We need to have a serious talk about corporate innovation.
For the last 30 years, the primary approach to innovation in corporations has been to set up an innovation team, give the team some degree of financial and operational autonomy, and task the team with identifying and developing new growth areas for the corporation.
Often, the stated goal for these innovation teams is to drive business model transformation for the corporation. They’re not expected to fiddle at the margins, they’re expected to help the corporation survive and thrive in the face of future industry change. Transformation means changing the underlying business model that propels the corporation in fundamental ways, like Netflix shifting from shipped DVDs to digital delivery, or IBM moving from hardware to services.
Despite nearly every corporation establishing an innovation team, there is not a single example of this approach leading to corporate transformation. Yes, this approach has generated many examples of important sustaining or even adjacent innovations, or innovation at the margins, and these are critical to the success of any corporation. But there is not a single example of a large company fundamentally transitioning to a new business model because of the work of an innovation team.
And we must ask ourselves why not? And why does the strategy persist if it doesn’t produce the intended results? It’s time for new approaches that recognize the reality of how the world works, not how we wish it worked. We wish it were easy for innovation teams to succeed. We wish the same systems of governance, incentives, talent, and processes that a corporation uses for scaled execution of the business could also be used to learn, explore, and develop transformative innovations. But they don’t, and they never will.
If you want to create real transformation, you must recognize that the old form of corporate innovation is dead, and new approaches are needed.
Let’s explore the primary reasons why corporate innovation teams fail to drive transformation. Embedded in these reasons is the secret to new forms of corporate innovation that overcome failure modes. If you want to create real transformation, you must recognize that the old form of corporate innovation is dead, and new approaches are needed.
1. Corporate innovation is funded as an operating activity
A scaled corporation’s primary metrics for success, like Internal Rate of Return (IRR) or Return on Invested Capital (ROIC), track capital efficiency, or the rate at which a dollar put into the business comes out the other side as something more. These metrics reward executives for improving capital efficiency by eliminating jobs, not creating jobs, or by streamlining manufacturing lines, not creating new businesses or products. Innovation programs that improve capital efficiency (often by reducing operating costs or incrementally improving products) are appropriately financed as an operating activity. For these kinds of opportunities, the timeline to payoff is short and fairly certain.
Transformative innovation is not capital efficient. The direct financial return, if it comes at all, takes a long time to materialize. Transformative innovation is best financed with balance-sheet capital–money that is patient and allows for long-term bets, often in new ventures.
Activities that involve high confidence in the payoff and a short timeline for return–like marketing spend–are best thought of–and funded–as operating activities. Activities that involve low confidence in the outcome and a long timeline for payoff–like the construction of a new factory, or a sizable acquisition–are best financed from the balance sheet. Transformative innovation can never be financed as an operating activity, because it will, 100% of the time, lose the budget battle to other short-term uses of funds like marketing spend that have a more obvious link to short-term ROIC. The only viable means of funding for transformative innovation is capital expense, not operating expense.
One trick to funding transformative innovation from the balance sheet is to pursue the innovation through a newly formed entity that sits outside the corporation, a new venture that can receive investment and allow for the corporation to depreciate the capital expense.
2. The wrong kind of governance is applied
As corporations scale, they get careful, and leaders become guardians and protectors of what they’ve built. In practice, this means decisions are made by consensus, and bureaucracy thrives. Committees are a feature, not a bug, of corporations built to propagate and extend a model that has historically performed well.
In contrast, startups are reliant on the decisions of a founder, or small team of risk takers, who have nothing to preserve, and everything to gain by building something new.
“I’ve searched all the parks in all the cities, and found no statues of committees,” G.K. Chesterton once quipped. Transformative innovation requires nimble governance, decision making in the hands of a single person or small team, with limited communication and buy-in required.
Most corporate innovation teams spend the bulk of their time simply communicating with the broader corporation about the opportunities they’re pursuing, and seeking buy-in.
Most corporate innovation teams spend the bulk of their time simply communicating with the broader corporation about the opportunities they’re pursuing, and seeking buy-in. This form of governance works well for the careful execution of a global enterprise; it is wholly inappropriate for the pursuit of the “new,” where mistake making is required, risks must be taken, and uncertainty abounds.
3. Incentives neuter talent
An ‘A team’ with a ‘B idea’ is always going to beat a ‘B team’ with an ‘A idea.’ The talent behind an innovation opportunity matters more than anything else. Every corporation has smart people with drive and passion, but the entrepreneurs who succeed at creating world-changing ventures are motivated by very different incentives.
Incentive alignment for those pursuing transformative opportunities is critical. In a startup venture, the founding team has uncapped upside (the opportunity to never have to work again if the venture succeeds). But the only way to have this is to accept the risk of a nearly uncapped downside. Inside a corporation, upsides and downside risks are capped for those driving innovation. This inherently breeds a different kind of risk tolerance and mentality. When recruiting for talent to pursue transformation, opt for leaders who are willing and able to do the impossible, and incentivize them to “move fast and break things.”
…Transformative innovation is best pursued through the vehicle of ventures built outside the walls of the existing corporation.
Matching the incentive systems of fast-moving startups is easiest for corporations to do by actually creating independent, fast-moving startups! The incentives of a real startup cannot be wholly replicated inside of a scaled corporation, whose incentives systems are optimized for safety, preservation, and predictability. This is one reason, among many, why transformative innovation is best pursued through the vehicle of ventures built outside the walls of the existing corporation.
4. Transformation’s link to corporate strategy is unclear
Transformative innovation that leads to the launch of new companies is (and should be) separate from work around the core business. But that doesn’t mean any offshoot startups created shouldn’t have a direct association with the corporate strategy.
Everyone who champions this work must ensure the innovation team’s efforts account for the North Star goals laid out by leadership.
Building for the sake of building (i.e., solving a problem through venture creation you only think matters to the corporation) often leads to questions later on by executives and board members around whether the new startup actually addresses a big issue of relevance to the business.
Innovation teams work hard to generate value for their organization. But if there isn’t total alignment on the innovation activities they’re asked to pursue, their efforts will be in vain.
5. Optimizing for the “right” business idea over the “many”
Innovation teams must collect as many insights as they can. The only way to do that is by running a high volume of experiments at the lowest possible cost per experiment.
Why? Because there’s no venture-building crystal ball. There’s no way to know ahead of time which innovation experiments or insights are going to lead to the breakthroughs that create meaningful transformation.
Execution of fast, cheap, and weird experiments that explore numerous (think dozens, even hundreds) of business opportunities is how large enterprises can acquire the knowledge needed to innovate (read: build ventures) at scale.
Arguably the whole reason corporate innovation teams exist is to gather insights, pursue novelty, and make (many) bold bets that drive the business forward.
Giving these teams the space and autonomy to test often means they can, in time, surface anomalies that could turn into transformative businesses that future-proof the organization, making it more resilient and helping it gain a competitive advantage. Learning and optionality should be the two primary objectives for any innovation team interested in transformation.
Ryan Larcom is the Managing Director of Studios at High Alpha Innovation.
