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In his book “Collective Disruption:   How Corporations & Startups Can Co-Create Transformative New Businesses,’ Michael Docherty lays out a vision of how established companies can create a strategy for innovation that includes partnering with startups, thereby enabling an “innovation ecosystem.”   This post is the first of ten reviewing the various chapters of his book in preparation for the Leadership Forum 2016 event put on by the Chicagoland chapter of the Project Management Institute on May 20th, 2016.

This post is on the first chapter, “The Era of Disruption,” which lays out the necessity for a more successful strategy for innovation.   The chapter opens the familiar tale of Kodak, which went in the 1970s from controlling a 90% market share of photographic film sales in the United States, to being in bankruptcy in 2012, because of people’s changing photography habits due to mobile phones.   Ironically, Kodak owned significant mobile camera technology but wasn’t able to capitalize on it.   It was a great example to open the chapter, because the Kodak experience is now being replicated by many big companies.

The next obvious question is:   why is this occurring more and more frequently?    Companies have the human capital, physical capital, and intellectual capital with which to innovate and create new products.   Why aren’t they succeeding?    In the past, incremental core business innovation was enough to drive business growth.   But with the advent of the digital revolution, the third industrial revolution (the first two occurred in the 18th century with the advent of steam power, and the end of the 19th century with the advent of electrical power).   The third industrial revolution not only swept in a tsunami of technology products, but more importantly it ushered in a new pace of innovation which is still increasing.

Now companies require core business innovation just to stay in the game, like the Red Queen in the book Alice in the Looking Glass by Lewis Carroll, who admonished Alice:  “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”   Michael uses the term “transformative innovation” to describe innovation opens up new sources of growth, as opposed to core business innovation which has an aim simply the maintenance of current sources of revenue.

Another reason why core innovative innovation is not enough is because consumers have more information at their fingertips because of the Internet, and this has a byproduct the raising of customer expectations.   Consumers are demanding not just a higher quality of the existing products in the marketplace, but are demanding new products and services, thereby shorting product cycles.   I walked into an AT&T store to get a 6S iPhone, and when I mentioned that I was upgrading from a 3S iPhone, the sales clerk looked at me incredulously as if I had stepped out of an episode of the Flintstones!

As external forces make the necessity of innovation ever starker, at the same time big companies had developed internal approaches that made them even less adept at coping with those forces.   Big companies are NOT built to support transformative innovation, but rather optimization of their core business.    They focus on becoming more and more efficient, i.e., doing things right, by creating standards, best practices, guidelines, rules and regulations.   This is a corporate culture with a mindset of risk avoidance.

Delving further into this subject of where innovation fits into the company’s product portfolio, Michael brings up the three-horizon framework  set forth in the book The Alchemy of Growth by Mehrdad Baghai, David White, and Stephen Coley.

1. Horizon 1–Defending and refreshing the core business, which just improves upon existing solutions within the company.
2. Horizon 2–Expanding the core and adding products which are adjacent, that is, which are new to the company but fit in the portfolio of existing solutions.
3. Horizon 3–Transformative growth, which creates options that are new to the market, let alone the company.

Horizon 3 or H3 work entails much more risk, which is why established companies focus on H1 and H2 work almost exclusively, largely for the reason stated above about the company culture being risk averse.    The best strategy, of course, would be a balanced portfolio of initiatives across all three horizons, with one favored strategy being 70% H1 (core), 20% (adjacent), 10% (transformative), which just happens to be the one used by Google.   It’s interesting, however, that in the long run, the distribution of returns is the reverse, where 70% of the total returns over time from innovations come from transformative innovation.

Understanding this three-horizon model is crucial to understanding the reason for Michael Docherty’s strategy for pairing existing companies with start-ups.   Start-ups LIVE in the space created by H3 initiatives, and this is what makes them ideal partners for corporations which live for the most part in the space of H1 and H2 initiatives.

Why not have existing companies move into the space of H3 initiatives rather than using start-ups to fill that niche?    The problem is that these spaces require structures and processes that are contradictory, which creates too much internal tension within the organization.   (Michael cites Google and 3M as exceptions, but they prove the rule, because they ARE exceptions.)

Why not have existing companies simply buy up start-ups once they have created products using transformational innovations?   Michael gives two reasons:

1. Acquiring start-ups in later stages rather than in beginning stages requires paying a premium due to the fact that they have already received significant venture capital.   If you partner with them earlier and supply them with venture capital, you will not have to pay such a premium.
2. Acquiring start-up in a traditional M&A fashion causes you to miss the opportunity to influence start-ups by aligning them towards your company’s strategic goals and growth aspirations.

So having laid out the necessity for transformative innovation, Michael states how his solution, where established companies leverage startups and entrepreneurs as extensions of their organizations, is one which shows real promise in generating new business opportunities.   But before going into this solution, Michael goes into how innovation is created and nurtured by entrepreneurs and start-ups.   That is the subject of the next chapter, and the next post.

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