Innovation guide part 3: Choose where to innovate

In the third instalment of the innovation guide, Alex Freeman discusses innovation around product leadership, operating excellence, and customer intimacy

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You've set the platform for innovation inside your organisation. Now, you have to be clear about the following three things:

What innovation means for you and your company
Where you will innovate
What degree and velocity of innovation you intend to achieve.

You can waste days arguing about what innovation means and you won’t achieve any greater success. Keep it simple. Innovation means creating a viable new offering. In everything I do in business I start by asking 3 questions:

Does the customer want it?
Can we build it?
Will it make money?

Asking ‘does the customer want it?’ is about listening to customers, which corporates are not very good at. Too often executives make assumptions. That is a key reason innovation in large enterprises often fails. Avoid making assumptions.

The general principle here is test your assumptions early and often. The assumption by business people is that the customer wants the product and they will want it enough to pay for it. In the next article, I am going to explain how to test those assumptions.

In the startup community, experienced entrepreneurs always start with a problem that needs to be solved. Typically they start with a big, global problem that bothers people enough to pay for the solution. That’s an excellent place to start.

Innovation means creating a viable new offering. ‘Viable’ means if your innovation doesn’t go to market, if it doesn’t create value, if it doesn’t return your investment, it doesn’t count and will eventually kill your innovation program.

‘Offering’ is used here in place of ‘product’ on purpose. On its own, product innovation is the least likely type of innovation to create sustained competitive advantage.

Product innovation can create value but there are many places where you can innovate that are more likely to deliver sustained competitive advantage. Let’s examine that a bit further now.

Where will you innovate?

Knowing where to innovate is as important as knowing how to innovate. Innovation goes nowhere if it is not specific and systematic. Setting up a team and calling it ‘innovation’ or ‘R&D’ on its own will not lead to revolutionary innovation.

Business success comes from 3 value disciplines: product leadership, operating excellence and customer intimacy. To succeed in business you need to be competent in all disciplines and excel in at least one.

Knowing your primary value discipline allows you to decide what success looks like, develop strategies for getting there and set performance measures to ensure you are all pulling in the same direction.

Examples of businesses with different core value disciplines include:

Product leadership: Ferrari, Apple, and Nike.
Operating excellence: Fed Ex, Virgin Australia & Ikea.
Customer intimacy: Nordstrom, casinos (for high rollers) & top hair salons.

So it makes sense to use value disciplines as a starting point to consider where you will innovate.

Product leadership innovation on its own is the least likely type of innovation to create sustained competitive advantage. It is the easiest type of innovation for competitors to copy.

Go and stand in the cereal, detergent or dental aisle of your supermarket and you will see endless variations of flakes and puffs, liquids and powders, pastes and brushes often within the same brand.

There is very little differentiation. Now go and visit the manufacturer and look at its strategies. I guarantee they are all about new flavours, colours and tweaks.

Product innovation can work but typically the competitive advantage is incremental and temporary. This is why patent trolls are a thing.

Apple is one of the exemplars of product leadership but the truth is its sustainable competitive advantage is a combination of product (protected by patents and a proprietary operating platform) plus operating excellence in the form of supply chain cost advantages.

These gains result from having huge scale, plus customer intimacy via channel innovation to use online delivery instead of physical media and a lot of investment in brand.

The operating excellence and customer intimacy domains of innovation deliver more, longer-term and more sustainable competitive advantage.

Operating excellence innovation is inward-facing and can include:

Process innovation such as lean production, developing intellectual property, crowdsourcing and the use of predictive analytics
Structural change including decentralising management, knowledge management, IT integration and asset standardisation
Network innovation such as partnerships, mergers and acquisitions, supply chain integration and open innovation
Business model innovations like microtransactions, forced scarcity, bundling, desegregated pricing, risk sharing and the uber-popular (pun intended) subscription economy
Service innovations like personalised, concierge or platinum-grade service or user driven communities and support services
Channel innovations including pop-up stores, channel and distribution partnerships, flagship stores and multi-channel ad retargeting
Brand innovation such as co-branding, white-labelling, certification and recently transparency has emerged as a trend
Customer engagement innovation including granting autonomy, authority, status and recognition, supporting product mastery, allowing curation and content generation or adding whimsy or personality.

Customer intimacy innovation is outward facing and can include any of the following:

Service innovations like personalised, concierge or platinum-grade service or user driven communities and support services
Channel innovations including pop-up stores, channel & distribution partnerships, flagship stores and multi-channel ad retargeting
Brand innovation such as co-branding, white-labelling, certification and recently transparency has emerged as a trend
Customer engagement innovation including granting autonomy, authority, status and recognition, supporting product mastery, allowing curation and content generation or adding whimsy or personality.

Note: Within each of the 2 lists above, each item will typically deliver more sustainable competitive advantage that the item before it.

What degree of innovation do you intend?

Be very clear about the nature, degree and velocity of innovation you intend to create. Are you seeking to create radical or incremental change? The world of innovation is about taking a risk but you have to be explicit about your risk appetite and the risk/reward profile you intend to create as a business. This will act as a guide to staff.

I strongly advocate you tackle (at least some of) the hardest problems first. In the previous article I explained the scale of disruption that is occurring today.

That in 2015, the 66 most successful startup companies achieved in one year a valuation greater than Australia’s largest business, the 100-year old Commonwealth Bank. Efficiency is no longer enough.

You can either disrupt or be disrupted. Large enterprises have a hard-to-match competitive advantage that is far too rarely exploited. Large enterprises have huge resources that can be applied to solving wicked problems and doing radical innovation.

It amazes me how often I advise large enterprises and their entire strategy is about fixing legacy problems and picking the low hanging fruit. There’s a long list of segments that have followed that playbook: News media, taxis, bookstores, postal services, broadcast TV. At best they’re all playing catch up now.

We have to be realistic though. Big companies already have a customer base, there are already revenues and hopefully profits and you mustn’t ignore the opportunities to do what you have always done, do it better and do it more profitably.

The problem I see more often or not is that the executive team is only doing this continuous improvement type of innovation. In today’s business environment that will ultimately get you fired or crush your business.

Below are some guidelines for each of 3 key types of innovation. Each column describes how to behave depending of whether you intend to execute better, extend your business model or exploring new business models.

You should work towards achieving a balance in your innovation investments between executing your existing business model better, extending your current business model and exploring new business models.

Each requires different behaviours, risk appetite and time horizons.

	Execute better	Extended your business model	Explored
Work where the business model is...	Known	Partly known	Unknown
...and the business model is...	Mature	Rapidly growing	Emerging
...and your business capabilities are...	Existing	Partly existing	To be created
...so the innovation effort pursues...	Certainty	Probability	Possibility
...and asks what can be...	Known	Done	Imagined
...you will innovate on...	Processes	The existing business model	A new/disruptive business model
...to produce...	Continuous improvement	Pilots	Prototype / MVP
...using the management method of ...	Product Management	Lean innovation management	Lean innovation management
your investment risk will be...	Low	Moderate	High
… and this will normally be...	60-70% % of your whole innovation effort	20-30% % of your whole innovation effort	5-10% % of your whole innovation effort