In the first three parts of our four part series on innovative business models we looked at the need for innovation and the drivers and enablers of innovation. In our final publication we look at who is innovating and what lessons we can learn from them.
In previous publications we have discussed the why, what and where of innovation. We conclude our four part series on business model innovation by looking at the who and how of innovation.
Who is innovating
Globally small business is driving innovation. What can Australia do to encourage this, and what can big business learn from them?
Small businesses in Australia account for around 35% of GDP. The Australian economy is primarily powered by medium and large enterprises.1 However, a recent study of 87 international business model innovation examples identified that over half were developed by small and medium sized businesses, and less than 10% were developed by the Global Fortune 500. Small businesses therefore represent a critical reservoir of innovation potential.
Business model innovation can occur in all industries, but a recent review identified retail, food and beverage, consumer durables and financial services as areas with the highest prevalence of identified business model innovation. Together, these industries represented over a third of all businesses reviewed.
It is not clear why these industries in particular were receptive to business model innovation. It could be their relative receptivity to new technology solutions3, or perhaps the predominant consumer focus of these industries enabled them to exploit changing consumer trends.
Startups - a treasure trove of fresh ideas
Given the preponderance of business model innovation within startup organisations, and their leveraging of new technologies to deliver new value propositions, it is perhaps not surprising that a recent report has identified the Australian technology startup sector as having the potential to contribute $109 billion (or 4% of GDP) to the Australian economy by 2033. But will the conditions be right to realise this potential?
The Australian technology sector is currently small. In 2012 there were 1,500 tech startups in Australia, with key hubs in Sydney and Melbourne. These firms range from one or two person startups created in the last 12 months, to more established businesses that have been around for a decade. There were very few startups between 2001 to 2006 that still exist today, but a significant increase of activity from 2007 onwards has created many of current startups.
An assumptions based model developed by PWC suggests there is potential for this sector to increase exponentially over the next 20 years. Although the growth path is unlikely to be linear. Assuming a 20% conversion rate of interested entrepreneurs to founders (based on Global Entrepreneurship Monitor survey data), and a 40% 'serial founder' rate (2 in 5 founders try again), 8,000 potential founders need to be interested in joining the tech startup community in 2014. Extrapolating this forward to 2023, 5,600 new tech startups would be required.4
This would be a significant achievement. But does Australia have the necessary economic ecosystem to achieve this?
Ecosystem for entrepreneurial growth
Culture, skills, opening markets, funding and regulation are the main areas of action that can accelerate the growth of startup ecosystems.5
The availability of startup funding is critical for fostering growth in tech startups. Funding for the sector exists but is in short supply. In 2012, $53 million was invested in 62 first round deals and there were 20 Venture Capital funds with around $600 million to invest.
In 2012 there were around 40 Accelerator and Incubator deals, 39 Angel and Micro-VCs deals ($21 million invested) and 15 early stage VC deals ($10 million invested).
Angels are the fastest growing investor group, but overall funding is relatively scarce. This is expected as VC funds are yet to generate sufficient returns to attract significant additional capital and deal values are currently too small for super funds to participate.
Recent global research suggests that almost 11 out of 12 startups will fail, so the 1 in 12 needs to generate sufficient returns on the whole for the investor to find the asset class worthwhile. The fact is that Australian VCs have had an overall industry track record of poor returns.
Unless and until the track record improves, startup funding is likely to remain relative scarce and lag behind many other developed nations.6
Startup industry focus - are we missing opportunities?
More than three quarters of Australian tech startups are focused on the Information Media and Telecommunications sector. Given the disruptive power of new technology, it is not surprising to see a bias toward technology related industries, but are opportunities in other industries being underserved?7
"There are additional opportunities for startups to tap into other larger industries in Australia today such as Finance and Insurance and Manufacturing. Over the longer term, the Health Care and Social Assistance industry will provide significant opportunities as the fastest growing industry in Australia and the expected highest contributor to GDP in 2050."
How to innovate
Understanding innovation and implementing it are two very different things. What steps should businesses follow to encourage business model innovation, and what are the associated risks?
Small companies want to be large. Large companies want to be small.
Startups are fertile ground for the development of innovative business models. But, as we have seen, the ecosystem necessary for their incubation is not fully developed and they are fragile entities with high failure rates. Large, existing firms, by contrast, have the resources to incubate and develop innovation, but often do not do so. Why? And how can this be overcome?
A question of physics
Established businesses, particularly large ones, have mass. Mass can be physical; warehouses of inventory, investment in fixed plant, investment in technology systems and hardware, large workforce. It can also be non-physical; long term contracts, long established ways of doing things, debt, internal process and bureaucracy. The laws of physics dictate that the larger the mass of an object, the more energy is required to change its direction. The same can be said for businesses.8
Business model innovation demands the courage to examine and challenge the dominant logic and a willingness to try something new. Established businesses typically have vested interests that stymie this approach. They lack the agility and flexibility of smaller businesses.9
There are ways to tackle these issues though. A number of large businesses have managed to demonstrate considerable innovation by emulating the agility and flexibility of their smaller counterparts through a number of methods.
Innovation platforms provide an avenue for large businesses to find and invest in, or pilot, innovative business models. For example, Proctor & Gamble launched 'Corporate Platforms', with responsibility and resources to disrupt existing business models through the exploration of new technologies and smarter products. One partnership, with an equity based Crowdfunding community called CircleUp, provides Proctor & Gamble with the means to identify business model innovations and new consumer products at an early stage.10
In house venture funds
In house venture funds allow large businesses to incubate and invest in early and mid stage startup ventures. For example, through BMW's iVenture arm, BMW has made a number of investments in start up ventures focusing on the area of mobility services. Investments have included ParkatmyHouse (the 'AirBnB of parking) and ChargePoint (an electric vehicle charging company). Closer to home, both Telstra and Westpac have recently launched their own venture funds. Funds of this type appear to work because they provide access to 'two kids in the garage' without direct exposure to the high failure risk associated with highly disruptive innovation.11
A recent US survey has shown the majority of CFOs are willing to abandon valuable projects in order to meet quarterly profit expectations. Google was forced to close its in-house development playground Google Labs after it was criticised for a lack of focus. Other research has shown that firms whose financial statements are analysed by a large number of financial analysts tend to produce less innovation: they generate fewer patents and patents with lower impact.12
Startups and venture capitalists do not suffer the same pressure: they are intrinsically less transparent and thus 'protected' from the scrutiny of financial analysts and activist investors. In house venture funds provide a way for large businesses to tap into this source of innovation without the same degree of short term accountability.
Acquisition is another way of 'buying in' innovation that has been particularly popular in the automobile industry. Large corporations have acquired carsharing start ups (Avis bought ZipCar in 2013), launched their own car sharing services (Daimler, BMW and VW) and partnered to target new consumers (Toyota connected with a real estate developer in Tokyo to offer electric vehicle sharing in local condominiums).13
Open innovation: innovative innovation
Innovation platforms, in house venture funds and acquisitions are all examples of open innovation. The term 'open innovation' was originally coined by Henry Chesbrough, and refers to a company opening up its research process to outside parties. It is, in essence, an innovative approach to innovation.14
Open innovation can be used by companies to create and capture value by systematically collaborating with outside partners. Such 'open innovation', it is argued, is more likely to create value than traditional 'closed innovation'.
Under the concept of innovation that prevailed during most of the 20th century, companies attained competitive advantage by finding large research laboratories that developed technologies that formed the basis of new products. Successful new products commanded high profit margins that could then be invested back into research. Vertical integration of the research function meant that firms that could not afford such research were at a disadvantage.15
"Open Innovation is fundamentally about operating in a world of abundant knowledge, where not all the smart people work for you, so you better go find them, connect to them, and build upon what they can do."
Open business models
How do you open up innovation with a business? Chesbrough distinguishes between 'outside-in' innovation and 'inside-out' innovation and business models exist for both approaches.17
|Outside-In innovation is when an organisation brings external ideas, technology, or intellectual property into its development and commercialisation processes.||Inside-Out innovation is when an organisation licenses or sells its intellectual property or technologies, particularly unused assets.|
|In the early 2000's the newly installed CEO at Proctor & Gamble rejuvenated the business by re-focusing on innovation. Rather than boosting R&D spending, a new innovation culture of 'Connect & Develop' was introduced, aimed at exploiting internal research through outside partnerships.||The inside-out approach to open innovation ordinarily focuses on monetizing unused internal assets (normally patents and technology). GlaxoSmithKline's patent pool research strategy was slightly different. The goal was to make drugs more accessible in the world's poorest countries and to facilitate research into understudied diseases.|
|Three 'bridges' were built into its business model: technology entrepreneurs (senior scientists within P&G who developed relationships with researchers at universities and other companies and acted as 'hunters' for outside solutions to internal P&G challenges), internet platforms (through which P&G connects with expert problem-solvers around the world who earn cash prizes for developing successful solutions) and retired scientists.||To achieve this, relevant IP was placed into a patent pool open to exploration by other researchers.18|
The risks of innovation
Innovation is difficult. It can also be risky. Whilst the argument that breakthrough innovation should be the growth strategy of last resort is probably overstating the position, gaining maximum advantage out of minimal innovation can be a sensible approach.
"Like swinging for the grand slam in baseball or betting on the trifecta in horse racing, going for broke with innovation is glamorous. Breakthrough innovations, whether the next blockbuster product or a next-generation business model, create a buzz in the boardroom while lesser forms of innovation go unnoticed".
Fostering business model innovation
Business model innovation promises much, but there can be formidable barriers to achieving it. Research and experience highlight a number of insights for companies looking to create new models of doing business.
Final word - five lessons from LEGO
LEGO is widely regarded as the most innovative toy company in the world. Riding high on the recent success of the blockbuster LEGO movie (which has grossed US$450 million to date) and a string of successful product launches, it is hard to imagine it was on the brink of insolvency ten years ago. Innovation helped revive LEGO's fortunes. But it also contributed to it near demise. LEGO has much to teach us about how (and how not) to innovate.
LEGO was founded in 1949 and through the second half of the twentieth century became a dominant player in the world-wide toy market. Then in 2003 they were very nearly insolvent. But since then, LEGO has reoriented and reinvented itself.
Both the near demise and subsequent resurrection were driven by innovation.
Lesson 1 - Explore the full spectrum of innovation . . .
LEGO has been unafraid to experiment with emerging new technologies to extend its brand from the world of physical play to the world of digital play. This is especially important because the current generation is growing up as the first all-digital generation. They are growing up with tablets and smartphones and expect to use them everywhere they go. LEGO has responded by searching out relevant technologies that are both relevant and complementary to the basic LEGO brick.
It's hard to think of a single other company that has so successfully bridged the gap between physical play and virtual play. Since 1998, when LEGO began releasing its DIY Mindstorms kits, people have been increasingly able to assemble robots, program them via computer, and then control them via a combination of Bluetooth, downloadable apps and voice commands. It's now possible for a child under the age of ten to get an introduction to programming in a way that's fun and intuitive. As new technologies such as augmented reality and 3D printing enter the mainstream, it will be interesting to see how LEGO adapts these trends in the creation of new products that both surprise and delight the next generation of designers, builders and innovators.14
Lesson Two - . . . but stay focused and look for incremental innovations
However, there are risks associated with explorative innovation, and LEGO can testify to them.
In the late 1990s, LEGO's market share had begun to decline. They decided they had to disrupt themselves, before someone else did. The outcome was a string of very expensive failed product launches. LEGO was over-innovating. If we think of innovation as executing new ideas to create value, LEGO were executing plenty of new ideas, but they were not creating much value with them.20
This was exemplified by the Galidor line of sci-fi action figures that completely omitted LEGO's iconic brick. It was a bid to tap into an action figure craze and was to be 'propagated' by its own television series. Fired up by its potential, the leadership team pushed for higher sales forecasts and heavily frontloaded sales channels. But it did not take. The television show - essentially a product pitch - flatlined. And so did sales. It was killed in a year and was LEGO's 'worst-selling' theme ever.
Meanwhile, LEGO was also exploring and expanding the customer experience with LEGOLAND theme parks and LEGO branded stores. Highly ambitious plans called for a new park to be unveiled every two to three years, and for 300 stores to open. Both taxed management know-how and drained an already precarious balance sheet.
The lesson learned? When it comes to ambitious innovations, you reduce the risk by taking a stepwise, learn-as-you go approach.21
LEGO's innovation model from 2003 focused on refresh and reconfigure. The first, simplest type of innovation was to refresh the existing range or products without requiring significant development and manufacturing costs. After the first launch of Bionicle, each subsequent release was an exercise in making incremental improvements. Adding new features, new story lines, and (later) vehicles for the Bionicle characters were small but very profitable innovations.
The next, more challenging innovation was to reconfigure-to change existing building systems or platforms to provide a new customer experience. LEGO had a blockbuster with its Star Wars toys and a minor but promising success with Slizer. Combining the two concepts to produce a set of buildable action figures with a rich, episodic story line meant that LEGO had to blaze a new path to profits, but it was starting from a familiar place. The result was a hit series of toys that generated significant sales for almost a decade.22
Lesson Three - Be customer Driven
In all of the pre-2003 innovation efforts, LEGO was obsessed with novelty - with doing new things. But they were so far removed from understanding what their customers wanted (or even who they were), that these new ideas failed to create value. Many of the misfires prior to 2003 were the result of not understanding what kids wanted. Most of the new products were based on assumptions about this, not on feedback from the customer base.
They thought that the power was in the brand, so they launched things like LEGO TV series. But really, the power was in the bricks. It was refocusing on this that started to turn the firm around.23
Lesson Four - Tap into the power of the crowd
With the arrival of the video games age the plastic bricks were seen as passe and children were ignoring them in their droves. All that changed when the company started to pay more attention to its relationship with its customers and with the introduction of Lego Mindstorms - programmable Lego bricks equipped with sensors that allow consumers to create moveable Lego designs and robots.
The product took a number of years to develop and Lego worked in close association with software developers and engineers at MIT.
Within three weeks of Mindstorms being launched more than 1,000 advanced users - in a campaign coordinated on the web - had hacked into the software that came with the construction toys to make unauthorized modifications with new functions. These were designs that were completely original and unforeseen by the company. Within a short space of time the hackers had vastly improved the original product and this resulted in many more units being sold, particularly to customers over the age of 18, who were not Lego's target market.
Initially Lego management were against these actions and even entertained the thought that the hacking might be illegal. However, in time Lego stopped fighting the hackers as they realized how beneficial their activities could be and therefore it opened up its software to see what customers would create.
Rather than rely solely on its own R&D department Lego thought it would be advantageous to tap the innovations of others. It's a case of simple math. Seven people from MIT worked on the original concept and they came up with a neat product. But that's nothing compared to the brain power of thousands of specialist users. This initiative was so successful that the next generation of Mindstorm products was developed with user-designed parts.24
Lesson Five - Build an innovation culture
Prior to 2003, LEGO management failed to build a strong and supporting innovation culture. The challenges of attracting top design talent to LEGO's headquarters in remote Billund, Denmark resulted in the creation of small project teams around the world. But those teams were never connected with the core product development teams, so their ventures went nowhere but management insisted on risk-taking, there was little tolerance for the number of failures being experienced. They were swept under the rug, not learned from. And while exhorting people to 'think different' when management was challenged, as happened with its decision to discard its mainstay sub-brand DUPLO for pre-schoolers, dissenters were told in no uncertain terms to fall in line.25
Central to LEGO's turnaround was a new structure for strategically coordinating innovation activities, led by a cross-functional team: the Executive Innovation Governance Group. LEGO managers take a broad view of innovation that includes not only new products but pricing plans, community building, business processes, and channels to market, all of which can be powerful business drivers. The company distributes responsibilities for innovation in all areas across four groups and expects different degrees of innovativeness from each of them.26
1Key statistics. Australian small business, Department of Innovation, Industry, Science and Research. Web 14 May 2014 http://workspace.unpan.org/sites/internet/Documents/UNPAN92675.pdf
2Model Behaviour: 20 Business Models for Sustainability, February 2014, SustainAbility. Web 9 April 2014 http://www.sustainability.com/library/attachment/470
4The startup economy - how to support tech startups and accelerate. Australian innovation PWC, April 2013. Web 8 May 2014 http://www.digitalpulse.pwc.com.au/wp-content/uploads/2013/04/PwC-Google-The-startup-economy-2013.pdf
8Rework - change the way you work forever, Jason Fried & David Heinemeier Hansson, 2010
9Model Behaviour: 20 Business Models for Sustainability, February 2014, SustainAbility. Web 9 April 2014
12Free to fail: why corporates are learning to love venture capital, Marco Navone, Senior Lecturer in Finance at University of Technology, Sydney, The Conversation. Web 8 May 2014 http://theconversation.com/free-to-fail-why-corporates-are-learning-to-love-venture-capital-24903
13Model Behaviour: 20 Business Models for Sustainability, February 2014, SustainAbility. Web 9 April 2014
14Business Model Generation, Alexander Osterwalder & Yves Pigneur, 2010. businessmodelgeneration.com
15Open innovation, QuickMBA.com. Web 16 April 2014 http://www.quickmba.com/entre/open-innovation/
17Business Model Generation, Alexander Osterwalder & Yves Pigneur, 2010. businessmodelgeneration.com
19Why LEGO is the most innovative toy company in the world, Dominic Basulto, Washington Post. Web 17 April 2014 http://www.washingtonpost.com/blogs/innovations/wp/2014/02/13/why-lego-is-the-most-innovative-toy-company-in-the-world/
20Innovation lessons from the rise, fall, and rise of LEO, Time Kastelle. Web 17 April 2014 http://timkastelle.org/blog/2013/10/innovation-lessons-from-the-rise-fall-and-rise-of-lego/
21How LEGO built up from innovation rubble, forbes.com. Web 17 April 2014 http://www.forbes.com/sites/scottdavis/2013/09/24/how-lego-built-up-from-innovation-rubble/
22Innovation lessons from the rise, fall, and rise of LEO, Time Kastelle. Web 17 April 2014 http://timkastelle.org/blog/2013/10/innovation-lessons-from-the-rise-fall-and-rise-of-lego/
24Lego success built on open innovation, IdeaConnection. Web 17 April 2014 http://www. ideaconnection.com/open-innovation-success/Lego-Success-Built-on-Open-Innovation-00258.html
25How LEGO built up from innovation rubble, forbes.com. Web 17 April 2014 http://www.forbes.com/sites/scottdavis/2013/09/24/how-lego-built-up-from-innovation-rubble/
26Innovating a turnaround at LEGO, Harvard Business Review, September 2009. Web 17 April 2014 http://hbr.org/2009/09/innovating-a-turnaround-at-lego/ar/1
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.