Innovation in Five (Not-So-Easy) Steps
Compass On Business Feature

Whether you innovate Big or innovate little, doing it continuously is what drives profitability.

It's a classic Catch-22: All great companies were born out of innovation, and virtually all leaders recognize the critical need for continuous innovation.

But, once beyond the early stages of entrepreneurship, most companies face almost insurmountable obstacles to true innovation: an inability to imagine the future, quarterly earnings pressures, lack of resources, a myriad of needs from current customers and stakeholders that must be satisfied today and the unwillingness or inability to lose investments when inventions fail, which most do.

Simply put, most companies fail at continuous innovation. Ultimately, that failure puts many companies out of business. Facing obstacles this large, what can you do to ensure that your company isn't a one-shot wonder, but rather manages to innovate continuously over time? Compass on Business talked to leaders in the field—academics and business leaders who excel at innovation—and uncovered the following five guidelines. Following them isn't easy, but the results are worth it.

1. Manage Risk
George Day, a professor at The Wharton School of The University of Pennsylvania, divides innovative activities into what he calls Big I and little I innovation. Big I innovation is exactly what it sounds like: inventions that are truly distinct from a company's previous products, services or ways of going to market, and when they succeed, they result in a huge payoff.

Big I innovations accounted for only 14% of a sample of business launches that Day studied, but were responsible for 61% of all profits. On the other hand, little i innovations are incremental improvements on an existing product line. While little i innovations are "necessary for continuous improvement," he writes, "[they] don't change the competitive balance or contribute much to profitability."

Not surprisingly, little i innovation is common, whereas Big I innovation is not. There are good reasons for this. Big I innovation is not only hard to accomplish, it's enormously risky: 70% to 75% of Big I innovations fail, Day says. Even incremental innovation is risky: 25% to 40% of little i innovations fail. With prospects like this, how does any company innovate at all? By managing the risk, just as an investor does—with a diverse portfolio of projects that span the gamut from little i through Big I innovations.

The "sweet spot," Day says, is in between the two. While little i innovation is nothing more than incremental improvements to existing products or services, and Big I innovation entails something completely new altogether, adjacency innovations are those in which you're bringing new products to an existing market or bringing existing products to a new one similar to which you already serve. Day suggests a portfolio of 30% to 40% in small i innovation, 30% to 40% in adjacencies, and 15% to 20% in Big I (with the caveat that high-tech businesses that get most of their sales from products they've introduced in the last three years may need to up their investments in Big I projects).

Companies committed to innovation are also committed to experimentation and testing. They'll give their employees enough rope to try things out, but not enough to hang themselves upon.

2. Find Ways to Capture "Weak Signals of Opportunity"
Some people and companies are skilled at reading the future. Most, however, are not. Consider this from an editorialist for the Boston Post in 1865: "Well-informed people know that it is impossible to transmit the voice over wires and that were it possible to do so, the thing would be of no practical value." Today, that sentiment is downright funny. The Post was simply demonstrating the classic problem we all have with innovation: in George Day's words, it's hard to catch the "weak signals" of where a market is headed five, 10 or even 20 years down the road.

"Early signals are masked by confusing and random noise, so their meaning is hard to discern," he writes. "If there [is] one thing that separates the sheep from the goats it is vigilant leaders," he says. "We contrast vigilant from operational leaders. They're very much about bringing market information in. They network widely, way beyond the boundaries of their industry. One of the reasons that you get trapped in industry models is that everybody goes to the same conferences and reads the same stuff."

So how do you listen for weak signals? You can deliberately devote your time to thinking about the future, as Bob Schlesinger did. He's the founder and CEO of Bookmans, a 30-yearold chain of six unusual used bookstores in Flagstaff, Mesa, Phoenix and Tucson, Arizona, that generates revenue in excess of $20 million annually. Over several years, he turned over most of the business' operational duties to trusted managers and now spends most of his time strategizing what he calls "the long direction of the company."

And he does mean long. His senior vice president has two children who are five and seven years old. "I look at, 'What decisions could I make now to at least have a chance that the two of them could work at Bookmans until they retire?'" he says. "Can we be doing a little bit every day, every month, every year, to prepare for what is going to happen 10, 15, 20 years from now?"

Even if you can't turn over all the operational duties to others, you can and should take in as much information from as many different sources as possible. Cultivate curiosity. Read widely and network like a fiend, not for business leads but to add to your knowledge base. Consider, for instance, the meaning of a parking structure.

When Fred Pope, founder of Satcom Resources, a satellite telecom company in Avon, Colorado, first moved to the state in 2000, he noticed a full parking structure outside of Vail. "I'm a trained economist," Pope says. "I saw the full parking structure, which meant that people were making a decent living here. I thought, 'There's no reason why I can't.'" The same year, Pope founded his company. Using those sorts of logical leaps, by 2006 he had built it into an $8 million business that made the Inc. 500 list of fastest-growing privately held companies in America. It's hardly just intuition that allows one to take those leaps. Pope had a significant knowledge base.

So too do most deliberate innovators, like Dan Nip, a real estate developer in Houston, Texas. Nip, who first entered the industry in 1980, has reinvented his business numerous times, responding to the boom-and-bust-and-boom Houston market. He'd already cultivated an ability to be ahead of the curve in his early years. When the Houston market bottomed out in 1982, a lot of developers lost everything. Nip, however, got out early enough to recoup his investments and even make a slight profit.

Today, Nip says, he manages both opportunity—when to jump in with new developments, for instance—and risk through rigorous study of market forces. He reads The New York Times and The Washington Post daily, along with all of the local real estate publications. He also attends trade functions, talks with friends daily and speaks with consultants who specialize in economic modeling.

"The bottom line is, we watch the market and it is our gauge [for how much risk to take]. As long as crude oil stays above $65 a barrel, Houston will continue to build new jobs and new houses for new employees moving into the city," Nip says. "But we are very sensitive. We are watching the market weekly." If oil prices drop to $64 a barrel, Nip will adjust his risk-taking significantly.

3. Be Open
Most innovative leaders are humble enough to look outside of themselves for ideas and solutions. Marty Schaffel founded Audio Visual Innovations Inc., based in Tampa, Florida, in 1979. Today, it is a $250 million company with 740 employees and seven divisions. "Trusting people is the only way I can function," Schaffel says. "Virtually every part of this company has been built by someone who had an idea and I gave them the go-ahead to run with it," he adds, citing one of his newer ventures, a division that merges IT and audio visual technology together to build command and control centers for the military and organizations, such as transportation agencies, that need multimillion dollar control rooms. An IT employee suggested the idea to Schaffel about five years ago. "I said, 'Go for it.' Today, it's probably a $20 million part of our company," he says.

4. Innovate in the Adjacencies
Remember George Day's "sweet spot?" The least risky innovation with potentially big payoffs is that which builds on your current expertise— by developing new products for your existing market, for instance. In fact, it's least risky to market new products to your existing market, rather than introducing existing products to a new market, Day says.

John Berger understands this concept well. Although at about two-and-a-half years old, his business, Standard Renewable Energy, is too young to have a proven track record in innovation, he's attempting to build a company that demands it. The $75 million Houston-based company is, as the name suggests, an alternative energy business. Presently it has two divisions; a division that sells bio-fuels and New Point Energy, an enterprise that sells a package of alternative energy—solar, wind power and efficiency technologies—to residential customers.

Because the alternative energy market is both emerging and moving rapidly, and because there are no entrenched ways, yet, of doing business, innovation is both necessary and opportunistic. "We're trying to come up with innovative packages for customers," Berger says. "So we're more dependent upon idea generation than the traditional energy company."

In a recent meeting, Berger says, a few employees suggested experimenting with alternative energy powered data centers, using partnerships to pioneer this new market. "We ended up saying 'Let's look at this. Let's gather some more evidence from real customers and see if it makes sense. Let's validate it.' Whether or not the concept will fly is unimportant. What's important is that the idea is a classic example of an adjacency."

So too is a far simpler concept, one that evolved opportunistically at Bookmans. Over the last 30 years of running his company, Schlesinger added other used products to the original used books. Some are those one might expect, like used records, replaced by CDs when LPs disappeared. Last year, however, Schlesinger added what he calls "tchotchkes"—old vases, trinkets, toasters. Today, he says, "It's the fastest-growing segment of our market. It's nuts!"

5. Experiment and Test
Note that Berger said Standard Renewable Energy will now gather evidence and validate the new data center concept. Most companies known for innovation do the same thing, using a combination of market research, focus groups, experimentation and testing. It's a crucial way of discovering the failures early in the process, before you've invested a fortune.

Another example comes from Bookmans' Schlesinger. Last year, he decided the company needed to sell products online—an obvious adjacency. Rather than invest considerable resources into building its own e-commerce site, he started by selling products through Amazon.com. He says that using Amazon taught him the basics. "It allowed us to figure out how to do shipping, receiving and posting. We've been experimenting very gingerly," Schlesinger notes. In only a year, Bookmans made more than $1 million in revenue through the online store. Based on the experience, it launched its own e-commerce site this summer.

As rewarding as the successes are, failures are unavoidable. When it comes to creating a culture that encourages continuous innovation, however, it's how you deal with those inevitable failures that matters. About 20 years ago, a well-known video product manufacturer introduced a digital camera that sold for $35,000 and required two accessory pieces of equipment that cost another $130,000. Audio Visual Innovations' Schaffel bought some demo units to sell. They bombed, and the then-$6 million company threw away $150,000 worth of equipment. Worse, Schaffel says, the company dedicated salespeople to the new product, and lost their valuable time.

"That investment almost broke me," Schaffel says. But it didn't change his resolve to continuously innovate, a resolve he built into the name of the company back in 1979. "If that caused me to never take a risk again, I'd probably be out of business. I couldn't allow it to change my attitude toward taking risks," he says. "I had to learn to be smarter about taking risks."

Opinions expressed are those of the author(s) and do not necessarily represent the opinions of Compass Bank.

February 2008