Although few people have lost money betting on the neuroses of the American consumer, Umagic’s prospects are hard to gauge (in ten years’ time, consulting a computer about your sex life might seem natural, or it might seem absurd). But the company and others like it are beginning to spook large American firms, because they see such half-barmy “innovative” ideas as the key to their own future success.

Innovation has become the buzz-word of American management. Firms have found that most of the things that can be outsourced or re-engineered have been (worryingly, by their competitors as well). The stars of American business tend today to be innovators such as Dell, Amazon and Wal-Mart, which have produced ideas or products that have changed their industries.

A new book by two consultants from Arthur D. Little records that, over the past 15 years, the top 20% of firms in an annual innovation poll by Fortune magazine have achieved double the shareholder returns of their peers.* Much of today’s merger boom is driven by a desperate search for new ideas. So is the fortune now spent on licensing and buying others’ intellectual property. According to the Pasadena-based Patent & Licence Exchange, trading in intangible assets in the United States has risen from $15 billion in 1990 to $100 billion in 1998, with an increasing proportion of the rewards going to small firms and individuals. 

And therein lies the terror for big companies: that innovation seems to work best outside them. Several big established “ideas factories”, including 3M, Procter & Gamble and Rubbermaid, have had dry spells recently. Gillette spent ten years and $1 billion developing its new Mach 3 razor; it took a British supermarket only a year or so to produce a reasonable imitation.

“In the management of creativity, size is your enemy,” argues Peter Chernin, who runs the Fox TV and film empire for News Corporation. One person managing 20 movies is never going to be as involved as one doing five movies. He has thus tried to break down the studio into smaller units—even at the risk of incurring higher costs.

It is easier for ideas to thrive outside big firms these days. In the past, if a clever scientist had an idea he wanted to commercialise, he would take it first to a big company. Now, with plenty of cheap venture capital, he is more likely to set up on his own. Umagic has already raised $5m and is about to raise $25m more. Even in capital-intensive businesses such as pharmaceuticals, entrepreneurs can conduct early-stage research, selling out to the big firms when they reach expensive, risky clinical trials. Around a third of drug firms’ total revenue now comes from licensed-in technology. 

Some giants, including General Electric and Cisco, have been remarkably successful at snapping up and integrating scores of small companies. But many others worry about the prices they have to pay and the difficulty in hanging on to the talent that dreamt up the idea. Everybody would like to develop more ideas in-house. Procter & Gamble is now shifting its entire business focus from countries to products; one aim is to get innovations accepted across the company. Elsewhere, the search for innovation has led to a craze for “intrapreneurship”—devolving power and setting up internal ideas-factories and tracking stocks (so that talented staff will not leave). 

Some people think that such restructuring is not enough. In a new book† Clayton Christensen argues that many things which established firms do well, such as looking after their current customers, can hinder the sort of innovative behaviour needed to deal with disruptive technologies. Hence the fashion for cannibalisation—setting up businesses that will actually fight your existing ones. Bank One, for instance, has established Wingspan, an Internet bank that competes with its real branches (see article). Jack Welch’s Internet initiative at General Electric is called “Destroyyourbusiness.com”.

Nobody could doubt that innovation matters. But need large firms be quite so pessimistic? A recent survey of the top 50 innovations in America, by Industry Week, a journal, suggested that ideas are as likely to come from big firms as from small ones.Another sceptical note is sounded by Amar Bhidé, a colleague of Mr Christensen’s at the Harvard Business School and the author of another book on entrepreneurship‡. Rather than having to reinvent themselves, big companies, he believes, should concentrate on projects with high costs and low uncertainty, leaving those with low costs and high uncertainty to small entrepreneurs. As ideas mature and the risks and rewards become more quantifiable, big companies can adopt them.

Mr Bhidé points out that such firms as Intel and Merck have tended to concentrate their research on existing core businesses, rather than chasing every shadow on the horizon. And he also thinks that it is possible to catch up, even if there are costs to being late: witness Microsoft’s astonishing conversion to the Internet. Many of the world’s most successful service companies, including Goldman Sachs and his own former employer, McKinsey, are hardly innovators.

Indeed, the current panic in many large firms may be driven less by any real crisis of innovation than by the inflated valuations of small Internet firms. Those valuations siphon away talented staff from big companies; they also allow companies without profits to remain independent—rather than becoming the prey of a big real-world company. And, of course, there is the psychic drumbeat of jealousy. Amazon is taking business from real-world booksellers, but would a profitable established retailer such as Barnes & Noble really be going quite so bananas if it was worth more than a profitless virtual rival such as Amazon?

Adding to big companies’ feelings of inadequacy is the way the concept of innovation is being stretched beyond product pipelines and R&D budgets. Ronald Jonash of Arthur D. Little points to how Chrysler built partnerships with suppliers. Wayne Sanders, the boss of Kimberly-Clark, thinks that innovation must include how the firm deals with retail customers and how it integrates mergers. Even in Kimberly-Clark’s somewhat earthy industry, marketing ideas—for instance, selling toilet paper because it cleans well rather than because it is even softer—can be just as innovative as technological ones. No wonder firms feel that innovation is threatening them from every side. Second thoughts And yet, even though the insecurity about innovation is getting out of hand, the basic truths are hardly comforting. Unlike cutting jobs, or making an acquisition, innovation does not happen just because the chief executive wills it. Indeed, it is confoundedly difficult to come up with new ideas year in, year out—especially brilliant ones. Underneath all the gurus’ diagrams, lists and charts, most of the available answers seem to focus on two strengths that are difficult to create by diktat: a culture that looks for new ideas, and leaders who know which ones to back.At Kimberly-Clark, Mr Sanders had to discredit the view that jobs working on new products were for “those who couldn’t hack it in the real business.” He has tried to change the culture not just by preaching fuzzy concepts but also by introducing hard incentives, such as increasing the rewards for those who come up with successful new ideas and, particularly, not punishing those whose experiments fail. The genesis of one of the firm’s current hits, Depend, a more dignified incontinence garment, lay in a previous miss, Kotex Personals, a form of disposable underwear for menstruating women. 

Will all this creative destruction, cannibalisation and culture tweaking make big firms more creative? David Post, the founder of Umagic, is sceptical: “The only successful intrapreneurs are ones who leave and become entrepreneurs.” He also recalls with glee the looks of total incomprehension when he tried to hawk his “virtual experts” idea three years ago to the idea labs of firms such as IBM—though, as he cheerfully adds, “of course, they could have been right.” Innovation—unlike, apparently, sex, parenting and fitness—is one area where a computer cannot tell you what to do. 

*Ronald Jonash and Tom Sommerlatte, The Innovation Premium (Perseus Books, 1999, $25)

†Clayton Christensen, The Innovator’s Dilemma, When New Technologies Cause Great Firms To Fail (Harvard Business School Press, 1997, $27.50)

‡Amar Bhidé, The Origin and Evolution of New Businesses (Oxford University Press, 2000, $35)

LINKS

Take a virtual tour of Umagic here. Read a summary of Arthur D Little’s innovation study on their website. Click the title to buy the book now from Amazon.com “The Innovation Premium” (or British edition). The Patent & Licence Exchange can be found here. Click the title to order Clayton Christiansen’s book now from Amazon.com “The Innovator’s Dilemma” (or British edition). Click the title to buy Amar Bhide’s book now from Amazon.com “The Origins and Evolution of New Businesses” (or British edition).

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