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Innovation Is The Only True Way To Create Value

2015 December 6
by Greg Satell

In The Outsiders, William Thorndike argues that the most essential skill for a manager is capital allocation. To prove his point, he profiles CEOs such as Henry Singleton of Teledyne and John Malone of TCI who, while not household names, achieved outsized returns by wisely deploying their firm’s resources.

Thorndike also points out that most CEOs get their jobs not through exhibiting financial acumen, but for excellence in some other area, like production, marketing or sales. So capital allocation is a skill that many executives lack, having no opportunity to gain experience with it until they reach the top job.

It’s a interesting argument, but its fatal flaw is that he omits innovators like Steve Jobs and Mark Zuckerberg—and even Sam Walton and Herb Kelleher—because they represent “genius” that is too uncommon to replicate. That’s a startling omission. I would argue that while capital allocation is an important skill, innovation is the only true way to create value.

How A Business Makes Money

The goal of every business is to defy markets. Any firm at the mercy of supply and demand will find itself unable to make an economic profit—that is profit over and above its cost of capital. In other words, unless a firm can beat Adam’s Smith’s invisible hand, investors would be better off putting their money in the bank.

That leaves entrepreneurs and managers with two viable strategies: rent seeking and innovation. Rent seeking behavior, although often given purely negative connotations because it is associated with activities like regulatory capture, can have a useful function, such as building a trusted brand name to earn loyalty with customers.

Innovation is far more valuable because it raises the productivity of both capital and labor. Some innovators, like Kelleher and Walton, use existing technology to improve processes. Others, such as Jobs and Zuckerberg, develop entirely new product categories and reshape industries. Unlike rent seeking, innovation creates new value that didn’t exist before.

Yet unlike Thorndike’s concept of capital allocation which, although difficult to master is relatively easy to understand, innovation is so mindumbingly complex that it can’t be reduced to a single person or even a single organization. Still, like anything else, successful innovation starts at the top and leaders need to be held responsible for it.

Navigating The Innovation Ecosystem

Innovation is never one event, but a process of discovery, engineering and transformation. It’s also not something that can be hermetically sealed inside the C-suite, but requires an entire ecosystem. To understand how complex the process is, let’s look at lithium-ion batteries, the technology that powers everything from smartphones to electric cars.

As Steve Levine explains in The Powerhouse, when John Goodenough first discovered the principles of lithium-ion batteries in 1979, it was little more than an academic curiosity and hardly anyone took notice. By the early 1990’s though, improved microchips created demand for more powerful portable devices and Sony developed a commercial version.

Today, battery research is one of the hottest things going. Public sector research continues at places like Argonne National Laboratory. Private companies contribute through their participation in JCESR consortium and proprietary research. Elon Musk’s Tesla is also helping to scale up the technology in its Gigafactory.

Yet even these efforts are only a small slice of the innovation going on. Advances in wind and solar help drive demand for energy storage. Charging stations need to be deployed for electric cars. New products need to be devised and designed. At each stage, financing needs to be found, technical problems worked out and business models dreamed up.

Clearly, Thorndike’s dismissal of innovation as an activity only for rare geniuses like Steve Jobs and Mark Zuckerberg falls short. There is more than enough opportunity to go around. The real challenge is for managers to learn to manage innovation effectively.

Defining Your Approach

As I explained in Harvard Business Review, there are four basic ways an organization can approach innovation: Basic research, breakthrough innovation, sustaining innovation and disruptive innovation.

Innovation Matrix w solutions
Basic research is generally done in the public or nonprofit sector. For example, Argonne national laboratory is where advanced research is done to produce the next generation of batteries. Those scientific breakthroughs are then used by sustaining innovators like Apple and Tesla to engineer new products, like thinner laptops and more powerful electric cars.

Sometimes, innovation is pursued to solve a well defined problem that needs a breakthrough. For example, P&G’s Connect and Develop program encourages outside researchers to help it find answers to thorny problems. Disruptive innovators, on the other hand, seek to find profitable uses for technologies that don’t seem to have a viable market.

What’s important is not so much what approach a firm takes, but that the direction is clear. Steve Jobs famously eschewed heavy R&D budgets and focused on engineering existing technologies into products people love. Microsoft, on the other hand, invests heavily in research, even basic research, and remains the world’s second most valuable firm.

Your approach to innovation will also define your limitations. Steve Jobs, for example, had the idea for a product that could “hold 1000 songs in your pocket” long before development on the iPod began, but had to wait for the right hard drive to become available. Nobody can do it all alone. Whatever your approach, you need to find the missing pieces elsewhere.

Seizing The Opportunity

A great business model is one that creates, delivers and captures value effectively. The CEOs that Thorndike holds up as models provided great returns to their shareholders, but mostly through capturing value rather than creating it. They prospered by seeing value where others did not, which is an impressive skill, but does not increase the overall pie.

And despite their success, which was considerable, it pales in comparison to truly great entrepreneurs like Steve Jobs and Mark Zuckerberg, not to mention others who create innovative solutions to important problems, like more powerful technology, cures to disease and new sources of energy.

Yet you don’t need to be a technological whiz to be a great innovator. Sam Walton saw that existing technology could revolutionize how goods are distributed and sold. Herb Kelleher imagined a better way to transport people. Both men continued to pursue thousands of smaller improvements and honed their business models over the span of decades.

Despite what William Thorndike implies, we don’t all need to be geniuses to innovate. There are no shortages of problems—large and small—to solve. True success is about more than just capturing value. We should all strive to create some too.

– Greg

6 Responses
  1. December 6, 2015

    Hi Greg,

    Correct me case being but I believe that Karl Marx is the first to have theorized the system e.g. that, if it were not for innovation, capitalism would die its good death (no returns).

    Since then we have had lots of useful analysis and insight on the processes ( Moore, Christansen lately), 3d generation R&D who came up with initial categorizations (that’s giving you hints about my age by the way).

    Too bad that currently the term disruptive is abused.

    This said I hope to see the amount of creativity that will be going on when we start tackling renewable energies, and CO2 life-cycle management, especially in the fields of energy generation/capture , energy transmission to point of use (even if micro sized) , energy storage or super fast loading stations (hyper conductivity).

    Keep posting! please.

    best
    jl

    Greg Reply:

    Jean-Louis,

    I’m not sure but I don’t think Marx ever did that. He did point out that the lack of a profit motive at equilibrium represented a “contradiction” that made capitalism unworkable. It was somewhat later that Schumpeter came along and showed that’s not necessarily the case as long as innovation continues.

    As for your point about energy, I wholeheartedly agree. It seems to me that the key technology is energy storage. We simply have to get under $100/KwH if we are ever to make the whole thing work. That’s not possible with existing technology, but there is a lot in the works at Argonne and other places, so hopefully we’ll get it settled by 2020 or so.

    If we do, we should hit a real tipping point and fossil fuels will be considerably less economical than renewables, if current trends hold.

    – Greg

    Johanna Dwyer Reply:

    Greg and JL,

    I completely agree about energy storage being the key technology of the future, and I also believe that we aren’t going to get there with traditional Lithium Ion technologies. The research and development into solid state Lithium battery technology is very interesting and may have deep future applications. Although it is very interesting that one of the preeminent start ups in this area (Sakti3) was recently acquired by a company that predominantly makes vacuum cleaners (Dyson), although one of their early investors was GM.

    The biggest hurdle, and particularly in transport applications, is energy density. It is an enormous challenge to meet or exceed the energy density of hydro carbon fuel in an internal combustion engine. Cost is only one factor in the discussion, which is low now with the oversupply of oil continuing in the market. But I’d argue a bigger factor is size, and that this is the challenge that really needs to be addressed.

    -JD

    Greg Reply:

    That’s a great point Johanna. In transportation, size and weight also affect cost, although it is not much of a factor in electricity production. Most likely, there will be two separate classes of technologies, one for power (possibly flux batteries) and another for transport.

    – Greg

  2. David permalink
    December 7, 2015

    Re Teledyne, Singleton was a brilliant autocrat. When he left the place went down pretty fast.

    These posts are great — I love their sweep. Just saw Ray Kurzweil speak — always appreciate the few who see the big picture in time and space.

    Greg Reply:

    Thanks David. I appreciate it.

    – Greg

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