You Can’t Outsource Innovation

28 September, 2016 / Articles

For senior executives, investing in organic innovation often feels like a triumph of hope over experience. They’ve seen initiatives from their own organizations over-promise and under-deliver year after year. Frothy headlines about startups disrupting virtually every industry increase their sense of urgency as well as unease about their ability to respond. Pressure from hyperactive investors to deliver near-term results makes it harder and harder to dedicate operating expense to longer-term priorities like innovation.

At the same time, the forces of interconnectivity transforming our planet—globalization, digitization, and others—have made it easier than ever before for organizations and individuals to connect and collaborate. Capabilities ranging from cloud computing to crowdsourcing not only make our world more discoverable and interoperable in unprecedented ways—they also make it easier, cheaper and less risky for startups to enter industries and develop new offerings. The grass outside starts looking greener and greener to senior executives desperate for innovation.

I’ve written earlier about how to put startups to work for you, and any scaled enterprise should be actively scanning the field for emerging businesses they should consider collaborating with (or even acquiring). There’s also real benefit in finding ways to innovate off of the balance sheet in addition to the P&L. However, I see too many organizations that are starting to almost entirely outsource innovation—in particular, relying heavily on M&A, joint ventures or setting up their own incubators and accelerators at the expense of organic investment. None of these strategies are likely to succeed, and at best limit upside in innovation ROI without really limiting downside. Instead, the best innovators seamlessly blend organic innovation with external collaboration and investment —each informing the other in a virtuous cycle.

Buying Innovation Instead Of Building It

No one bats a thousand in innovation. In our experience, as many as 95% of innovation initiatives can fail to exceed their cost of capital, and other analyses of new product launches (a hazy proxy for innovation) peg the failure rate at 50-90% (Andrew and Sirkin, 2003, Harvard Business Review). Given the low odds of success, it isn’t unreasonable for executives to turn to M&A instead as a seemingly less risky alternative—particularly given the tangibility of an existing asset or business when compared to the mere sheet of paper an internal charter or plan is printed on. “At least we’re buying something, right?”

This is false comfort. Estimated failure rates for M&A range widely—but the best figure I’ve seen is 50% (London Business School, 1987), with others ranging as high as 83%(KPMG, 1999) to 90% (Christensen et al, Harvard Business Review. March 2011). This isn’t much of an improvement over innovation hit rates, and it’s even worse when we consider the size of the denominator in failed M&A vs. internal innovation initiatives. Effective innovation portfolio management and governance methods will increase investment only as uncertainty declines and the odds of success increase. Structuring similar “agile” mechanisms in M&A is much more difficult (although pharma and biotech licensing, collaboration and co-development agreements are one model). We’re often forced to effectively make “waterfall” investments, and typically at levels that are orders of magnitude greater than even the most expensive internal initiatives. The tech sector has been particularly prone to this approach—and its shortcomings—in recent years as large incumbents struggle to react to seismic shifts in both core technologies and consumer behaviors.

Betting On Startups At The Expense of Your Own Innovators

Another model that’s grown in many sectors is for large enterprises to create their own startup accelerators or incubators—programs and facilities that work with rotating cadres of startups, offering them mentoring, resources and/or investment. Typically, the hope is that by building such programs and environments, large enterprises will gain preferential access to top businesses and talent.

The flawed premise underlying many of these corporate programs is effectively “if you build it, they will come.” The first question to ask is whether your industry needs another accelerator or incubator program—and if so, is yours likely to compete successfully with other established programs? The incubator and accelerator field is incredibly crowded; there are almost a 1000 programs across the U.S. alone(Brookings Institution, Pitchbook).

While the barriers to entry may be very low—anyone with some space and funding can declare themselves an incubator or accelerator—creating sustainably successful programs is very difficult. These are effectively network-based businesses; the most successful accelerators and incubators like Y-Combinator rely on seeing thousands of successful startups and accepting only the top fraction. Conversely, startups are drawn to top programs because of their pedigree and reputation. They’re not unlike higher education in that regard; it’s rather challenging to build Harvard from scratch. You need to be confident that you’ll have a similar “deal flow”—not only in volume, but in quality. You don’t want to become the last port of call for startups struggling to receive attention and backing (particularly since it will take you time to build the pattern recognition which the best incubators and accelerators have).

There are scenarios where creating new incubator and accelerator programs make sense. For example, a large apparel and footwear client of mine was not only large enough to preferentially attract startups, but one of its innovation areas—functional materials and textiles—received relatively little venture funding and investment. Its industry needed greater startup engagement and investment, and the company was indeed poised to compete very successfully against relatively few programs.

For many firms, however, the headcount, money and management attention needed to stand up an incubator or accelerator may be better spent elsewhere—in partnering with existing startup programs, and in plowing some of that resource back into its own innovation initiatives. That’s effectively the choice you need to consider—is my own innovation talent and portfolio either so over-subscribed or so barren that the best way for me to grow both is by attracting external firms? Even if the answer is “yes,” there are many ways to do that besides building your own incubator or accelerator.

Instead, See External Innovation As A Complement—Not A Substitute

Many of the best innovators seamlessly blend their internal and external innovation initiatives—constantly weighing whether to build vs. buy as they pursue innovation initiatives, and using innovation to radically amplify the value of any acquisitions they make. This approach creates a virtuous cycle where the M&A agenda is constantly informed by the innovation agenda, and vice versa.

What’s irreplaceable is having a clear, committed vision for what innovation needs to solve for your customers, your company and your industry. For example, I’m watching with great interest Medtronic’s push into services through a combination of internal innovation initiatives and M&A—such as the 2014 acquisition of NGC Medical in Italy to help create a cath lab management offering. The means for fulfilling this push into services are varied, but the vision is unambiguous and compelling—per CEO Omar Ishrak:

“We continue to see a push for experimentation with new models of delivery system operations, new payments schemes and integrated patient care as the critical mechanism to balance the cost and access challenges… This continues to drive our organization to move beyond medical devices to create integrated health solutions that complement and enhance our devices value, traditional wraparound services and solutions.”

Closing Thoughts

When management starts over-investing in external innovation, that can be a symptom of that missing foundation. There’s no end to the variety of business processes a firm can outsource today, and indeed, there’s even elements of innovation that may be best pursued through external means. But you can’t outsource your vision for what needs to happen next —for your customers, your company and your industry.

The science man and innovator, Fernando Fischmann, founder of Crystal Lagoons, recommends this article.



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