Too Big to Innovate

How Scale & Efficiency Are Trumping Innovation at U.S. Companies

Innovation is a popular buzzword in the business world today. Every company strives to be innovative. Everyone wants to be the next Apple or Facebook. They want to revolutionize their products and services by creating the next iPad or Zappos-style service model. But they don’t. They can’t. Most companies pump out the same old gadgets and services, placing more of a focus on cost and efficiency than creativity. They are so tied to Wall Street’s demands to “grow or die” that they are rarely able to get a fresh idea into the starter phase.

Many companies today, says Professor Ed Hess, are anti-innovative without even realizing it. And without a renewed focus on innovation, he says, U.S. companies will continue to see a decline in international competitiveness.

“Today’s companies are structured based on scale, efficiency, and execution,” says Hess, coauthor along with Jeanne Liedtka of The Physics of Business Growth: Mindsets, System, and Processes (Stanford University Press, 2012, ISBN: 978-0-8047847-7-1, $12.99). “With such rigid structures in place, it can be difficult to move any growth initiative through an organization, let alone create groundbreaking innovation.

“Growth exploration and innovation are inherently messy and seemingly inefficient-the complete opposite of how big corporations want to run-and they don’t and won’t happen overnight. That is a very hard pill to swallow in today’s ‘do more with less’ environment.”

In their new book, Hess and Liedtka present more than 15 years’ worth of research on how successful new growth actually happens in organizations. The Physics of Business Growth helps readers understand how to create growth in today’s business environment, providing them a roadmap and a set of practical tools to navigate its challenges. The book helps readers create the right mindsets and an enabling internal system that aligns culture, structure, leadership behaviors, measurements, and rewards to drive the right growth behaviors. Just as importantly, they set forth proven growth opportunity identification, experimentation, and portfolio design processes.

It’s a quick and easy read by design, created for busy C-level executives to use as a how-to guide as they seek to infuse their organizations with an entrepreneurial spirit-“a small company soul in a large company body”-with a focus on organic growth.

Understanding just how companies came to take on an anti-innovative nature demands a close look, notes Hess. Most companies think their primary purpose is to produce linear, reliable, predictable, and standardized low-variance results. And the bigger the companies the more powerful are the forces of conformity and low variance. In these organizations, the culture, processes, measurements, and rewards are designed and aligned to produce what Hess and Liedtka call the “physics of stability.”

Why this focus? Hess says it begins and ends on Wall Street.

“Wall Street’s maniacal view is that companies should grow in an ever-increasing, linear manner evidenced by increasing quarterly earnings,” explains Hess. “Institutional shareholders, by and large, own the vast majority of public company stocks for 12 months or less. They’re more like stock ‘renters’ than owners.

“Add to this the short average tenure of public company CEOs who are paid significantly through short-term stock options and you end up with a capital markets system that inhibits growth and innovation. Why? Because growth exploration and innovation are not short-term phenomena-they take time; they are not predictable or linear; and they are high-variance.”

The “physics of growth” is inherently different from the “physics of stability.” Uncertainty and ambiguity dominate growth exploration and innovation. They require different mindsets, internal enablers, and processes than operational excellence.

Companies should start, Hess recommends, by changing the following entrenched ways of thinking:

Efficiency and scale rule the day. The organizational design and management theories that gave rise to the dominance of industrial scale and efficiency in production assembly lines still dominate management practices today. And generally, the bigger the company the more the focus is on efficiency, scale, and low-variance operational excellence.

“The culture, behaviors, processes, measurements, rewards, and tolerance for failure needed to drive operational excellence are fundamentally different from those needed to create innovation, which requires an emphasis on exploration and invention,” explains Hess.

All things must be certain. Most companies have difficulty accepting the most fundamental natural law of innovation: The only certainty is uncertainty. With innovation, the dominating forces are ambiguity and change; and the processes at work involve exploration, invention, and experimentation. The pursuit of growth and innovation is inherently messy and inefficient.

“Operational excellence strives for 99 percent defect-free performance,” says Hess. “Contrast this to growth experimentation that can result in failure rates of 90 percent. In operational excellence environments, managers are rewarded for stamping out variance. Yet, in growth environments, variance is the norm. In fact, innovation is a high-variance activity. The mindset, culture, and processes that drive successful execution in an existing business can, if unexamined, drive innovation into the ground, exhausting and discouraging the very people who are trying hardest to accomplish it and killing inventive ideas before they see the light of day. All because many big companies have devoted themselves wholeheartedly to the mantra that ‘variation is the mother of waste.’ Bottom line, to be innovative, you must be willing to accept failure.”

Innovation always has to be revolutionary to be effective. Most scientific discoveries are built upon extensive learning from prior experiments. The same is true in innovation. Innovation is an iterative experimentation learning process.

“In reality, most innovations are not industry-changing disruptions,” explains Hess. “Most innovation is close-to-the-core improvements or add-ons or extensions to adjacent markets. The kind of ideas we want to generate-the kind we’ll call creative-are all about creating new value for customers. We don’t care if it’s already been tried or looks like ‘old wine in new bottles’ or has been borrowed from another industry. Does it create value for your customers that no one else has yet offered them? If the answer is yes, congratulations! You’ve got a winner. Chances are, most of the components of the valuable ideas generated will have been floating around in some form or another-perhaps for decades. Good innovators learn how to combine existing things differently or transfer concepts from different industries or domains.”

Innovation and execution can’t exist together. Famed physicist Geoffrey West of the Santa Fe Institute hypothesized that corporations begin to die when they reach the level of 50 to 100 employees because they become dominated by bureaucracy that kills creativity and innovation. In effect, he is skeptical that big companies can prevent the “physics of stability” from killing innovation.

“Most management theorists have thrown up their hands and concluded that an organization either has to segregate its innovation activities from its execution activities,” says Hess. “Or in the alternative, change organizational design from execution dominance to innovation dominance when innovation is needed.

“The management challenge facing U.S. companies is to deal with these realities and better manage the inherent inconsistencies, conflicts, and tensions between operational excellence and innovation. Yes, the bigger you get the slower you get-the less agile you are and the more likely you have to buy your innovation. But there are many companies that fight this reality by first recognizing that the ‘physics of stability’ is different from the ‘physics of growth.'”

“Can an execution culture and an innovation culture exist simultaneously in a company?” asks Hess. “We think so. Learning is the bridge that connects operational excellence and innovation. A learning culture with different learning processes and tolerances for failure, for innovation, and for operational excellence is the answer.

“If you want more innovation and more growth experimentation as well as operational excellence, there are many ways to achieve it,” he adds. “Empower and create small innovation teams. Protect those teams from the dominance of the ‘no-variance’ operational excellence mindset. Create a safe zone where experimentation failures are learning opportunities.

“Do not punish failures; instead, celebrate the learning that comes from trying. And finally, understand that growth experimentation is a probability game, and the sooner you get customers actively engaged in your experimentation game, the more likely you will win.

“Operational excellence or innovation is a false choice,” concludes Hess. “Both are possible in big companies if leaders confront and mitigate the natural proclivities of big organizations to inhibit innovation and new growth.”

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