CHAPTER SIXTEEN

The Innovative Organization

THE NEED TO INNOVATE is mentioned—indeed emphasized—in every book on management. But beyond this the books, as a rule, pay little attention to what management and organization need to be and need to do to stimulate, to direct, and to make effective innovation. Most discussions stress, almost exclusively, the administrative function of management, that is, the task of keeping going and of improving what is already known and what is already largely being done. Little thought or space is normally devoted to the entrepreneurial function of creating effectively and purposefully the new and the different.

In this neglect of the management of innovation, the books only mirror business reality. Every management stresses the need to innovate. But few, in the large as well as the small businesses, organize innovation as a distinct and major task. To be sure, during the past thirty years, that is, since the end of World War II, “research” has become fashionable. Large sums of money are being spent on it. But in many companies the outcome has been improvement rather than innovation.

This is even more true of the public-service institutions.

There were good reasons in the past for the focus on the administrative function to the neglect of innovation. When management first became a concern, in the early years of this century, the great and new need was to learn how to organize, structure, and direct the large-scale human organization which was suddenly coming into being. Innovation was largely not seen at all as a task for the manager. It was considered the job of the “inventor” working in his own workshop, maybe with a helper or two. And even when the “inventor” was succeeded by the organized research lab—the first of which came up in the years around 1900—“innovation” still remained the job of a “specialist,” that is scientific and technical and a matter for “Research.”

Moreover, there was not too much scope for innovation in the years from 1920 to 1950 when most of the basic work on management was being done. For contrary to common belief, these were not years of rapid change, either in technology or in society. They were years in which, by and large, technology built on foundations that had been laid before World War I, that is before 1914, and largely before 1900. And while they were years of tremendous political turbulence, social and economic institutions were stagnant. Indeed, the same can be said for social and economic ideas. The great revolutionary ideas which have been at work in the last fifty years are those of thinkers living, or at least rooted, in the nineteenth century.

Now, however, we may be entering a period of rapid change more comparable in its basic features to the closing decades of the nineteenth century than to the immediate past with which we are familiar. In the late nineteenth century, a new major invention, leading almost immediately to the emergence of a new major industry, surfaced every few months on average. This period began in 1856, the year that saw both Siemens’ dynamo and Perkins’ aniline dye. It ended with the development of the modern electronic tube in 1911. In between came typewriter and automobile, electric light bulb, man-made fibers, tractors, streetcars, synthetic drugs, telephone, radio, and airplane—to mention only a few. In between, in other words, came the modern world.

By contrast, no truly new major industry was started after 1914 until the late 1950s, when computers first became operational.

Between 1870 and 1914 the industrial geography of the world was in rapid change. A new major industrial area emerged on average every decade or so: the U.S. and Germany between 1860 and 1870, western Russia and Japan during the next twenty years, Central Europe (that is, the western part of the old Austria-Hungary and northern Italy) by 1900. Between World War I and World War II, however, no major new industrial area joined the “industrial club.”

Now, however, there are signs of rapid change, with Brazil and China, for instance, approaching “the takeoff point”—Brazil may well have reached it. Now, in other words, there are signs that fundamental economic relationships will be in rapid change and flux. The abandonment of the dollar as the “key currency” in 1971 ended the period in which yesterday was the norm and ushered in a period of great and rapid change and of major innovation in international economy, international currency, and international credit.

But the need for innovation will be equally great in the social field. And the public-service institutions too will have to learn how to manage innovation.

Just as the late nineteenth century was a period of tremendous innovative activity in technology, so also was it in social and economic institutions. And just as the fifty years after World War I were years of technological continuity rather than of rapid change and innovation, so also were they years of continuity in social and economic institutions. Government as we know it today had largely been created by the time of World War I. The Local Government reform in Great Britain which began in the middle of the nineteenth century started the work on re-defining one of man’s oldest institutions, government, created new institutions, new relationships, and, above all, established new tasks for government. And by 1860 the British had, in effect, created the modern government agency. Building the modem welfare state began shortly thereafter in Bismarck’s Germany. At about the same time—the 1880s—the United States made a major contribution to the arts and practice of government: the regulatory commission. Every one of the New Deal reforms of the 1930s had been discussed, worked out, and in many cases put in practice on the local or state level twenty years earlier, that is, in the Progressive Era just before World War I.

The great American university was the innovative creation of half a dozen brilliant university presidents between 1860 and 1900. The modern hospital was essentially designed between 1900 and 1920. Armed services took their present shape in the two major conflicts of the mid-nineteenth century, the American Civil War and the Franco-Prussian War of 1870. Since then, the development has been linear—larger armies, more firepower, more armor, but fundamentally the same strategies and tactics and indeed even the same stress on “hardware technology.” Even such radical technical innovations as the tank and the airplane were largely integrated into traditional command structures and traditional military doctrines.

Now the need for social and political innovation is becoming urgent again. The modern metropolis needs new governmental forms. The relationship between people and their environment has to be thought through and restructured. No modern government governs effectively anymore. The crisis of the world is, above all, an institutional crisis demanding institutional innovation.

The business enterprise, its structure and organization, the way in which it integrates knowledge into work and work into performance—and the way in which it integrates enterprise with society and government—are also areas of major innovative need and innovative opportunity. Surely there is need in the social and economic sphere for another period of innovative activity such as we last lived through in the second half of the nineteenth century.

In sharp contrast to the nineteenth century, however, innovation from now on will have to be built into existing organizations. Large businesses—and equally large public-service institutions—will have to become increasingly capable of organizing themselves for innovation as well as for administration.

In the first place, they command access to human resources and capital to a degree undreamed of a hundred years ago. But also the ratio between invention or research and the efforts needed to convert the results of research or invention into new businesses, new products, or new institutions has changed significantly. It is by now accepted, if only as a rule of thumb, that for every dollar spent on generating an idea, ten dollars have to be spent on “research” to convert it into a new discovery or a new invention. For every ten dollars spent on “research,” at least a hundred dollars need to be spent on development, and for every hundred dollars spent on development, something between a thousand and ten thousand dollars are needed to introduce and establish a new product or a new business on the market. And only after a new product or a new business has been established in the market is there an “innovation.”

Innovation is not a technical term. It is an economic and social term. Its criterion is not science or technology, but a change in the economic or social environment, a change in the behavior of people as consumers or producers, as citizens, as students or as teachers, and so on. Innovation creates new wealth or new potential of action rather than new knowledge. This means that the bulk of innovative efforts will have to come from the places that control the human resources and the money needed for development and marketing, that is, from the existing large aggregation of trained people and disposable money—existing businesses and existing public-service institutions.

This may be particularly true with respect to the public-service institution. A hundred years ago there were few of them and they were small. The task then was largely to create new institutions where none existed. Today these institutions are massive and dominate the social, political, and economic landscape. They represent existing bureaucracies, existing concentrations of expertise, existing assignments, and ongoing programs. If they cannot become innovative, the new we need has little chance of becoming effective innovation. It is likely to be smothered by muscle-bound giants of big government and big armed service, big university and big hospital, and many others.

This does not mean that the small business, or even the lone entrepreneur, will not continue to play an important role. Nothing is further from the truth than the hoary myth of the Populists that the small individual is being squeezed out of the marketplace by the giants. The innovative growth companies of the last twenty-five years all started as small businesses. And by and large the small businesses have done far better than the giants.

In every single industry, except those where monopoly is protected by government (e.g., in railroading), small upstarts which a few short years ago were unknown have acquired major market positions and have proven themselves more than capable of competition with the giants. This is particularly true, as has been said before, where the giants, through natural growth or deliberate policy, grew into conglomerates. In the chemical industry, in the electrical apparatus industry, and in many others, the traditional giant, a GE, has lost market position and market share in many markets—and largely to small or mediumsized newcomers with an innovative bent.

An established company which in an age demanding innovation is not capable of innovation is doomed to decline and extinction. And a management which in such a period does not know how to manage innovation is incompetent and unequal to its task. Managing innovation will increasingly become a challenge to management, and especially to top management, and a touchstone of its competence.

Innovative Examples

While in a minority, especially among big businesses, innovative companies do exist. One might mention Renault in France and Fiat in Italy, Marks & Spencer in England, ASEA in Sweden (The Swedish General Electric Company), Sony in Japan—or, between the two World Wars, the publishing house of Ullstein in Germany. In the United States 3M (Minnesota Mining and Manufacturing, St. Paul, Minnesota), the Bell Laboratories of the Telephone Company, or the Bank of America come to mind. These firms apparently have no difficulty innovating and no difficulty getting change accepted in their organizations. Their managements, one would expect, rarely have occasion to ask, “How can we keep our organization flexible and willing to accept the new?” These managements are much too busy finding the right people and the money to run with the innovations their own organizations force on them.

Innovative organizations are not confined to business. Both the Manhattan Project in the United States, which developed the atomic bomb during World War II, and the joint European organization for nuclear research and for peaceful application of atomic power, CERN (Conseil Européen pour la Rechrche Nucleaire), in Geneva under its first Director-General, Victor Weisskopf, furnish examples of innovative organizations. Both innovated scientifically and technically. But both also innovated in social terms; the forms of organization now popular as “team”or “matrix”organizations, e.g., were invented essentially by the Manhattan Project. This is all the more remarkable, as these two institutions were heavily staffed with university professors who, in their natural habitat, are remarkably resistant to change and notoriously slow to innovate.

These examples indicate that an organization’s ability to innovate is a function of management rather than of industry, size, or age of the organization, let alone to be explained with that common excuse of poor managers, a country’s “culture and traditions.”

Nor can the explanation be found in research. Bell Laboratories—perhaps the most productive industrial research laboratory—has indeed been stressing for many years fundamental inquiries into the laws of nature. But Renault and Fiat are not particularly distinguished for their research; what makes them innovative organizations is ability to get new designs and new models rapidly into production and on the market. The Bank of America, finally, innovated mainly in its customers’ businesses, and in terms of financial structure and credit, inventory and marketing policies.

These examples imply that the innovative organization institutionalizes the innovative spirit and creates a habit of innovation. At the beginning of these organizations there might well have been an individual, a great innovator. He might have succeeded in building around him an organization to convert into successful business reality his new ideas and inventions—as did Werner von Siemens in Germany a hundred years ago, A.P. Giannini in building the Bank of America seventy years ago, and as Edwin H. Land of Polaroid has been doing since World War II. But no such founding genius presided over Bell Laboratories, over 3M, or over Renault. The innovative organization manages to innovate as an organization, that is, as a human group organized for continual and productive innovation. It is organized to make change into norm.

These various innovative organizations are very different indeed in their structures, their businesses, their characteristics, and even their organization and management philosophies. But they do have certain characteristics in common.

1. Innovating organizations know what “innovation” means.
2. Innovative organizations understand the dynamics of innovation.
3. They have an innovative strategy.
4. They know that innovation requires objectives and goals that are different from management objectives and goals, and measurements appropriate to the dynamics of innovation.
5. Management, especially top management, plays a different role and has a different attitude in an innovative organization.
6. The innovative organization is structured differently and set up differently from managerial work and managerial organization.

The Meaning of Innovation

Innovation organizations first know what “innovation” means. They know that innovation is not science or technology, but value. They know that it is not something that takes place within an organization but a change outside. The measure of innovation is the impact on the environment. Innovation in a business enterprise must therefore always be market-focused. Innovation that is product-focused is likely to produce “miracles of technology” but disappointing rewards. Technically the IBM computer was for long years, at best “almost as good” as the products of the competitors—and the competitors developed most of the new technology until well into the ’sixties. But the competitors found out what the product could do—and then looked around for applications. IBM started out with the needs of the users and adapted technology to it—and acquired market dominance in a few short years.

The outstanding innovators among the world’s pharmaceutical companies define their goal as new drugs that will make a significant difference to medical practice and to patient health. They do not define innovation in terms of research, but in terms of the practice of medicine. Similarly, Bell Laboratories always starts out with the question “What will make a difference to telephone service?”

Not surprisingly, however, it is precisely the most market-focused innovator who has come up with some of the most important technical or scientific advances. Bell Labs, for instance, created the transistor, produced the basic mathematics of information theory, and is responsible for some of the fundamental discoveries underlying the computer.

To start out with the consumer’s or client’s need for a significant change is often the most direct way to define new science, new knowledge, and new technology, and to organize purposeful and systematical work on fundamental discovery.

The Dynamics of Innovation

Innovating businesses are aware of the dynamics of innovation. They do not believe that innovation is determined—or at least they know that there are so many factors in whatever causal patterns may exist that no one can possibly unravel them. Neither, however, do they share the common belief that innovation is haphazard and incapable of being predicted or foreseen.

They know that innovation follows a probability distribution. They know that it is possible to say what kind of innovation, if successfully brought about, is likely to become a major product or process, a major new business, a major market. They know how to look systematically for the areas where innovative activity, if it produces results, is likely to enjoy success and to be rewarding.

One such guide to finding what one could call “the innovation-prone” is basic economic vulnerability of a process, a technology, or an industry. Wherever an industry enjoys growing market demand without being able to turn the demand into profitability, one can say, with high probability, that a major innovation which changes process, product, distributive channel, or customer expectations will produce high rewards.

Examples abound. One is the paper industry, which, all the world over, has enjoyed rapidly expanding consumer demand—on the order of 5 to 10 percent a year, year in and year out—without being able apparently to earn a decent return on its capital. There is the steel industry, which is in a very similar position. But there is also life insurance, which is one of the few “products” a customer is ready to buy—one of the few products, by the way, in which producer and consumer have an identical interest in the policy holder’s surviving beyond a normal life-span,—and which yet has to be sold through “hardsell” methods and against apparently very high buyer resistance.

Similarly, innovative opportunity exists where there is glaring disparity between various levels of an economy or of a market.

The major growth industry in Latin America in the 1960s, for instance, was not manufacturing. It was retail distribution. Huge masses of people flocked into the cities and from a subsistence economy into a money economy. Individually they were, of course, mostly very poor. But collectively they represented large new purchasing power. Yet the distribution system in most Latin American countries remained in the pre-urban mold—small shops, undercapitalized, undermanaged, poorly stocked, and yet with very slow turnover. Wherever an entrepreneur moved in to offer modern distribution—Sears, Roebuck was the first to recognize the opportunity—success was instantaneous.

Another area of innovative opportunity is the exploitation of the consequences of events that have already happened but have not yet had their economic impacts. Demographic developments, i.e., changes in population, are among the most important. They are also the most nearly certain. Changes in knowledge are less certain—the lead time is difficult to predict. But they too offer opportunities. And then, most important, but least certain, are changes in awareness, changes in vision, changes in people’s expectations.

The pharmaceutical industry, for instance, earned its success largely because it anticipated the impact of fundamental changes in awareness. After World War II health care every place became a “good buy.” And drugs are the only way to health care easily accessible to poor and poorly educated rural countries. Where physicians and hospitals are scarce, drugs can still be dispensed and will be effective for a great many health problems. The pharmaceutical company which understood this and went into the developing countries found that, with respect to drug purchases, they are “fully developed.”

Finally, of course, there are the innovations which are not part of the pattern, the innovations that are unexpected and that change the world rather than exploit it. They are the innovations in which an entrepreneur sets out to make something happen. They are the truly important innovations. They are the innovations of a Henry Ford, who envisioned something that did not exist at the time, namely a mass market, and then set about to make it happen.

These innovations lie outside of the probability distribution—or, at least, they place so far toward the extreme as to be grossly improbable. They are also clearly the most risky ones. For every one such innovation that succeeds, there must be ninety-nine that fail, ninety-nine of which nothing is ever heard.

It is important for the innovating business to realize that these atypical innovations exist and that they are of supreme importance. It is important to keep watching for them. But, by their very nature, they cannot be the object of systematic, purposeful organized activity within the business enterprise. They cannot be managed.

And they are sufficiently rare to be treated as exceptions, despite their over-reaching importance. The business that focuses on the probability pattern and organizes its innovation strategy to take advantage of it will innovate. And it will in the process become sensitive to the exceptional, the great, the truly historic innovation, and equipped to recognize it early and to take advantage of it.

To manage innovation, a manager need not be a technologist. Indeed, first-rate technologists are rarely good at managing innovation. They are so deeply engrossed in their specialities that they rarely see development outside of it. It is not a metallurgist who is likely to recognize the importance of basic new knowledge in plastics even though it may, within a reasonably short time, obsolete a good many of his or her proudest products. Similarly, the innovative manager need not be an economist. The economist, by definition, becomes concerned with the impact of innovations only after they have become massive. The innovating manager needs to anticipate vulnerabilities and opportunities— and this is not the economist’s bent. The innovative manager needs to study innovation as such and to learn its dynamics, its pattern, its predictability. To manage innovation, a manager has to be at least literate with respect to the dynamics of innovation.

Innovative Strategy

Like all business strategies, an innovative strategy starts out with the question “What is our business and what should it be?” But its assumptions regarding the future are different from the assumptions made with respect to the ongoing business. There the assumption is that present product lines and services, present markets and present distribution channels, present technologies and processes will continue. The first objective of a strategy for the ongoing business is to optimize what already exists or is being established.

The ruling assumption of an innovative strategy is that whatever exists is aging. The assumption must be that existing product lines and services, existing markets and distribution channels, existing technologies and processes will sooner or later—and usually sooner—go down rather than up.

The governing device of a strategy for the ongoing business might therefore be said to be: “Better and More.” For the innovative strategy the device has to be: “New and Different.”

The foundation of innovative strategy is planned and systematic sloughing off of the old, the dying, the obsolete. Innovating organizations spend neither time nor resources on defending yesterday. Systematic abandonment of yesterday alone can free the resources, and especially the scarcest resource of them all, capable people, for work on the new.

Unwillingness to do this may be the greatest obstacle to innovation in the existing large business. That the General Electric Company did not succeed in establishing itself as a computer producer is, within the company itself, explained in large part as the result of unwillingness or inability to make available managers and professionals of the high quality and proven performance capacity needed. To be sure, GE assigned a great many good people to its computer group. But few of them were allowed to stay there long. No sooner were they gone from their original post in a research lab or a large division, than the cry went up “we cannot do without them,” and back they went to their old assignments of improving what was already known and what was already done.

The new and especially the as-yet unborn, that is, the future innovation, always looks insignificant compared to the large volume, the large revenue, and the manifold problems of the ongoing business. It is all the more important, therefore, for an existing business to commit itself to the systematic abandonment of yesterday if it wants to be able to create tomorrow.

Second in a strategy of innovation is the clear recognition that innovation efforts must aim high. It is just as difficult, as a rule, to make a minor modification to an existing product as it is to innovate a new one.

Michael J. Kami, who served successfully as head of long-range planning for IBM and Xerox, states as a rule of thumb that the projected results of innovative efforts should be at least three times as large as the results needed to attain company objectives. This is probably an underestimate. In improvement work—adding a new product, up-grading a product line, broadening the market, and so on—one can assume a success rate of 50 percent. No more than half the projects should be total failures.

This is not the way innovation works. Here the assumption must be that the majority of innovative efforts will not succeed. Nine out of every ten “brilliant ideas” turn out to be nonsense. And nine out of every ten ideas which, after thorough analysis, seem to be worthwhile and feasible turn out to be failures or, at best, puny weaklings. The mortality rate of innovations is—and should be—high.

Innovative strategy therefore aims at creating a new business rather than a new product within an already established line. It aims at creating new performance capacity rather than improvement. It aims at creating new concepts of what is value rather than satisfying existing value expectations a little better. The aim of innovating efforts is to make a significant difference. What is significantly different is not a technical decision. It is not the quality of science that makes the difference. It is not how expensive an undertaking it is or how hard it is to bring it about. The significant difference lies in the impact on the environment.

“Success” in innovating efforts is a batting average of one out of ten. This is, of course, the reason for aiming high in innovative efforts. The one winner has to make up for nine losers and has to produce its own results.

Bernard Baruch is mostly remembered today as the head of the U.S. war economy in World War I and the friend, confidant, and advisor of presidents from Woodrow Wilson to Harry Truman. But before Baruch became America’s elder statesman, he had amassed a very sizable fortune as a venture capitalist. While other financiers of his era, the thirty years before World War I, speculated in real estate and railroad bonds, Baruch looked for new and innovative businesses. He knew apparently little about technology—or at least affected ignorance. He invested in the person rather than in the idea. And he invested at the very early stage at which the budding business, as a rule, did not need much money beyond a few years’ support for someone with an idea. He invested on the principle that eight out of every ten investments would turn out failures and would have to be written off. But he maintained—and his own record proved him right—that if only two out of ten turned out to be successful, he would reap a far larger harvest than the shrewdest investor in already existing businesses could possibly attain.

An innovation does not proceed in a nice linear progression. For a good long time, sometimes for years, there is only effort and no results. The first results are then usually meager. Indeed, the first products are rarely what the customer will eventually buy. The first markets are rarely the major markets. The first applications are rarely the applications that, in the end, will turn out to be the really important ones.

The social impacts of new technology are very difficult, and sometimes impossible, to predict. But this difficulty extends to everything connected with the truly new—as demonstrated by the example of the gross underestimation of the size of the computer market in the thorough market-research study conducted around 1950. But even more difficult to predict than the eventual success of the genuinely new is the speed with which it will establish itself. “Timing is of the essence”—above all in innovation. Yet timing is totally incapable of being predicted. There are the computer, the antibiotics, the Xerox machine—all innovations that swept the market. But for every successful innovation that has results faster than anyone anticipates, there are five or six others in the end perhaps, equally successful ones—which for long years seem to make only frustratingly slow headway. The outstanding example may be the steam-driven ship. By 1835 its superiority was clearly established; but it did not replace the sailing ship until fifty years later. Indeed, the “golden age of sail” in which the great clippers reached perfection began only after the steamship had been fully developed. For almost half a century, in other words, the steamship continued to be “tomorrow” and never seemed to become “today.”

But then, after a long, frustrating period of gestation, the successful innovation rises meteorically. It becomes within a few short years a new major industry or a new major product line and market. But until it has reached that point it cannot be predicted when it will take off, nor indeed whether it ever will.

Measurements and Budgets

Innovation strategy requires different measurements and different use of budgets and budgetary controls from those appropriate to an ongoing business.

To impose on innovating efforts the measurements, and especially the accounting conventions, that fit ongoing businesses, is misdirection. It cripples the innovative effort the way carrying a one-hundred-pound pack would cripple a six-year-old going on a hike. And it also fails to give true control. Finally, it may become a threat when the innovation becomes successful. For then it needs controls that are appropriate to rapid growth, that is, controls which show what efforts and investments are needed to exploit success and prevent overextension.

The successfully innovating businesses learned this long ago.

The oldest, best-known, and most successful managerial control system is probably that of the Du Pont Company, which, as early as the 1920s, developed a model for all its businesses focused on return on investment. But innovations were not included in that famous model. As long as a business, a product line, or a process was in the innovating stage, its capital allocation was not included in the capital base on which the individual Du Pont division in charge of the project had to earn a return. Nor were the expenses included in its expense budget. Both were kept separate. Only after the new product line had been introduced in the market and had been sold in commercial quantities for two years or more were its measurements and controls merged into the budget of the division responsible for the development.

This made sure that division general managers did not resist innovation as a threat to their earnings record and performance. It also made sure that expenditures on, and investments in, innovative efforts could be tightly controlled. It made it possible to ask at every step, “What do we expect at the end, and what is the risk factor, that is, the likelihood of nonsuccess?” “Can we justify continuing this particular innovative effort or not?”

Budgets for ongoing businesses and budgets for innovative efforts should not only be kept separate, they should be treated differently. In the ongoing business, the question is always “Is this effort necessary? Or can we do without it?” And if the answer is “We need it,” one asks, “What is the minimum level of support that is needed?”

In the innovative effort the first and most serious question is “Is it the right opportunity?” And if the answer is yes, one asks, “What is the maximum of good people and key resources which can productively be put to work at this stage?”

A separate measurement system for innovative effort makes it possible to appraise the three factors that determine innovative strategy: the ultimate opportunity, the risk of failure, and the effort and expenditure needed. Otherwise, efforts will be continued or will even be stepped up where the opportunity is quite limited while the risk of nonsuccess is great.

Examples are the many broad-spectrum antibiotics produced with great scientific ingenuity by pharmaceutical companies in the late sixties. By then the probability of synthesizing a new broad-spectrum antibiotic with properties significantly better than those already on the market had become fairly small. The risk of nonsuccess was high, in other words. At the same time the opportunity had become much more limited than ten years earlier. Even an antibiotic with significantly better performance than the existing ones would have to compete against perfectly good products with which the physicians were familiar and which they had learned to use. Even a scientific breakthrough would in all likelihood have produced a “me-too” product. At the same time, the expenditure and effort needed to find anything really new in a field that had been worked over so thoroughly were rising fast. Traditional market thinking, that is, thinking that looks at the size of the market and deduces therefrom great success for a new product that is “better,” would have been totally misleading—as indeed it misled a substantial number of companies.

Nothing is therefore as inimical to successful innovation as a goal of “5 percent growth in profits” every year. Innovations for the first three or five years— some for longer—show no growth in profits. They do not show any profits at all. And then their growth rate for five to ten years should be closer to 40 percent a year than to 5 percent a year. It is only after they have reached relative maturity that they can be expected to grow year by year by a small percentage. But then they are no longer innovations.

Innovative strategy, therefore, requires a high degree of discipline on the part of the innovator. He has to operate without the crutch of the conventional budget and accounting measures which feed back fairly fast and reasonably reliable information from current results to efforts and investments. The temptation is to keep on pouring people and money into innovative efforts without any results. It is therefore important in managing innovation to think through what one expects, and when. Inevitably, these expectations are changed by events. But unless there are intermediate results, specific progress, “fall-outs” to actual operation along the way, the innovation is not being managed.

When Du Pont engaged, in the late twenties, in the polymer research that eventually led to nylon more than ten years later, no one was willing or able to predict whether mastery of polymer technology would lead to synthetic rubber, to textile fibers, to synthetic leathers, or to new lubricants. (In the end, of course, it led to all of them.) It was not until fairly close to the end of the work that it became clear that synthetic fibers would be the first major commercial product. But from the beginning Du Pont, together with Dr. Carrothers, the research scientist in charge, systematically laid out a road map of what kind of findings and results could be expected and when. This map was changed every two or three years as results came in but it was always redrawn again for the next stages along the road. And only when he came up with polymer fibers, which then made large-scale development work possible, did Du Pont commit itself to massive investment. Until then, the total cost was essentially the cost of supporting Carrothers and a few assistants.

The Risk of Failure

A strategy for innovation has to be based on clear acceptance of the risk of failure—and of the perhaps more dangerous risk of “near-success.”

It is as important to decide when to abandon an innovative effort as it is to know which one to start. In fact, it may be more important. Successful laboratory directors know when to abandon a line of research which does not yield the expected results. The less successful ones keep hoping against hope, are dazzled by the “scientific challenge” of a project, or are fooled by the scientists’ repeated promise of a “breakthrough next year.” And the unsuccessful ones cannot abandon a project and cannot admit that what seemed like a good idea has turned into a waste of people, time, and money.

But a fair number of innovative efforts end up in near-success rather than in success or failure. And near-success can be more dangerous than failure. There is, again and again, the product or the process that was innovated with the expectation that it would “revolutionize” the industry only to become a fairly minor addition to the product line, neither enough of a failure to be abandoned nor enough of a success to make a difference. There is the innovation which looks so “exciting” when work on it is begun, only to be overtaken, during its gestation period, by a more innovative process, product or service. There is the innovation which was meant to become a “household word” that ends up as another “specialty” which a few customers are willing to buy but not willing to pay for.

It is therefore particularly important in managing innovation to think through and to write out one’s expectations. And then, once the innovation has become a product, a process, or a business, one compares one’s expectations to reality. If reality is significantly below expectations, one does not pour in more people or more money. One rather asks, “Should we not go out of this, and how?”

Bernard Baruch knew this seventy years ago. When asked whether there were not investments in innovations that were neither great successes nor great failures, he is reported to have answered, “Of course—but those I sell as early as possible and for whatever I can get.” He then added, “In my early days those were the ventures on which I spent all my time. I always thought I could turn them around and make them the success we had originally expected. It never worked. But I found that I missed the real opportunities and that I misallocated my money by putting it into ‘sound investments,’ rather than into the big opportunities of the future.”

The Innovative Attitude

Resistance to change, by executives and workers alike, has for many years been considered a central problem of management. Countless books and articles have been written on the subject. Countless seminars, discussions, and courses have been devoted to it. Yet it is questionable that much progress has been made in resolving the problem.

Indeed, it is incapable of being resolved as long as we talk of “resistance to change.” Not that there is no such resistance, or that it is not a major obstacle. But to focus on resistance to change is to misdefine the problem in a way that makes it less, rather than more, tractable. The right way to define the problem so as to make it capable of resolution is as a challenge to create, build, and maintain the innovative organization, the organization for which change is norm rather than exception, and opportunity rather than threat. Innovation is, therefore, attitude and practices. It is, above all, top-management attitude and practices. The innovative organization casts top management into a different role and embodies a different concept of top management’s relationship to the organization.

In the traditional managerial organization such as management texts discuss, top management is final judge. This means, in effect, that management’s most important power is the veto power, and its most important role is to say no to proposals and ideas that are not completely thought through and worked out. This concept is caricatured in that well-known jingle composed many years ago by a senior executive of Unilever, the British-Dutch-American food and soap giant:

In the innovative organization, the first and most important job of management is the opposite: it is to convert impractical, half-baked, and wild ideas into concrete reality. In the innovative organization, top management sees it as its job to listen to ideas and to take them seriously. Top management, in the innovative organization, knows that new ideas are always “impractical.” It also knows that it takes a great many silly ideas to spawn one viable one, and that in the early stages there is no way of telling the silly idea from the stroke of genius. Both look equally impossible or equally brilliant.

Top management in the innovative organization, therefore, not only “encourages” ideas, as all managements are told to do. It asks continuously, “What would this idea have to be like to be practical, realistic, effective?” It organizes itself to think through rapidly even the wildest and apparently silliest idea for something new to the point where its feasibility can be appraised.

Top management in the innovative organization is the major “drive” for innovation. It uses the ideas of the organization as stimuli to its own vision. And then it works to make ideas a concern of the entire organization. Top management in the innovative organization fashions thought and work on the new into both organizational energy and entrepreneurial discipline.

This, however, presupposes restructuring relations between top management and the human group within the enterprise. The traditional organization, of course, remains. Indeed, on the organization chart there may be little to distinguish the innovative organization from the most rigidly bureaucratic one. And an innovative organization need not be “permissive” or “democratic” at all. But the innovative organization builds, so to speak, a nervous system next to the bony skeleton of the formal organization. Where traditional organization is focused on the logic of the work, there is also an additional relationship focused on the logic of ideas.

In innovative companies senior executives typically make it their business to meet with the younger people throughout the organization in scheduled (though not necessarily regular) sessions in which there is no “agenda” for top management. Rather, the seniors sit down with the younger group and ask, “What opportunities do you see?”

In the period of its greatest growth and development, the 3M Company was anything but a permissive company. It was tightly run by two or three executives at the top who made all the decisions. But even the most junior engineer was encouraged, indeed practically commanded, to come to the top-management people with any idea, no matter how wild. And again and again he would be told, “The idea makes no sense to me; but are you willing to work on it?” If the reply was yes, the engineer would then be asked to write up the idea, together with a budget request—and more often than not he would be freed from all other responsibilities, given a modest sum of money for a year or two, and told to go ahead. As a result, the company grew from a small and obscure producer of abrasives into one of America’s largest businesses.

Yet the young engineers at 3M were held strictly accountable. Not all of them succeeded, of course. Indeed, only one or two out of every ten did. And failure of an idea was not held against them—at least, not the first time. But failure to take responsibility, to organize the task, to work at it, and to appraise progress realistically—let alone to keep top management fully informed of the progress of the project—was not tolerated.

The innovative organization requires a learning atmosphere throughout the entire business. It creates and maintains continuous learning. No one is allowed to consider himself or herself “finished” at any time. Learning is a continuing process for all members of the organization.

Resistance to change is grounded in ignorance and in fear of the unknown. Change has to be seen as opportunity by people—and then there will be no fear. It is seen as opportunity by the Japanese because they are guaranteed their jobs and are not afraid of putting themselves or their colleagues out of work by proposing something new. And even in Japan, if workers know that the organization is overstaffed and that their jobs are really redundant—the grossly overstaffed Japanese National Railways are an example—there is dogged resistance to all change despite a legal guarantee of absolute job security. But fear and ignorance are also overcome in Japan by making continuing change the opportunity for personal achievement, for recognition, for satisfaction. The person who in a Japanese training session comes up with a new idea receives no monetary reward, even if the idea is a big and profitable one. But even if it is a very small improvement, the proponent derives stature, recognition, and public praise.

We need not go to Japan to learn this. Every one of the “suggestion systems” that are so widely used in American business teaches the same lesson. The suggestion system in which the reward is recognition, achievement, participation, is the successful system. And in those departments in a plant where the suggestion system is being run this way, there is very little resistance to change, despite fears for job security and union restrictions. Where this does not prevail—as in the great majority—the suggestion system is not a success, no matter how well it pays for successful suggestions. It also has none of the effect on worker behavior and attitude which the proponents of the suggestion system promise.

Structure for Innovation

The search for innovation needs to be organized separately and outside of the ongoing managerial business. Innovative organizations realize that one cannot simultaneously create the new and take care of what one already has. They realize that maintenance of the present business is far too big a task for the people in it to have much time for creating the new, the different business of tomorrow. They also realize that taking care of tomorrow is far too big and difficult a task to be diluted with concern for today. Both tasks have to be done. But they are different.

Innovative organizations, therefore, put the new into separate organizational components concerned with the creation of the new.

The oldest example is probably the Development Department at E.I. du Pont de Nemours in Wilmington, Delaware, founded in the early twenties. This unit is concerned exclusively with the making of tomorrow. It is not a research department—Du Pont has a separate, big research lab. The job of the Development Department is to develop new businesses; production, finance, and marketing are as much its concern as technology, products, and processes. 3M, too, has set up a business development lab in parallel with, but separate from, its research labs.

This was not understood in 1952 when the General Electric Company embarked on its massive reorganization which then became the prototype for major organization changes in large businesses around the world. Under the GE plan the general manager of every “product business” was to have responsibility for both the ongoing business and the innovative efforts for tomorrow’s new and different business. This seemed plausible enough. Indeed it seemed an inescapable conclusion from the idea that the general manager of a product business should, as much as possible, behave like the chief executive of an independent business. But it did not work—the general managers did not innovate.

One reason was the press of ongoing business. General managers had neither the time nor the motivation to work on obsoleting what they were managing. Another, equally important reason was that true innovation is rarely an extension of the already existing business. It rarely fits into the scope, objectives, goals, technologies or processes of today. But, of course, one can define only the scope, products, technologies, processes even the markets—of today. The most important innovative opportunities always fall outside existing definitions—and thereby outside the “assigned scope” of an existing decentralized product business. After ten years or so GE began to draw the proper conclusions from its frustrations and began to organize major innovation separately and outside of existing product departments and product divisions—and very similar to the way innovative efforts had been organized at Du Pont for many years, that is, in a separate organizational “business development” unit.

Experience in public-service institutions also indicates that innovative efforts best be organized separately and outside of existing managerial organization.

The greater innovative capacity of the American university as compared to the universities of continental Europe has often been remarked upon. The main reason is clearly not that American academicians are less resistant to change. It is the ease with which the American university can set up a new department, a new faculty, or even an entirely new school to do new things. The European university, by contrast, tends to be compelled by law and tradition to set up a new activity within an already existing department or faculty. This not only creates immediately a “war of ancients against the moderns” in which the new is fought as a threat by the established disciplines. It also deprives the new, as a rule, of the resources needed to innovate successfully. The ablest of the young scholars, for instance, will be under great pressure to stick to the “safe” traditional fields which still control the opportunities for promotion. For a significant innovation to move fast in the European academic setting usually requires “break-away institutions.” The great age of English physics and chemistry in the late seventeenth century was ushered in by setting up the Royal Academy outside the established university system. More than two hundred years later, a similar break-away institution, the London School of Economics, created the opportunity for genuine innovation in teaching—and learning—in the economic and social fields. In France Napoleon systematically set up the grandes écoles such as the École Polytechnique and the École Normale outside the university system as a vehicle for innovation in learning and research, e.g., to make effective the then brand-new idea that engineers and teachers needed training and could be trained. One of the main reasons why the Germans, in the decade before World War I, set up the separate scientific research institutes of the Kaiser-Wilhelm Gesellschaft (now Max-Planck Gesellschaft) was to gain freedom to develop new disciplines and new approaches in old disciplines, that is, to gain freedom for innovation.

Similarly the Manhattan Project, which developed the atomic bomb, as well as CERN, the European nuclear-research facility, were set up outside the existing academic and governmental structures precisely because their purpose was to be innovation.

Innovation as a “Business”

At the same time, the innovative organizations realize that innovation needs from the beginning to be organized as a “business” rather than as a “function.” In concrete terms, this means setting aside the traditional time sequence in which “research” comes first, followed by “development,” followed by “manufacturing,” with “marketing” at the very end. The innovative organizations consider these functional skills as part of one and the same process, the process of developing a new business. When and how each of these tools is to be put into play is decided by the logic of the situation rather than by any preconceived time sequence.

A project manager or business manager is therefore put in charge of anything new as soon as it is decided to pay attention to it. This manager may come from any—or from no—function at all, and usually he or she can draw on all the functions right from the beginning; use marketing, for instance, before there is any research; or work out the financial requirements of a future business even before knowing whether there will be any products.

The traditional functions organize work from where we are today to where we are going. The innovative function organizes work from where we want to be, back to what we now have to do in order to get there.

The design principle for innovation is the team, set up outside of existing structures, that is, as an “autonomous unit.” It is not a “decentralized business” in the traditional sense of the word, but it has to be autonomous and separate from operating organizations.

One way to organize innovative units within a large business might well be to group them together into an innovative group, which reports to one member of top management who has no other function but to guide, help, advise, review, and direct the innovating team at work. This is, in effect, what the Du Pont Development Department is. Innovation has its own logic, which is different from the logic of an ongoing business. No matter how much the innovative units may themselves differ in their technologies, their markets, their products, or their services, they all have in common that they are innovative.

Even such autonomous team organization may be too restricted for the kind of innovation that will increasingly be needed, innovation in fields that are quite different from anything that business has done so far. We may need to set up the innovating unit as a genuine entrepreneur.

Several large companies in the United States, e.g., GE and Westinghouse—and also several large companies in Europe—have set up innovative efforts in the form of partnerships with the “entrepreneurs” in charge. The innovative effort is organized as a separate company, in which the parent company has majority control and usually the right to buy out the minority stockholders at some prearranged price. But the entrepreneurs, that is, the people who are responsible directly for developing the innovation, are substantial shareholders in their own right.

One advantage of such a relationship is that it eases the compensation problem. Innovative people can command substantial salaries in the managerial organization, as senior research scientists or as senior marketing people. Yet it is highly undesirable to saddle an innovative venture with high salary costs—it cannot afford them. At the same time, it is highly desirable to compensate the entrepreneurs for results. But results in the innovative effort are unlikely to be known for a good many years. A method of compensation which induces these entrepreneurs to work for modest salaries until results are achieved, while promising substantial rewards in case of success whether through stock ownership or through a special bonus—is therefore appropriate. A “partnership” between the company and “entrepreneurs” makes this possible. It also—and this is no small advantage—lessens (although it never completely eliminates) the friction which setting up separate innovative organizations within the company structure otherwise creates.

The same results, however, can also be achieved without a partnership— provided the tax laws permit it (which, in many countries, they no longer do). 3M, for instance, never organized a partnership with its young engineers heading a project team. It never set up a separate corporation in which the entrepreneurs became shareholders. Still, the salaries of the entrepreneurs were kept low until the innovation had proven itself and had become successful. And then the entrepreneurs not only had the opportunity to stay on and manage what they had created, at salaries commensurate to the size and performance of the business they had built they also received handsome bonuses.

Whether these “confederations” in which the entrepreneurs become partners and shareholders will become general will depend as much on the tax laws as on economics or organization structure. The principle, however, is important: compensation of the innovators should be appropriate to the economic reality of the innovating process. This is a process in which the risks are high, the lead time long, and the rewards, in case of success, very great.

Whether the innovating team is a separate company or simply a separate unit, an innovating company is likely to apply some of the design principles of systems management. There will be managerial units engaged in managing what is already known and what is already being done. And there will be innovative units, separate from them, working with them but also working on their own, and charged with their own responsibility. Both will have to report independently of each other to the top-management group and work with top-management people. To innovate within existing organizations will require acceptance of a hybrid and rather complex organization design. It is neither centralized nor decentralized. Within such a company, functional organization, federal decentralization, simulated decentralization, and teams may all be found next to each other and working together.

The innovative organization, the organization that resists stagnation rather than change, is a major challenge to management, private and public. That such organizations are possible, we can assert with confidence; there are enough of them around. But how to make such organizations general, how to make them productive for society, economy, and individual alike, is still largely an unsolved task. There is every indication that the period ahead will be an innovative one, one of rapid change in technology, society, economy, and institutions. There is every indication, therefore, that the innovative organization will have to be developed into a central institution for the last quarter of the twentieth century.