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Innovation: The big idea

For most finance directors, the mere thought of embarking on a project with
the knowledge that it’s likely to result in costly failure is enough to bring on
a bout of the cold sweats, but, despite this, it’s likely to prove a prudent
business strategy for the future.

Granted, it’s not often that you’ll see the phrase ‘costly failure’ in the
same sentence as ‘prudent’. But the acceptance of an inherent risk of failure is
a central plank in the pursuit of innovation – critical if businesses are to
differentiate themselves from the competition in a world where it’s more
cost-effective to ship thousands of tonnes of waste paper to China to be
recycled, rather than do it on these shores.

The fact is that it’s impossible for western European companies to compete
with emerging economies such as China, India and Eastern Europe in terms of
cost. So, in order to remain successful 20 years down the line, companies in all
sectors must look to

innovation to provide that critical competitive edge.

Nowhere was the impact of globalisation more apparent than at the port of
Felixstowe this November when the 400-metre long Emma Maersk – the world’s
largest container ship – steamed into port laden with 45,000 tonnes of
Chinese-manufactured goods destined for the high street in time for Christmas.
How, it is not unreasonable to wonder, can western businesses possibly compete
with that?

Robert Austin, an associate professor at the Harvard Business School, is
adamant that they shouldn’t even try – or at least accept that they will always
be beaten on price and turn instead to innovation as a way of differentiating
themselves from what the Daily Telegraph described as “millions of tonnes of
festive crap” being shipped over from China.

Bang & Olufsen is an excellent example of a company that has long been
doing just that, he says. With a turnover of almost £400m, the Danish
manufacturer of stylish – and more to the point, expensive – audio and visual
goods has succeeded through design excellence and quality; not through squeezing
costs in order to reduce the price of its products. On the contrary, the fact
that Bang & Olufsen charges such high prices is attractive to consumers and
is something of a unique selling point.

While there is a limited number of people willing to spend the best part of
three grand on a CD player, the point is that if they are willing to spend that
on a CD player, they are likely to spend even more on a television. Rather than
adopting a high-volume, low-cost approach to sales, B&O has adopted almost
the exact opposite. It is an innovative strategy which is touched upon in Chris
Anderson’s famous book The Long Tail where he argues that “the future of
business is selling less of more”.

Dr Mike Tubbs, senior industrialist in the DTI’s innovation group, is in a
unique position to provide insight – being responsible for the department’s R
&D and Value Added Scoreboards. “The best example is that in this latest
scoreboard (released last month) South Korea and Taiwan are rising up the R
&D rankings. They are following the path of Japan [which benefited from
cheap labour after the war],” he says. “It’s quite clear that they recognise
they can’t compete with their neighbours in terms of labour costs. And it seems
to me that if they’re thinking that that’s the way to compete with China, then
there’s lessons to be learned in Europe.”

Writing in the DTI’s R&D Scoreboard, Sir David McMurtry, CEO and chairman
of Renishaw, the manufacturer of high-performance measurement components, adds
weight to the theory. “When I last wrote a commentary for the 2002 edition of
this publication, I remarked how global competition is turning many products
into commodities and how this makes innovation essential to avoid being priced
out of business. The only thing that has changed in the intervening years is the
intensity of this pressure. It is no longer possible to succeed as a ‘me too’
producer based in the UK,” he wrote.

But how, exactly, can companies throw serious amounts of money at innovation
programmes under the glaring eye of shareholders with the knowledge that they
are quite likely to fail? And what exactly is innovation and how can you
recognise it? There are three planks that lie behind every successful company:
good strategy; excellent customer service; and investments in the future. “And
innovation permeates everything,” says Tubbs.

By this he means that it’s just as important to have an innovative strategy
as it is to develop the latest all-singing all-dancing gadget. Smiths Aerospace,
for example, started life making clocks. It then moved into making dashboard
dials and speedometers as the motor car became prevalent in the mid-20th century
and then, with the war, got involved 4 in aviation where it remains. Today, it
enjoys global sales of $2bn (£1.04bn). When Direct Line started life in 1985 it
had nothing but a brilliant strategy aimed almost entirely at improving customer
service and the experience they had when taking out car insurance. Within eight
years, Direct Line had become the country’s largest insurer of privately-owned
motor vehicles.

In 2001, German car giant BMW was looking at building a new car production
plant. It chose a location in Leipzig, East Germany – which probably conjures up
images of drabness and an unhappy workforce. Nothing could be farther from the
truth. BMW wanted to provide an environment where its 5,500 staff would feel
part of the BMW team whether they were building an engine or boiling potatoes in
the staff canteen. The company commissioned architect Zaha Hadid and the result
was an award-winning building in which the car assembly line permeates every
part of the building: part-built cars literally trundle above administrative
offices and even the canteen on their way to the factory floor or paint shop.
The result is that everyone working in the plant feels part of something: morale
is boosted, car production improves and so, in theory, do profits.

The Leipzig factory is an example of process innovation. “It’s worth thinking
about pure process innovation,” says Harvard Business School’s Austin. “These
can impact on the customer because you may be able to pass on cost savings and

HSBC, for example, is currently involved in trials of windows that not only
provide a view on to the outside world, but which will also act as electronic
screens, with the result that the bank will be able to project images onto their
windows. “It will be a much easier way of sending our latest marketing campaign
to all our branches. We don’t have to design a marketing poster, have it
printed, perhaps discover changes that need to be made, re-print it then
transport it around the country and hope that the branch puts it in the right
location on the right day,” Rumi Contractor, CIO at HSBC told Computing Business
magazine. It will also provide competitive edge – interest rates on loans can be
instantly changed – and marketed – across the country with a press of a button.

No fear of failure

However, the fact remains that investing in innovation can become something
of a wild goose chase. “You can’t concentrate too much on returns,” says Austin.
“It’s pretty explicit that you’re going to fail a lot. If the finance director
is concentrating on risk aversion, then you’re going to have a problem.”

The secret is not to chase after one big innovation success at the expense of
others, but to actively encourage investment (whether financial or not) in lots
of smaller projects and innovations. Should your company be lucky enough to
develop an industry-changing product, strategy or process, great. But in the
mean time, if in trying, you develop lots of successful, but not necessarily
ground-breaking, innovations, the business is only going to benefit.

Volkswagen in the US is just one company that sees the value of innovation,
but also recognises the potential problems of accounting for it. It is an
investment with returns that are incredibly difficult to predict – accounting
for it goes beyond typical capital expenditure and even research and development
investment. According to Austin, the company uses “option creating investments”
in its accounts to specify spend that goes specifically on innovation projects.

Tubbs says that the accounting treatment is an extension of the well-known
Black and Scholes option pricing model, which came to prominence in the 1970s.
“Over the past five or six years, there’s been a move to use the Black and
Scholes way of accounting,” he says. “That method has been applied to research
and development projects, saying that you can value R&D on the option of
launching a product – or not – at some point in the future. It is a valuable
approach, but it can be taken too far.”

However you choose to account for expenditure on innovation, the critical
point is to make sure the business is investing and taking it seriously. And not
just at board level – innovative products, processes and designs can originate
at all levels throughout the business, hence the importance of communication to
the successful hatching of ideas.

Missed opportunities

Writing in the latest issue of the Harvard Business Review, Rosabeth Moss
Kanter describes a fabric maker in the US being hampered by a long-standing
problem with thread breakage. When a new executive joined the company, however,
one of his first moves was to open communication channels between all employees
in the search for new ideas and innovations. It turned out that doing so had a
result when a factory floor worker came up with a solution to the thread
breakage problem. But when the same executive asked how long he had had the
idea, he was told 32 years. “When people operate in silos, companies may miss
innovation opportunities altogether,” she wrote.

Actively pursuing an innovation strategy may not result in your company
developing the next Post-it note or Tetra Pak. But what it will do is give you
options. And having options results in far greater flexibility. After all, the
world’s largest, most successful manufacturer of mobile phones used to make
rubber boots. n

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