Reputations Go Online

These days, computer technology and inexpensive connectivity allow a merchant’s reputation, for better or worse, to be shared much more rapidly and widely, in much richer detail than ever before. Any number of detailed, up-to-date evaluations of a seller’s reputation can usually be found posted on various online review sites. People today can easily get the skinny on merchants they’ve never dealt with before, without even personally knowing anyone who has ever dealt with them. Amazon .com’s book reviews and eBay’s ratings of individual sellers are both good examples of business practices that empower consumers themselves to maintain the quality of the business offerings—in effect “co-creating” the product information necessary to inform other consumers prior to making purchase decisions. There are dozens of well-known Web sites where the reputations of different kinds of businesses and products can be updated or modified as consumers experience them, and then freely viewed by other consumers. Hotel reputations for service, convenience, and pricing can be probed on TripAdvisor.com, for example, and home-improvement or repair contractor reputations for competence and reliability can be found on Angie’s List. At most of these kinds of sites, other customers have posted their reviews of various products, and the more capable review sites allow a consumer to search not just by product category but by reviewer type—that is, to find reviews that are done by people whose past reviews have been rated the most helpful by other consumers, or even by reviewers who have similar tastes as the consumer. “Rating the raters” is an increasingly important mechanism for ensuring a robust and generally accurate review site, and over time we should expect review sites to become even more sophisticated and accurate in their assessments of businesses.

Largely because of cost-efficient interactive technologies, untrustworthiness is now something few businesses can keep secret. Any company that is unscrupulously exploitative of its customers will be quickly and efficiently outed, and its business will suffer. So it’s more and more financially risky to take short-term advantage of a customer, even in situations where it might seem easy to get away with. Once. But then a scorching exposé could easily go online where it could be downloaded by others, for years, and perhaps forever.

One of the very first online word-of-mouth episodes, in fact, is known as the “Yours Is a Very Bad Hotel” case. It seems that late one night in November 2001, two businessmen were due to check into a hotel in Houston, but when they arrived all the rooms were already taken. Apparently, the hotel’s night clerk was so surly and dismissive that these businessmen took the effort to create a hilarious 17-slide presentation about the incident, titling it “Yours Is a Very Bad Hotel” and e-mailing it to the hotel company. Now, years later, you can still find this presentation being passed around on the Web. Bloggers proudly point to the fact that they were officially warned by the hotel’s parent company to take its brand name off their Web site,² but it is, of course, way, way too late for that. If you want to see this example of “permanent” word of mouth for yourself, just go online and search for the phrase “Yours is a very bad hotel” and count the entries. That should tell you just how successful any company can be at cleaning up the customer’s milk once it has been electronically spilled. One advertising executive’s succinct advice: “You can’t un-Google yourself.”³

As we’ve discussed before, the demand for more and more trustability in business is being facilitated by the increasing use of social media, coupled with the dramatic expansion of peer-produced products and services. Social media interactions and collaborative, open-source developments of software and other information resources are governed by an ethos that is separate and distinct from the ethos governing more traditional, production-for-money economics. Although there is no formal code of conduct, and certainly no regulatory framework proscribing any particular types of activities or messaging in the arena of social interaction and production, there is nevertheless a very strong and fairly cohesive set of expectations as to what behaviors are acceptable, and the “crowd” is more than capable of enforcing these standards. The result is that peer-produced, community-owned products are thriving, in ways no one would have predicted a decade ago.

Overall, the increasing importance of community-owned products and services (software, encyclopedias, product reviews, etc.), coupled with the friend-to-friend ethos and rate-the-rater self-policing mechanisms of social media Web sites, has dramatically escalated the role of plain and simple trustability in commercial interactions. The more people begin participating in social media, the more they come to expect trustworthy behavior from the businesses they interact with. And more people are participating every day.

In short, there is probably no more forward-thinking business strategy to be found than constantly seeking to act in the interests of customers. It would be hard to find any single bit of advice for today’s business manager that is simpler, more straightforward, or more important in terms of the benefits provided to the enterprise. So one of the beacons any executive today should steer toward is the beacon of trust. No matter how confused the business situation, no matter how unsettled the industry, and no matter how volatile the technological landscape, one sure “safe harbor” for any business will almost certainly be that of earning and keeping the trust of its customers. Remember the mantra at USAA Insurance, established under the leadership of Brigadier-General Robert McDermott: “Treat the customer the way you’d want to be treated if you were the customer.”

Most businesses today consider themselves to be trustworthy, and by yesterday’s standards they are. They post their prices accurately, they try to maintain the quality and reliability of their products, and they generally do what they say they’re going to do. But that’s as far as most businesses go, and by tomorrow’s standards it won’t be nearly good enough.

The fact is that far too many businesses still generate substantial profits by fooling customers, or by taking advantage of customer mistakes or lack of knowledge, or simply by not telling customers what they need to know to make an informed decision. They don’t break any laws, and they don’t do anything overtly dishonest. Nevertheless, a lot of traditional, widely accepted, and perfectly legal business practices just can’t be trusted by customers, and will soon become extinct, driven to dust by rising levels of transparency, increasing consumer demand for fair treatment,⁴ and competitive pressure. A business can continue to try to keep things out of its customers’ sight, but technology now makes it more than likely that customers will still find out, one way or another. Some things that companies, governments, and other organizations never meant for people to know, they will know. Any business that fails to prepare for this new reality will soon be competed out of business by rivals who figure out how to do a better job of earning the trust of their customers.

What’s the difference between Navy Federal Credit Union and the other financial services companies we all know about? Or between JetBlue and some of the other airlines? Many of those other companies, with names familiar to customers around the world, are not bad companies. On the contrary: Their officers are ethical. Their legal departments make sure they don’t break any laws. They issue privacy policies and policy statements of all kinds, and then for the most part they do exactly what they say they’re going to do. And yet none of us—not even the executives of these well-run institutions—can tell us how they plan to compete against companies that customer love so much they don’t consider doing business anywhere else. What is the difference?

Being trustworthy is certainly better than being untrustworthy, but soon even trustworthiness won’t be sufficient. Instead, companies will have to be trustable.

Trustability is a higher standard than mere trustworthiness.

Rather than simply working to maintain honest prices and reasonable service, in the near future companies will have to go out of their way to protect each customer’s interest proactively, taking extra steps when necessary to ensure that a customer doesn’t make a mistake, or overlook some benefit or service, or fail to do or not do something that would have been better for the customer. Compare traditional “trustworthiness” and strategic “trustability”:

Although most of today’s successful companies implement many if not all of the policies and actions on the left side of Exhibit 15.1—that is, trustworthy policies—the vast majority of companies’ actions would still not be considered trustable, and only a very few companies have implemented the policies found on the right side of Exhibit 15.1. Trustworthy, yes, but highly trustable? No. A company might be scrupulous in its ethics, completely honest in its brand messaging, and highly involved in tracking its customer satisfaction, but will it be proactively watching out for its customers’ interests? If it wants to succeed in the Age of Transparency, yes. Because we will all be more and more interconnected—never less—we will live in an increasingly transparent world, and trustability is the only competitive response a company can have.

• What would a trustable [your company’s name here] look like?
• How will you compete against companies that balance making a profit with building long-term business value?⁵

Innovate, Innovate, Innovate

The second safe harbor beacon on these troubled business seas is innovation—not just in developing new and shinier products, but in constantly rethinking the very business model and how we make money from customers.⁶

In his marvelous book The Origin of Wealth, Eric Beinhocker gives a sweeping, comprehensive review of how the thinking in economics has changed over the last two centuries, and he makes a compelling case for the idea that economic progress and development should be seen as a process of evolution. This is quite different from traditional, classical economics, which is based on perfect markets and all-knowing, perfectly rational investors. Traditional economics thinking is based on the constant equilibrium of supply and demand. But Beinhocker’s argument is that, in just the last couple of decades, there has been a tectonic shift in thinking, as economists have increasingly glommed on to the fact that “equilibrium” is not a realistic way to describe how the economy works.⁷

In reality, the economy is never in a state of equilibrium. Economic activity is driven by change—by a constant flow of new products and services created by self-interested but not entirely rational people seeking a profit. As new products and services are produced, old ones fail and disappear. New companies come into existence constantly, replacing old ones that sink into business oblivion.

Increasingly, economists are coming to think of the economy as a different kind of evolutionary system. Under this theory, it is progress, creativity, and innovation that are the real drivers propelling economic activity. People create new things and devise new technologies in order to make a profit by meeting some need. The innovations that make the most profit are the most “fit” for survival, so they are likely to have a larger impact on overall progress as the economy continues to evolve into higher and higher technological states.

Changing technology and constant innovation make it extremely difficult for companies to survive and prosper over any substantial period of time. One comprehensive study examined thousands of firms in 40 industries over a 25-year period in order to understand how long the most profitable ones could maintain their superior economic performances—which the researchers defined in terms of a statistically significant difference relative to their peers. The study revealed that the periods during which any single company can consistently maintain above-average results are decreasing, regardless of industry, size of firm, or geography. Using a series of rolling 5-year periods for their analysis, the researchers found that just 5 percent of companies are able to string together 10 or more years of superior performance, and less than a half percent of their sample (only 32 firms out of the 6,772 analyzed) performed above their peers for 20 years or more.⁸

The truly outstanding performers in this study were those able to string together a series of short-term competitive advantages rather than maintaining a long-term advantage. You can gain a short-term advantage with a differentiated product or service, but to survive the evolutionary process you need the ability to respond to change and string a number of these advantages together. In Beinhocker’s words, the truly successful firms are those that “rise into the top ranks of performance, get knocked down, but, like a tough boxer, get back up to fight and win again.”⁹ This is certainly how Apple could be portrayed. And 3M. And GE. But note carefully: If this evolutionary view of economic progress is correct, then there really is no such thing as a “sustainable” competitive advantage for a business. Instead, success in business, as in the natural world, comes to those “most responsive to change.”

This is not Lake Wobegon, where all the children are above average. Here on Earth half of all businesses are below average, and because of the increasing pace of change, it takes less time than ever to slip below the line.

Economist Paul Romer suggests that one way to understand the role that innovation and new ideas play in an economy is to think of an idea as a kind of product. In contrast to a physical product, however, every newly created idea-product becomes virtually free for anyone to use (not just its creator). Even when patents are plentiful and well written, this is still true. Consider the flurry of accessories businesses that support iPhones and all the non-eBay employees getting rich from eBay—all without violating a single patent but using someone else’s very good idea. Because every new idea has the potential to lead to additional ideas, the more there are, the faster they come. This means the business of creating ideas is subject to increasing returns to scale, in sharp contrast to the diminishing returns that characterize traditional economics.¹⁰

However, while the possibility of increasing returns might lead us to conclude that creating a new idea should be a very profitable activity, we can’t forget that if anyone can use a new idea, then it may be difficult for us to make much money from it ourselves, even after going to all the trouble and expense of having come up with it; that is, profits can be generated only during the time periods that lie between when a new idea is devised and when it is duplicated by competition. And as the pace of change and innovation continues to accelerate, these time periods are getting shorter and shorter.

But here’s the real point: Instead of counting on making money from every new idea, a successful enterprise in the future must be able to produce more new ideas, constantly. Innovation, creativity, and adaptability are traits that are more important than ever, precisely because they’re more common than ever. A business’s most successful competitors have these traits. Business conditions change with every new innovation, and you will survive as a business only if you can adapt (i.e., innovate). Although technology has always marched steadily forward, the pace of this march seems to have accelerated in recent years to such an extent that the actual character of business competition has undergone a qualitative shift.

Note carefully, however, that innovation’s role is to help customers create value. Innovation, by itself, has no value. It can even be destructive. There is already a great deal of hype surrounding innovation, but to create real value for a business, innovation has to involve more than just coming up with cool new ideas for their own sake. That’s the kind of “innovation” that brings to market a remote device for home theater systems that can’t be decoded without a geek license. Innovation that isn’t wanted or valued by customers is just self-indulgence, and many of the most “innovative” technology companies in the world are guilty of it.

To overcome the hype and to focus on profitable innovation, we have to keep the customer’s future behavior firmly fixed in our minds. We have to constantly be aware of what it is actually like to be that customer; and we have to be willing to act in the customer’s interest, even when it sometimes means giving up short-term value for the enterprise itself. But if the whole organization isn’t already tuned to the customer’s wavelength, this just isn’t likely to happen.

Economist Romer suggests that if a government wants to promote economic growth, then it should create what he calls a “climate of innovation.” It could do this by, for instance, improving education, subsidizing research, bringing in new ideas from other societies and geographies,¹¹ and enforcing legal protections for intellectual property rights (interestingly, Yochai Benkler would disagree with Romer’s last point, arguing that patent protections today actually inhibit more innovation than they encourage).

Trying to create a climate of innovation is good advice for a business as well. For a business to grow, or even just to survive, it must be able to adapt to change and innovate. So how can an enterprise get better at coming up with new ideas and innovations and then putting them into production or operation? How can it turn employees into more flexible, adaptable, and creative people? And how will you architect your own firm, if your goal is to be adaptable, inventive, and responsive to change?

Apple, long regarded as one of the world’s most trusted brands, also has a reputation for creativity, consistently ranking first in polls of the world’s most innovative companies, even with an occasional disappointing product launch. According to one assessment, four factors have driven Apple’s inventiveness:

1. It relies on “network innovation,” regularly involving outsiders in its creative process, from technical partners to customers and others, rather than simply locking engineers away in the research and development (R&D) department.
2. It is ruthless about designing new products around customer needs with as much simplicity as possible.
3. It understands that customers don’t know what they don’t know; that is, breakthrough innovations will often fly in the face of what “the market” is saying. The iPod, for instance, was originally ridiculed when it was launched in 2001.
4. Apple has learned that one secret for constant innovation is to “fail wisely.” The iPhone rose from the ashes of the company’s original music phone, designed with Motorola. The Macintosh sprang from the original Lisa computer, which failed.¹²

Failing wisely. That’s an important clue for setting up a climate of innovation, because every new idea has a high probability of failure, but without making the attempt, the small proportion of successes will never be discovered, either. As hockey superstar Wayne Gretzky once said, “I never made a shot I didn’t take.” James Dyson, the British vacuum cleaner magnate, claims he built 5,127 prototypes of his revolutionary new vacuum before one of his designs made him a billionaire. The Wright brothers tested some 200 different wing designs and crashed seven of them before successfully lifting off at Kitty Hawk. And WD-40 is called “WD-40” because the first 39 “water displacement” formulas tested by the Rocket Chemical Company in 1953 failed.¹³

To keep the company’s chief financial officer from going apoplectic at the thought of supporting a froth of “creative destruction” and intrapreneurship, we should probably classify business failures into two different categories:

1. Fiasco failures are the result of stupid mistakes, lack of homework, laziness, misguided decisions, or incompetence, but
2. Wise failures are the result of well-executed smart ideas, based on carefully considered risks.

One of the obvious first steps, to encourage innovation, is to staff the company with more creative people, either by hiring more creative people in the first place or by teaching people to be more creative, if that’s even possible. The problem is that no one really knows what creativity is or how it happens. Don’t let anyone tell you otherwise. Just think about it: If we could define creativity and map out exactly how it occurs, it wouldn’t really be “creative,” would it? Nevertheless, anyone who thinks or writes much on the subject will agree that one secret to creativity seems to be crossing boundaries, cross-pollinating or combining different concepts, and taking new perspectives on old issues. A creative idea is usually the result of a single human brain making a connection between two previously unrelated concepts and having some blinding insight as a result—often an insight that appears to have nothing at all to do with the original concept. Or maybe it isn’t a blinding insight but just a glimmer of understanding, or even a suspicion of something sort of interesting. This is certainly one reason why Romer says the rate of innovation and change is accelerating in the world—because the more new ideas there are, the more combining and cross-pollinating can take place.¹⁴

In Walter Isaacson’s richly documented biography of Albert Einstein, he catalogs a number of factors behind the man’s extraordinary creativity, including that he was naturally rebellious and anti-authoritarian; that he was well read not just in physics but in philosophy, psychology, and other disciplines (he borrowed the term relativity itself from the budding field of psychoanalysis); and that he drew constant analogies between physics concepts previously thought to be unrelated (acceleration and gravity, for instance). To top it off, of course, Einstein was also a German Jew during the Nazi era—claimed by his home country as a celebrity but shunned by it at the same time.¹⁵

By most accounts, highly creative people tend to be intelligent and intellectually curious as well as flexible and open to new information. But they are also prone to be intense, motivated, mentally restless, anti-authoritarian, unorthodox, and often (as in Einstein’s case) a bit rebellious. For business, a productively creative person must also be extremely goal oriented, able to recognize and define problems clearly, and capable of putting information together in many different ways to reach solutions.

Regardless of how creative the individual employees are, no enterprise can simply command people to “innovate.” It doesn’t work that way. All a firm can do is create an environment in which innovation is encouraged to flourish—a climate of innovation. To facilitate this, an enterprise may decide to organize somewhat differently, and it should encourage creativity and experimentation with its policies, in addition to hiring people who are more likely to be original thinkers in the first place. But in the end, no firm’s creativity can be commanded. It must spring up from the culture.

Uh-oh. There’s that word again. But hey, guess what? The same corporate culture that will help a company earn the trust of its customers will also help it remain adaptive, resilient, and innovative.

The Importance of Corporate Culture

Harvard Business School professor Clayton Christensen (of “disruptive innovation” fame) suggests that any company’s ability to innovate and adapt depends on how it defines its capabilities, and that a company defines these capabilities differently as it goes through its life cycle. For a young firm, the resources it has available—things like people, technologies, expertise, or cash—represent its capabilities. During a company’s growth phase, these capabilities begin to morph into well-defined and understood processes—including processes for product development, manufacturing, budgeting, and so forth. Then, when a company matures into a larger firm, its capabilities will be defined by its values—including things like the limitations it places on its own business, the margins it needs before considering an investment, and its corporate culture. According to Christensen, the reason younger companies are more flexible, adaptable, and inherently innovative is that “resources” are simply more adaptable to change than are “processes” or “values,” which, by their very nature, are designed to turn repetitive activities into more efficient and predictable routines, and to minimize variation.¹⁶

In Christensen’s hierarchy, it is clear that he regards a company’s values and culture as the most hardened of capabilities, and we certainly agree with that. Nothing is quite so difficult to change as a company’s culture, and once “the way we do things around here” becomes “the way we’ve always done things around here,” a company already has one foot in the grave. Christensen’s argument also implies that a company simply cannot become large without losing its innovativeness.

However, what if the culture that hardens into a company as it becomes mature is a culture that celebrates change, creativity, and innovation applied to the business? What if the repetitive activities and routines that a firm’s culture enshrines have to do with a constant exploration for innovations and improvements? Some established, mature companies really do seem to have cultures that allow them to innovate and adapt more effectively, even while adhering to efficient business practices. Apple is not the only large firm with a track record of constant invention. GE, Disney, 3M, Google, and Toyota also come to mind.

Nevertheless, regardless of these successes, there does seem to be an inherent conflict between the process of constantly innovating new ideas and the process of operating an efficient, clockwork-like production organization. An interesting psychological study of professional football players once revealed some telltale differences between defensive and offensive players, by examining their lockers. Apparently, offensive players’ lockers were found to be neater and more orderly than those of defensive players, as a rule. Now, there may be many reasons for this, but the most obvious inference is probably right: Offensive players succeed by following well-crafted plans, executed flawlessly. Timing, position, and order are everything to them. Defensive players, in contrast, get ahead by wreaking havoc with others’ plans. They are simply more at home with disorder, chaos, and unpredictability.

A similar dichotomy seems to plague business when it comes to managing both execution and creativity. Efficient execution requires order, routine, and invariability. But creativity and innovation involve disorder, randomness, experimentation, and failure. Not many companies have resolved this inherent conflict successfully, although there are a few, just as there are a few pro ball players who can star on either side of the line. As the pace of change continues to accelerate, however, it will be increasingly important to navigate frequently between the close-ordered drill of efficient production and the chaotic experimentation of innovation.

A business enterprise is an organization made up of individual employees and managers who interact with each other and, while pursuing their own individual objectives, produce a collective outcome. Academics call this a “complex adaptive system.” Beehives are complex adaptive systems, too, as are economies, social networks, governments, and even weather patterns and galaxies. The behavior that emerges from a complex adaptive system is often different from what you’d expect if you observe the actions of any single member of the system. You could watch a honeybee’s actions all day, for instance, and still not be able to predict the shape, texture, or social structure of the hive.

Every year a business makes a profit or incurs a loss, and it builds or destroys customer equity. These events are the collective results of the individual actions of all the employees who make up the company. Like honeybees, the employees are each pursuing their own objectives, but the overall outcome of all the employees working together is the short- and long-term value that the firm creates for its shareholders. And this outcome itself becomes additional feedback driving future employee behavior.

Sometimes the behavior that emerges from a system can appear irrational or counterproductive. For example, if managers and employees can get ahead by achieving immediate, short-term results in their own particular areas, then the firm’s overall behavior may be characterized by a lack of coordination among various silos of the organization, coupled with frequent abuses of customers, perhaps in direct violation of the company’s written mission statement to “act in the customer’s interest at all times.” Even though no single manager thinks she is undermining the trust customers have in the firm, the overall behavior of the company might still have that effect.

The success of a complex system—beehives and businesses included—depends on its being able to strike the right balance between exploiting known food sources and exploring for additional sources. Honeybees are great exploiters, doing complex dances for the other bees that direct them to any new food source. But in addition to exploiting known food sources, bees are constantly exploring for new food, even when they already have more than they need. And they are excellent at it. Scientists have shown that bees will find virtually any viable new food source within about two kilometers of their hive with great efficiency, regardless of the nectar resources already available.

The analogy with business is clear. When a business is exploiting its known sources of income, it is living in the short term. Long-term success requires exploration as well as innovation. But one of the biggest problems with most businesses is that they just don’t do as good a job as honeybees do when it comes to constantly exploring for additional income sources. The way businesses are organized, financially measured, and rewarded simply makes most of them better at exploiting than exploring.

Not giving enough priority or attention to the “exploration” side of the business is the biggest strategic mistake most companies make. Dell had a marvelously large food source in the form of its novel business model: direct to consumer computer sales, generating revenue even before incurring inventory costs. For years, Dell was the only major personal computer manufacturer making any money, with profit margins 10 points higher than its rivals. In Chapter 11, we talked about how Dell focused on the short term at the expense of the long term. In some ways, we can think of this as Dell’s focus on exploitation at the expense of exploration. For Dell, as with most other firms, the tension between exploration and exploitation is complicated by two factors: (1) the ruthlessly short-term dynamic introduced by the expectations of the world’s financial markets and (2) the fact that the financial metrics used by most companies are plainly inadequate when it comes to tracking the daily up-and-down changes in the long-term value of a business (i.e., its customer equity).

Suppose, in an experiment, we could alter the DNA of a hive of bees, genetically programming them to focus exclusively on exploitation rather than exploration. Then we put that hive of bees down in the middle of a large field of flowers. What would happen? Over the short term the hive would grow much more rapidly than the surrounding hives, because every available bee would be put to the task of exploiting the field. But what happens next? Once the field is fully exploited, the growth in nectar supplies would tail off, and soon the hive would have to fire its CEO, get in a new management team, and try to move the whole operation into a different field somewhere.

To balance exploitation and exploration, an enterprise must be willing to devote resources to both activities. Google maintains its innovative edge by encouraging employees to dedicate one day per week to exploring innovative or creative initiatives of their own choosing. Think about it: that’s an investment equivalent to 20 percent of the company’s overall personnel budget. Emerson Electric has a strategic investment program that allocates as much as $20 million a year as seed capital for employees’ various unproven but potentially lucrative concepts.¹⁷ Traditionally, 3M’s researchers have been encouraged to spend 15 percent of their time on unstructured projects of their own choosing.

No matter how we define it—exploitation versus exploration, production versus innovation, or selling more today versus selling more tomorrow—it ought to be clear that a business will always experience some tension between short-term profit and long-term value creation. And we’ve already talked extensively about how important it is for a customer-centric company to balance short-term results and long-term value, optimizing the blend of current sales and changes in customer equity.

But besides the conflict between short-term and long-term measurement of value creation, there is another conflict as well—one that has been identified in a wide variety of both popular and academic business books.¹⁸ This is the conflict that arises when managers must choose how much to concentrate on operating a business for the present versus innovating for the future. Operating a business as flawlessly and efficiently as possible requires setting up fixed routines and repeatable processes while innovation requires you to encourage the nonroutine. To operate efficiently, a manager must eliminate variances, but innovation thrives on variances, at least insofar as they lead to more creative thinking.

This conflict has been sharpened immensely by the radical improvements in information technology (IT) we’ve seen over the last few decades. These technologies have fueled a global rush of efficiency-improvement and cost-reduction initiatives, as processes are more easily automated, routines are codified, and the everyday frictions of ordinary commerce melt away. The result is that while companies were always better at exploiting than exploring, technology has now made them even better at exploiting.

Exacerbating this problem is the fact that while efficiency-improvement programs, such as Total Quality Management, ISO 9000, or Six Sigma, can significantly improve a company’s operational execution and streamline its cost structure, they also may tend to limit a company’s ability to think outside the box, reducing or eliminating altogether the chance a firm will be able to bring to market a truly breakthrough idea. According to Vijay Govindarajan of Dartmouth, “The more you hardwire a company on total quality management, [the more] it is going to hurt breakthrough innovation. . . . The mind-set that is needed, the capabilities that are needed, the metrics that are needed, the whole culture that is needed for discontinuous innovation, are fundamentally different.”¹⁹ The problem, according to one IT industry analyst, is that innovative ideas can easily meet a roadblock when up against a “long-running, moderately successful Six Sigma quality effort led by fanatics.”²⁰

Thus, as more and more companies have used technology to streamline and accelerate their operations, they have become either less capable or less willing to consider game-changing innovations, which means the innovations most firms do come up with today tend to be more incremental and short-term in nature. These types of innovations involve less risk and are more likely to return a profit in the short term, of course, but they also have much less upside. The truth is, tiny or incremental improvements in a product barely qualify as real “innovation,” but that seems to be the type of innovation preferred more and more.

One academic study, for instance, found that the proportion of truly new-to-the-world innovations under consideration has declined precipitously in recent years, shrinking from 20 percent of all innovations in 1990 to just 11.5 percent in 2004.²¹ Another study, focused specifically on the types of patents issued in the paint and photography industry over a 20-year period, showed that after a company completed a quality improvement initiative, the proportion of patents based on prior work (i.e., incremental innovation rather than breakthrough innovation) went up dramatically.²² Still another study found that 85 to 90 percent of the innovation projects in a typical company’s pipeline today represent purely incremental improvements rather than creative breakthroughs.²³

Is it possible to be both efficient and innovative, both disciplined and creative? Can the order of execution coexist with the chaos of creation? This problem has always plagued businesses but has been brought into sharp relief by new technologies, which can automate and streamline operations in ways that were just not possible before. There’s hardly a management book writte nin the last several decades that doesn’t make at least a passing reference to this problem, whether it’s Creative Destruction,²⁴ suggesting that there is a tension between operating and innovating, or In Search of Excellence,²⁵ advocating that businesses need to be both “tight” and “loose,” or Winning Through Innovation,²⁶ arguing that a company must be “ambidextrous” to be successful both as an operator and an innovator.

But probably the single best overall description of the organizational traits more likely to succeed both in operating their current business and in innovating for the future can be found in Jim Collins and Jerry Porras’s classic 1994 best seller, Built to Last.²⁷ Collins and Porras identified a number of companies that have been consistently more successful than others in their competitive set not just for a few years but for decades. Then they directly compared the philosophies, policies, and characteristics of these long-lasting companies with other, not-so-successful firms, in order to uncover the secrets of long-term corporate success. What they found was an incredibly resilient ability to hold on to a core set of values while simultaneously tinkering, exploring, and experimenting with new ideas.

Above all, companies that prosper over the long term will almost inevitably have an extremely strong corporate culture. At most of the durably successful companies Collins and Porras studied, including Hewlett-Packard, Wal-Mart, Nordstrom, General Electric, Walt Disney, Johnson & Johnson, 3M, and Marriott, among others, the culture is something almost tangible. It is a quality that infuses the employees at these companies with a sense of purpose, a mission that goes well beyond simply making a profit or building shareholder value. The cultures at these long-lasting companies are “almost cult-like”—so strong that a new employee either fits in well or is “rejected like a virus.”

While respecting their core ideologies, long-lasting companies constantly experiment with new ideas and innovations, failing frequently but keeping what works. W. Johnson, founder of Johnson & Johnson, famously claimed that “failure is our most important product.” Motorola’s founder Paul Galvin encouraged dissent, disagreement, and discussion at the company, in order to give individuals “the latitude to show what they could do largely on their own.”

Experimentation, trial and error, and accidental innovation play a big role at most of the built-to-last companies studied by Collins and Porras. And this pattern of random-but-successful innovations is the unmistakable hallmark of a growth process based on an evolutionary model. “If we mapped 3M’s portfolio of business units on a strategic planning matrix, we could easily see why the company is so successful (“Look at all those cash cows and strategic stars!”), but the matrix would utterly fail to capture how this portfolio came to be in the first place.” In other words, 3M’s innovative success is yet another example of how a network of innovations grows over time. Its current set of businesses and products was not carefully planned in advance and then developed in an orderly way. Rather, 3M (and most other long-lasting, constantly innovative companies) arrived at its present state as the result of constant tinkering and experimentation, with the best, most desirable innovations claiming more and more of the firm’s resources over time.

One final thought about innovation: The corporate culture that is most likely to stimulate and encourage innovative ideas is one that tolerates dissent and celebrates respectful disagreement. This is a culture in which employees trust each other, and they trust management. People in an innovative organization won’t always agree, nor should they, but they must disagree respectfully. Handling disagreement in a respectful way holds a lot of implications for the type of workplace that best facilitates a climate of innovation. It means the boss shouldn’t just squash conversation by issuing edicts. It means setting up a “zing-free” workplace, where it’s not okay to make snide comments about coworkers, either in their presence or behind their backs. It means assuming that people who work together deserve explanation and clarity about what’s going on behind the scenes. It means rewarding people who work with others and serve as catalysts for group action, and not just the lone rangers who succeed because they trounce everyone else. It means no one at the company pulls the rug out from under people. What it means, in other words, is that a climate of innovation creates better customer experience, which builds customer equity. And it starts with a culture of trust.