Structural cracks – Are we seeing a structural shift in the business of innovation?

Paul McCarney
Consultant, Digital Technology Space

The function of innovation in the enterprise has been around since shareholders wanted a return on their investment (i.e. forever).

And, we have all observed over the years how this innovation can lead to industries getting ‘replaced’ (ice manufacturers to refrigeration, passenger rail to car, etc), and how profitable business models can be disrupted (newspaper classifieds to online auction, book publishing to ebooks, etc), however, the dynamics in the business of innovation is shifting.

The rate of business model innovation, the explosion in early stage innovation and shifting funding models are evolving extraordinarily fast, and as a result are further complicating many Enterprises ‘Innovation Dilemma’[1].

But before we get into the current changes in Enterprise innovation mechanics, lets quickly look at the practicalities of why Christensen’s Innovation Dilemma often exists in large Enterprises and put some context to what has changed to alter these mechanics.

Practical reasons why Innovators Dilemma exists;

• Customers and Shareholders, practically, dictate how resources are applied. Both parties have no real context or framework for disruptive innovation (See diagram below[2]). By the time the Enterprise customers are flocking to innovative solutions, the disruption has occurred.

• Small (innovative, newer) markets don’t satisfy the Enterprises growth needs. Waiting until markets are large enough to be interesting in the current market context (see below – Rate of Business Model Innovation) could well be too late.

• New market ROI is intangible – The business case for market entry for a non-existing market is hard to justify in Enterprises, which are often driven by next Quarter Shareholder return, management bonuses, sales culture and metrics.

• The Enterprises capabilities (process, culture and size) defines its innovation disabilities. These assets can compete with the nimbleness and flexibility required to commercialise true breakthrough innovation.

• Often Product/market disruptive innovation[3] will disintermediate the Enterprises ‘cash cow’ product, attempting to force the Enterprise to marginalise the current brand and revenue. Given the points above and management incentive structures, moving to ‘compete against your yourself’ is a tough strategic pill for an Enterprise CEO to swallow[4].

The rate of business model innovation

Every era, generations tend to think that they have seen the fastest rate of change. But the current ‘utilitisation’ of the Internet, the ability to buy the ‘Internet’ and related products as a service (from ‘the Cloud’), is causing a systemic disruption that is similar to the shift that occurred during the development of electricity.

In Nicholas Carr’s book ‘The Big Switch’ he makes a comparison between the “millwork” of Victorian-era factories and the complex custom software products today’s developers build for contemporary information factories:

• Millwork meant elaborate, complicated devices, unique to each location, designed to transfer the mechanical power from some source like a water-wheel to the factory’s wood making machinery.

• Once electricity came along things got simpler, but each factory still ran its own plant — until the electrical grid rendered that whole approach obsolete.

• This shift happened quickly; In 1900 <5% of manufacturers power came from electricity; By 1905 Engineering magazine declared “no one would now think of planning a new plant with other than electric driving”.

• In 1900, before electrical utilities became standard, there were over 50,000 US companies producing their own electricity.

• Carr argues, that Computing is turning into a utility and that the effects of this will change society in the same way electricity did.

There are a number of ways we can look at whether the rate and scale of disruptive innovation is increasing now more than ever, however I have chosen two macro indicators:

1. Patents registered – When we look at the historical number of patents registered per million people in the US we can see in the graph below that Rates of innovation peaked in 1915, dropping by half by 1985 before rising back to 75 percent of the 1915 rate in 1999.

Where are we today?

In 2010, calculations (from USPTO[5]) say that 395 patents were registered per million people in the US – more than any other time in recorded history!

2. Public Company Life Cycle – as a (proxy) measure of how frequently innovation has disrupted business models, according to a recent Business Week article[6], “in 1958, the average length of time a company remained on the Standard & Poor’s 500-stock index was 57 years. By 1983 it had dropped to 30 years. In 2008, it was just 18.

The Structural Shift – What’s Changed?

So what has changed from 1995 to 2010 for patents registered per million US people to go from 242 to 395 (an increase of 63% in just 15 years), and for mainstream conferences set up to promote innovative disruption[7]? There may well be a number of other macro-economic factors, but the rapid growth of innovative starts-ups can be accounted for practical changes like:

• Globalisation and the ‘Cloud’ has increased technology speed to market and drastically decreased cost – outsourcing websites like elance, freelancer and oDesk have drastically reduced the technical costs and time required to try/fail/succeed in the early stages of innovation. They started by offering cloud storage (S3) on a super cheap, pay-as-you consume basis.

• The ‘Cloud[8]’ and Open Source software has also increased Technology speed to market and drastically decreased cost – In 2000 when developing a technically based business, expensive software (Oracle, NT, etc) was sitting on costly servers in racks licensed from ISP’s. Today, services like Amazons AWS offer cloud storage on a super cheap, pay-as-you consume basis. When coupled with an innovators access to a free ‘stack’ of open source technology[9] we see a fast and cheap way to test and fail[10], which would have been preclusive 10 years ago.

• Internet and the Cloud breaking down customer access to information, decreasing need for intermediaries – 15 years ago the only way to find out who was selling what, was via a newspaper, clearly this has changed and we will the see Cloud related services continue this trend of content democratisation and more ‘intermediaries’ marginalised, as buyers and seller connect directly.

• More innovative startups than ever being fuelled by a market now online with no borders – With billions now online[11] Start-up accelerators like y-combinators, techstars and startmate, are not only driving the number of start-ups, but the promotion of ‘innovation’ as being a lucrative career.

• Decreased time to cash positive – lower overhead and online sales costs coupled with an increased focus on ‘time to market’ / iterative development is more and more innovation ‘out of the garage’.

• Increased access to funding/capital sources – Although we are seeing the number of US VCs declining[12] we have seen an influx of Angel (and ‘Super Angel’) funding in the last 5 years.

• Increased Internet penetration, enabling the PC, tablet games console, mobile and TV web now as a viable ‘on-demand’ distribution channel – in past years access to audience was capital intensive and not often mapped to immediate results. Current distribution mechanisms enable mass access to potential customers that can directly map marketing expenses to revenue.

• Online social connectivity as a channel and disruptive phenomena/opportunity – Past marketing mechanisms were costly and linear (broadcast, etc), with the recent rise in social connectivity we are seeing products and services go from zero to overnight success via social networks for little or no cost.

What we are witnessing in utility computing, is that it is providing a platform for innovation growth and opportunity for market/product disintermediation.

Why Innovating is Important for Enterprises Now!

Why should Enterprises consider scaling up their investment in innovation now?

• Utility computing, content democratisation, lower costs and performance based distribution channels will dramatically increase the rate of innovation, leading an increase in disruptive technologies.

• Funded innovation has a significantly better chance of success, but the funding options for innovation in this market is diverse, and in a state of flux – Venture Capital (VC) funds are declining and Angels funding are increasing. For scaled deployment to occur, these successful disruptive start-ups will need Series A, B and even C funding. With less ‘scale’ money available (less VCs), will there be opportunities for Enterprises to invest and leverage strategic assets, or will VCs be able to invest, scale and disrupt again?

• In each application/vertical (and within each business function) there will be only one primary (platform) winner – in most areas that race has yet to start (or, at least, is far from completed) – The opportunity for disruption in many markets/verticals/functions is still available.

• The pace of localisation is quickening – Business models are being proven overseas and vended locally with lower risk. Australian group deal clone, Spreets.com.au, went from starting to sale (circa AU$40M) to Yahoo Australia in 10 months.

With the majority of ‘business model’ (disruptive) innovation occurring outside of the Enterprise[13], is the time right for Enterprises to find a way to solve their dilemma, and participate in this systemic change before someone else does?

 

About the author

Paul McCarney is a Consultant, Investor and Entrepreneur in the Digital Technology space. The past 15 years has seen him develop shareholder value for a wide variety of companies.

At the end of 1999 Paul co-founded premier search marketing agency, Decide Interactive. At Decide, Paul developed the concept of Paid Inclusion, managed the development of DecideDNA (According to Jupiter, the worlds leading SEM platform) and oversaw search marketing strategies for some of the world’s largest companies, growing the business internationally, with offices in Sydney, London and San Francisco. In August 2004, Decide Interactive was sold to the NASDAQ listed, 24/7 Real Media. In 2005 Paul foundered Life Event Media P/L (‘LEM’), where he funded and guided the development and marketing of the Life Events lead generation SaaS Platform for Directories and Publishers around the globe. LEM runs the Quotify referral network of Australian sites – quotify.com.au. In Jan 2011 Paul sold LEM to Sensis, for a profitable outcome for all shareholders.

Paul is currently looking at investment models for Innovation inside Enterprises.