COMPASS MAGAZINE #11
COMPASS MAGAZINE #11

DISRUPTIVE INNOVATION For future growth, CEOs increasingly look to experts outside their companies

With growth slowing and low-cost labor disappearing, CEOs can no longer count on emerging markets to dress up their balance sheets. Instead, many are refocusing on great innovations that people want to own – and what they cannot invent in-house, they are willing to buy or form partnerships to get.

Not long ago, chief executives of the world’s largest multinationals were enraptured by emerging markets. As millions of people in China, India, Russia, Brazil and beyond emerged from poverty, they began to buy Philips lightbulbs, Procter & Gamble diapers, Coca-Cola beverages and Toyota cars.

With minimal effort, incumbent multinationals could achieve 10%-20% sales gains annually. Labor also was cheap, holding down the cost and boosting the margins of goods sold into mature markets.

But the bloom is off the emerging markets. China’s growth is slowing. Brazil is battling deep political problems. Economic sanctions against Russia have taken a toll. Though not retreating en masse from emerging markets, CEOs have recognized the need to look elsewhere for growth.

For many, this means a renewed focus on mature markets. But among mature markets, according to the Organization for Economic Cooperation and Development (OECD) in its March 2017 forecast, the US is projected to grow slightly more than 2% in 2017; Germany, the Eurozone, the UK and France are projected to grow less than 2%; and Japan and Italy are projected to eke out growth around 1%.

To generate revenues in these low-growth markets, therefore, many corporate leaders are doubling down on innovation in hopes of taking market share from their competitors.

LOOKING OUTSIDE FOR INNOVATION

In the Boston Consulting Group’s 2015 survey of corporate executives, 79% of respondents listed innovation as one of their top three priorities. “That’s the highest it’s ever been,” said Chicago-based Andrew Taylor, who leads BCG’s global innovation strategy work.

Because winning in mature markets means taking sales away from someone else, CEOs are investing to continuously disrupt their own businesses. Few are increasing their internal research budgets, however. Instead, in a trend known as “open collaboration,” they are multiplying the innovative potential of their activities through alliances and collaborations with universities, independent research centers and startups.

“NO MATTER WHO YOU ARE, MOST OF THE SMARTEST PEOPLE WORK FOR SOMEONE ELSE.”

BILL JOY CO-FOUNDER, SUN MICROSYSTEMS

“There’s no doubt that companies are becoming more externally focused in their innovation efforts,” Taylor said. “The basic theme is that there are a heck of a lot more people outside your organization than there are inside. The trick is how you tap them.”

THE DEMISE OF CHEAP LABOR

Executives are looking for new ideas in some old places. Antoine van Agtmael coined the term “emerging markets” more than three decades ago, but now sees the opposite dynamic at work.

“Now the cheap labor is no longer cheap,” van Agtmael said. ”In fact, it’s no longer so relevant. With modern production methods, including 3D printing, the advantage you get from cheap labor is getting less and less. The key to competitiveness over the next 20 or 25 years is smart innovation.”

In his latest book, The Smartest Places on Earth: How Rustbelts are the Emerging Hotspots of Global Innovation, co-written with Fred Bakker, van Agtmael identified and studied 35 of the world’s most innovative regions in the United States and Europe, including 20 considered “Rust Belt”: once-thriving manufacturing cities that were largely abandoned when manufacturing moved to emerging markets.

“These places have great universities,” he said. “They have an undervalued asset called ‘freedom of thinking.’ Innovation is done by out-of-the-box thinkers who need the oxygen of freedom of thinking. There is more of that freedom [in the West]. The West has a legal system that is supportive. And so the competitive edge is shifting back.”

BEHIND THE iV CURVE

One of van Agtmael’s innovation centers is Eindhoven, in the Netherlands. When it was the headquarters of the conglomerate Royal Philips, Eindhoven was known as a somewhat sleepy company town – and then as a company town at risk.

Philips struggled in many markets and was unsuccessful in commercializing its own research and development. In 2002, however, then-CEO Gerard Kleisterlee placed a big bet on the open innovation model.

“They basically began to outsource their innovation,” van Agtmael said. “They made a strategic choice to open up their lab to create a high-tech university and surround it by all kinds of little startups that are doing phenomenally well.”

Semiconductor-making equipment thrived in the new Eindhoven environment. ASML, which produces more than 60% of the world’s chipmaking equipment, is based there.

Philips also established a pattern of watching and then investing in the most promising small startup companies in technology clusters worldwide. Its resulting acquisition binge has thrust Philips back onto the cutting edge of technology in fast-growing fields such as health care.

In June 2016, for example, Philips acquired PathXL, a Northern Ireland-based leader in digital pathology image analysis, which enables researchers to study tissue via digital images rather than physical analysis. A month later Philips bought Wellcentive, a health management software company based in Alpharetta, Georgia. The Wellcentive acquisition gives Philips a premier position in helping hospitals manage different populations of patients to determine when hospital admission is justified.

US: DEEP PATTERNS OF COLLABORATION

Europe may have started the trend toward open collaboration, but Americans are taking it to the next level. Chipmaker Intel and health-care giant Johnson & Johnson (J&J), for example, have established venture capital operations that scour the world’s universities and research institutes for ideas to commercialize. At Intel, what happens next varies with the specific opportunity.

“THE KEY TO COMPETITIVENESS OVER THE NEXT 20 OR 25 YEARS IS SMART INNOVATION.”

ANTOINE VAN AGTMAEL AUTHOR, ‘THE SMARTEST PLACES ON EARTH’

“Every investment we make has to hit the nexus of strategic and financial,” said Ken Elefant, a vice president and managing director of software and security at Intel Capital. “If a company doesn’t have a strategic fit in some way with one or more of Intel’s business units, we won’t invest.”

J&J, on the other hand, manages development centers in San Francisco, San Diego, Houston, Boston and Toronto, where it invites startups – which may or may not have a business relationship with J&J – to locate.

“To collaborate with innovators everywhere, a company of our scale and complexity has to industrialize it,” said Robert G. Urban, the Boston- based head of Johnson & Johnson Innovation. “We work in specific areas that are in line with what our businesses are trying to achieve.”

To accelerate the pace of innovation, J&J nurtures relationships between its internal research scientists and startups in the same field.

THE JAPANESE VARIANT

Japanese companies have found it difficult to create innovation-stimulating conditions at home like those being exploited by competitors in the US and Europe.

Japan has technology clusters such as Minebea, which makes more than 60% of the world’s small ball bearings, and Horiba, which makes 80% of the world’s motor emission measurement systems.

But Japanese manufacturers tend to be more cautious, worried that their proprietary technologies will leak if they engage in open collaboration. Japanese universities also are less inclined to commercialize their technology, scientists are reluctant to leave universities and research centers to become entrepreneurs, and early stage capital is scarce.

“The country and its people have been trained to be risk-averse,” said Hideo Tamura, a professor at Waseda University in Tokyo. “Those perceptions have been imbedded so powerfully, like a tattoo in people’s heads.”

Tamura notes that even Japan’s traditional strengths in semiconductors and consumer electronics have been greatly eroded; maintaining Japan’s lead in robotics will require aggressive development.

Some Japanese companies are realizing, therefore, that they cannot lead by being a close follower of US or European rivals. Their CEOs are eager to obtain footholds in emerging technologies that include artificial intelligence, financial technology, next-generation robotics, autonomous driving, life sciences and the Internet of Things (IoT).

In a major shift, Japan has begun winning global recognition for cutting-edge research. Katsuhiko Hayashi of Kyushu University, for example, used mouse skin cells to create healthy mouse eggs, which in turn created healthy mice. His work is seen as a foundation for breakthroughs in infertility. In 2016, the journal Science ranked his work among the year’s 10 most important breakthroughs worldwide.

But basic R&D takes years to create a payoff. That’s why Toyota Motor Corporation, Japan’s largest company, is embracing a host of open innovation techniques.

New propulsion systems, advanced safety and autonomous driving techniques, plus a shift from individual ownership to shared-use vehicles are transforming the auto industry. For insights into how these trends might evolve, Toyota launched a plan in 2015 to invest US$1 billion over five years in an artificial intelligence (AI) research institute in Palo Alto, California, close to where Apple, Tesla and Google’s sister company, Waymo, are conducting autonomous vehicle research. Early results already are being tested in next-generation Toyota cars and assembly lines.

79%

In the Boston Consulting Group’s 2015 survey of corporate executives, 79% of respondents listed innovation as one of their top three priorities, the highest level the survey has ever measured.

In January 2017, Toyota unveiled a concept vehicle called the Yui, which talks like a humanoid robot and functions in place of a driver, furthering Toyota’s vision of autonomous driving. Affiliate DENSO Corporation launched a joint venture with Toshiba Corporation to develop a version of AI called deep neural network intellectual property (DNN-IP). DNN-IP will be used for next-generation image-recognition systems, which enable advanced driver safety features and, ultimately, fully autonomous vehicles.

In November 2016, Toyota announced the world’s first method for observing lithium-ion battery charges or discharges, a breakthrough that could lead to longer and more reliable battery performance. And in December, it announced the TOYOTA NEXT open innovation program, inviting other companies to offer Toyota technologies that it could co-develop or license.

“In TOYOTA NEXT, we will not be constrained by closed-loop business policy,” Shuichi Murakami, a Toyota managing officer, said at a recent news conference. “Instead, we will tap new ideas, technologies, solutions, and even existing services and others to co-develop new services.”

Other Japanese companies looking to the West’s industry clusters for technologies they can invest in or acquire include SoftBank Group, which acquired Britain’s smart-chip architecture company ARM Holdings in 2016. In October, under the leadership of CEO Masayoshi Son, SoftBank announced a joint venture with the Saudi Arabian government to create a US$100 billion investment fund specializing in IoT projects.

“Softbank’s thinking is that in the new tech world, achieving economy of scale with as many stakeholders as possible is indispensable for spreading out a technology or products,” said Darrel Whitten of Reading Advisors, an advisory firm based in Tokyo. “However big a company may be, it cannot develop a new technology alone.”

‘DE-RISKING’ NEW TECHNOLOGIES

Whatever model they use, the US, European and Japanese companies active in these technology centers are “de-risking” a technology before bringing it in-house, said Jenna Foger, senior principal of science and technology at the New York offices of Alexandria Real Estate Equities.

Because Alexandria specializes in creating facilities where large companies – especially those in life sciences – can co-locate their R&D operations with academics or doctors on the cutting edge of knowledge, Foger has a unique perspective on the grow-through-innovation trend.

Foger notes that large companies, such as Switzerland’s Roche, are leaving their traditional R&D campuses in low-cost but isolated areas in favor of urban technology hubs. Roche’s move from suburban New Jersey into Manhattan spawned a burst of 65 partnerships with researchers and small firms in the span of just three years.

“Collaborating among companies, more and more we’re finding we need to do that,” Roche Global Innovation Leader Judith Dunn said.

SHOW US THE MONEY

Like Roche, Foger finds that the innovation-focused companies she works with are seeking four attributes: location, talent, a tradition of intellectual property (IP) generation and protection, and a ready pool of early-stage funding.

Urban areas tend to win on the location and talent metrics, because talented young people are attracted to the active lifestyles of urban areas. The IP metric gives established Western economies a major advantage. The availability of early-stage funding attracts and encourages the startups that spawn new ideas established companies can buy or help to commercialize.

Established companies now provide a quarter of venture capital dollars invested in the United States, according to CB Insights, a market intelligence firm. And those investors want to be close to industry clusters, where other investors will amplify their own investments.

Add it all up and it’s a formula for faster innovation. “It’s cheaper and less risky to partner with a smaller company than to focus on a specific area (internally) so pharmaceutical companies can fill their pipelines more cheaply and quickly,” Foger said.

THE MENTAL MODEL

Whatever a company’s nationality or industry, the pressures are mounting on all CEOs to develop management systems that allow them to specify which new technologies the company will pursue, which products will continue to be made and which ones should be phased out as part of a permanent process of disrupting existing product lines.

Vijay Govindarajan, Coxe Distinguished Professor at Dartmouth's Tuck School of Business in New Hampshire and author of The Three Box Solution, argues that only CEOs can decide which technologies to put in which box. Budgets and personnel must be allocated to the different boxes and their performance measured depending on where their products fit.

“They require different capabilities and different metrics,” Govindarajan said. “This is the central strategic challenge.”

Not everyone agrees with his three-box concept, however. Take Brian Goldner, CEO of Hasbro, the US$5 billion toymaker based in Pawtucket, Rhode Island. Its new product “box” totals 75-80% of Hasbro’s products each year.

“I think of the three-box strategy as being more like the Matryoshka Russian dolls that nestle together,” Goldner says. “You are managing the present and selectively forgetting the past. But you also may find a new truth that changes current beliefs. That is the future. You have to think about all of these at once. They inform each other.”

CEOs must think about how they link talent acquisition goals to innovation strategies, BCG’s Taylor said.

“If a big company wants to do rapid expansion in a whole bunch of different adjacencies, what you need is a whole bunch of entrepreneurs,” he said. “You need people who can break down walls. But if, in another business, you are taking a fast-follower model, you need a different kind of person. You can’t shift people into a new function that they are not well-suited for. You have to ask yourself, ‘What is the talent I need to enable my strategy?’”

To achieve gains in mature markets, it’s clear that the world’s incumbent multinationals must reinvent themselves to focus on permanent, high-speed innovation and permanent high-speed disruption of their own businesses. If they don’t do it, someone somewhere is creating a startup that will.

by William J. Holstein and Toshio Aritake Back to top