‘Why are we so bad at innovation?’ It’s something that clients regularly ask us, from banks to restaurant chains to retailers.
And it’s no wonder – innovation is as hard as it is important. You can’t just ask customers what they will want in the future, and you can’t be good at it without failing once or twice along the way.
But framing the question in a negative way can do more harm than good, leading to a focus on superficial fixes – when the answers often lie in the economic model at the heart of the business.
That’s why we’ve developed five questions that we ask all clients who want to innovate. These questions allow us to get to the underlying economics behind a business’s innovation needs, and demonstrate how they affect innovation decisions at all levels.
This approach helps our clients innovate faster, better and in areas that create more value. And it’s flexible too, able to support individual product innovations or more strategic overhauls.
Let’s take a look at the five questions we ask all clients who want to innovate.
Source: Frontier Economics
What type of innovation do you want?
Before you start any innovation journey, you need a sense of where you want to go. There are some key steps to take in setting your innovation goal:
- Find a balance between big bets and incremental changes. Innovation is often associated with a blockbuster new product or service that radically changes consumer behaviour. And sometimes you do need those disruptive bets. But innovation isn’t just about re-inventing the wheel – it’s also about conceiving new ways of using it. As big companies know, there’s a lot of value in incremental change: making mobile banking a few clicks faster, or optimising routes for delivery drivers. Finding a balance between these smaller tweaks and the bigger bets is crucial.
- Decide if innovation should reduce costs or drive revenues – or both. Pursuing innovation without a specific revenue or cost objective makes it very difficult to judge trade-offs. Is it more valuable to improve logistics efficiency by x%, or to open up a growth market that could be worth y% in five years’ time? The answer depends on the market you’re in, the technology you have and the competitive advantage you’re protecting.
- Work out the level of risk you’re willing to take. If you haven’t set a risk appetite upfront, it’s tricky to assess the value of different ideas. Let’s say your competitors are collecting increasing amounts of customer data, and betting on future technology. But use cases are not yet clear. How much are you willing to invest in collecting customer data too? Many innovative businesses have the right mix of risk profiles and time horizons to create value over time. That’s a great first step – and one that should be revisited regularly to ensure changes in the market are considered.
How does innovation fit with economics and culture?
Businesses often start with an ambition to change their ‘innovation culture’. But while culture is an important driver of behaviour, it’s rarely the root cause of innovation blockages.
Instead, we have found that a business’s economic model tends to determine what type of innovation it’s good at (and what type it isn’t).
That’s not to say culture doesn’t matter. But culture is driven by incentives – like how people are paid and how bonuses are set; and goes beyond that into social norms, defaults and psychological reward. And incentives tend to align with economic models.
Assessing your model means understanding how you make money today, but also what your market might do tomorrow and how your competitive advantage will see you through that. The model determines the processes, defaults and behaviours that teams follow, including in innovation. This means there’s some important knowledge to arm yourself with:
- Know what type of innovation your economic model is good at. Different economic models suit different types of innovation. Large, successful companies find disruptive innovation difficult, fearing damage to their brand if a big bet falls flat. But companies like these are great at high-frequency, incremental innovation. Their processes are set up to do it efficiently, reducing risk of unwanted customer outcomes to almost zero.
- Identify natural weaknesses – and turn them into strengths. Sometimes, the innovation you need won’t be reflected by your natural strengths. But recognising these obstacles doesn’t mean you can’t overcome them. Understanding your economic model can help to create positive situations from potential blockages. A risk-averse business, for example, may have instilled the need for perfection among its staff, and would fear this as a block on innovation. But recognising that supposed weakness could help the business convert it into a strength – by setting targets for running the ‘perfect’ innovation trials.
What type of process do you need?
Companies need the right systems for innovation – ways to create, explore and filter the ideas they want to pursue. One size does not fit all, and the right option depends on the type of innovation you want to pursue. There are two important things to get right:
- Define where you should use default processes. Lots of businesses innovate through a small number of default processes. They’re usually dictated by economics – the time period within which innovation needs to pay back, the risk profile you’re willing to accept, the standard assumptions that need to be made. A retailer, for example, might expect their product innovations to reach scale within 12 months, create a growth rate within an expected range and hit an average margin. Default processes like this can be a very efficient approach, guiding employee behaviour and speeding up decision making and approvals.
- Recognise risk and value in your assessments. In some cases, default testing processes won’t be suitable. Standard business plans may be suitable for evaluating investments where future revenues can be projected with confidence – but what if you’re placing a bet on an innovative product with an uncertain outcome? In that case, you’d need to estimate opportunity costs and option value, instead of forecasting revenue – which may require a different team and a new approach. In other cases, the challenge may be about exploring many alternative ideas at once (rather than gold-plating one) and more dynamic business sprints might work best.
We’ve found that businesses who use a wider toolbox of processes make more robust innovation decisions, and maximise their chances of creating a well-balanced portfolio.
Should you do it yourself or with a partner?
Partnerships can be helpful in bringing specific innovations to market and in navigating innovation strategy. But partnerships (or acquisitions) shouldn’t be treated as a shortcut to innovation – because if you can buy something, so can your competitors. Two key steps have the highest impact here:
- Pick a partner for the right reasons. Economics has a lot to say about whether a partnership is the right choice. This can be the case if:
- it is faster (and / or cheaper) to buy innovation than build it;
- the partner has technology or skills that you do not have (and cannot easily acquire); and
- they operate with a culture / incentives / approaches that you need in order to create innovation.
- Define a fair share for both partners. Partnering works best when it’s win-win. Economics can dictate how to define the details of the relationship in order to create and share value. The best version of this should incentivise all parties to make the pie as big as it can be, and share it fairly in the long run.
How will you make it work in practice?
After months or years of development, many innovations fail here – at the point of implementation.
Of course, no change is without risk, and many innovations are simply not strong enough to take off. But often propositions that do have potential still fail to bear fruit, as a result of misguided implementation.
Again, this often boils down to economics. Incentives, KPIs and targets must be judged correctly if teams and individuals are to implement innovation plans properly.
If you know a new launch will be slow to grow, for example, you should avoid linking managers’ bonuses to a profit target. The same could be said if the new product will cannibalise an existing product that those same managers are in charge of.
Small tweaks to incentives at this stage can make a big difference – so bear this in mind before returning to BAU in the face of a perceived implementation failure.