfy their needs for achievement. Large corporationsmay have their fair share of "inventors," that is, people who have new, creativeideas, but they do not nurture or motivate "innovators," people who take cre-ative new ideas and make them into commercially successful products. This fun-damental difference in motivational capacity is one reason why small companiescommercialized more innovations in the 20th century, and it is why they willcontinue to do so in the next.

Why Are Small Companies the Sourceof Most Radical Innovations?

Small companies succeed in introducing more radical innovations becauseof their genetic makeup. Often, the entire organization can be built around asingle breakthrough concept. Therefore, they have little emotional or economicinvestment in the status quo. In fact, they often see themselves as being at warwith the existing order of things. Unlike their large company counterparts, the

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leaders of small companies with a radical new technology will often bet most oftheir limited resources on commercializing the innovation. Just like the openingexample of "Liquid Lifers," they may knowingly risk the enterprise trying toprove out and expand the viability of a new idea. Small company R&D functionsare sometimes subject to the same conflicts as large company functions, but theirsmall size puts them closer to the market and makes them more agile, lessbureaucratic, and more responsive to the unpredictable nature of the commer-cialization process.

The most important aspect of the small company genetic makeup, how-ever, is the concentration of inventive entrepreneurs found in them. Because ofwho they are and where they work, these entrepreneurs can be ruthless aboutlistening to the market and adapting their ideas in order to make themsuccessful.

Researchers have known for many years what motivates entrepreneurs.In the 1960s, we called it "achievement motivation."* A recent article in Fortunemagazine labeled it the "need for accomplishment."' However it is described, thephenomenon is the same. Innovators and entrepreneurs are driven by fourneeds:

to compete against an internal standard of excellence, to make a unique contribution to the world, to engage in activities perceived to be moderately risky (that is, where the

chances of success are close to 50/50, rather than impossibly difficult ortoo easy), and

to constantly receive concrete, measurable feedback on their performanceand progress.High achievers are planners. Aware of things that will hinder their

progress, they constantly search for ways to overcome these obstacles. They seek(and are motivated by) tangible feedback rather than vague or hard to under-stand measures. They learn from this feedback. They art on it. High achieversare not simply idea peoplethey are builders. They take ideas and put them towork, and this is what makes them successful as entrepreneurs.

Unfortunately, entrepreneurs often have well-earned reputations forbeing poor team players. They view other people as a means to an end, and theycan be stubborn, ruthless, and drivennot by fame or fortune, but by their needto accomplish something real, meaningful and tangible. As Fortune states,"Entrepreneurs with the right stuff don't think much about taking risks or get-ting rich. Instead, they are obsessed with building a better mousetrap."'"

It is not hard to imagine why large company environments frequentlydiscourage and de-motivate entrepreneurs who are the drivers of radical innova-tion: too many rules, too much compromise, too many meetings, and too littlewillingness to "just do it."


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Stimulating Innovation in Large CompaniesGiven this picture of the kind of people most likely to commercialize a

radical new invention and stick with a "crazy idea" until it either succeeds orfails, how have large companies tried to alter their own genetic code? How havelarge companies tried to attract and motivate entrepreneurs? How have theytried to reconcile the conflicting interests of those who want to innovate fortomorrow and those who want the profit for today? Moreover, why have theyso often failed? Successful innovators use nine different strategies to attack theproblem. They are listed below in the order of their potential for generating radi-cal innovation and their usefulness in dealing with rapid industry and techno-logical change. Unfortunately, the order also reflects what might be called "thedegree of desperation." The first two or three are relatively conventional initia-tives that are easier to implement but unlikely to generate a wealth of break-through innovation. The next few are harder to structure and more difficult tomanage, but they have more potential for driving radical innovation in indus-tries that are rapidly evolving. The final group of strategies are even more radicalapproaches that are quite risky and much harder to implement but more likelyto result in big ideas that are commercially viable in emerging new industries.

Working From the Inside OutThe first five strategies have been employed by large companies who

believe they can significantly increase the flow of radical innovation by workingwith their existing resources and organization. These strategies attack the prob-lem of stimulating innovation with incremental investments, formal policies,and leadership.

Strategy #1: Make breakthrough innovation a strategic and cultural priority.Talk about the need for new products and unconventional thinking. Set

stretch goals that can only be achieved by doing things differently. Challengebusiness units to increase the percentage of their revenues derived from newproducts or services. Generate benchmark measures that show how importantradical innovation is likely to be in your industry. Publicly highlighting the per-formance gap caused by the lack of big ideas and radical innovation creates asense of urgency that often stimulates increased entrepreneurial activity, evenin conservative companies. General Mills has been able to out-innovate itsarchrival Kellogg by constantly emphasizing the need for innovation in its cerealdivision, as well as its corporate strategy.

The problem with this strategy is that it seldom works very well on itsown. It is not enough to exhort people to support big ideas. Organizations thathave consistently innovated combine the rhetoric with one or more of the otherstrategies.

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Strategy #2: Hire more creative and innovative people.Although this initiative can be frustrating and expensive, there is little

doubt that new blood tends to invigorate an old-line organization. Years ago,when Citibank decided to expand its consumer businesses in the Western Hemi-sphere, Ed Hoffman (then the president of the Western Hemisphere ConsumerGroup) recruited a cadre of entrepreneurial consumer products executives andchallenged them to "break the rules." He wanted them to apply their consumergoods experience to the more conservative world of banking. Known around theWHCG as the "dog food managers" (several of them had come from GeneralFoods, maker of Pet dog food), they successfully introduced a number of radicalinnovations to Citibank's portfolio of consumer products.

Few of these executives remain today at what is now known as Citigroup.Bringing in radical innovators can stir up the organization's creative juices, butgenerating a stream of commercially viable breakthrough ideas takes more thanthe individual efforts of a few high achievers and entrepreneurs. At Citibank,when the real estate crises of the early 1990s put pressure on the bottom line,the "dog food managers" found that the bank's appetite for innovation was verylimited.

Strategy #3: Grow informal project laboratories within the traditionalorganization.

Grant innovators free time to invent by building flexibility and fat intoR&D budgets and by modifying the performance management system so that"crazy" new ideas that do not have immediate payoffs are not punished. Theconcept of informal project laboratories is at the heart of 3M's success at inno-vating. Made famous in the early 1980s by Peters and Waterman's bestseller. InSearch of Excellence, the story of innovation at 3M is impressive. One can onlywonder if the more recent decline of radical new products from 3M is, in part,a result of their emphasis on cost cutting and the possible reduction of projectlab budget flexibility.

The biggest problem with the project labs strategy is that it flies in theface of what is believed to be good management practice. Leaving "fat" in bud-gets and looking the other way when scientists fail to justify their project expen-ditures or when researchers do not account for their time are not the habits oftraditional well-run companies. Even in organizations where project labs find alife, it is often difficult to commercialize the innovations that are generated.Surinder Kumar, the former head of R&D for the Pepsi-Cola Company, canattest to this. He used to encourage innovation, especially radical newapproaches to certain aspects of Pepsi's technology, but only those projects thatmet rigorous evaluation criteria were ever funded for commercial or markettesting."


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Strategy #4: Create "idea markets" within the organization.Establish autonomous teams, called "idea markets" or "knowledge mar-

kets," to identify and commercialize radical innovations. Traditional companieslike Royal Dutch/Shell Group, Nortel, and Procter & Gamble are more and morefrequently putting together small teams of volunteer internal entrepreneurs andcharging them with the responsibility for driving radical innovation. Fundedseparately from the traditional R&D budget, these teams collect the best ideasfrom throughout the corporation and independently develop and commercializethose that make the most sense. The World Wide Web allows these idea marketsto flourish across geographic and organizational boundaries with decentralizedresources, greatly reducing the bureaucratic constraints on the teams. At RoyalDutch/Shell, idea market teams (known as GameChangers) have stimulatedover half of the company's top business initiatives for 1999.

Idea markets are not as easy to manage as traditional project labs. Themost effective programs create truly autonomous teams and allow these teamsto control their own destinies. They hire their own people, are free to tap intothe corporation's resources, write their own rules, and often report directly intothe CEO. Rewarding idea market team members is, perhaps, the most significantchallenge. Nortel uses "phantom stock" to compensate those who.volunteer forspecial, high-risk projects, and it agrees to "buy" these projects as if they wereindependent companies and were going public.

Not surprisingly, it is easier to use the idea market strategy as a source ofbreakthrough concepts than it is to use them as the vehicle for commercializingthe innovations. For this reason, most companies pass off the responsibility forimplementing the idea market projects to established business units. This has notalways worked because the greatest barriers to innovation are often found at thebusiness unit level. Recognizing this, P&G's CEO Durk Jager has put aside $250million of seed money to fund a centralized and independent Corporate NewVentures division that he hopes will stimulate breakthrough innovation in thenew millennium. Like many of its big company peers, P&G needs to find a newapproach to innovation management. The company has not introduced a newproduct line since 1983.

Strategy #5: Become an "ambidextrous organization."This is a strategy described and advocated by Michael Tushman and

Charles O'Reilly in their recent book. Winning Through Innovation. They definetechnology life cycles and innovation in terms of "streams" and explain how aselected few large companies have managed to create two different organizationsunder one roof to manage these streams. One is dedicated to maximizing thevalue of the traditional technology, the other to commercializing radical inno-vation. Tushman and O'Reilly are quick to point out the difficulties with suchdual strategies: "The contradictions inherent in the multiple types of innovationcreate conflict and dissent between the organizational unitsbetween those

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How To Manage Radical Iniiovation

historically profitable, large, efficient, older, cash-generating units and theyoung, entrepreneurial, risky, cash-absorbing units."'^

How do these authors say that these difficulties should be overcome?How should their "ambidextrous organizations" be created and managed? First,keep the radical innovators completely separate from the traditionalists who runthe core business. "The management team must not only protect and legitimizethe entrepreneurial units, but also keep them physically, culturally, and struc-turally separate from the rest of the organization."'' Second, try to leverage theradical innovation for the benefit of the total company. This, they admit, is thehard part. Unfortunately, their guidelines for integrating radical innovation intothe fabric of the large corporation are not always crisp and clear.

According to Tushman and O'Reilly, the most important tool for dealingwith the conflicting interests of the two parts of the organization is having aclear vision for the total business. When Seiko defines its mission in terms ofbeing in the "watch business," not just the "mechanical watch business," it canmore easily accept, exploit, and integrate the radical innovation of quartz watchmovements. They quite correctly point out that the problem is the same aswhen the railroads denied they were in the transportation business. In otherwords, the answer to the lack of foresight about radical innovation is to havegreater strategic foresight.

Tushman and O'Reilly also stress the importance of having a highlyskilled senior leadership team. "In managing streams of innovation, senior teamsare like jugglers, keeping several balls in the air at oncearticulating a single,clear vision while simultaneously hosting multiple organizational architectureswithout sounding confused or, worse, hypocritical. Most management teams cando one thing well, but keeping a multitude of activities going at once requiresgreater skill."'"

Perhaps the reason why Tushman and O'Reilly's guidelines are somewhatfuzzy is because the task is so daunting. When attempting to implement any ofthese five strategies, innovation-starved companies soon realized the difficultyof altering what is inside their organization's boundaries. More recently, old-linecompanies trying to compete in rapidly changing industries have looked more tothe outside to stimulate radical innovation.

Working From the Outside InStrategy #6: Experiment with acquisitions, JVs, cooperative ventures,and alliances with outside innovative entities.

The first external strategy that stodgy companies have tried to employ isto acquire or purchase radical innovation. If. innovations could not be bought,large companies tried to form alliances and hybrid ownership arrangements withinnovators. Unfortunately, most mergers, acquisitions, JVs, and other kinds ofexternal alliances have failed to generate an ongoing stream of commercial

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breakthroughs. The innovation-hungry company usually saw itself as acquiringa new product, rather than acquiring a new capability. Even when they realizedthat the radical innovation involved more than a specific product, they did notknow how to learn about the capability. Too often, when this was the case, theacquisition or alliance created less, not more, innovation in the core business."

In addition to the failure to learn from the alliance or acquired partner,the stumbling block frequently turned out to be the structure, culture, andbureaucracy of the company desperate to innovate. Time and again, promisingnew products or technologies proved to be too radical, too threatening, or toodifferent to be developed to their full commercial potential or to be leveragedback into the company's base business. A classic example of this was illustratedby the experience of Quaker Oats. Competing in the slow growth food industry,Quaker wanted to innovate in beverages. After all, they dominated the sportsdrink market with Gatorade. In 1994, Snapple was acquired with high hopes.Three years later, it was sold for $300 milliona shocking $1.4 billion less thanwhat they had paid for it.

On occasion, the big company simply drove away the entrepreneurs andinnovators by attempting to guide, control, or influence the commercializationof their ideas. In other words, innovation-seeking industry leaders looked out-side but kept trying to bring the innovations inside. Their focus on control andownership of the innovations and the innovators, though appealing to the largecompany mentality, not only did not produce the desired stream of new com-mercial successes, it inhibited that stream by providing a false sense of progress.

Even though the track record for an innovation-by-alliance strategy isdiscouraging, it makes good sense as part of an overall program of innovationmanagement. High-technology companies have employed this approach withgreater success than large companies in other industries. Cisco Systems, Intel,Microsoft, and Hewlett-Packard have demonstrated that you do not have to owna big idea to benefit from it. They have spent a lot of time and energy figuringout how to manage their external partnerships, not just how to negotiate them,and this may account for their higher success rate. Peter Cohan, in his recentbook. The Technology Leaders, outlines how these companies do it. They take thefollowing steps:

Make sure the partners share common objectives. Assign respected executives from both companies to be accountable for the

venture's success. Build joint teams to enhance knowledge transfer and mutual trust. Develop a clear business plan for the joint venture. Link people's incentives to the success of the partnership. Pay attention to the people issues, especially the need to effectively resolve

conflicts. Develop a common understanding of how the alliance will end.'*


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Strategy #7; Engage in corporate venturing.Corporate venturingcreating and supporting new businesses that are

managed apart from a company's existing businessis another strategy that canbe employed to stimulate radical innovation. Corporate venturing departmentstake internal resources and attempt to treat them as if they were externalresources. A few select companies^Teradyne, Sun Microsystems, and Intel, forexamplehave succeeded in driving their growth agenda by means of corporateventuring, but the successes have been discouragingly rare. The most thoroughreview of corporate venturing is Zenas Block and Ian MacMillan's Corporate Ven-turing. These authors highlight the fact that most successful corporate venturesinvolve incremental, not radical, innovation, and they use Gannett's creation ofUSA Today as an example. Although USA Today involved new printing technol-ogy and a new approach to marketing, Gannett leveraged many of its existingcapabilities in launching USA Today.

Block and MacMillan emphasize how difficult it is to commercializebreakthrough ideas within the typical big company's corporate venturing struc-ture. All the tenets of good corporate governance drive large companies to overcontrol their captive ventures, managing them as little more than extensions ofthe internal R&D function. Venture division managers, corporate executives, andboards of directors are accountable, and this puts obvious limits on the indepen-dence of any venture sponsored by the company. The task of managing trulybreakthrough ideas in a corporately sponsored new venture is so complicatedthat Block and MacMillan devote over 30 pages of their book to describing vari-ous ways to link radical innovations to the sponsoring firm without ruining theventure.'^ Traditional large companies want to own the most promising radicalinnovations they sponsor. This ownership mentality leads them to focus on theformal, contractual, and legal aspects of the relationship, paying less attention tothose aspects that cannot be codified. Unfortunately, legal ownership of a newidea is only part of its potential value. Most new technologies, products, andservices do not become commercial successes without applying a wealth of non-codified knowledge. It is often the informal conversations between the sponsorand the venture that create real understanding of what is required to commer-cialize a radical innovation. Most big companies concentrate so much on owningand controlling things, they do not attempt to learn from the ventures theysponsor. Block and MacMillan stress the importance of learning, stating emphat-ically: "In organizing a venture, learning remains the primary challenge, and thenew business should therefore be organized in such a way as to maximize learn-ing."'* Ironically, Block and MacMillan are referring only to the venture's abilityto learn from the big company. However, their examples, guidelines, and adviceare aimed in the wrong direction.

The semi-independent status of a corporately sponsored venture is notgood enough for most innovators and entrepreneurs. The proof of this lies withthe experience of entrepreneurs who have sought corporate funding for theirradical innovations. One successful innovator in the health care field fiatly stated

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that "corporate money has no clue what makes a breakthrough innovationreally successful. Even sophisticated corporate venturers can't stay out of ourway long enough to commercialize the idea the way it should be. They placeall sorts of demands and unrealistic constraints on us. I guess these make sensefrom their point of view, but they make little sense from ours!""

Working with Venture CapitalIf small companies are more suited to the task of successfully commercial-

izing radical innovations, recent research has shown that being small and agile isonly part of the reason for their success. Commercialization of radical new ideasrequires a special kind of partnership^partnering with independent venturecapitalists. A recent study by Thomas Hellmann and Manju Puri of StanfordUniversity's Graduate School of Business demonstrates that venture capital sup-port plays a critical role in bringing innovative ideas to market.^" Their examina-tion of 170 emerging companies in Silicon Valley from the mid-1980s to themid-1990s finds that high innovators tend to use independent venture capitalfunding and tend to bring their products to market far faster than those compa-nies that do not align themselves with venture capital firms. They also find thatventure capital funding does not speed up the launch time of incremental inno-vations (what they label as "imitator" companies). In other words, radical inno-vation goes hand in hand with venture capital. The support that independentventure capitalists offer involves more than money. "Particularly through theiractive participation on company boards, venture capitalists provide critical guid-ance and help recruit key managers," says Hellmann.^'

With the value of venture capital in mind, large companies are nowexperimenting with two additional external strategies to generate more radicalinnovation.

Strategy #8: Establish a corporate venture capital fund.This involves putting aside a pool of money specifically earmarked for

investments in start-up enterprises in fields related to the company's growthstrategy. Block and MacMillan point out that the track record of such corporateventure capital funds has been mixed, and they state that the single biggest rea-son for failure has been the lack of clarity regarding the mission of the corporateventure capital activity. Does it exist to support the big company's R&D and mar-ket expansion plans or does it exist to support the interests of the portfoliocompanies?^^

J&J Development Corporation (JJDC) is one of the best examples of arelatively successful corporate venture capital initiative. JJDC has been doingventure investing since 1973 and has accumulated 25 years worth of practicalexperience. JJDC executives observe, among other things, that issues of controland independence are very important for most entrepreneurs, who are afraid oflosing control of their operations and the theft of their ideas. Over the years,JJDC's outstanding corporate reputation, along with hard protective work by


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JJDC executives, have partially overcome these fears. Qther venture capitalistsare also wary of corporate venture capitalists, in part because sponsoring corpo-rations are impatient with the long time franies venture capitalists use to mea-sure success. JJDC has earned their trust by sharing quality deals and bypledging to stick with investments in later financing rounds. Perhaps the mosttroubling lesson learned by JJDC relates to their ability to attract and retainhigh-quality venture capitalist talent to work for them. JJDC simply cannot offerthe incentives and the equity participation in the venture capital fund that thebest venture capitalists

Strategy #9; Participate in an "emerging industry fund" (EIF).Large companies like Lucent Technologies, Merck, and DuPont have been

investing in start-up ventures for years. The research firm. Venture One Corp.,estimates that 27% of all venture capital rounds in 1998 included one or morecorporate investors.^" However, the vast majority of these investments are pas-sivemade by the large company's pension fundand include no systematicmechanisms to insure that the corporate investor gains any strategic insight fromits investment. Today, a few far-sighted industry-leading corporationswho aredesperate to innovate because they do not know how their industries willevolveare contributing capital to a specially created venture capital fund andsetting up knowledge transfer processes to learn how radical innovations arebeing commercialized.

A Fortune 500 food company and major U.S. pharmaceutical company, forexample, have recently joined forces to invest in the emerging health and well-ness industry. Adobe and Texas Instruments have established fuftds that aremanaged by H&Q Venture Associates. These companies invest in, but do notcontrol, the operations of the fund. In its pure form, the majority of EIF capitalcomes from institutional investors who are seeking above average financialreturns and believe that the fund's unique structure provides them with a lowerrisk way to accomplish this objective. The EIF often invests in companies in needof growth capital, not early stage start-ups. This eliminates much of the contro-versy and risk involved with radical innovations and allows the EIF's corporateinvestors to more quickly "see" the commercial potential of the new ideas. As anexecutive from the pharmaceutical company observes: "the primary risk is mar-ket development, not technology or science."^'

The EIF is managed by independent venture capitalists (VCs). This fea-ture, along with the inclusion of-institutional capital, distinguishes the EIF fromother corporate venturing initiatives and dramatically changes both its natureand purpose. Unlike the typical corporate venture or corporate sponsored ven-ture fund, EIF corporate partners are not playing with just their own money, andthe VCs are not part of the corporate family. Without the leverage of third-partycapital and the skills, greed, and discipline of the independent venture capitalist,the fund will be constrained by the same factors that limit captive corporateventure funds.


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F I G U R E I . Strategies for Stimulating Radical Innovation in Large Companies

Control overInnovation and Likely Motivational Availability ofCommercialization Impact on the Economic and

Strategy

1. Talk about Innovation

2. Hire More nnovators

3, Infomnal ProjectLaboratories

4. Idea Markets

5. Dual Strategies

6. Acquisitions andAlliances

7. Corporate Venturing

8. Corporate VentureFunds

Process

Complete

100%As Long as TheyStay

100%At Least in theBeginning

Moderate to High

High

Moderate to High

HighAt Least in theBeginning

ModerateOften aContentious Issue

Radical Innovators

Lovi'

Low

Moderate

ModerateIt Depends onthe Degree of Autonomy

MixedIt Depends on theComplexity of theOrganization

ModerateIt Depends onthe Degree of AllianceIntegration

Moderate to High^TheMore "Hands Off" theBetter

High^As Long as the Fundis Very "Hands Off"

Emotional Support

Unpredictable

Mixed

Low

Could Be High, If ProperlyStructured

Moderate to High

Will Depend Entirelyon the Deal

LimitedDepends onthe Budget

Moderate to High

9. Emerging IndustryFund (EIF)

LowIt Is Indirect Very High Potentially Very High,Depending on Arrange-ments with CorporateInvestor and VC Manager

If the EIF structure prohibits the innovation-starved corporate investorfrom exercising control over the entrepreneurs, what is in it for the large corpo-ration? Why participate in an EIF? The answer is certainly not hard to under-standthey want to make above average investment returns. However, when itcomes to stimulating radical innovation, what advantages does this strategy haveover the eight others? (See Figure 1 for a comparison of the important charac-teristics of all nine of the innovation-stimulating strategies.) The secret of successfor an EIF is the quality of the independent VC firm that manages the fund. Notonly must the VCs invest wisely, they must orchestrate a network of relation-ships that accomplishes the objectives of the fund's investors. All investors wantto maximize their economic returns. However, the EIF makes greater strategic


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F I G U R E I . Strategies for Stimulating Radical Innovation in Large Companies (continued)

Strategy

Innovator'sPerception ofthe Quality ofthis Support

Opportunity toLearn about theFull Potential ofthe Innovation

Degree ofDifficulty ofthis Learning

1. Talk about Innovation

2. Hire More Innovators

3. Infomnal ProjectLaboratories

4. Idea Markets

5. Dual Strategies

6. Acquisitions andAlliances

7. CorporateVenturing

8. Corporate VentureFunds

Low

Low

Low

Low, but Depends on theInnovator's Political Savvy

High, If Conflicts Are WellManaged

MixedWill Dependon How Connplementarythe Innovation is

MixedComes with"Strings" Attached

Can Be High, If theCorporation's MotivesAren't Questioned

LowOnly One Way

Probably LowDependson the Courage of theHired Innovators

Low to Moderate

Moderate, IfThere Is a"Hands OfT" Policy

MixedVery Hard toStray Too Far From theCore Technology

HighUnless theInnovator-Partner inPushed in One Direction

Moderate^Very Hardto Keep from Meddling

High, If Innovators areCiven Freedom

Very Easy

Easy

Easy, If Ideas AreIncremental

Easier with IncrementalInnovation

Somewhat Difficult Dueto Conflicts

Mixed^The Questionis W h o Learns What?

Easy

Often Quite DifficultOften Depends onExpectations

9. Emerging IndustryFund (EIF)

HighWill Depend onthe Quality of theVCs

HighIf Learning GoalsAre Clear and ProperMechanisms Are in Place

DifficultIt Takes Patienceand Discipline

sense for the innovation-seeking corporate investors when they participate in arobust knowledge transfer process that allows them to learn about the commer-cial feasibility of the radically new ideas being developed by the fund's portfoliocompanies. The learning process is three-dimensional and is "behind thescenes," with none of the mechanisms impeding the fund's primary objectiveof generating high economic returns. In fact, the multi-dimensional knowledgetransfer process significantly enhances the EIF's ability to generate above averagereturns. The more the VCs know about the emerging industry and how tbe newmarkets differ from old ones, the "smarter" their money will be. The more theentrepreneurs in tbe portfolio companies know about the independent VCsbusiness management practices and the corporate lead limited partners' market-

CAUFORNIA MANAGEMENT REVIEW VOL 42, NO. 4 SUMMER 2000 85


ing, sales, or distribution practices, tbe faster they will be able to grow their com-panies. The more the large corporate investors know about tbe potential of tberadical innovations, the higher tbe value tbat will be placed on each of the suc-cessful portfolio companies. Even tbe less successful ones will be worth morebecause of tbe active, focused, and informed VC support they received beingpart of the EIF portfolio.

Researcb by Walter Powell at the University of Arizona and Rob Crossand Lloyd Baird at Boston University sheds ligbt on bow this knowledge transferprocess works and bow it stimulates innovation in large companies. Powell stud-ied the field of biotechnology and concluded that companies that have activecollaborative networks, including involvement with new ventures and emergingcompanies trying to commercialize radical innovation, are exposed to more newideas and are potentially more innovative. Tbe key to being more innovativeturns out to be tbe company's ability to absorb knowledge, not the availability ofradically new ideas.^* Cross and Baird found that knowledge transfer dependedmore on personal interactions than on technology or data bases.^ ^

Building on these insights, corporate participants in an EIF can use sevenknowledge transfer mechanisms to enhance their appreciation of the potentialvalue of the radical innovations they indirectly invest in:

Place an Executive in the Office of the VC. This keeps the corporate participantsfully informed of the fund's deal flow and tbe commercialization activitiesof its portfolio companies. The on-site executive also belps the portfoliocompanies access the resources of the large corporate investors.

Designate an EIF Network Manager. Tbe Network Manager, located at corpo-rate headquarters, is at the receiving end of the knowledge flow from theEIF. He or she is responsible for enhancing and sustaining tbe dialoguebetween the corporation and the R&D professionals, the marketers, theoperators, and the executives of all the companies associated with thefund.

Create Absorption Teams within the Corporation That Wants to Learn. Tbe goalis to ensure tbat new ideas are spread around the corporate partner'sorganization by turning individual expertise and insight into organiza-tional learning. Identify small teams of people who will be responsible forlearning about the experiences of each portfolio company, with differentpeople assigned to each venture in order to assure rapid and diffuseabsorption of tbe new knowledge.

Set Up an Idea Library. Eacb corporate participant sbould establish a centralrepository for tbe documentable knowledge tbat emerges from the EIFactivities and investments. Tbe library would include working papers, duediligence reports, memos, presentations made by various experts, legaldocuments, and the minutes of the fund's Advisory Board.


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Create an EIF Web Site. To encourage scientific dialogue, all tbe portfoliocompanies, tbe corporate partners and the VCs sbould have secure accessto tbe EIF's own web site.

Establish Formal Forums to Compare Notes. In forums bosted periodically byeach corporate participant, representatives of tbe fund's portfolio compa-nies and its Advisory Board focus on specific tecbnologies, ideas, or issues.Participants can present issues, ideas, successes, failures, and insigbts andcan explore ways to capitalize on their pooled experience.

Respond to Requests for Informal Exchanges. Perbaps tbe most importantknowledge transfer mechanism is the informal conversations andexchanges between tbe corporate limited partners and tbe individualportfolio companies. Tbese include cross-functional and multi-functionalproblem-solving meetings aimed at helping a specific entrepreneur com-mercialize his or ber innovation.Strategy #9 is too arm's-lengtb, too expensive, and too risky to be relied

upon as tbe sole source of commercially viable radical innovations. However,when combined with one or more of the otber strategies, it may provide multi-ple windows tbrougb which a company can view tbe future evolution of anemerging industry. Moreover, it gives the large corporation informed strategicoptions it would otberwise not have.

Think Ahead

what is tbe likelihood tbat tbe leaders of major U.S. industries will growby virtue of homegrown breakthrough innovations? Will companies like GM,Philip Morris, and Exxon lead tbe way in defining and then meeting the needsof tomorrow's consumers? Is it not more likely that small, emerging companieswill discover and exploit tbe best new ideas? If companies like J&J, Intel, andCisco Systems continue to generate a constant stream of innovations, migbt it bebecause tbey bave adopted truly unconventional approacbes to tbe innovationmanagement process?

During times of disruptive change, just wben tbe need for new initiativesand radical tbinking is tbe greatest, most industry leaders engage in more mar-ket researcb on tbe value propositions of existing customer segments. Tbey biremore consultants who explore ways to expand and sustain tbe company's cur-rent sources of competitive advantage; and they fund more detailed and com-prehensive analyses of the banks of data in tbe company's arcbives. Theseresponses to tbe need for greater innovation are all part of tbe genetic code oftbe typical big company. In tbe new millennium, tbe leaders of traditional indus-tries are going to bave to apply new innovation management strategies if tbeyare to maintain tbeir leadersbip positions.


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Hov\/To Manage Radical Innovation

Notes1. Curt Wang, "Seven Ways Brand Management Kills Innovation," Food Processing

(September 1999), pp. 35-40.2. CorpTech database, owned by Corporate Technology Information Services, Inc.,

see Hanson, Stein, and Moore (1984).3. Samuel Kortum and Josh Lerner, "Does Venture Capital Spur Innovation?"

National Bureau of Economic Research Working Paper, Cambridge, MA, 1998.4. "Stall Points," Research Report of the Corporate Strategy Board, 1998.5. Clayton Christensen, The Innovator's Dilemma (Boston, MA: Harvard Business

School Press, 1997).6. "Getting to 'Eureka'!" Business Week, November 10, 1997, p. 76.7. David McClelland, Human Motivation (Cambridge: Cambridge University Press,

1986).8. George Litwin and Robert Stringer, Motivation and Organizational Climate (Boston,

MA: Harvard University Press, 1968).9. Brian O'Reilly, "What it Takes to Start a Startup," Fortune, June 7, 1999.

10. Ibid., p. 13511. Comment in a personal interview with the author.12. Michael Tushman and Charles O'Reilly, Winning Through Innovation (Boston, MA:

Harvard Business School Press, 1997), p. 171.13. Ibid., p. 171.14. Ibid., p. 173.15. For ideas and a discussion of how to squeeze the most out of business alliances

and partnerships, see Jordan Lewis, Partnerships for Profit (New York, NY: TheFree Press, 1990); Kathryn Harrigan, Managing for Joint Venture Success (New York,NY: Lexington Books, 1986).

16. Peter Cohan, The Technology Leaders (San Francisco, CA: Jossey-Bass, 1997),pp. 79-81.

17. Zenas Block and Ian MacMillan, Corporate Venturing (Boston, MA: Harvard Busi-ness School Press, 1993), pp. 196-228.

18. Ibid., p. 196.19. Comment in a personal interview with the author.20. Thomas Helimann and Manju Puri, "The Interaction between Product Market and

Financing Strategy: The Role of Venture Capital," Stanford University GraduateSchool of Business Research Paper No. 1561, May 1999.

21. Business Week, October 11, 1999, p. 28.22. Block and MacMillan, op. cit., p. 343.23. Private correspondence with the author.24. Luisa KroU, "Entrepreneurs Big Brothers," Forbes, May 3, 1999.25. Comment in personal interview with the author.26. Walter Powell, "Learning from Collaboration: Knowledge and Networks in the

Biotechnology and Pharmaceutical Industries," California Management Review, 40/3(Spring 1998): 228-240.

27. Rob Cross and Lloyd Baird, "Technology is Not Enough: Improving Performanceby Building Organizational Memory," Sloan Management Review, 41/3 (Spring2000): 69-78.

CALIFORNIA MANAGEMENT REVIEW VOL 42, NO. 4 SUMMER 2000

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