how to manage radical innovation a

CMR180

How To Manage Radical Innovation

Robert Stringer

© 2000 by The Regents of

the University of California

California

Management

Summer 2000 | Vol.42, No.4 | REPRINT SERIES

How To Manage

Radical Innovation

Robert Stringer

70 CALIFORNIA MANAGEMENT REVIEW

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 years

trying to commercialize a radical innovation called “Liquid Life,” an all-natural

beverage made 100% from pureed fruit. They had developed an attractive plastic

package, six good tasting flavors, and eye catching point-of-sale promotional

materials. Grocery stores had told them they loved the idea and would gladly

carry the product. However, consumers knew nothing about “Liquid Life” and it

would take millions of dollars to commercialize the innovation the way the three

entrepreneurs wanted to do it. Now, they had run out of money and time.

Four other people were at the meeting. Two were investment bankers, one

a venture capitalist, and one a vice-president from Big Food, Inc., a Fortune 100

food and beverage company. Three of these four tried, once again, to convince

the “Liquid Life” entrepreneurs to sell their ideas and technology to the food

company. Once again, this advice was met with an emotional refusal.

The argument was always the same: the food company loved the breakthrough

technology and was desperate for a radical new idea that might pump life into

one of its existing product categories, but they could not pay much for an

unproved innovation. The “Liquid Lifers” loved the idea of having a big

company’s resources behind them, but they knew the food company would stran-

gle their commercialization dreams and control the way they developed future

products. None of them wanted to join a large—though very successful—public

company. The investment bankers had brought the food company to the meeting

and advised the “Liquid Lifers” to sell. The venture capitalist wasn’t so sure.

This scene is played out every week. Entrepreneurs see opportunities to

introduce radical innovations and they act on this opportunity. Their analysis

may 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

VOL. 42, NO. 4 SUMMER 2000


Innovation Is a Strategic Imperative

CALIFORNIA MANAGEMENT REVIEW

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.2 A recent

Harvard and Boston University study of 20 U.S. industries from 1965 to 1992

discovered that small companies supported by venture capital produced six

times as many patents as a similar amount of traditional corporate R&D spend-

ing.3 Another recent study of the growth records of the Fortune 50 sponsored by

Hewlett-Packard and the Corporate Strategy Board concluded that the single

biggest growth inhibitor for large companies was “mismanagement of the inno-

vation process.”4

The recent emergence of the e-business model places an even greater

premium on the ability to quickly commercialize radical innovation. In the age

of the Internet, information—about new technologies, new applications, new

research results, product performance, customer experiences, and competitive

reactions to new ideas—is increasingly available to everyone. Not only is there an

ever-larger array of radical new value propositions for both buyers and sellers,

the need for speed in finding, assessing, and commercializing innovative ideas is

dramatically increased. In an e-world that runs on e-time, speed to market is

measured in days and weeks. A conservative and deliberate company will find it

hard to survive, much less prosper, in the world of e-business.

Though the world demands more innovative organizations and the largest

U.S. companies want to be innovative, most are poorly equipped to implement a

growth strategy based on radical innovation because most large companies are

genetically programmed to preserve the status quo. They do not have the right

organization, culture, leadership practices, or personnel to collect and success-

fully commercialize radical new ideas. In addition, when they are exposed to

entrepreneurs who have potentially profitable breakthrough innovations, they

do not seem to learn fast enough and well enough to take full advantage of the

exposure and the innovations.


Not surprisingly, history tells us that most large companies are not radical

innovators. They are good at making close-in changes to existing products or

technologies, but they do not often commercialize breakthrough ideas. Accord-

ing to Marketing Intelligence Service’s Innovation Ratings, more than 25,000

new consumer packaged goods were launched in 1998, most of them by large

companies. Over 93 percent of these were judged to be “not significantly

innovative.”1

71

other hand, may realize that their industries are suddenly changing and that the

winners 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 cannot

bring themselves to learn by doing.


Why Aren’t Large Companies More Innovative?

Industry Leaders Can’t Afford to Embrace Radical Innovation

Structures and Cultures Discourage

Bringing Big Ideas to Market


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 innovation

impairs 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 for

the company to reallocate resources fast enough to capitalize on the opportunity.

This gives industry leaders mixed motives. They sense the world is changing, but

they have too much invested in the status quo to embrace the radical innova-

tion. They prefer to focus on making incremental improvements to their core

technologies.

Size and shape make a difference. Large scale, while often a powerful

source of competitive advantage, leads to bureaucratic structures that discourage

bringing breakthrough or radical innovations to market. The brand management

organization in most consumer goods companies encourages short-term think-

ing and incremental product improvements, not breakthrough ideas. Radical

innovations often require dramatic shifts in production capabilities, distribution

mechanisms, or customer relationships. These shifts threaten the status quo and

upset 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, especially

when they threaten to sweep away the old order of things, destabilizes the orga-

nization. Inventions that are considered isolated “good ideas” will be tolerated,


Powerful 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-winning The Innovator’s Dilemma,

explains the difference between “sustaining” and “disruptive” technologies and

points out how poorly equipped industry leaders are to cope with radical or dis-

ruptive innovation.5 Sustaining technologies foster improved performance of

existing products or services. Industry leaders must (and usually do) invest

heavily in sustaining technologies. When disruptive technologies emerge in an

industry, they may lead to worse product performance for mainstream customers,

even though the radical innovation often embodies a new and improved value

proposition for rapidly growing segments of non-mainstream customers.

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.


often encouraged, but rapid and widespread commercialization of an untested

and unproved new idea is another matter.

Relying Too Much on Internal R&D


Relying 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 to

believe it will work with all the new technologies and business models being

introduced today. Internal R&D projects cannot possibly anticipate or support all

of these emerging designs all the way to the marketplace. During times of rapid

change, industry leaders who want to stay leaders need to place multiple bets on

a wide range of promising innovations. Furthermore, they need to see how

these 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 use

decisions over time. Most R&D departments have limited responsibility for the

start-to-finish commercialization process, so pouring more money into internal

R&D is not the answer. To complicate the industry leaders’ R&D dilemma even

more, they must continue to invest in their existing technology. To stay on top,

they must constantly develop their existing products and services, while at the

same time engaging in robust search and learning behaviors that allow them to

quickly discover, influence, or respond to the emerging technology or business

model. These multiple demands on internal R&D inevitably put pressure on the

budget. Many large companies have responded to this pressure by decentralizing

R&D. All this does is ensure that immediate sales and marketing needs will take

precedence over longer-term investments in radical innovation. Even in a cen-

tralized R&D function, industry leaders must be very careful about prematurely

assuming 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 stuck

with a bad idea.

All of this is a tall order for any internal R&D department, no matter how

well funded, how well managed, or how well positioned in the strategic decision

making process of the corporation. Traditional methods of evaluation of the

portfolio of internal R&D projects (e.g., discounted cash flow analysis) also serve

to inhibit the commercialization of radical innovations. The criteria used to judge

radically 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 of

fully developed breakthrough ideas.

A classic example of this problem was played out at IBM. If it had not

been for Bernard Meyerson, one of IBM’s research fellows, the development of

silicon-germanium semiconductors would have been aborted back in the early

1980s. According to all of IBM’s sophisticated portfolio analyses, this project was

never 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


73


Large Companies Don’t Attract or Retain Radical Innovators


Research shows that the motivational profile that is most likely to be

successful in a large corporate environment is one dominated by the need for

power, not the need for achievement.7 Social skills—including the ability to

influence others, the patience to work across organizational boundaries, and the

mastery of the political aspects of organizational life—count for more than hav-

ing an aggressive competitive spirit. Innovators tend to be high achievers, and

they are attracted to working environments where they can “call the shots” and

be individually responsible for results. Smaller companies offer far more opportunity for innovators to satisfy their needs for achievement. Large corporations

may have their fair share of “inventors,” that is, people who have new, creative

ideas, 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 companies

commercialized more innovations in the 20th century, and it is why they will

continue to do so in the next.

Why Are Small Companies the Source

of Most Radical Innovations?

Small companies succeed in introducing more radical innovations because

of their genetic makeup. Often, the entire organization can be built around a

single breakthrough concept. Therefore, they have little emotional or economic

investment in the status quo. In fact, they often see themselves as being at war

with the existing order of things. Unlike their large company counterparts, the


There is a strong logic for saying that the evaluation and funding of

breakthrough R&D should be separated from a large company’s normal R&D

decision-making processes. In order to avoid the trap of incremental thinking, all

aspects of breakthrough innovation must be carved out; this includes identifying

promising radical innovations, funding them, testing them, screening them, and

commercializing those that make sense. However, if you separate accountability

for introducing radical innovations, how do you maintain control? How does

the large company know when a development project is to be considered break-

through? These become sensitive political issues. How can a large company give

up control over even part of its investment in R&D? After all, that control is the

whole point of the internal R&D portfolio management process.

for years for silicon germanium in the face of supposedly more feasible R&D

projects in IBM’s R&D portfolio. The internal battle for support for radical ideas

must have been fierce at IBM. Meyerson himself admits he was following the

advice 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 grossly

exceeding your authority, you’re probably not doing your job.”6


Researchers have known for many years what motivates entrepreneurs.

In the 1960s, we called it “achievement motivation.”8 A recent article in Fortune

magazine labeled it the “need for accomplishment.”9 However it is described, the

phenomenon is the same. Innovators and entrepreneurs are driven by four

needs:

▪ 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 or

too easy), and


▪ to constantly receive concrete, measurable feedback on their performance

and 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 act on it. High achievers

are not simply idea people—they are builders. They take ideas and put them to

work, and this is what makes them successful as entrepreneurs.

Unfortunately, entrepreneurs often have well-earned reputations for

being poor team players. They view other people as a means to an end, and they

can be stubborn, ruthless, and driven—not by fame or fortune, but by their need

to 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.”10

It is not hard to imagine why large company environments frequently

discourage and de-motivate entrepreneurs who are the drivers of radical innova-

tion: too many rules, too much compromise, too many meetings, and too little

willingness to “just do it.”


The most important aspect of the small company genetic makeup, how-

ever, is the concentration of inventive entrepreneurs found in them. Because of

who they are and where they work, these entrepreneurs can be ruthless about

listening to the market and adapting their ideas in order to make them

successful.

75

leaders of small companies with a radical new technology will often bet most of

their limited resources on commercializing the innovation. Just like the opening

example of “Liquid Lifers,” they may knowingly risk the enterprise trying to

prove out and expand the viability of a new idea. Small company R&D functions

are sometimes subject to the same conflicts as large company functions, but their

small size puts them closer to the market and makes them more agile, less

bureaucratic, and more responsive to the unpredictable nature of the commer-

cialization process.


Stimulating Innovation in Large Companies

Working From the Inside Out


The first five strategies have been employed by large companies who

believe they can significantly increase the flow of radical innovation by working

with 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. Challenge

business units to increase the percentage of their revenues derived from new

products or services. Generate benchmark measures that show how important

radical 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 a

sense of urgency that often stimulates increased entrepreneurial activity, even

in conservative companies. General Mills has been able to out-innovate its

archrival Kellogg by constantly emphasizing the need for innovation in its cereal

division, as well as its corporate strategy.

The problem with this strategy is that it seldom works very well on its

own. It is not enough to exhort people to support big ideas. Organizations that

have consistently innovated combine the rhetoric with one or more of the other

strategies.


Given 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 or

fails, how have large companies tried to alter their own genetic code? How have

large companies tried to attract and motivate entrepreneurs? How have they

tried to reconcile the conflicting interests of those who want to innovate for

tomorrow and those who want the profit for today? Moreover, why have they

so often failed? Successful innovators use nine different strategies to attack the

problem. 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 “the

degree 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 to

manage, but they have more potential for driving radical innovation in indus-

tries that are rapidly evolving. The final group of strategies are even more radical

approaches that are quite risky and much harder to implement but more likely

to result in big ideas that are commercially viable in emerging new industries.


Strategy #2: Hire more creative and innovative people.

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, but

generating a stream of commercially viable breakthrough ideas takes more than

the 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 very

limited.

Strategy #3: Grow informal project laboratories within the traditional

organization.


Grant innovators free time to invent by building flexibility and fat into

R&D budgets and by modifying the performance management system so that

“crazy” new ideas that do not have immediate payoffs are not punished. The

concept 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, In

Search of Excellence, the story of innovation at 3M is impressive. One can only

wonder 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 project

lab budget flexibility.

The biggest problem with the project labs strategy is that it flies in the

face 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 of

traditional well-run companies. Even in organizations where project labs find a

life, it is often difficult to commercialize the innovations that are generated.

Surinder Kumar, the former head of R&D for the Pepsi-Cola Company, can

attest to this. He used to encourage innovation, especially radical new

approaches to certain aspects of Pepsi’s technology, but only those projects that

met rigorous evaluation criteria were ever funded for commercial or market

testing.11


77

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 Consumer

Group) recruited a cadre of entrepreneurial consumer products executives and

challenged them to “break the rules.” He wanted them to apply their consumer

goods experience to the more conservative world of banking. Known around the

WHCG as the “dog food managers” (several of them had come from General

Foods, maker of Pet dog food), they successfully introduced a number of radical

innovations to Citibank’s portfolio of consumer products.


Strategy #4: Create “idea markets” within the organization.

Idea markets are not as easy to manage as traditional project labs. The

most effective programs create truly autonomous teams and allow these teams

to control their own destinies. They hire their own people, are free to tap into

the corporation’s resources, write their own rules, and often report directly into

the CEO. Rewarding idea market team members is, perhaps, the most significant

challenge. Nortel uses “phantom stock” to compensate those who volunteer for

special, high-risk projects, and it agrees to “buy” these projects as if they were

independent companies and were going public.

Not surprisingly, it is easier to use the idea market strategy as a source of

breakthrough concepts than it is to use them as the vehicle for commercializing

the innovations. For this reason, most companies pass off the responsibility for

implementing the idea market projects to established business units. This has not

always worked because the greatest barriers to innovation are often found at the

business unit level. Recognizing this, P&G’s CEO Durk Jager has put aside $250

million of seed money to fund a centralized and independent Corporate New

Ventures division that he hopes will stimulate breakthrough innovation in the

new millennium. Like many of its big company peers, P&G needs to find a new

approach to innovation management. The company has not introduced a new

product 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 define

technology life cycles and innovation in terms of “streams” and explain how a

selected few large companies have managed to create two different organizations

under one roof to manage these streams. One is dedicated to maximizing the

value of the traditional technology, the other to commercializing radical inno-

vation. Tushman and O’Reilly are quick to point out the difficulties with such

dual strategies: “The contradictions inherent in the multiple types of innovation

create conflict and dissent between the organizational units—between those


Establish autonomous teams, called “idea markets” or “knowledge mar-

kets,” to identify and commercialize radical innovations. Traditional companies

like Royal Dutch/Shell Group, Nortel, and Procter & Gamble are more and more

frequently putting together small teams of volunteer internal entrepreneurs and

charging them with the responsibility for driving radical innovation. Funded

separately from the traditional R&D budget, these teams collect the best ideas

from throughout the corporation and independently develop and commercialize

those that make the most sense. The World Wide Web allows these idea markets

to flourish across geographic and organizational boundaries with decentralized

resources, greatly reducing the bureaucratic constraints on the teams. At Royal

Dutch/Shell, idea market teams (known as GameChangers) have stimulated

over half of the company’s top business initiatives for 1999.


historically profitable, large, efficient, older, cash-generating units and the

young, entrepreneurial, risky, cash-absorbing units.”12

According to Tushman and O’Reilly, the most important tool for dealing

with the conflicting interests of the two parts of the organization is having a

clear vision for the total business. When Seiko defines its mission in terms of

being in the “watch business,” not just the “mechanical watch business,” it can

more easily accept, exploit, and integrate the radical innovation of quartz watch

movements. They quite correctly point out that the problem is the same as

when the railroads denied they were in the transportation business. In other

words, the answer to the lack of foresight about radical innovation is to have

greater strategic foresight.

Tushman and O’Reilly also stress the importance of having a highly

skilled senior leadership team. “In managing streams of innovation, senior teams

are like jugglers, keeping several balls in the air at once—articulating a single,

clear vision while simultaneously hosting multiple organizational architectures

without sounding confused or, worse, hypocritical. Most management teams can

do one thing well, but keeping a multitude of activities going at once requires

greater skill.”14

Working From the Outside In


Perhaps the reason why Tushman and O’Reilly’s guidelines are somewhat

fuzzy is because the task is so daunting. When attempting to implement any of

these five strategies, innovation-starved companies soon realized the difficulty

of altering what is inside their organization’s boundaries. More recently, old-line

companies trying to compete in rapidly changing industries have looked more to

the outside to stimulate radical innovation.

Strategy #6: Experiment with acquisitions, JVs, cooperative ventures,

and alliances with outside innovative entities.

The first external strategy that stodgy companies have tried to employ is

to acquire or purchase radical innovation. If innovations could not be bought,

large companies tried to form alliances and hybrid ownership arrangements with

innovators. Unfortunately, most mergers, acquisitions, JVs, and other kinds of

external alliances have failed to generate an ongoing stream of commercial


79

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 run

the core business. “The management team must not only protect and legitimize

the entrepreneurial units, but also keep them physically, culturally, and struc-

turally separate from the rest of the organization.”13 Second, try to leverage the

radical innovation for the benefit of the total company. This, they admit, is the

hard part. Unfortunately, their guidelines for integrating radical innovation into

the fabric of the large corporation are not always crisp and clear.


On occasion, the big company simply drove away the entrepreneurs and

innovators by attempting to guide, control, or influence the commercialization

of their ideas. In other words, innovation-seeking industry leaders looked out-

side but kept trying to bring the innovations inside. Their focus on control and

ownership of the innovations and the innovators, though appealing to the large

company 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 is

discouraging, it makes good sense as part of an overall program of innovation

management. High-technology companies have employed this approach with

greater success than large companies in other industries. Cisco Systems, Intel, Microsoft, and Hewlett-Packard have demonstrated that you do not have to own

a big idea to benefit from it. They have spent a lot of time and energy figuring

out 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 recent

book, The Technology Leaders, outlines how these companies do it. They take the

following 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.16


In addition to the failure to learn from the alliance or acquired partner,

the stumbling block frequently turned out to be the structure, culture, and

bureaucracy of the company desperate to innovate. Time and again, promising

new products or technologies proved to be too radical, too threatening, or too

different to be developed to their full commercial potential or to be leveraged

back into the company’s base business. A classic example of this was illustrated

by the experience of Quaker Oats. Competing in the slow growth food industry,

Quaker wanted to innovate in beverages. After all, they dominated the sports

drink market with Gatorade. In 1994, Snapple was acquired with high hopes.

Three years later, it was sold for $300 million—a shocking $1.4 billion less than

what they had paid for it.

breakthroughs. The innovation-hungry company usually saw itself as acquiring

a new product, rather than acquiring a new capability. Even when they realized

that the radical innovation involved more than a specific product, they did not

know how to learn about the capability. Too often, when this was the case, the

acquisition or alliance created less, not more, innovation in the core business.15


Strategy #7: Engage in corporate venturing.

Block and MacMillan emphasize how difficult it is to commercialize

breakthrough ideas within the typical big company’s corporate venturing struc-

ture. All the tenets of good corporate governance drive large companies to over

control their captive ventures, managing them as little more than extensions of

the internal R&D function. Venture division managers, corporate executives, and

boards of directors are accountable, and this puts obvious limits on the indepen-

dence of any venture sponsored by the company. The task of managing truly

breakthrough ideas in a corporately sponsored new venture is so complicated

that 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 the

venture.17 Traditional large companies want to own the most promising radical

innovations they sponsor. This ownership mentality leads them to focus on the

formal, contractual, and legal aspects of the relationship, paying less attention to

those aspects that cannot be codified. Unfortunately, legal ownership of a new

idea is only part of its potential value. Most new technologies, products, and

services do not become commercial successes without applying a wealth of non-

codified knowledge. It is often the informal conversations between the sponsor

and the venture that create real understanding of what is required to commer-

cialize a radical innovation. Most big companies concentrate so much on owning

and controlling things, they do not attempt to learn from the ventures they

sponsor. Block and MacMillan stress the importance of learning, stating emphat-

ically: “In organizing a venture, learning remains the primary challenge, and the

new business should therefore be organized in such a way as to maximize learn-

ing.”18 Ironically, Block and MacMillan are referring only to the venture’s ability

to learn from the big company. However, their examples, guidelines, and advice

are aimed in the wrong direction.

The semi-independent status of a corporately sponsored venture is not

good enough for most innovators and entrepreneurs. The proof of this lies with

the experience of entrepreneurs who have sought corporate funding for their

radical innovations. One successful innovator in the health care field flatly stated



Corporate venturing—creating and supporting new businesses that are

managed apart from a company’s existing business—is another strategy that can

be employed to stimulate radical innovation. Corporate venturing departments

take internal resources and attempt to treat them as if they were external

resources. A few select companies—Teradyne, Sun Microsystems, and Intel, for

example—have succeeded in driving their growth agenda by means of corporate

venturing, but the successes have been discouragingly rare. The most thorough

review of corporate venturing is Zenas Block and Ian MacMillan’s Corporate Ven-

turing. These authors highlight the fact that most successful corporate ventures

involve incremental, not radical, innovation, and they use Gannett’s creation of

USA Today as an example. Although USA Today involved new printing technol-

ogy and a new approach to marketing, Gannett leveraged many of its existing

capabilities in launching USA Today.

81


Working with Venture Capital


With the value of venture capital in mind, large companies are now

experimenting with two additional external strategies to generate more radical

innovation.

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 growth

strategy. Block and MacMillan point out that the track record of such corporate

venture 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 corporate

venture 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 portfolio

companies?22

J&J Development Corporation (JJDC) is one of the best examples of a

relatively successful corporate venture capital initiative. JJDC has been doing

venture investing since 1973 and has accumulated 25 years worth of practical

experience. JJDC executives observe, among other things, that issues of control

and independence are very important for most entrepreneurs, who are afraid of

losing control of their operations and the theft of their ideas. Over the years,

JJDC’s outstanding corporate reputation, along with hard protective work by


If small companies are more suited to the task of successfully commercial-

izing radical innovations, recent research has shown that being small and agile is

only part of the reason for their success. Commercialization of radical new ideas

requires a special kind of partnership—partnering with independent venture

capitalists. A recent study by Thomas Hellmann and Manju Puri of Stanford

University’s Graduate School of Business demonstrates that venture capital sup-

port plays a critical role in bringing innovative ideas to market.20 Their examina-

tion of 170 emerging companies in Silicon Valley from the mid-1980s to the mid-1990s finds that high innovators tend to use independent venture capital

funding 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 that

venture 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 independent

venture capitalists offer involves more than money. “Particularly through their

active participation on company boards, venture capitalists provide critical guid-

ance and help recruit key managers,” says Hellmann.21

that “corporate money has no clue what makes a breakthrough innovation

really successful. Even sophisticated corporate venturers can’t stay out of our

way long enough to commercialize the idea the way it should be. They place

all sorts of demands and unrealistic constraints on us. I guess these make sense

from their point of view, but they make little sense from ours!”19


Strategy #9: Participate in an “emerging industry fund” (EIF).


A Fortune 500 food company and major U.S. pharmaceutical company, for

example, have recently joined forces to invest in the emerging health and well-

ness industry. Adobe and Texas Instruments have established funds that are

managed by H&Q Venture Associates. These companies invest in, but do not

control, the operations of the fund. In its pure form, the majority of EIF capital comes from institutional investors who are seeking above average financial

returns and believe that the fund’s unique structure provides them with a lower

risk way to accomplish this objective. The EIF often invests in companies in need

of 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 corporate

investors to more quickly “see” the commercial potential of the new ideas. As an

executive from the pharmaceutical company observes: “the primary risk is mar-

ket development, not technology or science.”25

The EIF is managed by independent venture capitalists (VCs). This fea-

ture, along with the inclusion of institutional capital, distinguishes the EIF from

other corporate venturing initiatives and dramatically changes both its nature

and purpose. Unlike the typical corporate venture or corporate sponsored ven-

ture fund, EIF corporate partners are not playing with just their own money, and

the VCs are not part of the corporate family. Without the leverage of third-party

capital and the skills, greed, and discipline of the independent venture capitalist,

the fund will be constrained by the same factors that limit captive corporate

venture funds.


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 more

corporate investors.24 However, the vast majority of these investments are pas- sive—made by the large company’s pension fund—and include no systematic

mechanisms to insure that the corporate investor gains any strategic insight from

its investment. Today, a few far-sighted industry-leading corporations—who are

desperate to innovate because they do not know how their industries will

evolve—are contributing capital to a specially created venture capital fund and

setting up knowledge transfer processes to learn how radical innovations are

being commercialized.

83

JJDC executives, have partially overcome these fears. Other venture capitalists

are also wary of corporate venture capitalists, in part because sponsoring corpo-

rations are impatient with the long time frames venture capitalists use to mea-

sure success. JJDC has earned their trust by sharing quality deals and by

pledging to stick with investments in later financing rounds. Perhaps the most

troubling lesson learned by JJDC relates to their ability to attract and retain

high-quality venture capitalist talent to work for them. JJDC simply cannot offer

the incentives and the equity participation in the venture capital fund that the

best venture capitalists seek.23


FIGURE 1. Strategies for Stimulating Radical Innovation in Large Companies

Control over

Innovation and

Commercialization

Process

Complete

100%—As Long as They

Stay

Strategy

1. Talk about Innovation

2. Hire More nnovators

Low

Low

4. Idea Markets Moderate to High

5. Dual Strategies High

6. Acquisitions and

Alliances

Moderate to High

7. Corporate Venturing High—At Least in the

Beginning

8. Corporate Venture

Funds

Moderate—Often a

Contentious Issue

Low—It Is Indirect


9. Emerging Industry

Fund (EIF)

If the EIF structure prohibits the innovation-starved corporate investor

from 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-

stand—they want to make above average investment returns. However, when it

comes to stimulating radical innovation, what advantages does this strategy have

over 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 success

for an EIF is the quality of the independent VC firm that manages the fund. Not

only must the VCs invest wisely, they must orchestrate a network of relation-

ships that accomplishes the objectives of the fund’s investors. All investors want

to maximize their economic returns. However, the EIF makes greater strategic

Moderate—It Depends on

the Degree of Autonomy

Mixed—It Depends on the

Complexity of the

Organization

Moderate—It Depends on

the Degree of Alliance

Integration

Moderate to High—The

More “Hands Off ” the

Better

High—As Long as the Fund

is Very “Hands Off ”

Very High


3. Informal Project

Laboratories

100%—At Least in the

Beginning

Moderate

Unpredictable

Mixed

Low

Could Be High, If Properly

Structured

Moderate to High

Will Depend Entirely

on the Deal

Limited—Depends on

the Budget

Moderate to High

Potentially Very High,

Depending on Arrange-

ments with Corporate

Investor and VC Manager

Likely Motivational

Impact on the

Radical Innovators

Availability of

Economic and

Emotional Support


FIGURE 1. Strategies for Stimulating Radical Innovation in Large Companies (continued)

Innovator’s

Perception of

the Quality of

this Support

Low

Low

Strategy

1. Talk about Innovation

2. Hire More Innovators

Low—Only One Way

Probably Low—Depends

on the Courage of the

Hired Innovators

Low to Moderate

4. Idea Markets Low, but Depends on the

Innovator’s Political Savvy

5. Dual Strategies High, If Conflicts Are Well

Managed

6. Acquisitions and

Alliances

Mixed—Will Depend

on How Complementary

the Innovation is

Mixed—Comes with

“Strings” Attached

7. Corporate Venturing

8. Corporate Venture

Funds

Can Be High, If the

Corporation’s Motives

Aren’t Questioned

9. Emerging Industry

Fund (EIF)

High—Will Depend on

the Quality of the VCs

sense for the innovation-seeking corporate investors when they participate in a

robust knowledge transfer process that allows them to learn about the commer-

cial feasibility of the radically new ideas being developed by the fund’s portfolio

companies. The learning process is three-dimensional and is “behind the

scenes,” with none of the mechanisms impeding the fund’s primary objective

of generating high economic returns. In fact, the multi-dimensional knowledge

transfer process significantly enhances the EIF’s ability to generate above average

returns. The more the VCs know about the emerging industry and how the new

markets differ from old ones, the “smarter” their money will be. The more the

entrepreneurs in the portfolio companies know about the independent VC’s

business management practices and the corporate lead limited partners’ market-


Moderate, If There Is a

“Hands Off ” Policy

Mixed—Very Hard to

Stray Too Far From the

Core Technology

High—Unless the

Innovator-Partner in

Pushed in One Direction

Moderate—Very Hard

to Keep from Meddling

High, If Innovators are

Given Freedom

High—If Learning Goals

Are Clear and Proper

Mechanisms Are in Place


3. Informal Project

Laboratories

Low

Very Easy

Easy

Easy, If Ideas Are

Incremental

Easier with Incremental

Innovation

Somewhat Difficult Due

to Conflicts

Mixed—The Question

is Who Learns What?

Easy

Often Quite Difficult—

Often Depends on

Expectations

Difficult—It Takes Patience

and Discipline

85

Opportunity to

Learn about the

Full Potential of

the Innovation

Degree of

Difficulty of

this Learning


Building on these insights, corporate participants in an EIF can use seven

knowledge transfer mechanisms to enhance their appreciation of the potential

value of the radical innovations they indirectly invest in:

▪ Place an Executive in the Office of the VC. This keeps the corporate participants

fully informed of the fund’s deal flow and the commercialization activities

of its portfolio companies. The on-site executive also helps the portfolio

companies access the resources of the large corporate investors.


▪ Designate an EIF Network Manager. The Network Manager, located at corpo-

rate headquarters, is at the receiving end of the knowledge flow from the

EIF. He or she is responsible for enhancing and sustaining the dialogue

between the corporation and the R&D professionals, the marketers, the

operators, and the executives of all the companies associated with the

fund.

▪ Create Absorption Teams within the Corporation That Wants to Learn. The goal

is to ensure that new ideas are spread around the corporate partner’s

organization by turning individual expertise and insight into organiza-

tional learning. Identify small teams of people who will be responsible for

learning about the experiences of each portfolio company, with different

people assigned to each venture in order to assure rapid and diffuse

absorption of the new knowledge.

▪ Set Up an Idea Library. Each corporate participant should establish a central

repository for the documentable knowledge that emerges from the EIF

activities and investments. The library would include working papers, due

diligence reports, memos, presentations made by various experts, legal

documents, and the minutes of the fund’s Advisory Board.


Research by Walter Powell at the University of Arizona and Rob Cross

and Lloyd Baird at Boston University sheds light on how this knowledge transfer

process works and how it stimulates innovation in large companies. Powell stud-

ied the field of biotechnology and concluded that companies that have active

collaborative networks, including involvement with new ventures and emerging

companies trying to commercialize radical innovation, are exposed to more new

ideas and are potentially more innovative. The key to being more innovative

turns out to be the company’s ability to absorb knowledge, not the availability of

radically new ideas.26 Cross and Baird found that knowledge transfer depended

more on personal interactions than on technology or data bases.27

ing, sales, or distribution practices, the faster they will be able to grow their com-

panies. The more the large corporate investors know about the potential of the

radical innovations, the higher the value that will be placed on each of the suc-

cessful portfolio companies. Even the less successful ones will be worth more

because of the active, focused, and informed VC support they received being

part of the EIF portfolio.


▪ Create an EIF Web Site. To encourage scientific dialogue, all the portfolio

companies, the corporate partners and the VCs should have secure access

to the EIF’s own web site.

Strategy #9 is too arm’s-length, too expensive, and too risky to be relied

upon as the sole source of commercially viable radical innovations. However,

when combined with one or more of the other strategies, it may provide multi-

ple windows through which a company can view the future evolution of an

emerging industry. Moreover, it gives the large corporation informed strategic

options it would otherwise not have.

Think Ahead


What is the likelihood that the leaders of major U.S. industries will grow

by virtue of homegrown breakthrough innovations? Will companies like GM,

Philip Morris, and Exxon lead the way in defining and then meeting the needs

of tomorrow’s consumers? Is it not more likely that small, emerging companies

will discover and exploit the best new ideas? If companies like J&J, Intel, and

Cisco Systems continue to generate a constant stream of innovations, might it be

because they have adopted truly unconventional approaches to the innovation

management process?

During times of disruptive change, just when the need for new initiatives

and radical thinking is the greatest, most industry leaders engage in more mar-

ket research on the value propositions of existing customer segments. They hire

more consultants who explore ways to expand and sustain the company’s cur-

rent sources of competitive advantage; and they fund more detailed and com-

prehensive analyses of the banks of data in the company’s archives. These

responses to the need for greater innovation are all part of the genetic code of

the typical big company. In the new millennium, the leaders of traditional indus-

tries are going to have to apply new innovation management strategies if they

are to maintain their leadership positions.


▪ Respond to Requests for Informal Exchanges. Perhaps the most important

knowledge transfer mechanism is the informal conversations and

exchanges between the corporate limited partners and the individual

portfolio companies. These include cross-functional and multi-functional

problem-solving meetings aimed at helping a specific entrepreneur com-

mercialize his or her innovation.

87

▪ Establish Formal Forums to Compare Notes. In forums hosted periodically by

each corporate participant, representatives of the fund’s portfolio compa-

nies and its Advisory Board focus on specific technologies, ideas, or issues.

Participants can present issues, ideas, successes, failures, and insights and

can explore ways to capitalize on their pooled experience.


Notes

88

1. 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. 135

11. 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: The

Free 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 Hellmann and Manju Puri, “The Interaction between Product Market and

Financing Strategy: The Role of Venture Capital,” Stanford University Graduate

School 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 Kroll, “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 Performance

by Building Organizational Memory,” Sloan Management Review, 41/3 (Spring

2000): 69-78.

CALIFORNIA MANAGEMENT REVIEW VOL. 42, NO. 4 SUMMER 2000

how to manage radical innovation a

Documents

california management review

independent venture capitalists

corporate venture funds

stimulate radical innovation

introduce radical innovations

manage radical innovation

funds portfolio companies

large corporate investors