Rotman Management Magazine
Introducing: Creative Construction
Creative Construction: The DNA of Sustained Innovation Harvard Professor Gary Pisano describes the antidote to creative destruction for established organizations: creative construction.
Creative destruction—the idea that successful innovators sow the seeds of their own destruction—was defined by Joseph Schumpeter over 70 years ago. Is this still a phenomenon today?
Gary Pisano: Absolutely. Schumpeter nailed it when he coined that term, and it’s amazing that he was writing 70 to 80 years ago. Today, many aspects of economic progress and competition are defined by the dynamics he described. We are seeing the constant, almost incessant creation of new enterprises that are thinking of new and innovative ways to do things, challenging existing players with new technologies and business models. As a result, competition today has two levels: existing incumbents challenging each other and new entrants entering the space to challenge incumbents. In the last few decades we’ve seen countless established companies fall by the wayside because they’ve been swept away by Schumpeterian new entrants — who themselves go on to become behemoth. The rise of Amazon and what has happened in the retail sector is a classic example of creative destruction.
You write that, sadly, efforts towards transformative innovation inside of large enterprises are often viewed as a waste of shareholder’s money. Do people really believe that?
Absolutely. You just have to look at analysts’ reports about R&D spending or listen to conversations at board meetings. Particularly when shareholder activists or hedge funds get on company boards, they often make a play to take control and cut R&D expenses. In some sense, this short-term focus on shareholder value creation just amplifies the forces of creative destruction: If you’re a large company and you believe that because your shareholders don’t want you to invest in innovation, you won’t. And, of course, if you don’t invest in innovation, it’s a self-fulfilling prophecy, because you will just be waiting around for someone to come along and push you aside.
In my work I do what I can to challenge this flawed thinking. While it is true that large companies can’t just spend their way to glory, if they are designed and led in the right way, they can be very effective innovators — just as effective as start-ups, I would argue.
In general, innovations that disrupt industries tend to originate from new entrants. Talk a bit about the exceptions to this ‘small=good at innovation, big=bad at innovation’ rule.
Many people still believe that big organizations lack the DNA for innovation. But unlike you or me, organizations can manipulate their DNA by doing three things: systematically creating an innovation strategy; designing an innovation system; and building an innovation culture. With these elements in place, an enterprise can achieve transformative innovation regardless of scale.
I want to point out that new entrants can come from within an industry or from outside of it, and they can be start-ups or existing companies — sometimes very large ones. Intel revolutionized the semiconductor industry by inventing and commercializing the microprocessor. It wasn’t a new entrant. And Amazon is now entering all sorts of service businesses: cloud computing, grocery delivery and entertainment, to name a few. They are by no means a new company, nor are they small; yet they’re entering all these new industries and in many cases, disrupting them. Another example of a big company playing the role of new entrant is Honda, which is getting into the jet market and trying to transform it.
It’s less prevalent, but there are also occasions where companies transform their own industry. IBM is a phenomenal example. In its heyday in the 1960s, it completely transformed the computer industry with the IBM 360, at a time when it was the dominant mainframe computer maker, with 90 per cent of the market.
Of course, history is still playing out, but I find what’s going on in the auto industry to be fascinating. Many people have written off most of the incumbents and believe Tesla is going to sweep them away; but I’m not so sure. I think the big auto companies are being very aggressive at investing in technologies for electrification. They’re studying the market really closely and being sensitive to where it is heading.
So we do see large companies who are able to transform their industries as opposed to just sitting there and letting disruption happen. Executives know by now that everything is changing, and as a result, no responsible leadership team or board of directors can ever be satisfied with the status quo.
How do you define creative construction?
We celebrate entrepreneurs for good reason. And yet, as tough as it is to build an innovative company from the ground up, creative construction is even tougher. To make an analogy, entrepreneurship is like building a new house from the ground up, but creative construction is akin to renovating your house while you’re living in it. It entails redesigning the enterprise in a fundamental way while still operating the core business.
It takes real creativity to build something new out of something old. Let’s face it, big companies got to be large because they were really, really good at something. Unless that business is rapidly disappearing, the company can still enjoy the fruits of its core business. Creative construction is about creating completely new growth opportunities for the future — while at the same time maintaining profitability and the routine innovation required to thrive in your existing businesses. This requires a delicate balance of exploiting existing resources and capabilities without becoming imprisoned by them. This, to me, is the fundamental challenge for leaders of large enterprises.
Some organizations set out to become great at innovating. What is wrong with that approach?
It’s not enough to say, ‘Let’s get really good at innovation’, because it begs the question, what type of innovation? Are you talking about building upon your current business model and technical capabilities, or venturing into new territory? Innovation means so many things that if you just say, ‘We are great at innovating’, it means nothing. I’ve seen so many companies launch innovation initiatives where they don’t have a strategic purpose or a clear idea of what it is they’re trying to excel at.
If you are trying to get good at something, it really helps to define what that something is — and the same is true of innovation. A good innovation strategy specifies how innovation will create value and how the company will capture that value. Innovation strategies don’t need to be complicated; in fact, the simpler, the better.
Southwest Airlines — arguably the most successful airline over the past four decades — has a very simple strategy: Offer convenient (non-stop and frequent) low-cost service between medium-sized cities not typically served by traditional airlines. This simple strategy framed many of the company’s subsequent
decisions: which routes to cover, what type of planes to use, how to organize staff, etc. Strategies do not require a 75-page PowerPoint presentation. They need to be clear enough to take certain options off the table and make others no-brainers.
To help companies form their innovation strategies, you have developed an Innovation Landscape Map. Please describe how it works.
The map draws together my work with that of several of my colleagues and predecessors. People like Kim Clark, William Abernathy, Rebecca Henderson, Mike Tushman and Clayton Christensen have also studied the key dimensions of innovation. I found that as a whole, our theories highlighted two critical dimensions of innovation that are relevant across a broad range of industries: The degree to which innovation involves a significant change to technology; and the degree to which innovation involves a significant change to a business model.
I used these two dimensions to map out a firm’s innovation opportunities. On the technology dimension, we can think about whether a particular innovation will either leverage a firm’s existing technological capabilities or require it to develop new ones. The same logic applies to the business model dimension. Does an innovation build upon our existing business model (say, selling products) or does it require us to master a new business model (say, selling services)? Although each dimension exists on a continuum, together they suggest four distinct categories of innovation.
Please summarize the resulting four categories of innovation.
The first is Routine Innovation, which leverages your existing technological abilities and fits with your existing business model. For example, Intel launching increasingly powerful microprocessors. This fits with their technical expertise and with the business model that has fuelled their growth for decades. Nextgeneration iphones from Apple are another example. ‘Routine’ doesn’t imply easy or trivial: In each of these cases the company has invested significant resources and is working on solving tough technical problems.
Next is Disruptive Innovation — a category named by my Harvard colleague Clay Christensen. This requires a new business model but not necessarily a tech breakthrough. For that reason, it also challenges the business models of other companies. For example, Google’s Android operating system for mobile devices is potentially disruptive for companies like Apple and
Microsoft, not because of any significant technical differences, but because of the business model: Android is given away for free, while the others are not.
The third type is Radical Innovation. This is the polar opposite of Disruptive Innovation in that the challenge here is purely technological. The emergence of genetic engineering and biotech as an approach to drug discovery is an example of this. Established pharma companies faced a major hurdle in building competencies in molecular biology. Yet drugs derived from biotech are a good fit with the companies’ business models, which already call for heavy investment in R&D, funded by a few highmargin products.
The fourth type is Architectural Innovation, which combines significant technological and business model changes. Digital photography is a great example. For companies like Kodak and Polaroid, entering the digital world meant mastering completely new competencies. It also meant finding a way to earn profits from cameras rather than from ‘disposables’ (film, paper, processing chemicals). Not surprisingly, Architectural Innovations are the most difficult for incumbents to pursue.
How does a company know which quadrant to focus on?
The quadrant you choose to focus on is really a function of the innovation strategy you have chosen to pursue. I mentioned earlier how important it is to have such a strategy in place. Take an existing car company like Ford. Say it created its own autonomous vehicle and decided to sell it just like it sells its regular cars, so that you could go to a car dealership and pick out an autonomous car that would drive you home. This would be quite radical in the sense that the technology is very different, but from a business model perspective, there would be no difference. They would still be selling cars that could be purchased or leased from a dealership.
But now, imagine if Ford chose to embrace the fact that autonomy itself opens up the possibility of ride sharing on a vast scale. So, instead of selling or leasing you a car, it would be selling you access to cars. It could decide to sell ‘car capacity per hour’ — similar to the way we buy electricity. It could build up a massive suite of autonomous vehicles that would be available in different areas of a city, and people could sign up to get access to them and pay by the hour. This would be Architectural Innovation, because it would be a fundamentally different business model for Ford. The quadrant you focus on depends upon your strategy, and where you are placing your bets.
Are there any rules for deciding how much to invest in each type of innovation?
There is no magic formula that all companies should adhere to. I’ve seen articles where people say, ‘The optimum balance is a 40/30/30 split’, but that’s incorrect. The right mix will always depend on two key factors that vary by industry, technology and company. First, it depends on technology cycles and where you are in terms of the maturity of the technology. If you are offering products or services based on a new technology that has just emerged, you probably have some time and a lot of headway to grow in creating performance improvement.
Second, it depends on competitive cycles. Where does your company stand with respect to competitive dynamics? Is the market saturated? Have customers become satiated with what the current technology can provide? Are they looking for alternatives?
I like to use the example of Google versus Goodyear. Google has a very rapidly growing core business, which is the advertising tied to its search engine. This business continues to grow — so it shouldn’t be surprising that Google puts a lot of its R&D resources into making their search even better over time. They know there is still a lot of growth potential there.
Goodyear, on the other hand, is in a business (tires) that is only growing at about two per cent per year. It would be very difficult to grow that business by a significant rate just by investing in research into tires — and therefore, they need to be looking at business model innovations that can really inject growth into the company.
If your core technology is still young and full of lots of opportunity, then by all means, continue to invest there. You may not have to look elsewhere for a while. But if you’re in a mature business where there is very little opportunity to create growth through innovation, you should be looking at investing in other technologies to generate growth, or at developing new business models. These are the sort of context-dependent factors you have to look at in order to come up with the right formula for your organization.
Disruptive Innovation seems to be the Holy Grail for many companies. But you caution that it works best in particular situations. Please describe them.
Clay Christensen has shown that industries are ripe for disruption under particular circumstances — the main one being when a customer is satisfied along one dimension of their preferences but at the same time, dissatisfied along another. For instance, say customers want to shift to convenience as opposed to product performance or they suddenly want something at lower cost.
My favourite recent example is what’s happening in shaving products. For years, incumbents like Gillette focused on adding more and more blades to give you a closer and closer shave. But let’s face it: there is only so close you can get! Customers started to become less willing to pay more for a closer shave, but were looking for convenience and lower cost — and that’s why online suppliers like Harry’s and Dollar Shave Club thrived. They saved you all the hassle of going to the store to buy a razor, and offered a product that they claimed was just as good as Gillette’s, at a lower cost.
Is incremental innovation still of any value?
Definitely. If you only think about headline-grabbing breakthroughs like autonomous vehicles or the iphone as innovation, you are missing about 99 per cent of the innovation landscape. Routine innovations are all around us. Consider something we see every day: Those bags of ready-to-eat salad that come washed and cut. These were first introduced in 1983 by a small California lettuce producer. While this did involve some process innovations (the multiple-washings process, mechanized cutting), the core components — lettuce and plastic bags — were hardly new. This innovation may not have generated the excitement of the iphone, but it was nonetheless economically important: Ready-to-eat produce now accounts for about half of the leafy vegetable market.
People sometimes dismiss improvements to packaging, manufacturing processes or product features as ‘merely incremental’, but that misses the point. The way to judge innovation is not by whether or not it grabs headlines, but by whether it generates value. The fact is, companies make most of their profits on routine innovation. Just look at Apple, which introduced the iphone in June of 2007 and has since launched numerous variations on it. All of that is routine innovation. Some people criticize Tim Cook, saying, ‘That would never have happened under Steve Jobs; he would have come up with other things’. But in reality, Apple had a huge platform to exploit, and they have spent 12 years doing just that — and making unbelievable amounts of money. Apple’s market capitalization today has increased by about 400 per cent since it launched the first iphone thanks to routine innovation.
Routine innovation makes the most sense when your business model is healthy and your technology platform is still rich with opportunities. The danger comes when a company pursues only routine innovation. We’ve seen that happen, and it can be devastating. Microsoft probably tried to milk the Windows and Office platform for too long and it was late to cloud. That of course changed under CEO Satya Nadella. In the end, it’s really about balance. All four types of innovation very likely have some place in your company’s overall innovation portfolio.