The Three Key Reasons to Keep Innovating

Everyone can agree that innovation is import--for every type of organization. I was reading the "Innovator's Solution" the other day and Christensen made an interesting observation in one of his footnotes that I think is worthy of further discussion, which are the three key reasons to keep innovating: to keep investors happy, to keep employees, and to enable the adoption of technology.

First the traditional view: keeping investors happy. I did a hasty search on the web to see what other bloggers are saying about why innovation is important and from what I can tell they give several reasons that support only this one. Frankly, I think growing profitability and market share are what the general population generally thinks about as the ONLY reason to innovate. Out of the three reasons, this one is the only one that is directly measurable--the hard reasoning--but there are two soft reasons which are dependent on this first one.

Innovation is important for keeping employees also. So long as the company is growing the employees will have a sense that there are opportunities for career opportunities. As growth slows the sense that career opportunities lie outside the firm will be perceived more and more frequently. Unfortunately, it will be the top employees that will have the greatest opportunities, which means it is the less capable employees that are left to shoulder the firm's growth.

The third reason to keep innovating is that investment in new technologies becomes more difficult. When the firm stops growing it will have to do more with what its got because it will be less capable to support the capital investment required to bring new technologies into the organizational architecture.

No one needs to be reminded why innovation is important--the idea is intuitive. Nevertheless, as you are looking at new companies to invest in or work for you can ask yourself if the pace of innovation in the firm under inspection can be sustained to keep the top talent AND whether they are able to invest in new innovations. The two soft reasons to innovate support the major reason to innovate and are the key to impacting the fundamental metrics of innovation: product value, costs and the pace of innovation. 

How Product & Service Innovation Works: Disequilibrium, Discovery and Entrepreneurship

Full Speed Ahead
"The only way to beat the competition is to stop trying to beat the competition."1 In Blue Ocean Strategy, the authors describe the insanity of traditional strategic management logic which guides managers to fight head-on battles with competitors; to fight for the same customers; and to take actions that ultimately commoditize products and services. Blue Oceans are lucrative market spaces with a relative absence of direct competition. Although traditional strategic management definitely has its place, they do offer an attractive line of thinking.

Tactical and Strategic Entrepreneurship
If you believe as I do, that the landscape of the industries never really stand still, then you might also believe as I do that businesses have continuous opportunities to discover "blue oceans". Nevertheless, in order to navigate the complexity, managers need special tools to help them detect and harness the opportunities that are out there. Clearly, the best tools for evolving the enterprise's strategies are those that detect disequilibriums, aid the discovery of alternative strategies, and uses entrepreneurial analytics to harness value. In this posting, I'd like to delve into how disequilibrium, discovery, and entrepreneurship are the essential components to innovation.

Disequilibrium
In How Markets Work 2 (the inspiration for this post), Kirzner highlights the importance of disequilibrium to entrepreneurship. Kirzner is a proponent of "Austrian economics", which dismisses the mainstream economics notion of market equilibrium:

The set of assumptions required by mainstream theory to demonstrate how a smoothly operating market might work are far too demanding in terms of the economics systems we know. the empirical unrealism of that theory's assumptions suggests that it conclusively demonstrates that real-world markets should not be able to spontaneously co-ordinate. Thus the obvious co-ordinating properties of real-world markets turn out to be counter-intuitive phenomena crying out even more desperately for an explanation.

Austrian economics places a large emphasis on "entrepreneurial discovery", where decentralized decision makers take advantage of disequilibrium to improve upon that individual's future prospects. Namely, "[m]ovements in prices, production methods, choices of outputs, and resource owner incomes generated by entrepreneurial discovery tend to reveal where current allocation patterns are faulty, and to stimulate changes in the corrective direction." Therefore, when an entrepreneur perceives a disequilibrium he/she will make decisions that ultimately affect the entire market dynamic...., which generates new disequilibriums because ultimately the decisions are made based on imperfect information. Alternatively, this concept of disequilibrium brings light to the fact that opportunities may go unnoticed and therefore ungrasped. Indeed, "Boldness, impulse, and hunch are the raw materials of entrepreneurial success (and failure); they seem to render the possibility of systematic, determinate chains of events unlikely."

Discovery
The tools of discovery are both qualitative and quantitative, where the qualitative tools are akin to maps on a submarine which can be used to plot the general path and the quantitative tools are the sonar devices that help to identify and navigate obstacles along the way. An example of a qualitative tool for discovery is the business model canvas offered up by Osterwalder & Pigneur in Business Model Generation.3  Many manager talk about business models, but have a difficult time explaining their business models in a way that everyone shares the same conception. The business model canvas is a great way to represent business models in a visual way such that all the interactions and implications can be made clear. Indeed, the business model canvas was the inspiration for one of the primary tools used by the Wissmann Group, called the Enterprise Value Map. Another example of a powerful qualitative tool was offered in Blue Ocean Strategy, which is referred to a "value curve". Value curves are a graphical technique for comparing alternative business strategies, which make it clear if the business will be engaging competition directly or if they have a strategy that will guide them towards "blue oceans".

Qualitative methods are definitely useful, especially when it comes to pointing the metaphorical ship in the right direction. Nevertheless, quantitative analytics also have a role to play and with the advent of business intelligence (BI) systems there has never been a better time to integrate them into business management systems. Three examples of quantitative tools that can be used to discover disequilibriums are (1) Demand-Price Analysis, (2) the Direct Value Method, and (3) Attribute Value Curve Analysis.4 Demand-Price (DP) Analysis uses point of purchase data to yield estimate of product value (a metric to estimate the market's average willingness-to-pay for a product). Monitoring product value using this technique can make product managers aware of changes to market tastes, competitor offerings and aid in effective value based pricing. The Direct Value Method (DVM) is a survey based tool that helps identify product changes that could improve product value, which can improve profitability and market share. Attribute Value Curve Analysis examines each product attribute for its ability to impact product value. As consumer's preferences are non-linear over the range of an attribute's performance, sometimes making small improvements to an attribute can make huge impacts on overall product value. The key is to know which knob to turn! (see "Value Driven Product Planning and Systems Engineering" to learn more).

Entrepreneurship
Entrepreneurship is about allocating resources in the best way possible to take advantages of perceived disequilibriums in price and supply. Kirzner offers the following key insight to entrepreneurship as it relates to disequilibrium and discovery:

• At any given moment, businesses are likely to be suffering from unawareness of the true plans of other businesses.
• This business awareness may take the form of undue optimism leading to a disequilibrium price for a good that is too high or too low to clear the market. Disequilibrium prices generate direct disappointment of plans. Such disappointments can be expected to alert entrepreneurs to the true temper of the market. Prices that were too high will tend to be lowered; those that were too low will tend to be bid upwards.
• Unawareness may also take the form of undue pessimism. Sellers may underestimate the eagerness of buyers to buy. Buyers may underestimate the eagerness of sellers to sell. Such unawareness leads to more than one price for the same good. Such price differences constitute opportunities for pure profit and therefore attract the attention of entrepreneurs. 
• In the course of the market movements achieved through disequilibrium, not only will resources and product prices be modified, but resources will be shifted continually from less important uses to more important uses; and undiscovered sources of new resources will tend to be discovered.
• In the real world of incessant change in underlying consumer preferences, resource availabilities and technical possibilities, these corrective tendencies may be partly or wholly frustrated or interrupted. In addition, these tendencies, operating in different parts of the ever-changing market may interrupt and confuse each other. 
• The direction of the powerful forces of entrepreneurial discovery will be shaped and moulded by the above-described systematic and corrective processes of error, disappointment, discovery, and surprise.

Here is the key insight as it relates to entrepreneurship:

In order to innovate, the business must offer superior solutions, which are only made possible through superior abilities to detect new ways to harness value.













1. W.C. Kim and R. Mauborgne (2005). Blue Ocean Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant. 
2. I.M. Kirzner (2000). How Markets Work: Disequilibrium, Entrepreneurship, and Discovery.
3. A. Osterwalder and Y. Pigneur (2010). Business Model Generation.
4. H. Cook and L. Wissmann (2007). Value Driven Product Planning and Systems Engineering.

Clarity Please-A Product Value Metric for Decision Making

In "Clarity Please-Customer Value for an Individual"  I defined the metric to measure a single consumer's willingness to pay, which I labeled VI. Nevertheless, because a market is composed of many consumers, this single estimate of value does us no good when it comes to make decisions involving the whole market. What we need is an overall metric of product value that summarizes the willingness-to-pay of the entire market of consumers. This overall metric is critical to modeling how the market will respond to alternative product and service offerings.

According to Harry E. Cook (an expert in the area of measuring customer value), there are three properties that an overall measure of value for an economic good must possess (Cook 1997):

1. It must have the same units as price
2. The net value of an economic good to the consumer decrease as price approaches value
3. If a product change creates an increase in demand while holding price constant, value has been increased.

Let's say our TV manufacturer wants to determine an overall metric that sums up the willingness-to-pay of those consumers that actually purchased his TVs and he wants to call this metric VB (buyer's value).

Let's also say that the TV manufacturer was able to get a representative sample of the market to participate in a survey that was able to discern the VI of each respondent (idealistic I know, but work with me) and when he graphs out the results it looks like the maroon curve in the figure below. The demand curve between the green and the yellow dots represents the consumers who wouldn't take the TV unless you paid them (maybe its unfashionable to own a TV in their neighborhood!). The demand curve between the yellow and the red dots represent the consumers that believe the TV is a positive economic good (they'd pay for it). The red dot represent the market's reservation price (no one will buy the TV if it is priced larger than the red dot).

Now, for any given price we can draw a line that is tangent to the demand curve and this line will intersect the dollars axis. Let's call this intersection VB (labeled as such in the figure above). This my friends is our metric that provides the TV manufacturer with an overall metric for the willingness-to-pay for those consumers who would actually buy the product. Over the course of this blog we will talk about VB (total product value or just product value) and how business leaders can use it to drive innovation, drive revenue growth, drive profitability, and drive customer satisfaction.