Dispatches from the Frontier

Innovation is Harder than We Think

I believe that "growing inventions into innovation" is an inherently worthwhile activity, and it can be lucrative.  I love working with people who are passionate about practicing "the art of the new."  In the realm of innovation, optimism is healthy and necessary.  However, the landscape is littered with those organizations that were blindly optimistic, and most of us are too optimistic.

Consider this assertion by Art De Vany:

Pervasive optimistic bias is based on (1) unrealistically positive self-evaluations; (2) unrealistic optimism about future events and plans; (3) an illusion of control.  People exaggerate their control over events and the importance of their own actions in ensuring desirable outcomes.

Certainly, there is craft in doing innovation, and some people are more expert than others.  Even so, such expertise almost always takes longer to develop than we acknowledge.  The good news is that expertise is within our reach, if we do the work.  As neuroscientist Daniel Levetin observes:

The emerging picture...is that ten thousand hours of practice is required to achieve the level of mastery associated with being a world-class expert—in anything...Learning requires the assimilation and consolidation of information in neural tissue.  The more experiences we have with something, the stronger the memory/learning trace for that experience becomes...Memory strength is also a function of how much we care about the experience...It is impossible to overestimate the importance of these factors; caring leads to attention, and together they lead to measurable neurochemical changes.

Unfortunately, most of aren't really that good at learning.  As experimental psychologist Cordelia Fine notes:

Our first problem is that we are, at root, very poor scientists.  All sorts of biases slip in unnoticed as we form and test our beliefs, and these tendencies lead us astray to a surprising degree...[E]ven when we genuinely seek the truth, our careless data collection and appraisal can leave us in woeful error about ourselves, other people, and the world.

Even if we successfully apply diligence, passion, and healthy skepticism to the cultivation of our craft, the accumulation of skill is insufficient.  As I use the term, innovation means the adoption of a new way of doing something by users, and the interdependent social dynamics of users are impossible to predict or control.  That matters, because users play a major role in determining the success of a prospective innovation.  As De Vany concludes:

The craft of filmmaking can be learned, but there is no learnable craft when it comes to predicting how a movie will play with audiences.

I can't help but agree with Andy Hargadon, when he writes:

The pursuit of innovation requires patiently and humbly building a new network of people, ideas, and objects around the original [idea].

Patience and humility: repeat that 10,000 times, Dave.

For more reading: How Breakthroughs Happen, Hollywood Economics, A Mind of its Own, and This is Your Brain on Music

Managing Innovation

Today's Wall Street Journal includes an article¹ describing a discussion about cultivating a culture of innovation among senior executives from Cisco Systems, Packet Design, Google, and IDEO.  The conversation spans some topics that I've touched upon recently in this blog, including time span of discretion:

WSJ: In a big company, how do you get people to think beyond 18 months if the whole company is focused on 18 months?

MR. SOLOMON [IDEO]: I think it's very difficult to do in most big companies, and very few big companies have been able to do it.  There are a number of different models that have been tried...But in big companies, they have the resources, but they don't always have the thought processes and the skills to really think outside their current business, nor the permission to really do it.

Judith Estrin, chief executive of Packet Design, notes that part of the problem is the lack of spare capacity:

MS. ESTRIN: One of the challenges I think about is that all of the things that companies have done for quality and efficiency are essentially enemies of innovation.  They are the things that have made us so efficient and so productive, we've taken out all of the slop and all of the room that you need for innovation.

A relatively short time span of discretion combined with a lack of spare capacity is at odds with the observation by Marthin De Beer, senior vice president of the emerging-markets technology group at Cisco:

MR. DE BEER: It probably takes about four years at a minimum to get from an idea to a successful business.

The perception of risk and the cost of failure also come into play:

MR. MERRILL [Google]: Every company in the world says, "It's OK to fail."  And for 99% of them, it's probably not true.

MS. ESTRIN: If you're very successful in one business, it tends to take all of the oxygen of the company.  New ideas--everybody says they're too small.  In order to start an idea, you have to go in front of a committee, you have to show a [return on investment] that's going to meet a certain return over a period of time.  Those types of processes that are put there to vet ideas that stop people from trying are just the type of things that will kill the surprises that are going to end up being big.

  Ms. Estrin draws upon a familiar analogy in order to suggest a way to mitigate the problem:

MS. ESTRIN: In thinking about large companies, think of them as farms.  And what you're trying to do is grow rows of corn.  You don't want surprises, you want it to work well, you apply incremental innovation to be as productive as you can.  And then when you're thinking about start-ups or disruptive innovation, think about that as either a greenhouse or maybe a small garden plot, where surprises are fun...you can decide to develop greenhouses and small garden plots on the farm.  But you have to keep them separate, and then the trick is transplanting...[H]ow are the best ways to transplant...How much do you let the business grow before you transplant it, how do you prepare the soil?

Cisco's industry is characterized by a highly developed venture capital industry that serves as a greenhouse for prospective innovations:

MR. DE BEER: We've acquired 120 companies, most of them small.

The Open Innovation model is more developed in the high technology sector than it is elsewhere, which is not surprising given the sector's relative clockspeed.  The consumer products sector, however, appears to be following on a similar evolutionary trajectory.  That said, there is little venture capital infrastructure that connects big consumer products companies with incubating innovations.  Consequently, a reliance on acquisitions can be expensive.  So, I lean toward Ms. Estrin's perspective:

A systematic approach to innovation mitigates large companies' disadvantages while leveraging its advantages.   The idea would be to incubate products in a small company environment and then facilitate the rapid, and relatively inexpensive, transplant of validated growth opportunities prior to the investment in redundant capacities.  That prescription may be obvious; the trick is in the design of collaborative protocols.

Here's a video excerpt on the topic of "enemies of innovation":

¹Managing Innovation: How to get the most out of your company's big ideas; September 24, 2007; Page R6.

A High Rate of Product Innovation Pays

A couple of months ago, I made the following observation about the game of professional basketball:

While crunching the numbers on 3-pointers, I noticed something kind of funny about Kobe [Bryant]: he's the highest producing scorer in the NBA, but his shooting accuracy doesn't stand out - he's pretty average, in fact.  (Granted, the average NBA player can shoot the ball very well, but in a competitive world, it's relative, not absolute, performance that matters.)  So, how can an average shooter be the league's leading scorer?  Simple: he takes more shots per minute than his peers.  Kobe scores a lot of points because he's willing to miss shots at a higher rate than his competitors.

It turns out that my analogy to business and product innovation wasn't a stretch.  According to PRTM, a global consulting firm that helps large companies innovative faster and more effectively:

The [PRTM Global Product Innovation Benchmark] study...revealed a remarkable finding about development productivity–that is, delivering more products for the same R&D investment or less.  Companies that experience the greatest revenue growth launch up to 45 percent more products for the same development budget as compared with low-growth companies.  Source: Cashing In on Innovation: Lessons on managing product development for greater profitability and growth (registration required)

In other words, the highest scoring companies take more shots on goal per development dollar.  Furthermore, they take faster shots:

PRTM found that the fastest companies could launch a new product in 40 weeks and pay back research and development outlay in 25.  Source: CNBC European Business: The Innovation Issue

Let's be clear: these high performing companies aren't throwing spaghetti on the wall to see what sticks.  Their foundational skills in product development, supply chain management, and marketing are competitive.  However, the league-leading scorers–like Kobe–are willing to take more shots faster than their competitors.  They are able to embrace the counter-intuitive notion that exposing oneself to a higher incidence of failure can lead to a higher rate of relative performance.

Large Companies' Systematic Aversion to Failure

Fail fast and cheap.

It is a key to successful innovation in an uncertain world.  However, large companies have a consistent and strong aversion to ambiguity and the prospect of failure.

Why?

It can be tempting to make dispositional attributions regarding the people who comprise large companies.  "If we could just learn how to become more creative, our company could become more innovative and successful," goes this line of thought.  There is little doubt that becoming more creative, cultivating collaborative capacity, and being more open to Open Innovation can help.  Nevertheless, there is good reason to believe that large companies' aversion to failure is systematic and, thus, resistant to purely dispositional remediation.

What is an acceptable rate of failure?  10%?  90%?  Nassim Taleb provides the answer:

The frequency or probability of [a] loss, in and by itself, is totally irrelevant; it needs to be judged in connection with the magnitude of the outcome.

In other words, for a given magnitude of anticipated success, a high cost of failure means that you cannot fail very often.  Furthermore, the perceived cost of failure at a large company is inherently high:

• Critically, the opportunity cost of a large company is high.  Large companies, by definition, have more to lose than small companies.  For starters, established brands represent an accumulation of trust, and trust is easier to destroy than to build.
• Decision-making cycles are slow at large companies.  Consequently, the commitment of resources tends to occur in relatively large chunks.  Expenditures can mount before somebody can hit the kill switch.
• Hierarchy exacerbates the bias toward commitment escalation.  As a consequence, large companies are more likely to put good money after bad than are small companies.
• Individual benefits and losses may be asymmetric.  Individual decision-makers in a large company can typically assume that she'll have to share the credit for success, but may bear a disproportionate burden of a failure.  Risk aversion is an emotional response that is likely to increase the perceived cost of failure.

Given the high cost of failure, large companies' growth strategies tend to cluster around two scenarios:

• Very high revenue impact—In this scenario, the "size of prize" measured in incremental revenue is relatively large.  Because new, large businesses typically don't spring full-grown from the ground, this scenario typically manifests itself  as an acquisition.
• Low risk of failure—This approach take the form of incremental improvements to, and extensions of, existing products and brands.

Acquisitions are expensive and encourage the development (and subsequent destruction) of redundant manufacturing, marketing, and distribution capacities.  Brand extensions and incremental innovations can dilute brand equity and expose the company to disruptive innovation.  Nevertheless, these corporate behaviors are entirely and systematically consistent with a high cost of failure.

Systematic solutions must be part of large companies' innovation strategy.  Small companies are better suited to exploring the fitness landscape than large companies, because small companies have a lower cost of failure.  They are advantaged in their ability to fail fast and cheap.  On the other hand, small companies are challenged by success: scaling a consumer product company fast enough to hit the market window of opportunity is a daunting challenge.  Large companies have the advantage there.  A systematic approach to innovation mitigates large companies' disadvantages while leveraging its advantages.   The idea would be to incubate products in a small company environment and then facilitate the rapid, and relatively inexpensive, transplant of validated growth opportunities prior to the investment in redundant capacities.  That prescription may be obvious; the trick is in the design of collaborative protocols.

Collaborative Entrepreneurship & Behavioral Protocols

Cambrian House is an innovation cooperative:

Cambrian House is home to the world's first crowdsourcing community: a Web 2.0 community that allows businesses or individuals to harness the wisdom and participation of crowds for commercial purposes.

According to Collaborative Entrepreneurship, the success of such efforts is likely to be a function of the adoption of appropriate behavioral protocols (most importantly, a commitment to equitable—not equal—sharing of rewards).  I think Cambrian House is off to a good start with its description of "How we work."

• Operate on fact, not forecast.  Don't become emotionally attached to any one idea.  Test, don't guess.
• Employ intense candor.  Life's too short.  We are neither consultancy, nor the UN.
• Fail fast.  We're not afraid to fail our way to success.  When we don't know the answer, we try something.
• Optimize for the user.  What's better for us may not be better for the user.  Always side with the user.
• "Flintstone" first—automate last.  Have humans do the work first.  Only automate if it's worth automating.
• Be borderless.  Pwn conventional wisdom.  Think outside your preconceived notions and thoughts.  There is no spoon.
• Work it out on paper.  Experience it manually.

It's a list that echoes the adaptive behaviors encouraged by Eric Beinhocker in The Origin of Wealth:

• Performance orientation.  Always do your best, go the extra mile, take initiative, and continuously improve yourself.
• Honesty.  Be honest with others; be honest with yourself; be transparent and face reality.
• Meritocracy.  Reward people on the basis of merit.
• Mutual trust.  Trust your colleagues' motivation, and trust in their skills to get the job done.
• Reciprocity.  Live the golden rule; do unto others as you would have them do unto you.
• Shared purpose.  Put the organization's interests ahead of your own, and behave as if everyone is in it together.
• Nonhierarchical.  Junior people are expected to challenge senior people, and what matters is the quality of the idea, not the title of the person saying it.
• Openness.  Be curious, open to outside thinking, and willing to experiment; seek the best, wherever it is.
• Fact-based.  Find out the facts; it is facts, not opinions, that ultimately count.
• Challenge.  Feel a sense of competitive urgency; it is a race without a finish line.

Our mental models become tacit.  Consequently, the assumptions imbedded in our mental models can be difficult to recognize, much less test and change.  It's excruciatingly difficult to change people's mental models.  So, experiments like Cambrian House are probably right in making their values and mental models explicit in order to attract like-minded collaborators.  I suspect—and hope—Cambrian House will be successful, because it seems to address a key shortcoming in current organizational theory, as identified by Ray Miles, Chuck Snow, and Grant Miles:

Indeed, the primary reason that [large-scale collaborative entrepreneurship] does not yet exist is that only a few people are even thinking about this type of organization—and those who are cannot fully describe how it operates or prove that it will work...while current theory can provide explanations and support for the development of large, diversified business enterprises operating in a global economy, it cannot yet easily accommodate a network of independent firms engaging in collaborative entrepreneurship...[the most fundamental] shortcoming of the [current] theory of the firm is its flawed conception of human motivation.  The theory assumes that people in organizations act only in their own self-interest and often with guile, and the entire theoretical apparatus is built on this faulty assumption.  Other human motives, such as sharing, working together, or being generous, have no place in the current theory of the firm and, by implication, are illegitimate behaviors in organizations.

There is little doubt that selfish interests do come into play.  My kids like to eat—every day.  Consequently, as a condition of my participation in a collaborative effort, I need to have confidence that I will be rewarded equitably.  But, innovation is not a linear process, which makes the design of compensation systems tricky:

[I]t is increasingly well understood that innovation is based on the collaborative creation and sharing of knowledge, both explicit and tacit, and that such sharing is primarily intrinsically motivated...efforts to hierarchically direct and monetarily reward knowledge sharing are usually counterproductive.  People share knowledge because the process is exciting and rewarding in and of itself.  Once incentives are introduced, participants are likely to begin to calculate the value of their contributions, and the voluntary sharing of knowledge is diminished.

Andy Fastow and the Psychology of Good and Evil

Andy Fastow, the disgraced and imprisoned former CFO of Enron, is back in the news today.  Andy has been on my mind, because he's a personal reminder of the fragile line between good and evil in business.

I crossed paths with Andy three times in my life.  In the mid-1980s, we sat next to each other as members of the corporate finance department at Continental Bank in Chicago.  In the early 1990s, I had lunch with Andy in Houston, soon after he'd been hired by Skilling to work at a cool-sounding "Gas Bank" at an up-and-coming company called Enron.  The next time I heard about Andy was 10 years later when I got a call from an investigative reporter at The New York Times asking me what I knew about the guy who was at the eye of the hurricane enveloping Enron.

I didn't know Andy well.  As I recall, he wasn't particularly well-liked by his peers at Continental.  Andy was a bit immature, a little arrogant, and his ambition was a bit abrasive.  In other words, Andy and I were more similar than I can comfortably admit.  After all, Andy was Evil.

I use the word Evil in the manner suggested by psychologist Philip Zimbardo:

Evil consists in intentionally behaving in ways that harm, abuse, demean, dehumanize, or destroy innocent others—or using one's authority and systemic power to encourage or permit others to do so on your behalf.

By his own admission, Andy did great evil at Enron.  It would be personally quite comforting to believe that Andy, by disposition, was the evil mastermind that Skilling, among others, portrays.  As Zimbardo notes,

The idea that an unbridgeable chasm separates good people from bad people is a source of comfort for at least two reasons.  First, it creates a binary logic, in which Evil is essentialized...a quality that is inherent in some people and not in others...Upholding a Good-Evil dichotomy also takes "good people" off the responsibility hook.

But, I know better.  Early in our careers, I was very much like Andy Fastow.  And, over time, I came to recognize, what C.S. Lewis called, the "passion for the Inner Ring."  Each of us is capable of doing evil, and the path to becoming a "scoundrel" is subtle.  I think it worthwhile to follow Zimbardo's lead and consider an extended quote from Lewis:

To nine out of ten of you the choice which could lead to scoundrelism will come, when it does come, in no very dramatic colors.  Obviously bad men, obviously threatening or bribing, will almost certainly not appear.  Over a drink or a cup of coffee, disguised as a triviality and sandwiched between two jokes, from the lips of a man, or woman, whom you have recently been getting to know rather better and whom you hope to know better still—just at the moment when you are most anxious not to appear crude, or naive or a prig—the hint will come.  It will be the hint of something which is not quite in accordance with the technical rules of fair play, something that the public, the ignorant, romantic public, would never understand.  Something which even the outsiders in your own profession are apt to make a fuss about, but something, says your new friend, which "we"—and at the word "we" you try not to blush for mere pleasure—something "we always do."  And you will be drawn in, if you are drawn in, not by desire for gain or ease, but simply because at that moment, when the cup was so near your lips, you cannot bear to be thrust back again into the cold outer world.  It would be so terrible to see the other man's face—that genial, confidential, delightfully sophisticated face—turn suddenly cold and contemptuous, to know that you had been tried for the Inner Ring and rejected.  And then, if you are drawn in, next week it will be something a little further from the rules, and next year something further still, but all in the jolliest, friendliest spirit.  It may end in a crash, a scandal, and penal servitude; it may end in millions, a peerage and giving the prizes at your old school.  But you will be a scoundrel.

Recommended reading: The Lucifer Effect: Understanding How Good People Turn Evil, Behaving Badly: Ethical Lessons from ENRON, The Social Psychology of Good and Evil, The No Asshole Rule: Building a Civilized Workplace and Surviving One That Isn't, and Somebodies and Nobodies: Overcoming the Abuse of Rank

Asymmetric Partnerships

Kirsimarja Blomqvist has devoted much of her research toward understanding the dynamics of partnerships between large and small firms¹.  Beyond the obvious asymmetry of size, Blomqvist has concluded that differences in pacing and strategic intent make such partnerships very difficult to consummate.

In asymmetric partnerships the complementary strengths, skills and knowledge may be used for common good and cooperating partners may aspire goals they could not reach for themselves.  However the small and large...firms' different logic of strategy, mode of operation and diverging cultures cause also problems...It is expected that if we can understand the core differences due to asymmetry and their effects on partnership formation, we may be able to build better partnerships with higher chance to succeed.

The perceived benefits of collaboration between large and small firms is straightforward.  Large firms want better access to promising innovations.  Small firms want access to manufacturing and marketing capacities.  Nevertheless, beyond that high level of agreement, there are at least two key differences in approach.

First of all, large and small firms view the strategic objective of partnerships differently.  Small firms view "partnership as necessity" while large firms perceive "partnership as an opportunity window."   In other words, a large firm will typically view a partnership with a small firm as a real option–the right, but not the obligation, to invest in a growth opportunity:

Partnerships allow large firms to change their focus more easily and thus cut their losses, if the new technology will not prove itself.  R&D projects with outsiders are usually much easier to terminate than internal projects, where in-house politics step into the picture.  Also the commitment to small firms need not necessarily be made until the risk is clearly reasonable and the rewards to be seen...Strategic partnerships with long-term commitment are necessary to [small firms], but large firms approach [partnerships] with small firms more like strategic options with tentative commitment.

That is, partnerships between large firms and small firms offer flexibility to the former if and only if commitment is contingent.  Small firms, of course, want the opposite–they desire the immediate commitment of their partner's manufacturing, marketing, and distribution resources.  Furthermore, "Commitment is also relative.  In large firms there are many ventures and in the small firm there may be only one venture for which the small firm is totally committed."  Even if the small firm extracts a sufficient degree of commitment from the large firm, "Commitment is person-based and...there is always the risk that [champions] change their position..."

Second of all, the pace of decision-making at large and small firms is dramatically different.  At small firms, decisions can be made almost instantaneously.  In contrast, decision making at large firms is slow, complex, and unpredictable.

The net result, quite often, is that "these differences cause unrealistic expectations, misinterpretations, confusion and mistrust among parties."  In addition, "Both parties suffer from additional transaction costs of search, negotiation and adaptation but these costs are probably relatively larger to innovative small firms."

Lack of trust may well explain much of the commonly experienced difficulties in technology partnerships among small and large technology firms.  If the parties are very different (asymmetric) from each other they might have difficulties to understand and appreciate each other.  If parties are able to build trust and obtain trusting relationships with the key actors, the evident minor troubles may not break the relationship.  Trust is a necessary ingredient for cooperation and it can not be created without some understanding and appreciation of the other party's competencies and norms of conduct.

Because the business logic of collaboration between large firms and small firms (and even individuals) is so compelling and because the challenges to successful collaboration can be formidable, I believe that there is a role for innovation intermediaries in moderating the divisive forces of asymmetric strategic objectives and relative pacing:

• An innovation intermediary can take a portfolio approach, which helps to align its strategic intent more closely with that of large firms.  Closer alignment, in turn, enables the innovation intermediary to take a longer view of a relationship, which helps to mitigate relatively high search and transaction costs.  Strategic alignment is also consistent with the objective of developing personal relationships with senior management at large firms, who have the ability to make more durable commitments.
• At the same time, the innovation intermediary's relatively small size enables it to better match the speed and flexibility of the small firm.

Even so, collaboration is difficult–however necessary it may be.

¹Asymmetric Partnerships: Different Characteristics and Motivation of Small and Large Technology Firms, Telecom Business Research Center Lappeenranta Working Papers 3, 1999.

Is the Pace of Business Really Increasing?

In his Innovation Matters blog, Richard Veryard expresses skepticism regarding whether the pace of technological change is really accelerating:

I have always been wary of the common belief that technological change is accelerating.  I think this belief derives from a combination of proximity, selectivity and distorted perception.  I think we can sometimes be disproportionately impressed by the glamour of recent technology, and misled by the commercially-driven measures of intellectual property (such as volumes of patent activity and product releases).

He makes a fair point.  I do suspect that our perspectives can distort our perception of pacing.  After all, time seems to run much more slowly to my 10 year-old than it does for me.  Is the pace of life really accelerating just because I'm aging?

Nevertheless, researchers such as Charles Fine present persuasive evidence that the pace of change varies across industry. That is, industry clockspeed varies quite significantly. Fine's multi-dimensional approach to measuring clockspeed suggests that substantial changes occur in high clockspeed industries every 2 to 4 years, while similarly substantial changes occur, on average, in slow clockspeed industries every 10 to 20 years.

Furthermore, I find Stephan Haeckel's logic persuasive:

Because the information component of product can change faster, it will change faster.  Because information can be rapidly disseminated, it will be rapidly acquired by others.  As a result, product life cycles will continue to shrink, and the pace of change will continue to accelerate.

The average product life cycle in high information content businesses including movies, novels, high fashion clothing, and consumer electronics devices can be very short.  All fall into the fast-clockspeed category per Fine's accounting.  (However, high information content doesn't always lead to fast clockspeed.  The barriers to entry to the commercial aircraft and computer operating systems businesses, for example, slow industry clockspeed dramatically.)  I also understand that research by Haim Mendelson and Ravindran Pillai confirms that the measured clockspeed of a wide range of industries is accelerating.

An industry's average product life cycle is but one indicator of clockspeed and is, no doubt, incomplete.  Furthermore, proximity may very well distort our perception of clockspeed.  And, as Veryard suggests, technological evolution may well be punctuated.  Nevertheless, a decrease in product life cycle is operationally important–"variations and mutations" may not "be remembered in fifty years time," but they are still important to individual businesses and their stakeholders.

(See also Veryard's critique of my Red Queen model.)

The Trust Paradox - Take 2

In a previous post, I made the following assertion:

[T]rust may be hardest to build when it is needed the most.  The building of trust takes time, requires commitment, and is emotionally demanding.  In other words, the building of requisite trust through productive friction is expensive.  Because it is expensive, one has to make choices in the face of a great deal of uncertainty.  Choose correctly, and you will reap the full benefits of Open Innovation.  However, if you are less lucky in your choices, you stand to lose a great deal.

Kirsimarja Blomqvist makes a similar observation.  As the attached illustrates, the need for trust increases as uncertainty or complexity increases.  However, the prospects for the incremental development of trust diminishes with uncertainty or complexity.  In other words, trust is most needed precisely when it is most difficult to cultivate.

Increasing clockspeed exacerbates the dilemma.  To make matters even worse, the diversity that enables productive friction among collaborators can make it harder to cultivate a sufficient degree of trust within a relevant timeframe.  That is one of the reasons it can be extremely hard for large corporations to collaborate with individual inventors and very small companies.  Asymmetry in organizational size is a source of potential value, but it is also a factor that tends to inhibit trust.

Investing in trusting relationships in advance of an opportunity is expensive.  It is also risky.  In a dynamic environment, one cannot predict the emergence of opportunity.  Consequently, it is impossible to know, in advance, the best people with whom to partner.  A portfolio approach to relationship investing is one plausible strategy.  Blomqvist's research suggests that "fast trust" between large and small companies is also possible - at least in certain contexts.

The following lecture is long (52 minutes) but very worthwhile, if you really want to understand–and overcome–the barriers to Open Innovation:

An overview of trust and trust building in networks
Kirsimarja Blomqvist

The Ideology of Innovation

I have expressed concern about the collaborative capacity of large companies in the U.S.  In their essay titled "The Ideology of Innovation," researchers Ray Miles, Chuck Snow, and Grant Miles conclude that pessimism is warranted.  Here's how I understand their hypothesis:

• Innovation requires collaboration among knowledgeable people.  Increasingly, such collaboration is among people from different organizations.
• Effective innovation requires trust.
• Mental models shape our perceptions, decisions, and behaviors that, in turn, influence our capacity to trust and our perceived trustworthiness.
• Our mental models are strongly influenced by systematic and situational factors.  That is, organizational context matters.
• In turn, the mental models of senior management have a strong influence on organizational culture, particularly in hierarchies.
• The managerial values conducive to trust have eroded significantly over the last 25 years.
• U.S. company's competitiveness in a knowledge-based, innovation-driven economy may be declining as a consequence.

Here's how the authors put the problem:

[T]he United States and other advanced countries compete primarily on the basis of knowledge-driven innovation and entrepreneurship.  Knowledge is shared most freely in organizational settings where trust is anticipated and consistently maintained.  Trust, in turn, is created and sustained when equitable treatment is valued and pursued by both the leaders and members of the firms...It is our contention that the managerial values essential to the creation of conditions such as these have been eroding in the U.S. marketplace for more than two and a half decades, a decline that threatens to weaken the ability of U.S. firms to compete through continuous product and service innovation.

Businesses that are lead by kleptocrats are less likely to trust or be trustworthy.  Therefore, they are less likely to be benefit from deep, fast collaborations.  So, their fitness in a fast-paced, highly uncertain environment is questionable.

Open Innovation: Some Keys to Success

As innovation capitalists, my partners and I have the opportunity to test our theories in the market on a daily basis.  We also get to observe how other firms–large and small–are approaching the challenge of innovating in a world ruled by the Red Queen.  The purpose of this post is to summarize what I'm learning about some of the keys to unlocking the potential of Open Innovation.

We live in a highly uncertain business environment.  Prediction is foolish at best and often dangerous.  Consequently, one key to success over time is to cultivate a portfolio of growth options. (Click on image to enlarge.)  Many–even most–companies will fail in their quest to become more open at this point.  That's because options thinking embraces uncertainty and the likelihood of failure.  Failing fast and cheap is easy to say but very difficult for most of us to do.  That is particularly true in a hierarchical environment.

(For more reading, see Hollywood Economics, The Origins of Wealth, Fooled by Randomness, Open Innovation, The Strategy Paradox, 20/20 Foresight, and Real Options.)

Obviously, in order to build a portfolio of growth options, one must make investments.  The ability to make investments in growth options is limited by one's collaborative capacity.  Collaborative capacity, in turn, is a product of collaborative capability and the resources committed to the task.

As researcher Henry Chesbrough notes:

The Open Innovation paradigm treats R&D as an open system.  Open Innovation suggests that valuable ideas can come from inside or outside the company and can go to market from inside or outside the company as well.  This approach places external ideas and external paths to market on the same level of importance as that reserved for internal ideas and paths to market in the earlier era.

The practice of Open Innovation is inherently collaborative.  As John Hagel and John Seely Brown observe, the benefits of collaboration extend beyond access to external ideas and business models.  The very act of collaboration can accelerate the development of one's own capabilities:

We call this concept leveraged capability building to indicate that, no matter how effectively any individual company builds its own capabilities, it will push its performance to new levels faster by forming partnerships with companies with complementary specializations...For leveraged capability building, the real test is whether companies can create relationships that accelerate the capability building of all participants.

(For more, see The Only Sustainable Edge.)

Put a little differently, a firm's collaborative capability increases over time in a process of learning by doing.  Collaboration is a practice that can–and, indeed, must–be learned over time.  Learning by doing is an example of a reinforcing process that is characterized by an "S-curve".  Initially, capability building comes very slowly, but at some threshold level, capability grows exponentially.  Consequently, small differences in initial capabilities can yield large differences in relative capabilities over time.

Unfortunately, in my experience, most firms have nominal collaborative capability, so they have a lot to learn before they will have the capacity to cultivate a sufficiently diverse portfolio of real options.

Think of collaborative capability as a function of collaborative mindset × access to tools × collaborative skill.  If any one of those factors are "zero", then collaborative capability will be zero.  If collaborative capability is zero, then the capacity to invest in growth options will, in effect, be zero–notwithstanding the resources that are thrown at the task!  Many firms cannot get out of the starting gate, because they confuse collaboration with cooperation.  Per Ray Miles, Grant Miles, and Chuck Snow:

[W]e suggest that collaboration differs from competition and cooperation...cooperation is motivated by the benefits each party expects to receive from sharing ideas, information, or resources...because cooperative behavior ultimately involves the pursuit of self-interest, it requires periodic or even continual assessment by each participant of the amount of trust and commitment of the other party.  In collaborative relationships, on the other hand, each party is as committed to the other's interests as it is to its own, and this commitment reduces the need for continual assessment of trust and its implications for how rewards will be divided.

A firm having a cooperative (but fundamentally transactional) mindset will be disadvantaged.  Not only will its starting collaborative capacity be low, but it is likely to be a poor learner.  It is not likely to be able to take advantage of the accelerated capability building that comes from what Hagel and Brown call productive friction.  Without sufficient trust, productive friction devolves into friction.

(For more reading, see Everyone is a Customer and Collaborative Entrepreneurship.)

Of course, collaborative capability is only part of the equation.  After all,  being a highly skilled collaborator means little if no resources are committed to the task of investing in growth options.  Again, the flow of committed resources might be thought of as the product of the potential resources available times the capability to commit resources.  Capability, in this context, can be thought of as a function of the time frame of discretion, personal disposition, and even a decision-maker's expected duration in her position.  After all, the development and execution of growth options takes time, and it may not be in one's personal interest to underwrite risk today in exchange for uncertain, future benefits.

Organization and budget practices can have a perverse effect on resource commitment.  We are familiar with companies that have charged business unit heads with the responsibility of investing in growth options.  Ironically, while such senior decision-makers have the capability to commit resources, resources are not always available to them.  As business unit heads, they are held accountable for the results as measured by their unit's P&L statement.  Consequently, they can be held hostage by  accounting conventions.  Expenditures that are expected to yield results within 12 months are accounted for as expenses, while expenditures that are expected to yield benefits further in the future are accounted for as long-term assets.  Often, business unit heads can incur expenses but cannot book long-term assets.  So, to the extent they make investments in growth options, business unit heads are, in practice, forced to book an expense and face a hit to their near term profits.  As a result, in an era of very tight budgets, even senior decision-makers find their hands tied.  Having authority but no effective budget yields the same results as having a budget but no authority: too few resources are committed to investing in growth options, and the company is subject to strategic risk as a consequence.

Nevertheless, if resources are committed to investing in real options, and if collaborative capability is sufficient, a portfolio of growth options can be developed.  Some of those options will be executed successfully.  If there are mechanisms in place to associate current success with past investment activities, success will fuel another reinforcing effect.  Success will help decision-maker's become more confident in the efficacy of committing resources to option-generating activities, and the amount of resources available for such activities is likely to increase.  Success breeds the conditions that increase the likelihood of more success.

To sum up the model, success over time depends upon the cultivation of a portfolio of growth options and the successful execution of some subset of those options.  A firm's ability to cultivate a portfolio of growth options is to increasing degree limited by its collaborative capacity.  Although it is initially very difficult to increase collaborative capacity, practice and success can trigger two mutually reinforcing processes: learning by doing and success reinforces confidence and breeds future success.

As you might infer from my comments here and elsewhere in my blog, I believe that few firms will be able to take full advantage of a collaborative, open approach to the economic generation and execution of real options.  But for those that make a sustained effort, I expect the competitive results will be substantial.  Furthermore, I believe a company's chances of success will be increased if it takes the following actions:

• Senior management must champion an open and collaborative mindset.  Frequent and public statements regarding the importance of, and the company's commitment to, an open, collaborative approach to sustained innovation is likely essential to creating a conducive environment.  CEOs need to preach and practice adaptive norms of behavior.    Failures tend to come faster than successes, so senior management can expect to take a lot of heat.  It takes a courage to pursue this path.
• Learning must be facilitated.  Collaboration and innovation are very noisy processes.  Learning comes hard.  Systems, people, and resources must be put into place to create effective feedback loops and disseminate learning.  The difference between good failure and bad failure isn't always obvious, but people can learn the distinction.
• Resources must be committed over time.  The difference between strategy and tactics is time.  Trying to force strategic option creation into tactical, near-term operating budgets is not likely to work.  On the other hand, creating an investment pool for real option creation demands discipline and accountability.  However, the disciplined management of a portfolio of real options is different than the management of the execution of growth options.
• Patience is essential.  Success through innovation requires a certain amount of luck.  Consequently, success cannot be engineered.  However, luck and success can be cultivated.  Nevertheless, luck is a crop that, most often, takes a substantial amount of time to bear fruit.  For most firms, it may take a decade or more to hit the inflection point on the S-curves described above.  The alternative, though, is an increased chance of corporate failure.

(For more reading, see Why Most Things Fail.)