Innovation in the modern sense is about coming up with solutions to defined or not defined problems that can create a new world. Breakthrough innovations might try to solve in a whole new way, well-defined problems. Business innovation might start by finding solutions to well-defined problems by continuously improving on them.
- Innovators as heroes of our times
- When “innovation” meant a death penalty
- Fordism, mass production, process innovation and assembly lines (1930s-1970s)
- The lean manufacturing years and the optimization of the supply chain (the 1970s-1990s)
- The years of financial innovation, private equity, and leveraged buyouts
- Dot-com bubble: a technological Cambrian explosion
- Software ate the world, super angels on the rise
- Lean startup and the birth of demand-side optimization frameworks
- Welcome in the era of demand-side business frameworks and customer-centrism (customer obsession)
- Types of innovation
- From technological innovation to business model innovation
- Is business model innovation the future?
Innovators as heroes of our times
Innovation is at the center of the debate in many endeavors. From business to medicine, and politics. In any of those fields, you will listen to the interviewed experts emphasizing how “innovation” led to the evolution of the field.
As you will learn, innovation became an integral part of today’s public dialogue, and it acquired a positive meaning only in modern times. Indeed, during the past innovation wasn’t coupled with evolution or betterment of things.
As a result, innovation has become an empty concept, meaningless, and used by many but understood by a few.
On FourWeekMBA, I’ve been looking at hundreds of organizations that dominate our times to understand the several facets of innovation, and as we’ll see, companies can evolve, based on several types of innovation, each with its own features.
When “innovation” meant a death penalty
“E pur si muove” (and yet it moves), Galileo Galilei
In 1633, when the Italian mathematician, physicist, and philosopher Galileo Galilei whispered “e pur si muove” (and yet it moves) he could not help but keep defending his theory for which was not the Sun to move around the Earth, but the opposite. The Earth was not, anymore, at the center of the Universe.
That was a breakthrough idea that would lead to a scientific revolution in the centuries to come. And yet it was not well accepted, to say the least. The innovator, just like in Galileo‘s story was a heretic.
The years in which innovation would become synonymous with betterment were still far to come.
The more those people, usually mavericks, outsiders and in many cases individual explorers, built things which were extremely new (what we would later call “breakthrough”) the more innovators went from impostors to heroes.
Until from Marx to Schumpeter, the whole concept of creative destruction became widely accepted.
Fordism, mass production, process innovation and assembly lines (1930s-1970s)
“Any customer can have a car painted any color that he wants so long as it is black.” Henry Ford
When Ford’s Model T got introduced in 1908 that was almost ready for mass production. And yet Ford would say “When I’m through, about everybody will have one.”
A few years later, in 1913, he installed the first moving assembly line. That would be the apex of mass production. According to history.com, “it took (Ford) to build a car from more than 12 hours to two hours and 30 minutes.”
Fordism is well represented by the quote “Any customer can have a car painted any color that he wants so long as it is black.“
And it would become a core paradigm for most of the first and second part of the 20th century. And it would be applied to many industries.
A standardized product improved primarily through the manufacturing processes and division of labor to make it possible to scale and be mass-produced.
Ford combined the car (made for the first time by Karl Benz by the and of the 1800s) and improved on top of the idea of the assembly line (an idea which started to be developed centuries before) for the mass production of cars.
The car would no longer be a product in the hands of a few, rich people.
A mass product needed to be cultural manufacture first. For that, it needed to be functional, affordable but also desirable.
That is how you developed a competitive advantage, and it was also the force that enabled mass production.
When Ray Kroc took over McDonald’s, he leveraged on the existing “Speedy Service System” developed by the McDonald’s brothers (what we would later call “fast food”) which was an incredible process development able to provide an improved product at a faster pace as recounted in digital business models map.
For decades the process, plus the product and the mass appeal would become the dominant mode to transform small businesses in mass manufacturers.
The lean manufacturing years and the optimization of the supply chain (the 1970s-1990s)
“The Japanese auto industry should] catch up with America in three years. Otherwise the Japanese auto industry will never stand on its own.” Kiichiro Toyoda (1945), quoted in: Kazuo Sato (2010), The Anatomy of Japanese Business, p. 135, source wikiquote
Born in Japan the lean manufacturing model became dominant also in the western world as Japanese companies (Toyota would be the bedrock for this model starting 1930s) proved their ability to scale nonetheless their small size.
That happened through the application of the Kaizen or a process of continuous improvement of the supply chain where wasted resources would be gradually reduced to reach a point of perfection.
Lean manufacturing would further help organizations introduce gradual improvements, but quickly, with a process that would be iterative, and fast.
It dominated the western world throughout the 1970s to the end of the 1990s which represented the peak for lean manufacturing.
To be sure lean manufacturing is still a popular operating model today and methodologies built on top of it (like Lean Six Sigma) are still popular in the management world.
In the peak era of mass production and lean manufacturing competitive advantage would be achieved through the optimization of supply-side processes.
The years of financial innovation, private equity, and leveraged buyouts
“What’s worth doing is worth doing for money.” Gordon Gekko in Wall Street, source: imdb.com
While the private equity industry was born in the late 1940s, for most of its years it had been in the shadow. But when the 1980s came, a “financial innovation“called leveraged buyout would become the prime mode of domination.
In short, private equity firms would take over companies with a mixture of equity and debt (primary debt), thus leveraging on what at the time was seen as a financial optimization model.
The private equity fund would take over a company by pumping massive debt. The debt would be issued on the market as a bond, that given its risky features and low credit quality would also get the name of junk bond.
This new financial model, which would become the bedrock for private firms over the years, worked something along these lines:
- The private equity firm uses the target company assets as collateral for the leveraged buyout.
- It starts with a listed, public company that gets delisted.
- The private equity firm pumps debt, which gets issued as obligations (what over the years would be called junk bonds) to repay the debt used in the operation.
- At the same time, the private equity firm aggressively performs cuts to make the balance sheet looks good.
- The cash flow generated by the target company gets used to repay back the debt.
- And the debt itself carries (in theory, as in practice many. of those LBOs would bankrupt target companies) smaller costs, compared to equity, as the company could expense its interest at costs, thus reducing the taxable income (the so-called tax shield).
- The private equity firm would eventually (if the LBO would turn successful) exit with a massive return with a sales of the target company or the listing.
LBOs became very aggressive during the 1980s, culminating in the take over of RJR Nabisco, Inc., an American conglomerate, with. a battle for its control that would be recounted in the book “Barbarians at the Gate: The Fall of RJR Nabisco,” later turned in a popular HBO movie.
During that time, financial structure optimization would be used as a competitive advantage.
To be sure, leverage buyout would also continue throughout the 2000s, and after the explosion of the dot-com bubble.
However, the 1980s represented the apex of this era. And in the meantime another form of private equity financing would dominate after the 1990s: venture capital.
Dot-com bubble: a technological Cambrian explosion
“Great markets make great companies.” Sequoia’s Don Valentine, source: somethingventured.com
As a form of private equity financing, venture capital also got a start during the 1950s. However, it would show its potential when a few capital firms financed a whole industry that would become multi-billion dollar markets (Computer first, Internet later).
During the 1970s venture, capital firms like Kleiner Perkins and Sequoia Capital were born, and over the years the number of venture capital firms would skyrocket.
Venture capital initial rise in the private equity industry
If you recall though, during the 1980s another form of private equity financing would be quite popular (leveraged buyout) and venture capital firms would primarily focus on small technological firms (at the time those were the outsiders), that over the years became the first tech giants.
Venture capital firms developed at a different model focused on the so-called “startup.” Indeed, venture capitalists would finance those startups along several stages of their journey (from idea validation to aggressive growth).
But the impact of venture capital would become even more apparent when, in the middle 1990s, a new technology would prove commercially viable: the Internet.
Silicon Valley would become the center of that revolution. Venture capital firms would double down on the bets placed on internet companies.
In the end, missing a small bet would have meant losing the next tech venture going for a trillion-dollar market.
That gold rush brought to the dot-com bubble.
The new gold rush
The apex of that bubble was a company called Webvan. The first e-commerce company for groceries, Webvan was a brilliant idea backed by the smartest venture capitalists.
The company had acquired almost a billion in venture capital funds, and it was ready to roll. Webvan IPO’d in 1999, just to blow up in 2001 when the dot-com bubble exploded.
Indeed, Webvan’s idea was great. In 2007, Amazon would start AmazonFresh and in 2017, Jeff Bezos’ would further complete the acquisition of Whole Foods. Today the integration between AmazonFresh and Whole Foods is proving brilliant and viable.
But was it just a matter of timing? Indeed, timing mattered, and yet Webvan did have a customer base. Yet it was burning cash at incredible speed.
A viable business model is needed
If the company had iterated with a viable business model, it could have survived the bubble and slowly built a viable company.
Yet Webvan, endowed with massive amounts of capital allocated for market domination (there was no market yet at the time) went all-in with a strategy intended to appeal to everyone, building a massive infrastructure with huge operating costs.
As Webvan highlighted in its financial statements in 2000:
Webvan's facilities do not currently operate at or near their originally designed capacity. Webvan does not expect any of its facilities to operate at designed capacity in the foreseeable future. Webvan cannot assure you that any facility will ever operate at or near its designed capacity.
Webvan ran ahead of its business plan without a reality check. It wasn’t just the peak of the gold rush in Silicon Valley and the fall of the dot-com.
It also showed the weakness of a venture capital model that was trying to dominate the upcoming Internet era based on capital alone.
Software ate the world, super angels on the rise
“Software is eating the world” Marc Andreessen
As the dot-com bubble burst, the survived venture capital firms would pick up from there. For all, the dot-com bubble had brought a lot of attention to the potential commercial applications of the Internet.
And when the bubble bust all those interested in the short gains also got kicked out. The few (both venture capital firms and companies) who survived were craving to focus on the few “killer commercial applications” (e-commerce, media and advertising) that were proving extremely viable.
In those times, super angels acted as “smart money” counteracting upon the previous madness of the dot-com bubble where a lot of “dumb money” had entered the game.
As reported in a 2010 article from FastCompany:
Super angels give startups much less money than VCs, but they expect a lot less in return. Typically, they don’t take a seat on the startup’s board; they take a small stake in the firm and hand over their funds in weeks rather than months. This frees up entrepreneurs to work on building great products rather than worry about satisfying their funders — which, after all, is the only way they’ll succeed.
The whole venture capital game would be shaped by that, and it would become more agile as a consequence.
In this era, growth capital was allocated to that product who was prone to product-market fit.
Lean startup and the birth of demand-side optimization frameworks
“It’s a methodology called the “lean start-up,” and it favors experimentation over elaborate planning, customer feedback over intuition, and iterative design over traditional “big design up front” development.” Steve Blank in Why the Lean Start-Up Changes Everything
Lean startup represents the first application of the principles of lean manufacturing to the demand side.
Where previous models and frameworks looked at optimizing business processes to bring products to market more quickly, or perhaps more efficiently.
During the startup age, where “software was eating the world” many products turned into bits and codes. Thus, (potentially) requiring less time to build, making it possible to release them, even when not perfect.
From physical to digital the whole playbook changed.
In short, the lean startup methodology wouldn’t look anymore at the optimization to reduce waste in terms of the supply chain (software has no additional marginal cost), instead, it becomes a process of iteration where customers need to be brought early on, in the product development process.
That’s because the primary risk isn’t any more time to market or the ability to produce a product at scale, but rather making sure to build something people want.
Where lean software development took inspiration from lean manufacturing. The lean startup methodology would take this further into the business world.
The lean startup practitioner doesn’t spend months in crafting a business plan. Instead, the lean startupper focuses on testing the few untested hypotheses about the business, quickly.
This implies that customers or potential customers needed to be brought in the loop early own in the product development cycle. Thus, making it possible to build a valuable product for a set of customers.
At the core of this methodology sits the customer development process, where several stakeholders (from customers to partners) can give their feedback to help the entrepreneur build a viable business model made of nine building blocks represented in the business model canvas.
During this iterative (or at times abrupt) process of change, entrepreneurs could build their business model and gain a competitive advantage.
This brings us to the era of demand-side business frameworks, where all that mattered was whether customers wanted it, in the first place.
Welcome in the era of demand-side business frameworks and customer-centrism (customer obsession)
At the turn of the century, Amazon was among the company that survived the dot-com bubble, lucky or not, it had to master a new business playbook.
As Jeff Bezos highlighted in Amazon‘s 2018 Shareholders’ Letter:
Much of what we build at AWS is based on listening to customers. It’s critical to ask customers what they want, listen carefully to their answers, and figure out a plan to provide it thoughtfully and quickly (speed matters in business!). No business could thrive without that kind of customer obsession. But it’s also not enough. The biggest needle movers will be things that customers don’t know to ask for. We must invent on their behalf. We have to tap into our own inner imagination about what’s possible.
In this era, a competitive advantage is achieved via a customer-centered approach, where your loyal customers/users base became the most important asset.
Types of innovation
Innovation can come in several formats, depending on whether it uses the past as a foundation for building up the future. And in that case, the process of innovation might be following a gradual, and organic path.
In other cases, innovation follows a whole new set of principles, no longer attached to the past, and in some cases contrasting with that (see how Galileo refuted the previous paradigm).
Another way to look at the types of innovation is highlighted by Greg Satell in the Innovation Matrix by looking on whether a problem is well defined, and whether the domain where this problem might apply is well defined.
As we move in a well defined problem and domain we move in the domain of sustaining innovation. As we move in a context where both the problem and domain are not well defined we have basic research.
This makes us look into four kinds of innovation:
In basic research, according to the Innovation Matrix, both the problem and the domain where the problem needs to be solved are not well defined.
the Godfather of Disruptive Innovation, Clayton Christensen defined it as when new products or services enter at the bottom of a market and overtime move up, thus displacing established incumbents.
While a breakthrough innovation takes a leap forward, it might start with a well-defined problem, which is extremely hard to solve (the domain is not well defined).
As an iterative process, in this case, innovation builds up over time, gradually. There is a pretty clear idea of what problems need to be solved and what skill domains are required to solve them.
From technological innovation to business model innovation
In today’s context when we hear the term innovation most probably the reference is at IT innovation. That’s not a surprise. The PC, then the Internet and all the platforms born on top of it enabled technological innovation to become ubiquitous.
Companies that didn’t exist at the turn of the century, became the tech giants we know today. As we’ll see throughout the guide this is a misconception.
When in 1996, Google (still an academic project is known as BackRub) built a new way to index the web, its search engine took off. Yet, by 1999, Google still hadn’t figured out a whole business model that would also enable revenue traction (it would come a couple of years later with Google AdWords).
It was the combination of technological innovation with a business model innovation (Google would redefine the way advertising was delivered making it relevant and almost invisible to the average user), which made the company scale from a business standpoint.
Is business model innovation the future?
A business model is an holistic concept to describe an organization, and also help it shape the overall business (from product up to profit formula) to evolve in the marketplace.
Business model (or business) innovation comes in many forms. In some cases, that is a recombination of several known business patterns. Those patterns have proved successful in other domains and industries, or for other players in the same industry.
Therefore, a business can experiment with those patterns almost like a chef experiment with ingredients and how by changing the dosage of an ingredient changes the final output.
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