Probably the most daunting challenge in delivering growth is that if you fail once to deliver it, the odds that you ever will be able to deliver in the future are very low. This is the conclusion of a remarkable study, Stall Points, that the Corporate Strategy Board published in 1998.8 It examined the 172 companies that had spent time on Fortune’s list of the 50 largest companies between 1955 and 1995. Only 5 percent of these companies were able to sustain a real, inflation-adjusted growth rate of more than 6 percent across their entire tenure in this group. The other 95 percent reached a point at which their growth simply stalled, to rates at or below the rate of growth of the gross national product (GNP). Stalling is understandable, given our expectations that all growth markets become saturated and mature. What is scary is that of all these companies whose growth had stalled, only 4 percent were able to successfully reignite their growth even to a rate of 1 percent above GNP growth. Once growth had stalled, in other words, it proved nearly impossible to restart it.
The equity markets brutally punished those companies that allowed their growth to stall. Twenty-eight percent of them lost more than 75 percent of their market capitalization. Forty-one percent of the companies saw their market value drop by between 50 and 75 percent when they stalled, and 26 percent of the firms lost between 25 and 50 percent of their value. The remaining 5 percent lost less than 25 percent of their market capitalization. This, of course, increased pressure on management to regenerate growth, and to do so quickly—which made it all the more difficult to succeed. Managers cannot escape the mandate to grow.9 Yet the odds of success, if history is any guide, are frighteningly low.
TABLE 1 - 1
Portion of Selected Firms’ Market Value That Was Based on Expected Returns from New Investments on August 21, 2002
Percent of Valuation
That Was Based on:
Fortune
500 rank Company Name Share
Price New Investments Existing Assets
53 Dell Computer $28.05 78% 22%
47 Johnson & Johnson $56.20 66% 34%
35 Procter & Gamble $90.76 62% 38%
6 General Electric $32.80 60% 40%
77 Lockheed Martin $62.16 59% 41%
1 Wal-Mart Stores $53.88 50% 50%
65 Intel $19.15 49% 51%
49 Pfizer $34.92 48% 52%
9 IBM $81.93 46% 54%
24 Merck $53.80 44% 56%
92 Cisco Systems $15.00 42% 58%
18 Home Depot $33.86 37% 63%
16 Boeing $28.36 30% 70%
11 Verizon $31.80 21% 79%
22 Kroger $22.20 13% 87%
32 Sears Roebuck $36.94 8% 92%
37 AOL Time Warner $35.00 8% 92%
3 General Motors $49.40 5% 95%
81 Phillips Petroleum $35.00 3% 97%
Source: CSFB/HOLT; Deloitte Consuting analysis.
Is Innovation a Black Box?
Why is achieving and sustaining growth so hard? One popular answer is to blame managers for failing to generate new growth—implying that more capable and prescient people could have succeeded. The solve-the-problem-by-finding-a-better-manager approach might have credence if failures to restart growth were isolated events. Study after study, however, concludes that about 90 percent of all publicly traded companies have proved themselves unable to sustain for more than a few years a growth trajectory that creates above-average shareholder returns.10 Unless we believe that the pool of management talent in established firms is like some perverse Lake Wobegon, where 90 percent of managers are below average, there has to be a more fundamental explanation for why the vast majority of good managers has not been able to crack the problem of sustaining growth.
A second common explanation for once-thriving companies’ inability to sustain growth is that their managers become risk averse. But the facts refute this explanation, too. Corporate executives often bet the future of billion-dollar enterprises on an innovation. IBM bet its farm on the System 360 mainframe computer, and won. DuPont spent $400 million on a plant to make Kevlar tire cord, and lost. Corning put billions on the line to build its optical fiber business, and won big. More recently it sold off many of its other businesses in order to invest more in optical telecommunications, and has been bludgeoned. Many of the executives who have been unable to create sustained corporate growth have evidenced a strong stomach for risk.
There is a third, widely accepted explanation for why growth seems so hard to achieve repeatedly and well, which we also believe does not hold water: Creating new-growth businesses is simply unpredictable. Many believe that the odds of success are just that—odds—and that they are low. Many of the most insightful management thinkers have accepted the assumption that creating growth is risky and unpredictable, and have therefore used their talents to help executives manage this unpredictability. Recommendations about letting a thousand flowers bloom, bringing Silicon Valley inside, failing fast, and accelerating selection pressures are all ways to deal with the allegedly irreducible unpredictability of successful innovation.11 The structure of the venture capital industry is in fact a testament to the pervasive belief that we cannot predict which new-growth businesses will succeed. The industry maxim says that for every ten investments—all made in the belief they would succeed—two will fail outright, six will survive as the walking wounded, and two will hit the home runs on which the success of the entire portfolio turns. Because of this belief that the process of business creation is unfathomable, few have sought to pry open the black box to study the process by which new-growth businesses are created.
We do not accept that most companies’ growth stalls because the odds of success for the next growth business they launch are impossibly low. The historical results may indeed seem random, but we believe it is because the process for creating new-growth businesses has not yet been well understood. In this book we intend to pry open the black box and study the processes that lead to success or failure in new-growth businesses.
To illustrate why it is important to understand the processes that create those results, consider these strings of numbers:
1, 2, 3, 4, 5, 6
75, 28, 41, 26, 38, 64
Which of these would you say is random, and which is predictable? The first string looks predictable: The next two numbers should be 7 and 8. But what if we told you that it was actually the winning numbers for a lottery, drawn from a drum of tumbling balls, whereas the second is the sequence of state and county roads one would follow on a scenic tour of the northern rim of Michigan’s Upper Peninsula on the way from Sault Ste. Marie, Ontario to Saxon, Wisconsin? Given the route implied by the first six roads, you can reliably predict the next two numbers—2 and 122—from a map. The lesson: You cannot say, just by looking at the result of the process, whether the process that created those results is capable of generating predictable output. You must understand the process itself.
The Forces That Shape Innovation
What can make the process of innovation more predictable? It does not entail learning to predict what individuals might do. Rather, it comes from understanding the forces that act upon the individuals involved in building businesses—forces that powerfully influence what managers choose and cannot choose to do.
Rarely does an idea for a new-growth business emerge fully formed from an innovative employee’s head. No matter how well articulated a concept or insight might be, it must be shaped and modified, often significantly, as it gets fleshed out into a business plan that can win funding from the corporation. Along the way, it encounters a number of highly predictable forces. Managers as individuals might indeed be idiosyncratic and unpredictable, but they all face forces that are similar in their mechanism of action, their timing, and their impact on the character of the product and business plan that the company ultimately attempts to implement.12 Understanding and managing these forces can make innovation more predictable.
The action and impact of these forces in shaping ideas into business plans is illustrated in a case study of the Big I
dea Group (BIG), a company that identifies, develops, and markets ideas for new toys.13 After quoting a senior executive of a multibillion-dollar toy company who complained that there have been no exciting new toy ideas for years, the case then chronicles how BIG attacks this problem—or rather, this opportunity.
BIG invites mothers, children, tinkerers, and retirees who have ideas for new toys to attend “Big Idea Hunts,” which it convenes in locations across the country. These guests present their ideas to a panel of experts whose intuition BIG executives have come to trust. When the panel sees a good idea, BIG licenses it from the inventor and over the next several months shapes the idea into a business plan with a working prototype that they believe will sell. BIG then licenses the product to a toy company, which produces and markets it through its own channels. The company has been extraordinarily successful at finding, developing, and deploying into the market a sequence of truly exciting growth products.
How can there be such a flowering of high-potential new product opportunities in BIG’s system, and such a dearth of opportunities in the large toy company? In discussing the case, students often suggest that the product developers in the toy company just aren’t as creative, or that the executives of the major company are just too risk averse. If these diagnoses were true, the company would simply need to find more creative managers who could think outside the box. But a parade of people has cycled through the toy company, and none has been able to crack the apparent lack of exciting toy ideas. Why?
The answer lies in the process by which the ideas get shaped. Midlevel managers play a crucial role in every company’s innovation process, as they shepherd partially formed ideas into fully fledged business plans in an effort to win funding from senior management. It is the middle managers who must decide which of the ideas that come bubbling in or up to them they will support and carry to upper management for approval, and which ideas they will simply allow to languish. This is a key reason why companies employ middle managers in the first place. Their job is to sift the good ideas from the bad and to make good ideas so much better that they readily secure funding from senior management.
How do they sift and shape? Middle managers typically hesitate to throw their weight behind new product concepts whose market is not assured. If a market fails to materialize, the company will have wasted millions of dollars. The system therefore mandates that midlevel managers support their proposals with credible data on the size and growth potential of the markets that each idea targets. Opinions and feedback from significant customers add immeasurably to the credibility of claims that an idea has potential. Where does this evidence come from, given that the product hasn’t yet been fully developed? It typically comes from existing customers and markets for similar products that have been successful in the past.
Personal factors are at work in this shaping process, too. Managers who back ideas that flop often find their prospects for promotion effectively truncated. In fact, ambitious managers hesitate even to propose ideas that senior managers are not likely to approve. If they favor an idea that their superiors subsequently judge to be weak, their reputation for good judgment can be tarnished among the very executives they hope to impress. Furthermore, companies’ management development programs rarely leave their most talented middle managers in a position for longer than a few years—they move them to new assignments to broaden their skills and experience. What this means, however, is that middle managers who want a reputation for delivering results will be inclined to promote only those new-growth ideas that will pay off within the time that they reside in that particular job.
The process of sorting through and packaging ideas into plans that can win funding, in other words, shapes those ideas to resemble the ideas that were approved and became successful in the past. The processes have in fact evolved to weed out business proposals that target markets where demand might be small. The problem for growth-seeking managers, of course, is that the exciting growth markets of tomorrow are small today.
This is why the senior managers at the major toy company and at BIG can live in the same world and yet see such different things. In every sizable company, not just in the toy business, the set of ideas that has been processed and packaged for top management approval is very different from the population of ideas that is bubbling at the bottom.
A dearth of good ideas is rarely the core problem in a company that struggles to launch exciting new-growth businesses. The problem is in the shaping process. Potentially innovative new ideas seem inexorably to be recast into attempts to make existing customers still happier. We believe that many of the ideas that emerge from this packaging and shaping process as me-too innovations could just as readily be shaped into business plans that create truly disruptive growth. Managers who understand these forces and learn to harness them in making key decisions will develop successful new-growth businesses much more consistently than historically has seemed possible.14
Where Predictability Comes From: Good Theory
The quest for predictability in an endeavor as complex as innovation is not quixotic. What brings predictability to any field is a body of well-researched theory—contingent statements of what causes what and why. Executives often discount the value of management theory because it is associated with the word theoretical, which connotes impractical. But theory is consummately practical. The law of gravity, for example, actually is a theory—and it is useful. It allows us to predict that if we step off a cliff, we will fall.15
Even though most managers don’t think of themselves as being theory driven, they are in reality voracious consumers of theory. Every time managers make plans or take action, it is based on a mental model in the back of their heads that leads them to believe that the action being taken will lead to the desired result.16 The problem is that managers are rarely aware of the theories they are using—and they often use the wrong theories for the situation they are in. It is the absence of conscious, trustworthy theories of cause and effect that makes success in building new businesses seem random.
To help executives to know whether and when they can trust the recommendations from management books or articles (including this one!) that they read for guidance as they build their businesses, we describe in the following sections a model of how good theories are built and used. We will repeatedly return to this model to illustrate how bad theory has caused growth builders to stumble in the past, and how the use of sound theory can remove many of the causes of failure.17
How Theories Are Built
The process of building solid theory has been researched in several disciplines, and scholars seem to agree that it proceeds in three stages. It begins by describing the phenomenon that we wish to understand. In physics, the phenomenon might be the behavior of high-energy particles. In the building of new businesses, the phenomena of interest are the things that innovators do in their efforts to succeed, and what the results of those actions are. Bad management theory results when researchers impatiently observe one or two success stories and then assume that they have seen enough.
After the phenomenon has been thoroughly characterized, researchers can then begin the second stage, which is to classify the phenomenon into categories. Juvenile-onset versus adult-onset diabetes is an example from medicine. Vertical and horizontal integration are categories of corporate diversification. Researchers need to categorize in order to highlight the most meaningful differences in the complex array of phenomena.
In the third stage, researchers articulate a theory that asserts what causes the phenomenon to occur, and why. The theory must also show whether and why the same causal mechanism might result in different outcomes, depending on the category or situation. The process of theory building is iterative, as researchers and managers keep cycling through these three steps, refining their ability to predict what actions will cause what results, under what circumstances.18
Getting the Categories Right
The middle stage in this cycle—getting the categories right�
��is the key to developing useful theory. To see why, imagine going to your medical doctor seeking treatment for a particular set of symptoms, and before you have a chance to describe what ails you, the physician hands you a prescription and tells you to “take two of these and call me in the morning.”
“But how do you know this will help me?” you ask. “I haven’t told you what’s wrong.”
“Why wouldn’t it work?” comes the reply. “It cured my previous two patients just fine.”
No sane patient would accept medicine like this. But academics, consultants, and managers routinely dispense and accept remedies to management problems in this manner. When something has worked for a few “excellent” companies, they readily advise all other companies that taking the same medicine will be good for them as well. One reason why the outcomes of innovation appear to be random is that many who write about strategy and management ignore categorization. They observe a few successful companies and then write a book recommending that other managers do the same things to be successful too—without regard for the possibility that there might be some circumstances in which their favorite solution is a bad idea.19
For example, thirty years ago many writers asserted that vertical integration was the key to IBM’s extraordinary success. But in the late 1990s we read that non-integration explained the triumph of outsourcing titans such as Cisco and Dell. The authors of “best practices” gospels such as these are no better than the doctor we introduced previously. The critical question that these researchers need to resolve is, “What are the circumstances in which being integrated is competitively critical, and when is a strategy of partnering and outsourcing more likely to lead to success?”
The Innovator's Solution Page 2
