Applied Innovation: A Handbook

By Stephen A. Di Biase, PhD

DEDICATION

To my beloved Denise (Tix) who is my supporter, confidant, best friend and the source of my

greatest happiness;

To my parents Helen and August Di Biase, who always had faith that I would be successful in life

when I was uncertain;

To my three children, Christopher, Stephanie and Nicholas for making us the proudest parents in

the world;

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ACKNOWLEDGEMENTS

“We who have been given much must give much back to those who follow.”

~ Author Unknown ~

There are many definitions of an entrepreneur. For me it’s a person who’s made something out of nothing in the face of huge obstacles. Those who immigrate to any foreign land, making a life for themselves, against all odds, are truly entrepreneurs. I say anyone willing to make the journey, and the sacrifices, are welcome to my home because they’re what we want future Americans to embody.

My grandfather emigrated from Italy to the United States in 1920, right after World War I, without resources, no language skills and with my grandmother in tow. They had seven children, all of whom became successful professionals. My grandpa was the “Chairman of the Board” for the “Family Enterprise” but my grandma was the “CEO” who focused on getting results that improved the life of the family. Together my grandparents, and my parents who followed, made it clear that being an entrepreneur is all about getting results.

Beyond family, I’ve had the privilege of spending my youth with some of the most innovative and entrepreneurial people imaginable. I learned much from watching them becoming successful business people with essentially no formal education. The thought of obtaining a business degree, let alone an MBA, wasn’t even a remote possibility. These entrepreneurs learned by watching, and by doing, what those who came before them did to be successful. It was an apprenticeship, learning from a Master.

My high school chemistry teacher owned a chain of successful dry cleaning facilities and taught me about the interface of technology and business. As a teen I worked for an Italian baker who invested 50 years of his life building an enterprise. He taught much by his example of loving his customers. Reaching the workforce after graduate school, and while the topics of innovation and entrepreneurship were still embryonic, my exposure to those who simply innovated out of need and passion was significant. It’s to these Masters I owe much. Once in the real world, I watched other Masters innovate and build businesses where judgment- based decision-making was excellent: There weren’t troves of data, and what was available was always too late to be useful. The lesson learned is that a little knowledge combined with purpose, imagination, curiosity, passion, determination and judgment will allow someone to be both an innovator and entrepreneur, creating wealth for many they touched. The lesson learned was simple: There is no recipe for innovation and entrepreneurship. It’s hard but pleasurable work, and very situational. I also learned that successful entrepreneurs and innovators are attentive and observant of opportunities, taking advantage of those opportunities to make their own luck.

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Finally, my blessing is having many generous and effective mentors helping me avoid many of the common, and sometimes fatal, errors that befall the inexperienced. These selfless professionals put up with my immaturity and ignorance because they saw more in me than I could see in myself. They deserve the greatest credit for anything I have accomplished. Without this select group of humanitarians I would have failed for sure.

For anyone who has benefited like me, it’s our responsibility to give back to those who follow, which is the main driver for writing this book: Sharing some of this learning in order to enlighten and catalyze the thinking of the next generation of successful innovators and entrepreneurs.

I’ve explicitly left all of my many mentors anonymous, because it would be unfair to single out the few among the many who were there for me. Being the kind of mentors I envy, they would prefer to be anonymous since what counts most is doing good for its own sake, without any expectation of return.

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CONTENTS

DEDICATION ........................................................................................................................................................................................................ II

ACKNOWLEDGEMENTS .............................................................................................................................................................................. III

CONTENTS ............................................................................................................................................................................................................ V

PREFACE ........................................................................................................................................................................................................... VIII INNOVATION, CAPITALISM AND PROSPERITY .........................................................................................................XIII

PART I: DOING THE RIGHT THINGS – IT’S ALL ABOUT STRATEGY .................................................................................. 1 CHAPTER 1: PART I INTRODUCTION – STRATEGIC ELEMENTS OF INNOVATION ......................................... 2

Historical Context for Innovation ...................................................................................................................................................... 3 CHAPTER 2: THE FOUNDATIONS OF INNOVATION .................................................................................................... 7

Nine Foundations of Successful Innovation .................................................................................................................................. 7 Four Pre-‐Innovation Questions ......................................................................................................................................................... 9 Innovation Pitfalls ................................................................................................................................................................................. 17 Chapter 2 Summary .............................................................................................................................................................................. 17

CHAPTER 3: MANAGING ONESELF – KNOWLEDGE WORKERS LEADING THEMSELVES ..........................19

Self-‐Management Questions for 21st Century Workers...................................................................................................... 19 Chapter 3 Summary .............................................................................................................................................................................. 35

CHAPTER 4: MAKING THE CORRECT CHOICES – WISDOM FROM MICHAEL PORTER ...............................36 Elements of Porter’s Five Forces Model ....................................................................................................................................... 36 Porter’s Industry Positioning Strategies ..................................................................................................................................... 41 Chapter 4 Summary .............................................................................................................................................................................. 47

CHAPTER 5: THE NEW VENTURE .....................................................................................................................................48 Four Requirements of Entrepreneurial Management ........................................................................................................... 48 Chapter 5 Summary .............................................................................................................................................................................. 59

PART I SUMMARY ....................................................................................................................................................................60 PART I STUDY QUESTIONS – STRATEGIC ELEMENTS OF INNOVATION ..........................................................62

PART II: HOW PEOPLE INNOVATE – A UNIQUELY HUMAN EVENT ............................................................................... 64 CHAPTER 6: PART II INTRODUCTION – TACTICAL ELEMENTS OF INNOVATION ........................................65

Chapter 6 Summary .............................................................................................................................................................................. 71 CHAPTER 7: THE SEVEN PRIMARY TACTICAL ELEMENTS OF INNOVATION ................................................73

The Adjacent Possible: First Order Combinations ................................................................................................................... 73 Liquid Networks: The Goldie Locks Approach .......................................................................................................................... 75 The Slow Hunch: Ideas take time to develop into innovations ......................................................................................... 76 Serendipity ................................................................................................................................................................................................ 77 Errors: A Special Gift to Ourselves ................................................................................................................................................. 78 Exaptation and Diversity: Legos in Action ................................................................................................................................. 79 Platforms: Building on the Past, Creating the Future ........................................................................................................... 80 Tricks of the Trade ................................................................................................................................................................................ 81 The Innovation Process ....................................................................................................................................................................... 83 Creativity Techniques .......................................................................................................................................................................... 84 Chapter 7 Summary .............................................................................................................................................................................. 85

PART II STUDY QUESTIONS – TACTICAL ELEMENTS OF INNOVATION ............................................................87

PART III: IT’S ALL ABOUT PEOPLE ..................................................................................................................................................... 88 CHAPTER 8: IT’S ALL ABOUT PEOPLE ............................................................................................................................89

Field of Vision .......................................................................................................................................................................................... 89

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The CEO Brand ........................................................................................................................................................................................ 90 Seven Key Organizational Elements for the CEO ..................................................................................................................... 92 Chapter 8 Summary ........................................................................................................................................................................... 102

CHAPTER 9: CULTURE – LEADERSHIP, INQUIRY AND CONFLICT .................................................................... 105 Leadership Essentials ........................................................................................................................................................................ 108 Eleven Leadership Derailers .......................................................................................................................................................... 111 Inquiry-‐Driven Leadership ............................................................................................................................................................ 112 Managing Conflict .............................................................................................................................................................................. 122 Chapter 10 Summary ........................................................................................................................................................................ 129

CHAPTER 10: LEADING INNOVATION – THE ODOR CONTROL CASE STUDY .............................................. 131 Chapter 10 Summary ........................................................................................................................................................................ 139

CHAPTER 11: ORGANIZATIONAL DESIGN – BRINGING IT ALL TOGETHER ................................................. 140 Drivers of Organizational Design ................................................................................................................................................ 141 The Star Model: A Proven System ................................................................................................................................................ 144 Dimensions of Structure .................................................................................................................................................................. 149 Chapter 11 Summary ........................................................................................................................................................................ 155

CHAPTER 12: ALIGNING EMPLOYEE DEVELOPMENT WITH BUSINESS STRATEGY ................................ 157 Chapter 12 Summary ........................................................................................................................................................................ 162

PART III STUDY QUESTIONS ............................................................................................................................................ 164

PART IV: PROCESSES – THE MEANS TO THE END.................................................................................................................. 167 CHAPTER 13: PART IV INTRODUCTION – THE IMPORTANCE OF PROCESSES ........................................... 168 CHAPTER 14: INNOVATION ROADMAPPING – WHERE TO GO .......................................................................... 170

Chapter 14 Summary ........................................................................................................................................................................ 173 CHAPTER 15: PORTFOLIO CREATION – WHY GO THERE .................................................................................... 174

Chapter 15 Summary ........................................................................................................................................................................ 181 CHAPTER 16: OPEN INNOVATION – LOOK OUTSIDE ............................................................................................ 182

Chapter 16 Summary ........................................................................................................................................................................ 186 CHAPTER 17: PORTFOLIO MANAGEMENT USING STAGE GATES – WHERE TO GO FIRST .................... 188

Chapter 17 Summary ........................................................................................................................................................................ 194 CHAPTER 18: PROJECT MANAGEMENT – GETTING THERE ............................................................................... 196

Chapter 18 Summary ........................................................................................................................................................................ 200 CHAPTER 19: PRODUCT LIFE CYCLE MANAGEMENT (PLM) – CLOSING THE LOOP ................................ 202 CHAPTER 20: BIG DATA – GETTING TO GREAT DECISIONS ............................................................................... 212 CHAPTER 21: SOCIAL MEDIA – NEW TOOLS FOR INNOVATORS ...................................................................... 227

Chapter 21 Summary .................................................................................................................................................... 249 PART IV STUDY QUESTIONS ............................................................................................................................................ 250

PART V: SUSTAINING THE BUSINESS BY SERVING CUSTOMERS .................................................................................. 252 CHAPTER 22: PART V INTRODUCTION – CUSTOMER INTIMACY: SUSTAINING THE BUSINESS ......... 253 CHAPTER 23: CUSTOMER DEVELOPMENT – THE MOST CRITICAL ACTIVITY OF ANY ENTERPRISE256

Chapter 23 Summary ........................................................................................................................................................................ 269 CHAPTER 24: THE BUSINESS MODEL – CREATING AN ENDURING COMPETITIVE ADVANTAGE ...... 270

Chapter 24 Summary ........................................................................................................................................................................ 291 CHAPTER 25: INVESTMENT – FINDING THE DOUGH AND ABUNDANCE MENTALITY .......................... 293 CHAPTER 26: PROTECTING THE BUSINESS – INTELLECTUAL PROPERTY STRATEGIES ...................... 316 CHAPTER 27: THE ADVISORY BOARD – SELECT WELL, MANAGE PROACTIVELY .................................... 333 CHAPTER 28: CORPORATE GOVERNANCE – STRATEGICALLY ADVISING THE FIRM .............................. 338 PART V STUDY QUESTIONS .............................................................................................................................................. 344

PART VI: CASE STUDIES ......................................................................................................................................................................... 347

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CHAPTER 29: CRISIS-‐DRIVEN INNOVATIONS – THE FRUITS OF WAR ...................................................................... 348 CHAPTER 30: HOW THE BEST DID IT .......................................................................................................................... 362

Josiah Wedgewood (1735 – 1790) .............................................................................................................................................. 362 Marshall Field (1834 – 1906) ....................................................................................................................................................... 363 Michael Dell (1965 -‐ ) ....................................................................................................................................................................... 364 Estee Launder (1906 – 2004)........................................................................................................................................................ 365 Natural Light Labeling ....................................................................................... Error! Bookmark not defined. Odor Mitigation Technology: Air Scrubber Case Study ..................................................................................................... 367 Emulsion Fuel Case Study – A Failed Business Development Project ......................................................................... 374 Innovations in the Pipeline ............................................................................................................................................................. 379

CHAPTER 31: PLACE-‐BASED INNOVATION – CHICAGO’S TOP 20 INNOVATIONS .................................... 383 1: The nuclear reaction (1942) .................................................................................................................................................... 383 2: The Skyscraper (1884) ................................................................................................................................................................ 383 3: The cell phone (1973) .................................................................................................................................................................. 384 4: Open-‐heart surgery (1893)...................................................................................................................................................... 385 5: Balloon frame construction (1833) ....................................................................................................................................... 386 6: Mass-‐producing the McCormick Reaper (1848) ............................................................................................................ 388 7: First gay rights group in the US (1924) .............................................................................................................................. 390 8: Reversing the Chicago River (1900)...................................................................................................................................... 391 9: Televised political debate (1960) ........................................................................................................................................... 392 10: FermiLinux (1998) ..................................................................................................................................................................... 392 11: The farm silo (1873) .................................................................................................................................................................. 393 12: The Ferris wheel (1893)........................................................................................................................................................... 393 13: Deep dish pizza (1943) ............................................................................................................................................................. 394 14: Consumer preference research (1928) .............................................................................................................................. 396 15: The mechanical dishwasher (1886) ................................................................................................................................... 397 16: Pullman sleeper car (1864) .................................................................................................................................................... 398 17: The softball game (1887) ........................................................................................................................................................ 399 18: The Zipper (1893) ....................................................................................................................................................................... 399 19: Mail-‐order retail (1872) ......................................................................................................................................................... 401 20: The vacuum cleaner (1868) ................................................................................................................................................... 402

INDEX ................................................................................................................................................................................................................. 404

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PREFACE

Companies depend on innovation for their long-term survival, yet the innovation process is plagued with uncertainty, risk, surprise and failure. In US-based companies, more than 90% of all innovation initiatives are either abandoned or fail, costing Fortune 1,000 firms alone nearly $80 billion per year.1 Fortunately, innovation doesn’t have to be a chance occurrence or a random event that is contingent on serendipity or luck.

There is a better way, but it requires managers to think differently about innovation. They must recognize that innovation is not an art form and not random event, but rather a critical business process; a process with specific steps that if managed and controlled would yield desired and predictable results.

If you made it this far you may be asking yourself, “Does the world need another book on innovation”? If you Google the term innovation you’ll obtain 120 million hits in seconds, suggesting there’s a lot of information available on the topic. Some of the greatest minds in the

field like Peter Drucker2, Clayton Christianson3, James Utterback4, Steven Johnson5 and many others, have written brilliantly and extensively describing innovations from many points of view. So why should anyone else bother adding another book to this already substantial library? The evidence suggests innovation has not been treated as a skill that anyone, from students to senior executives, across any field, can learn in order to become more innovative. I’m not advocating a universal recipe for becoming innovator. That would be a fool’s errand. I’m asserting that certain basic elements of innovation can be learned, taught and mastered, making innovation a discipline. The premise is that a person can become innovative in the same way they learn to ride a bicycle. The analogy is that innovation is natural to human beings, something they can learn at an early age and master to a significant degree and never forget how to do. In fact, learning how to become innovative should be as easy as learning how to ride a bicycle, and is a skill that can be developed at a very early age. So the question becomes, “How does one synthesize what has been published about innovation allowing an individual to acquire the required educated point of view useful in developing innovative behaviors?” Accepting the definition of innovation as being a human response to, and exploitation of, a change creating wealth in the present, then it seems reasonable that a process can be delineated enabling individuals to become more innovative by first recognizing change, defining its meaning to the individual’s circumstances, assessing what responses to make and why, combined with a starting point of how to exploit the change force, creating wealth in the present and then preserving the wealth created. A precondition for such a process to work is that innovation must have common features that are independent of the context in which the innovation will occur.

1 This information is based on the finding of Kuczmarski and Associates, a Chicago-based consultancy, and a footnote in Wellspring of Knowledge, Chapter 7. 2 Edersheim. Elizabeth Haas. The Definitive Drucker, McGraw-Hill, 2007 3 Christensen, Clayton. The innovator's dilemma: When new technologies cause great firms to fail, Harvard Business Review Press, 2013. 4 Utterback, James M. Mastering the Dynamics of Innovation, Harvard Business Press, 1996. 5 Johnson, Steven. Where Good Ideas Come From: The Natural History of Innovation, Riverhead, 2004.

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These common features suggest that innovation is fractal, looking the same whatever your vantage point.

The approach for developing this educated point of view is combining the thinking of thought leaders in the field of innovation, with the experiences of actual practitioners, into a holistic framework. This framework begins with a strategic view defining what change forces should be responded to, why they’re valuable to the endeavor, which specific choices will be made as to where to invest time and money, supported by specific plans, yielding measurable and desirable results. This text is divided into six parts beginning with strategy and tactics – what to do and how to do it, followed by very specific approaches to leadership, processes, managing relationships and data in the information age. People do not innovate alone, so how people interact with each other when swimming in an ocean of data is a critical component of being more innovative today. This is followed by a treatise for converting the innovation into something a customer will value and pay for creating wealth. This part deals with business models, financing, delivery, protection and propagating the success. Finally I’ll close with some case studies of successful innovations leading to well-known enterprises spanning the globe over the past 300 years in several unrelated industries. The critical objective of these case studies will be to identify the common themes that reoccur when innovation takes place.

The first part will consider the imperative of doing the right things, strategic elements of innovation requiring the enterprise to know what its objectives are, and what they are not and why, allowing resources to be deployed in an effective manner. The second part focuses on the tactical elements of innovation and considers the handful of basic approaches enabling people to interact with their environments in more innovative ways and is underpinned by how people make choices. The third part deals with conducting innovations in the correct way by defining the cultural norms facilitating innovation to adapting innovative behaviors to the information age. While many innovative techniques withstand the test of time, the tools used to execute these techniques evolve with the advent of new knowledge as represented by social media tools. Given the tools available to innovators, they are ever improving many age-old concepts such as the role of leadership, ability to inquire effectively and managing conflict, among others, are still critical success factors. Especially critical, given that only people can innovate and that data, information and knowledge are expanding at an unmanageable rate, is strategy for deploying “knowledge workers” in organizational designs that facilitate, rather than disable, innovative outcomes. The worker of the present and future, being far more knowledgeable than in the past, will need to be educated in dealing with ever increasing levels of complexity and ambiguity combined with time constraints.

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The fourth part deals with processes providing the framework within which work is actually done and measured, focusing on such processes as roadmapping, open innovation, stage-gates, and so on. The concept of Big Data is a euphemism for undecipherable data sets that must be used in decision-making, without relying on deep analysis. This requires a person to exercise excellent judgment in making effective decisions in a timely manner. This circumstance demands methodologies for effective decision making in the absence complete understanding.

The fifth part considers the conduct required when investing resources for serving customers with valuable offerings thereby creating the virtuous cycle of the enterprise making profits available for future investments responding to new change forces. The most important employee in this cycle is the Chief Executive Officer whose leadership skills will define the return on invested resources. Finally, this cycle is embodied in various forms of intellectual property which must be protected by patents, trade secrets, know-how, relationships and other forms of security. The sixth and final part will explore how crises drive innovation with unexpected consequences. Specifically, conflict, or threat thereof, is a powerful catalyst for innovation that often impacts society long after the military justification has passed. This is the paradox of innovation destroying wealth before creating it. These generic examples will be followed by specific case studies of well-known innovations occurring between 1700 and 2010 where critical common features can be identified in the circumstances, and innovators themselves, proving instructive to present and future innovators. Given the breadth of the topic I’ve carefully narrowed this treatise focusing on what anyone can do immediately to become more innovative and delivering their innovations to customers. The action of the innovator, serving a customer, is what makes them an entrepreneur driving wealth creation. The innovator does this by interacting with other people in the correct way and context, combined with enough business acumen, to generate value. In the end innovation and entrepreneurship is all about people. So what do people need to do to become more innovative and using their innovative ability in making the world a better place? What follows is my attempt to answer this question in a way that the average person can learn. Most people learn from their own experiences, an expected outcome, but then there is a smaller population who can learn from the experiences of others, by witnessing or by reading about, events. These people are wise and the audience I’m reaching out to. My contribution is to synthesize an educated point of view, from the great minds in the field, such that anyone can become more innovative by just reading the work and pondering how it impacts the way they respond to change. During my 40-year career in industry and academics I’ve often learned the “hard way” by trial and error or the “Edisonan Method” which, while effective at times, is very inefficient and physically hazardous for some professions. However, I learned those lessons well and now endeavor to share my learning with those who are “wiser” than me and can learn by reading and visualizing these experiences.

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Often, innovation is thought of as the domain of scientist, engineers and the like, but nothing could be further from the truth. Innovation is “hard-wired” into everyone’s DNA and is how we all adapt to change. Therefore everyone can be an innovator in the correct circumstances.

My target audiences are those passionate and ambitious individuals who want to make the world a better place through their pursuit of innovative activities independent of their background or education. Innovation is the providence of anyone, regardless of their journey in life, educational level, or socio-economic position. Being innovative is a uniquely human phenomenon and one that is concurrently challenging and pleasurable

If this hypothesis is correct, that everyone can innovate, why is it so uncommon? As a starting point, a simple and actionable framework doesn’t readily exist that communicates how innovation comes from a person’s imagination, curiosity and inquiry. My intent is for the thoughts I share on the following pages to provide a starting point anyone can build upon. Disciplines are skills that, once taught, learned, and mastered, enter our toolkit as strengths that can be further developed and exploited. The discipline of innovation requires identifying a set of skills that can be mastered, like riding a bicycle, and once learned never forgotten. Becoming a disciplined innovator involves one caveat: This treatise merely provides a roadmap someone can use to embark on the journey leading to becoming an innovator. It is not a destination in and of itself. If being innovative is part of our basic genetic makeup, then what diminishes the innovative capacity of so many people and how can this be reacquired? Humans are their most curious at the age of five. Why age five? Why not ages three or seven? Age five is the age a person is smart enough to ask a genuine question but not smart enough, or educated enough, to have an answer. What happens after age five is the person goes to school and it taught to give answers rather than ask questions, and curiosity is extracted from the student for the next twenty years by the process known as their formal education. Given that curiosity is the root of innovation, does our educational system deprive students of their most valuable trait, which is the willingness to ask a genuine questions driven by their innate curiosity? I’m afraid so. Innovation is like the weather: Widely discussed, poorly understood and always of interest. CEOs want innovation to be predictable, systematic and even prescriptive so they can factor it into their firm’s ability to create shareholder wealth. People agree innovation is critical for improving quality of life, yet finding an actionable definition is difficult. Innovation is clearly situational, but there are common attributes that can be defined, and when combined with our own experiences, offer a useful template by which anyone can become more innovative. So what are these secrets? Assuming that the basic principles of innovation are fractal, meaning no matter how one looks at innovation it appears the same regardless of the context, then anyone can apply these principles, independent of their situation, becoming more innovative. Further, these basic principles allow the innovator to learn, teach, and master it as a discipline. These principles become highly enriched when they’re considered in varying contexts.

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Innovation has been studied by many great minds over the years, leading to almost innumerable texts on the topic, ranging from the theoretical to the very applied. Despite this vast domain of knowledge, transferring innovative behaviors from one organization to another, or one person to another, is confounded. What works for General Electric or IBM doesn’t work outside of their environments. If you ask someone for their definition of innovation, you’ll get many descriptions, most of which are not actionable. Webster says that innovation is a new idea, device, or method. Alternatively, it can be the active process of introducing new ideas, devices, or methods. Wikipedia says that innovation is the application of better solutions that meet new requirements, unarticulated needs or existing market needs. These definitions, and many others, are clearly not actionable.

Peter Drucker, arguably one of the greatest minds in business management in the 20th century,

said, “Innovation is the specific instrument of entrepreneurship: The act that endows resources

with a new capacity to create wealth.”

Building on Drucker’s insight, my own actionable definition of innovation is the following:

Innovation is the human response to, and exploitation of, a change creating wealth in the

present.

This definition focuses on actions:

Who: Only people are capable of being innovative. What: Those individuals will exploit the change, Why: To create wealth, When: In the present.

Leaving only the context in which innovation will occur: “The How.” Combining this view of innovation with a complementary definition of leadership, one begins to

frame conditions where an average person can develop their skills to be a leader of innovation.

Again, there are many definitions of leadership but the one that I believe fits the context of

innovation is the following: A leader is an individual who has a continuous stream of insights that

are so compelling that followers will subordinate their self-interest for the leader’s objectives.

Critically, these insights must be differentiated, recognizing relationships between observations that are not intuitively obvious to others. These insights, combined with the ability to connect unrelated dots, are what make leaders innovative. Leaders use their insights to frame change as an opportunity that empowers their followers and themselves to create significant value. Leaders accomplish this by cultivating curiosity in their followers, encouraging them to experiment, learn and exploit the change. Exceptional leaders use this process to garner even more powerful insights to perpetuate innovation as a “living laboratory” where their team learns to innovate by being innovative.

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As such, making innovation a discipline is an apprenticeship process where innovative people teach others to innovate in a specific context. My intention is to catalyze people’s desires to become more innovative, thereby sponsoring their own continuing development. Once a person becomes an innovator, where these skills are second nature, they are empowered to change the world around them and beyond.

Innovation, Capitalism and Prosperity

Capitalism has yielded massive increases in human prosperity, particularly in the West in the 19th and 20th centuries. More recently, it has lifted hundreds of millions from poverty in emerging economies. Yet despite these historic accomplishments, it’s also easy to worry that something is wrong with how the system is performing today. A more educated point of view may emerge by examining the intersection of innovation, capitalism and prosperity in the context of the definition of innovation being a human response to change creating wealth in the present. It’s arguable that the massive positive changes human kind have experienced in the past 300 years are the direct result of innovation, and not efficient use of resources, although the latter is a consequence of innovation. It is correct to believe that capitalism has been the major source of historical growth and prosperity, but identifying how and why it worked so well is less certain. Conventional economic theories we have relied upon for the past century have misled us about the workings of capitalism. For the past century, the dominant economic paradigm—neoclassical economics—has painted a narrow and mechanistic view of how capitalism works, focusing on the role of markets and prices in the efficient allocation of society’s resources. Only by replacing our old theories with better and more modern ones will we build the deeper understanding necessary to improve our capitalist system.

The Present

The story is familiar: Rational, self-interested firms maximize profits; rational, self- interested consumers maximize their utility; the decisions of these actors drive supply to equal demand; prices are set; the market clears; and resources are allocated in a socially optimal way. Andy Haldane, the chief economist of the Bank of England, notes that the conventional theory views the economy as a rocking horse that, when perturbed by an outside force, sways for a while before predictably settling back down to a static equilibrium. But, as Haldane has pointed out, what we saw during the crisis was more like a herd of wild horses—something spooks one of them, it kicks another horse, and pretty soon the whole herd is running wildly in a pattern of complex, dynamic behavior. Empirical economists have identified anomalies suggesting that financial markets aren’t always efficient. And the macroeconomic models

built on neoclassical ideas performed very poorly during the financial crisis. 6

6 See Eric D. Beinhocker, The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics, Boston,

MA: Harvard Business School Press, 2006; andNick Hanauer and Eric Liu, The Gardens of Democracy: A New American Story

of Citizenship, the Economy, and the Role of Government, Seattle, WA: Sasquatch Books, 2011.

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Since the crisis, a new view is emerging that holds the economy aligns with “Chaos Theory” by constantly evolving, interacting network of highly diverse households, firms, banks, regulators, and other agents, more like Haldane’s wild herd than a rocking horse.

The economy—a complex, dynamic, open, and nonlinear system—has more in common with an ecosystem than with the mechanistic systems the neoclassicists modeled their theory on. The implications of this emerging view are only just beginning to be explored, but will have a fundamental impact on how people think about the nature of capitalism and prosperity. Significantly, this view shifts our perspective on how and why markets work from their allocative efficiency to their effectiveness in promoting creativity. It suggests that markets are evolutionary systems that each day carry out millions of simultaneous experiments on ways to make our lives better. In other words, the essential role of capitalism is not allocation—it is creation. Life isn’t drastically better for billions of people today than it was in 1800 because we are allocating the resources of the 19th-century economy more efficiently. Rather, it is better because we have life-saving antibiotics, indoor plumbing, motorized transport, access to vast amounts of information, and an enormous number of technical and social innovations that have become available to much (if not yet all) of the world’s population. The genius of capitalism is that it both creates incentives for solving human problems and makes those solutions widely available. And it is solutions to human problems that define prosperity, not money. What is Prosperity?

Most of us intuitively believe that the more money people have, the more prosperous a society must be. America’s average household disposable income in 2013 was $38,001, versus $28,194 for Canada. Therefore, people believe America is more prosperous than

Canada7

. However, taking the average American income and attempting to re-create your quality of life among an indigenous people it would fail for obvious reasons. Prosperity in America, and everywhere else, is based on the accumulation of innovations building upon each other to yield a fabric of life we often take for granted. This can’t be defined merely in terms of money and is why prosperity in human societies can’t be properly understood by looking just at monetary measures, such as income or wealth. Therefore, prosperity in a society is the accumulation of solutions to human problems. These solutions run from the prosaic (crunchier potato chips) to the profound (cures for deadly diseases). Ultimately, measuring the wealth of a society is the range of human problems it has solved and the availability of those solutions to its people. Every item in a modern retail store can be thought of as a solution to a different kind of problem—how to eat, dress, entertain, make homes more comfortable, and so on. The more and better the solutions available to us, the more prosperity we have.

What is Meaningful Growth?

7 OECD Better Life Initiative, OECD Better Life Index: Country Reports, 2013, oecd.org.

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The problem with using GDP to measure growth is that it doesn’t necessarily reflect how growth changes the real, lived experience of most people. In the United States, for example, GDP has more than tripled over the last three decades. Although those increases have been concentrated at the top of the income spectrum, people across the board have benefited from improvements in technology, such as safer cars, new medical treatments, smartphones and so on. Other changes, though, have been accompanied by unintended consequences, such as the stress many knowledge workers feel from 24/7 connectivity. Is life actually better or worse for most people? How are the gains of growth shared? GDP cannot answer these questions.

If the concept of growth is to have significance, it should represent improvements in lived experience. If the real measure of a society’s prosperity is the availability of solutions to human problems, growth cannot simply be measured by changes in GDP. Rather, it must be a measure of the rate at which new solutions to human problems become available. Some examples of growth not measured by GDP are the following:

Going from fearing death by sinus infection one day to having access to life-saving antibiotics.

Going from sweltering in the heat one day to living with air conditioning the next is growth.

Going from walking long distances to driving is growth.

Going from needing to look up basic information in a library to having all the world’s information instantly available on your phone is growth.

Growth is best thought of as an increase in the quality and availability of solutions to human problems. Problems differ in importance, and a new view of growth must take this into account. Finding a cure for cancer would trump many other product innovations, but in general, economic growth is the actual experience of having our lives improved.

This is different from other alternative measures of growth. For example, research shows that happiness does not necessarily correlate with GDP growth—Bhutan has even famously developed a Gross National Happiness (GNH) Index. Likewise, the United Nations created a Human Development Index (HDI) based on Amartya Sen’s theory of human capabilities and freedom. Growth sits somewhere between GDP and these measures. Like GDP, it is intended to be a definition of material prosperity. But it is also a more meaningful way of thinking about material standards of living than GDP. While the rate at which solutions appear, and their availability, is not measured, it should be possible. Inflation is measured by looking at changes in the prices of goods and services in a basket typically consumed by households. Similarly, it’s possible to look at how the actual contents of such a basket are changing across time or how they differ across countries or levels of income. What kind of food, housing, clothing, transport, healthcare, education, leisure, and entertainment do people have access to?

What is Capitalism?

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If prosperity is created by solving human problems, a key question for society is what kind of

economic system will solve the most problems for the most people most quickly or, put another

way, be the most innovative. This is the genius of capitalism: It is an unmatched evolutionary

system for being innovative.

Finding new solutions to human problems is rarely easy or obvious. If it was, they would have already been found. For example, what is the optimal way to solve the problem of human- powered transportation? There are a multitude of options such as bicycles, tricycles, unicycles, scooters, and so on. Human creativity develops a variety of ways to solve such problems, but some inevitably work better than others, and we need a process for sorting the wheat from the chaff. We also need a process for making good solutions widely available. Capitalism is the mechanism by which these processes occur. It provides incentives for millions of problem-solving experiments to occur every day, provides competition to select the best solutions, and provides incentives and mechanisms for scaling up and making the best solutions available. Meanwhile, it scales down or eliminates less successful ones. The great economist Joseph Schumpeter called this evolutionary process “creative destruction.” The orthodox economic view holds that capitalism works because it is efficient. But in reality, capitalism’s great strength is its problem-solving creativity and effectiveness. It is this creative effectiveness that by necessity makes it hugely inefficient and, like all evolutionary processes, inherently wasteful. Innovation, by being a human endeavor, is messy. Proof of this can be found in the large numbers of product lines, investments, and business ventures that fail every year. Successful capitalism requires what venture capitalist William Janeway calls

“Schumpeterian waste.”8

The Role of Business

Every business is based on an idea about how to solve a problem. The process of converting

great ideas into products and services that effectively fulfill fast-changing human needs is

what defines most businesses. Thus, the crucial contribution business makes to society is

transforming ideas into products and services that solve problems.

This sounds simple and obvious, and many executives would say, “Of course that is what we do.” But again, that is not what standard theory says businesses should do. In the 1970s and 1980s, academic work based on neoclassical theory argued that maximizing shareholder value should be the sole objective of business. If corporations just did this, said these professors, they would maximize overall economic efficiency and social welfare. This focus did correct some deficiencies in the previous system, most notably by empowering shareholders to push back against CEOs who maximized the size of their empires rather than economic returns.

8 William H. Janeway, Doing Capitalism in the Innovation Economy: Markets, Speculation and the State, Cambridge, UK: Cambridge University

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But some argue that elevating the creation of shareholder value to the status of primary objective is based on a faulty assumption—that capital is the scarcest resource in an economy, when in reality it’s knowledge that’s the scarce, critical ingredient in solving

problems.9 It has also led to a myopic focus on quarterly earnings and short-term share price

swings, to say nothing of a decline in long-term investment.10 This is in startling contrast to the attitudes of even the recent past.

If you asked a CEO in the 1950s, an era of tremendous prosperity growth, what his job was, his first reply would probably have been “to make great products and services for customers.” After that, the CEO might have said something about looking after his company’s employees, making profits to invest in future growth, and then, finally, giving the shareholders a decent, competitive return. A reorientation toward seeing businesses as society’s problem solvers rather than simply as vehicles for creating shareholder returns would provide a better description of what businesses actually do. It could help executives better balance the interests of the multiple stakeholders they need to manage. It could also help shift incentives back toward long-term investment since few complex human problems can be solved in one quarter. This is not to say that shareholders or other owners are unimportant. But providing them with a return that is competitive compared with the alternatives is a boundary condition for a successful business; it is not the purpose of a business. Having enough food is a boundary condition for life—but the purpose of life is more than just eating. Some companies already think in these terms. Google, for example, defines its mission “to organize the world’s information and make it universally accessible and useful,” a statement about solving a problem for people. And it famously refuses to provide quarterly financial forecasts.

What is the role of Government?

Traditional economic theory holds that markets are efficient, inherently maximize welfare, and work best when managed least. But such perfect markets don’t seem to exist in the real world.

Furthermore, this view fails to recognize that the great genius of capitalism—solving people’s problems—has, by necessity, a dark side. The solution to one person’s problem can create problems for someone else. This is the age-old puzzle of political economy. How does an economic system resolve conflicts and distribute benefits? A fancy derivative product may help corporate treasurers solve their problem of managing corporate risk, and it might make bankers rich, but it might also create.

9 Clayton M. Christensen and Derek van Bever recently called the assumption of capital scarcity into question in “The capitalist’s dilemma,” Harvard Business Review, June 2014, hbr.org. 10 See Dominic Barton and Mark Wiseman, “Focusing capital on the long term,” Harvard Business Review, January– February 2014, hbr.org, for more on the unintended consequences of maximizing shareholder value.

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greater systemic risk for the financial system as a whole. It can be challenging to distinguish

between problem-solving and problem-creating economic activity. And who has the moral

right to decide? Democracy is the best mechanism humans have come up with for navigating

the trade-offs and weaknesses inherent in capitalism. Democracies allow its inevitable

conflicts to be resolved in a way that maximizes fairness and legitimacy and that broadly

reflects society’s views. Seeing prosperity as solutions helps explain why democracy is so

highly correlated with prosperity. Democracies actually help by doing the following:

Creating prosperity because they do several things better than other systems of government

Building economies that are more inclusive, enabling more citizens to be both creators of solutions and customers for other people’s solutions.

Offering the best way to resolve conflicts over whether economic activity is generating solutions or problems.

Many (though not all) government regulations are created to do just that—to encourage economic activity that solves problems and to discourage economic activity that creates them—thus fostering trust and cooperation in society. Business people often complain about regulation, and indeed many regulations are poorly designed or unnecessary, but the reality is that solving capitalism’s problems, innovation , requires the trust and cooperation that good regulation fosters. It is notable that the most prosperous economies in the world all mix regulation with free markets, while unregulated and anarchic economies are universally poor.

Defining Yourself by What Problems You Solve

Once we understand that the solutions, or innovations, capitalism produces are what creates real prosperity in people’s lives, and that the rate at which we create solutions is true economic growth, then it becomes obvious that entrepreneurs and business leaders bear a major part of both the credit and the responsibility for creating societal prosperity. But standard measures of business’s contribution—profits, growth rates, and shareholder value—are poor proxies. Businesses contribute to society by creating and making available products and services that improve people’s lives in tangible ways while simultaneously providing employment that enables people to afford the products and services of other businesses. It sounds basic, and it is, but today’s economic theories and metrics don’t frame things this way. The purpose of today’s innovators must be to provide solutions to human problems advancing mankind. One objective of this book is to encourage everyone who reads it to define themselves by “What problems do you solve?” instead of how much money do I make or what status do I have. This is a meaningful way of using innovation to make the world a better place for having lived in it.

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Table of Contents

Chapter 1 – Doing the Right Things – “It’s All about Strategy”

Context for Innovation Historical framework

Strategic Elements of Innovation What must innovation be

Michael Porter Approach to strategy

The New Venture The beginning

Managing Oneself Knowledge workers

Learning Methods Knowing yourself

Abstract Chapter 1: “Doing the Right Things” considers knowing what the objectives are, and

what they are not, and why, allowing the deployment of resources in an effective manner given

the context in which innovation must occur. Combining this view with a framework for an

employee managing themselves and Porter’s Five Choices model, helps the innovator focus on

the handful of approaches people should take when interacting with their environments which is

the underpinning of how people make choices leading to innovative outcomes. Also embedded in

the treatise will be a description of what roles individuals play in making a New Venture

successful.

Chapter 2 – “Only People Can Innovate”

Innovator Agency Understanding the context

Learning Methods What to leverage

Tactical Elements of Innovation Hiding in plain sight

Adjacent Possible First order combinations

Liquid Networks The “Goldie Locks” approach

The Slow Hunch It takes time

Serendipity Divine intervention

Errors A special gift to ourselves

Exaptation and Diversity Legos in action

Platforms Building on the past, creating the future Becoming Wise “Tricks of the Trade”

Abstract Chapter 2: “Only People Can Innovate”, termed the “Innovator’s Agency”,

addresses the context under which innovation occurs followed by a detailed assessment of six

methods proven to drive greater innovative outcomes. Critical to becoming innovative is how a

person learns and processes data into actionable knowledge. Given most innovations are derived

from existing items, which are modified for a new purpose; some “Trick of the Trade” will be

considered providing ideas of where to begin.

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Table of Contents

Chapter 3 – “Doing Things the Right Way”

Role of the 21st Century CEO The firm’s critical leader

The Culture

Effective Leadership Key characteristics

Leadership Essentials It’s all about you

Inquiry Driven Leadership Tis better to question than answer

Managing Conflict A fact of life Leadership in Action Odor control case study

Organizational Design Bringing it all together

Abstract Chapter 3: “Doing Things the Right Way” considers how cultural norms of

behavior, especially during rapid change, impacts innovation. While many innovative techniques

withstand the test of time new tools and techniques are constantly emerging the role of

leadership, inquiry, managing conflict and change effectively remain standards of any innovative

methodology. Data availability and new tools like Social Media are impacting the role of the

individual and how people do work leading to organizational designs, becoming sources of

sustainable competitive advantage. Easy inquiry and access to large amounts of data do not

necessarily yield actionable knowledge and more innovation.

Chapter 4 – “Processes: The Means to the End”

Innovation Roadmapping Where to go

Portfolio Creation and Management Why go there

Open Innovation and Stage Gates Looking outside

Project Management Getting there

Product Life Cycle Management Closing the loop

“Big Data” Getting to great decisions

Social Media Techniques Driving high energy idea collisions

Abstract Chapter 4: “Processes: The Means to the End”, addresses processes necessary for

sustainable innovation especially the unmanageable amounts of data being generate every day.

Given that only people can innovate and that data, information and knowledge are expanding

dramatically, a strategy for deploying “knowledge workers” in organizational designs becomes

critical. Supporting these designs are decision making tools such as Road Maps, Portfolio

Creation, Stage Gates, Project and Product Life Cycle Management, and managing “Big Data”

all in the light of newly emerging Social Media techniques.

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Table of Contents

Chapter 5 – “Sustaining the Business by Serving Customers”

The Business Model Creating an enduring competitive advantage

Value Proposition

Go to Market Model

Exit Strategies

The Lead User They’ll know it when you show it to them

Investment An abundance mentality for making “The Pie”

bigger

Protection You’re only as strong as your Intellectual Property

The Advisory Board Select well, manage proactively

Corporate Governance Strategically advising the firm

Abstract Chapter 5: “Sustaining the Business by Serving Customers”, deploys the concepts

in the first four chapters, while framing the role of the 21st century CEO. The CEO’s leadership,

defined by their field of vision, are essential to any enterprise thriving. From the CEO’s vision

will emerge how the enterprise creates its business model, acquires financial support, and

protects their innovations once deployed while closing with the elements of effective corporate

governance creating a virtuous cycle of innovation. Core to chapter 5 will be a case study of

“Customer Driven Innovation”.

Chapter 6 – “Case Studies: How Some of the Best Did It”

The Fruits of War Innovations from crisis

Chicago’s Innovations The top 20 innovations

Josiah Wedgewood Fine chinaware

Marshall Field Retail

Michael Dell Personal computers

Estee Launder Cosmetics

Laser Applications Technologies Food labeling

Air Scrubber Odor mitigation

Emulsion Fuel Low emission diesel fuel

The Pipeline Innovations yet to come

Abstract Chapter 6: “How the Best Did It”, assesses case studies like Joshua Wedgewood’s

building the first high quality chinaware business in the 1700’s to Michael Dell, of the Dell

Computer, in the 1980’s. Interestingly the context encountered by both innovators was the same.

Examples, including Chicago’s Top 20 innovations, are reviewed comparing successes to

failures where the context was correct but something was amiss. Given many innovations, result

from crisis we’ll explore how war drives innovation with unexpected consequences. A paradox

of innovation from war is destroying wealth before creating it.