Category: Innovation

A few years ago I was sitting in a classroom at the London School of Economics debating unemployment with my nobel prize winning professor. The conversation was centered around another LSE nobel prize winner, Ronald Coase, who in 1937 observed in his scholarly paper, The Nature of the Firm, that firms exist in order to reduce transaction costs and take advantage of economies of scale. Barring external forces, firms will tend to grow larger and larger over time. This is the fundamental economic framework powering the world economy since the industrial revolution, driving corporate behaviors such as: corporate structure, the rise of M&A, and 20th century management theory.

A few weeks later, Ronald Coase at 101 years old, would go on a podcast and declare his 80 year old nobel winning thesis obsolete. No longer do you need to scale the size of a firm just to obtain efficiency, with modern technology and today’s demographics, you can capture the same value with much smaller firms. Companies will still grow to be larger over time, however, they won’t grow as large as they have in the past.

Since then I have been thinking deeply about what has broken down Coase’s theory which was the fundamental underpinning of the world economy since the Industrial Revolution. After several years of reflection on this, I have come up with four forces:

• The rise of the freelancer economy
• Millennials’ behaviors and impact
• IoT and lean hardware
• SaaS economics and the democratization of IT

The Rise of the Freelancer Economy

According to a report by Intuit, by 2020 approximately 40 percent of the U.S. workforce will be working as freelancers. Another study predicts 50% by 2025. As more members of the workforce decide to freelance, the number of marketplaces to facilitate them will proliferate. In the past you would hire the reputation of a Brand. Tomorrow freelancers will build a reputation on a marketplace and the marketplaces will build a brand.

This trend will lead to more commodity based and strategic outsourcing. Commodity based outsourcing will consist of outsourcing HR, legal, accounting/finance, manufacturing, and software development. Strategic based outsourcing via the freelancer economy will outsource product development, design, and even management.

Millennials’ Behaviors and Impact

By 2020, Millennials will consist of 20% of the workforce, and by 2025, 75%. Millennials were born mobile and digital; their behaviors will change the way companies interact with their customers as well as how companies interact with their employees. Everything changes from preferred methods of communications (messaging) to marketing (social media) to commerce (mobile first). Traditional management models start to break down with Millennials managing Millennials and selling to Millennials.

IoT and Lean Hardware

At the same time the Millennials are taking over the workforce, we will have 26 billion IoT sensors in production and connected to the internet by 2020. Cheap sensors and widespread availability lead to more big data driven analysis about everything from the lighting in your office, self-driving cars, the temperature of your home, to how your dishwasher runs. Abundant sensors combined with cheaper and small batch manufacturing will drastically change business models, pushing them to be more service oriented. Robotics and AI will eliminate most unskilled jobs, driving employment to be more skilled and knowledge based.

SaaS Economics and the Democratization of IT

While the move to the cloud has already begun, over the next few years, it will be massive. The economics of SaaS software has shifted the decision making power to the line worker from the management and IT. Since you can swiftly deploy cloud-based software within your organization with a free trial, cheap monthly credit card payment, and no physical installation, employees are now making the purchasing decisions, not the IT department. This is breaking down siloed data, enabling remote/distributed teams, and creating more capital efficient companies.

The Next 10 Years

As we enter the post-Industrial era, the dynamics of the firm and the workforce are going to change radically. As the forces that are breaking down Coase’s model only grow stronger, many companies are remaining stagnant. The success of a company no longer depends on growing larger, but now depends on being the optimal size in order to fend off the disruptive smaller companies. Google figured this out when it broke the company into smaller pieces and formed the parent holding company, Alphabet.

The larger this gap between big and optimal sized companies grows, the less chance there is of survival for companies trying to grow by growing bigger, opening up great opportunities for disruptive startup companies. Even more interesting is that this transformation will happen in the next ten years. How tomorrow works is radically different than it is today.

Innovation is a goal across the startup, corporate and non-profit worlds. But our education system and work environments have trained us to pass tests, follow orders and respond to requests. No wonder true innovation is still rare.

Fortunately, we all at some point in our lives experienced curiosity, which is the first step of innovation. The next steps are simply to observe, ask questions and experiment. But what should people be looking for when observing? Which questions lead to insight? How can experiments be most helpful?

The following six paths have worked in the past, sometimes spectacularly well. They all start with curiosity and end with innovation but each path is different.

Innovation Path 1: Connections
When the iPhone was first introduced, it was presented as combining phone + music + Internet. All of those individual components had existed before the iPhone. Nokia was one of the world’s largest companies serving mass market phones, Apple itself had a thriving iPod music player business at the time and Internet access was widespread in other forms. The combined value of making connections is non-linear, with the biggest benefits typically emerging as surprises. The app store was not mentioned in the original press release, and yet apps became the defining idea of the iPhone.

Innovation Path 2: Outliers
In 1988, Christian Sommer was snorkeling on the coast of Italy collecting sea creatures for further study. He collected hundreds of these and observed them in his petri dishes, recording their life cycle. One rare species, Turritopsis dohrnii, did something very strange: it appeared to age in reverse, getting younger until reaching its earliest stage of development, and then reversing and starting to age again. This process contradicted a basic law of nature, that life progress forward until death, an outlier of huge magnitude. Sommer, to his credit, did not ignore the observation. Even decades later, we still do not know much about what is really going on in this case, but this jellyfish may hold the secret to immortality.

Innovation Path 3: Patterns
Imagine spending some time tutoring your cousin in math over the phone. Things go surprisingly well and so you also start tutoring the cousin’s brothers. Word spreads, a few more people ask to be tutored. Since scheduling becomes a real challenge because you have a full time job, you start posting videos online. More and more people keep watching. This is the pattern that Sal Khan experienced starting in August 2004 and it led to the formation of Khan Academy, impacting millions of lives and resulting in more than one billion questions answered. Humans are natural pattern spotters and so the challenge is to remain objective enough to separate true patterns from the ones we wish would appear.

Innovation Path 4: Gaps
Seeing what’s missing is just as important as seeing what’s there. These missing pieces are gaps. The most direct opportunities related to gaps come from problems and frustrations encountered in everyday life, seemingly obvious and yet undiscovered. Sara Blakely identified a gap in the market for undergarments. Rather than simply forget about it or complain, she found a solution. Then, she went through the process of filing a patent on her idea and continued on the journey of turning the solution into a very successful business, Spanx. The company has evolved to include multiple products based on the original foundation of seeing what’s missing and filling the gaps.

Innovation Path 5: New applications
Sometimes, existing constraints help the creative process. When creating a new game for students to play in the winter, PE teacher James Naismith re-purposed what already existed. A ball was important, but rather than kicking the ball or running with hit, he focused on passing the ball and then throwing it at a target. The target was also a new application for an existing object, a peach basket. Combining the two key components gave the new sport its name: basketball. The score in the first game was 1-0. Clearly, the game has evolved over time while having a tremendous impact on society. But at the origin, there were no grand plans of creating an empire, just a simple goal of creating a new sport to play in the winter using existing tools.

Innovation Path 6: First principles
In order to build SpaceX and Tesla, Elon Musk used a first principles approach. Rather than relying on analogy and observing what other people were already doing, he focused on truly understanding limitations at a physical level. Pushing those limitations created the opportunity to simultaneously create new performance standards and reduce costs by up to a factor of 50x. This is not an easy approach to take and patience is definitely required, but the potential upside from breakthroughs is substantial as the examples of both SpaceX and Tesla have proven.

Every one of these paths to innovation starts with curiosity but each approach is unique. Understanding the core idea underlying each approach is helpful as a rough guide. Of course, the biggest innovations usually require going completely off any path and into the unknown.

“Prediction is very difficult, especially if it’s about the future.” – Niels Bohr

The Decision

Imagine that you are a key decision maker at the dominant communication network in the world, having successfully grown through astute acquisitions and network effects. The company’s market value has increased by more than 100x in a short period of time and you are now clearly the market leader.

Along comes a new startup with a proposal, actually a founder and his angel investors who are short of money and are looking for a face saving exit. They are asking for US$100,000 in exchange for their business. Of course, their business has no revenue and their new technology looks like a toy. Your internal team is far superior and has concluded that there is nothing interesting. The chances of this new toy market taking off are extremely small. Finally, even if you needed to compete with them, you could move quickly. Therefore, you dismiss them.

This is no imaginary case. The dominant communication network is the telegraph, owned and operated by the Telegraphy Company. The investors are Gardiner Hubbard and Thomas Sanders. The founder is Alexander Graham Bell and the toy is the telephone.

Of course, it turned out that the incumbent underestimated the founder and his investors, the toy market was not a toy after all and even when the Telegraph Company entered the telephone market it could not win, finally transforming entirely to become a money transfer business.

Problems and Solutions

Why is story from history particularly relevant today? All around the world, incumbents are vulnerable like the Telegraph Company. A downward spiral can begin anytime as the number of startups continues to grow. What are the key problems and, more importantly, solutions for improving corporate innovation?

Problem #1

The smartest people are always and without exception outside of your company.

Solution #1

Build a diverse network outside of your company. This means more than simply going to conferences and collecting business cards. It means building strategic relationships with key players who have diverse networks themselves. The focus should especially be on people connected with early stage startups because that is the most diverse ecosystem and large companies are poorly equipped to try and engage directly with early stage startups.

Problem #2

The structure of power laws results in impact being more important than probability.

Solution #2

Focus on imagination, not knowledge. Knowledge deals with what has happened in the past. It anchors our reality, which is generally helpful for day to day living, but is relatively poor at dealing with power laws and high impact but low probability events. Imagination empowers us to think about the future without the constraints of knowledge. The best way to start building something like imagination is through habits, starting small at first.

Problem #3

The world is path dependent and small inflection points have significant consequences.

Solution #3

Experiment early despite limited information. It is tempting to rely on being a fast follower but, as the Telegraph Company found out, even reversing a decision quickly may already be too late. Instead, it is more helpful to have a portfolio of experiments. That way, you can be involved in potential breakthroughs before it is too late. In addition, even the unsuccessful experiments will result in some learning, building the foundation for better decision making.

Beyond Predictions

Rather than being discrete problems and solutions, all of these issues are related and can be integrated. The common theme is that large companies should to find ways to engage with the diverse startup ecosystems globally.

Of course, the actual mechanics of engagement are not trivial. Holding contests and events is helpful for marketing but does not really address the issue of deeper engagement. On the other extreme, starting a corporate venture capital fund is not simple. For most companies, the most practical route is to partner with early stage venture funds who can act as a bridge with startups.

Regardless of the implementation, all companies need to find a way to make better decisions about the future and their corporate innovation strategy in order to avoid being replaced by toys which transform into platforms.