By Johanna Nordin
Disruption: opportunities and how to respond
Companies that fail to innovate risk extinction. Blockbuster, Kodak and, more recently, Sears show what happens when you fail to think long-term about responding to change. What did these companies
miss? Why did they not anticipate and respond to the explosion of online streaming, digital photography and online shopping? They were blind to the disruption surging towards their business and failed to act.
To avoid this, and to innovate with purpose, businesses need to balance business-as-usual with innovation to extract value from current core capabilities and to create future value. This starts with a deep appreciation of the external environment influencing tomorrow’s changing consumer.
Organisations should of course deliver shareholder returns. To ensure future survival executives are compelled to chase growth. Business leaders recognise innovation as key, but it is a challenge that requires critical thinking about current capabilities to generate future profit. The short-term pressure on executives emphasises quarterly results, so the board should encourage value creation to prevent executives excessively focusing on immediate outputs. Pursuing innovation proves difficult when the firm resists initiatives that threaten current processes, so executives need to align the organisation along a common long-term trajectory. Otherwise efforts will be undermined by ad-hoc attempts to innovate with no focus on creating revenue. This becomes more important when the socio-political environment changes and firms need to adapt to a different market.
To sustain future growth, executives need to be determined in their efforts to innovate. They must go beyond incremental improvements to critically consider how they will flourish during fundamental change. We are suggesting that in the quest of survival, a firm needs an annually reviewed and updated formal process for their innovation methods.
In this whitepaper we define innovation as ‘The creation of future earnings enhancing revenue through propositions and methods not currently used’.
Ambidexterity: balancing business-as-usual with innovation projects
The primary goal of any organisation is continuity. Business-as-usual is deeply rooted in daily operations, so conflicts with change projects. Executives therefore need to ambidextrously balance the paradox of preserving the status-quo and with the less natural process of evolution.
An ambidextrous organisation efficiently manages business-as-usual while adapting to shifts in their external environment. Just as a right-handed person would find it challenging to skilfully use their left hand, businesses find adopting ambidexterity difficult. Core capabilities are entrenched in the organisation and have developed over time as a response to clear signals and linear changes in the industry, making change hard. Innovation requires different values, skills and systems that deal with hard to discern, non-linear changes.
Business-as-usual maintains the idea that a firm’s current offering will result in future revenue simply because it is profitable today. This misconception means that innovation necessitates a degree of creative destruction to sustain economic growth. Innovation projects move against the conformity and group think of the organisation and consequently need to be protected against the corporate immune system. Just as the biological immune system attacks foreign invaders, organisational processes drive out anything that is anomalous to the host. The body may reject an organ transplant that is meant to bring long-term benefit, and so the corporate immune system will view change initiatives as potentially harmful. Professor Vijay Govindarajan suggests that such projects should therefore be separated both physically and psychologically from the organisational antibodies.
Firms have no choice but to challenge current paradigms. The fast- moving external environment makes it vital to consciously and continuously question the traditional. Thinking critically about current capabilities means making hard choices. In the case of Blockbuster, it would have meant closing stores and letting staff go to favour lower cost distribution. To open the organisation up to these conversations and to prevent the corporate immune system from killing new ideas, organisations require a structured, evidence-based innovation pipeline; a process that operates with speed and determination, and that helps executives discover and prioritise problems and ideas. A formal innovation method will help executives balance business-as-usual’s strive for continuity and survival’s requirement for
Value creation: protect long-term change initiatives
Long-term focus is key to long-term success. Yet executives are struggling to commit due to short-term pressure. Since the 2008 financial crisis, the need to refocus on a long-term mindset has routinely been on the meeting agenda of the World Economic Forum, the Organisation for Economic Co-operation and Development and the G30. Despite the proliferation of voices urging for such a shift it is often eclipsed by quarterly capitalism.
Numerous reasons lead to the short-term emphasis. Executives desire guaranteed returns and tend to manage the measurable. This means discounting long-term projects due to uncertainty. Organisational incentives such as investor pressure, bonuses and job evaluation push short-term action. There is also human nature; people focus on the short-term because of the
gratification of quickly tackling a problem. Short-term pressure results in short-term management and as a result, firms are less able to build long-term value.
80% of CFOs have rejected projects expected to produce positive long-term results because it would lower the firms’ quarterly earnings 79% of executives feel they need to deliver strong results within 2 years and 63% claim the pressure is increasing. McKinsey found that, when estimating the potential embedded in a company’s
stock price, 70-90% of value is related to cash flows expected more than three years out. If the majority of a firm’s value depends on future outcomes, but executives are compelled to deliveresults within two years, then businesses today have a problem. Annual budgeting should hence be supplemented with long-term projections, as the fiscal year is too short a time-span to meet growth targets. It will support executives in setting aside, and protecting, the esource required to successfully innovate. Just like the gardener is required to cultivate the soil and remove the weeds to nurture new growths, and would not expect to grow fruit immediately, so should the CEO foster new ideas without expecting instant results.
In addition, new research by innovation consultancy Fearlessly Frank found that companies believe just half of their revenue in ten years’ time will come from products or services they are currently
selling yet only one in six admit to planning that far ahead4. On top of merely managing a small portion of the total value, firms also inadequately plan how they will make money in the future.
So, in the interest of long-term success, firms need an innovation plan that focuses on creating value rather than instant
output and protects the necessary resources from the immediate concerns of the business.
A new partnership: how boards can participate in setting the innovation agenda
Unparalleled market change means that the risk of complacency outweighs the risk of action. To avoid being left behind, firms need to reform business-as-usual. The focus of the corporate board should
therefore be progressing innovation.
Corporations positively depict growth by reporting record
profit levels. Other metrics tell us a different story. Being an industry leader is becoming a fleeting characteristic, as revenue and market share are increasingly vulnerable. The past five decades have
witnessed an economy-wide regression in return on assets5. To John Hagel, Chairman of the Deloitte Centre for the Edge, this implies a declining ability to capture opportunities relative to current assets.
The consequence are firms that struggle to build and execute long-term strategies. When paired with the increasing emphasis on quarterly capitalism, the need for purposeful, growth focused
innovation becomes ever more necessary.
Yet, boards are enhancing the short-term anxiety that afflicts executives. Over half of executives in a McKinsey survey claim that pressure to deliver short-term results stem from the board6. A recent Harvard Business Review survey also found that innovation only ranks fifth in a list of top strategic challenges7. Conventional concerns such as competitive threats, regulatory environment and attracting talent ranked high. In the pursuit of growth, boards should avoid solely focusing on the ‘value protection’ of current assets but reflect on the ‘value creation’ of new ones.
In an ecosystem undergoing major shifts, boards should be at the vanguard of transformation. They must participate in critically rethinking the details of their business model to prepare for a different market. Just as the lighthouse stands tall and strong, and shines a light over troubled water, so the board should guide the organisation through new territories. To achieve this, the board needs to develop a clear view of how their company, and the market, will look in 10-20 years. Two or three initiatives should fall out of this exercise accelerating the firm towards the long-term target. Ensuring that this is a practical exercise, not a theoretical one, will help executives to not be consumed by business-as-usual.
Charged with advising, guiding and challenging management, the board is in a unique position to focus on the evolution of the company. In the interest of successfully anticipating and responding to change, implementing a formal innovation plan is imperative to both identifying new scenarios and executing strategies to exploit emerging opportunities.
Sustaining growth: institutionalising innovation efforts
Innovation frequently fails. Despite investing time and money, it remains a challenging pursuit. It is inherently risky as it takes valuable resource from other projects. Even when firms successfully innovate,
they battle to sustain it. The problem is rooted in the lack of an innovation strategy.
Innovation needs to be managed, tracked and measured as a core component of a firm’s growth ambitions. Executives admit to the value of innovation but there is little evidence that companies have a formal innovation process integrated into their strategic management agenda. For example, one third of executives say innovation occurs on an ad-hoc basis8. 19% exclude innovation and growth completely by solely focusing on budgeting and forecasting in their planning processes9. If companies pursue innovation as one-off manoeuvres, they end up chasing inconsistent priorities. Without a formal process, innovation boils down to of-the-moment schemes such as setting up an internal venture capital arm, pursuing M&A, implementing crowdsourcing, open innovation or rapid prototyping, just to mention a few. These methods fall at the feet of populism without considering long-term revenue creation. Random innovation hence becomes self-defeating.
In the quest of sustainable innovation, firms should lift innovation efforts out of ad-hoc haphazardness and into a strategic long-term plan attached to growth trajectories. The innovation strategy should align groups around collective priorities and articulate clear objectives related to sustaining value creation. The framework needs to consider what complementary capabilities are required to innovate. Just as the person at the top of the mountain did not just fall there but had to prepare, including the mundane details such as how to provide sufficient oxygen to survive at 28,000 feet, so does the CEO need to comprehensively plan for success.
Hence, a firm’s capability to sustain innovation stems from having an innovation system. Executives are naturally devoted to their firm’s survival, so they should implement a formal innovation process that institutionalises innovation efforts at board level.
A new revolution: how to beat disruption
The fourth industrial revolution is profoundly changing how we live, work and connect with each other. Many technological advancements, for example artificial intelligence, the internet of things, biotechnology and robotics, are still in their infancy but have already instigated major changes across the physical, digital and biological domains.
These shifts manifest themselves through the
disruption of incumbents, the emergence of new business models and the evolution of how humans consume, produce, use transportation and communicate. To spot commercial opportunities, executives first need a deep appreciation of the emerging environment influencing their customers. These changes, according to Professor Klaus Schwab, are so significant due to their velocity, scope and impact that ‘there has never been a time of greater promise or potential peril’10. It requires executives to, now more than ever, think strategically about the forces that will shape our future. The immediate concern of the next financial quarter is not the key to business continuity.
The global scale of these shifts necessitates cooperation across national, political, social and industry boundaries to ensure the best possible outcome. Countries that introduce preferable regulation will position themselves at the forefront, as legislation shapes the ecosystem in which companies operate. The key question for economies is unlikely to be whether it is an emerging or maturemarket but to what extent it can innovate. For example, while North America and the EU represent some of the most innovative markets, others are quickly catching up. China is shifting towards a market focused on providing services and innovation and are catching up at three times the growth rate of the EU’s innovation performance. What becomes clear is that policy choices govern companies’ capability to capitalise on new opportunities.
This gives rise to questions of how Brexit will affect the UK’s innovation landscape. UK businesses are devoting significant resource to Brexit in an attempt to assess risks and opportunities. Yet much remains unknown which compels firms to examine various scenarios and the impact they would have. According to UK executives, this is a resource intensive and time-consuming task; 57% of firms believe
Brexit is taking time away from other priorities12. Just as a football team studies the opposition and plans the game but are able to respond to changes in real time, so does a firm need to study their
environment and strategise but then embrace change.
While preparing for challenges that will arise due to Brexit, businesses need to proactively adopt and seek opportunities. Original research by innovation consultancy Fearlessly Frank found that while 7 out of 10 UK companies believe innovation will become more important after Brexit only 3 out of 10 strongly believe their firm is identifying specific innovation initiatives13. Additionally, a Deloitte survey found that when asked what factors will enable firms to innovate, executives focused on business-as-usual requirements such as access to skills (66%), tariff-free access to goods (41%) and keeping common regulatory standards (38%)14. There was no mention of the need of a formal innovation plan or progressing towards long-term value creation.
The world is moving faster, new types of consumers are emerging, and political, social and economic shifts, such as Brexit, are unsettling business-as-usual. No organisation has ever beaten disruption by just doing what they currently do better. So, the mandate of the CEO to establish new growth paths becomes an obligation rather than a well-intentioned thought. In the pursuit of commercial
opportunities and to expose new growth markets, executives require an innovation method that appreciates deep shifts and recognises significant tides in the environment.
An innovation process: how to flourish in the face of fundamental change
Those that fail to innovate risk extinction. 88% of Fortune 500 firms that existed in 1955 have either gone bankrupt or fallen from the list15. At the start of each new era, the present paradigm will vigorously
resist but, sooner or later, every organisation needs to transform themselves. Author Carl Sagan once said, “Extinction is the rule. Survival is the exception”16. As the life expectancies of companies
shrink, they need to be more vigilant than ever to continue growing. To be the exception, and to innovate with purpose, businesses need to implement an annually reviewed formal plan for their innovation
Organisations are increasingly compelled to seize opportunities without being constrained by risk, and to survive they must turn those opportunities into deliberate action. Successful companies will be the ambidextrous organisations that keep their core business sailing smoothly while investing time and resource to renew business- as-usual. Long-term survival lies in the firm’s ability to focus on the transformation of the organisation, identifying growth opportunities that might fundamentally change the business. However, as the future is always unpredictable, it is critical that the firm sets an innovation
strategy with structured processes to take advantage of opportunities as they appear. The focus then moves from how the future will disrupt current business toward deliberate preparatory action. Thinking
critically about the type of talent, resources, structures and systems the organisation will require should be done alongside planning for today’s business-as-usual projects.
Changes in the external environment increases the urgency. Businesses are being disrupted by changing patterns of how we live, behave, interact, work and consume. While the reflex will be to improve efficiency and cut costs, there will be a day where falling back on business-as-usual is no longer possible. The tendency to incrementally improve business-as-usual is never enough to sustain growth when diminishing returns set in.
To adapt to these shifts, businesses are forced to think anew about what their future holds. Board members have a vital role to play in guiding this transformation, challenging basic assumptions and
fostering a culture where innovation is protected. By shifting away from a short-termism mentality and engaging the board in rethinking the fundamentals of the business, executives can prevent ad-hoc
Companies tend to view innovation as a set of unrestricted activities with no discipline, but for innovation to benefit the firm it needs to be designed as an organised process from start to finish. Without a process, there is no accountability on executives to follow through and although new projects are well-intentioned there is no objective way of deciding which route is worth pursuing. The firm hence requires an evidence-based innovation process that supports executives in recognising looming disruptions, identifying rising tides and prioritising initiatives.
To avoid extinction, all companies need a formal plan for their innovation methods. It will allow them to think freely, unconstrained from business-as-usual. It needs to break the corporate stronghold
and consider how, in the face of major change, how do we thrive? As the urgency to innovate intensifies, a firm’s capability to imagine a very different future and to define an innovation strategy that delivers
growth will determine whether they have a future or not.