Innovation

The Innovation Value Chain by Morten T. Hansen and Julian Birkinshaw

From the Magazine (June 2007)

Summary.   Reprint: R0706J The challenges of coming up with fresh ideas and

realizing profits from them are different for every company. One firm may excel at

finding good ideas but may have weak systems for bringing them to market.

Another organization may have a terrific…

Executives in large companies often ask themselves, “Why aren’t we

better at innovation?” After all, there is no shortage of sound advice

on how to improve: Come up with better ideas. Look outside the

company for concepts and partners. Establish different funding

mechanisms. Protect the new and radically different businesses from

the old. Sharpen the execution.

Such strategic counsel, however, is based on the assumption that all

organizations face the same obstacles to developing new products,

services, or lines of business. In reality, innovation challenges differ

from firm to firm, and otherwise commonly followed advice can be

wasteful, even harmful, if applied to the wrong situations.

Consider how two different CEOs confronted the innovation

challenges facing their companies. When Steve Bennett joined Intuit,

the maker of the financial software programs Quicken and

QuickBooks, in January 2000, it was a company with lots of ideas—

more

most collected from outside the organization—but little discipline for

bringing those ideas to market. “We had a lot of energy focused on

learning from customers,” the CEO recalls, “but we were struggling to

decide which ideas would have the highest impact.” To fix this,

Bennett demanded that clear business objectives be set for ideas in

development, and he held people accountable for delivering on them.

Intuit is now just as good at executing on ideas as it is at generating

them. The company’s revenues and profits are up 47% and 65%,

respectively, from three years ago, in part because of this effort.

About the same time that Bennett took the helm at Intuit, A.G. Lafley

became CEO of Procter & Gamble, a company that had traditionally

been good mainly at developing new products internally and bringing

them to market. But a persistent weakness was its insular culture.

Lafley wanted the company to become better at cultivating ideas from

the outside. After five years of investments, P&G now has a state-of-

the-art process for sourcing ideas externally, which includes a global

network of resources and online knowledge-exchange sites. This

process complements P&G’s core competency in executing on ideas

and has helped fuel an increase in sales and profits of 42% and 84%,

respectively, over the past five years.

Bennett and Lafley faced different innovation challenges, which

required different solutions. Intuit and Procter & Gamble probably

would be worse off today had their CEOs simply imported the latest

best practices in innovation management. Now consider a computer

hardware company we analyzed. Buying into the latest advice about

innovation—companies should focus on generating more ideas—

managers set up a series of formal brainstorming sessions. Idea

generation wasn’t the problem, however. The company had

inadequate screening and funding processes: Concepts never

flourished, nor did they die. The brainstorming sessions actually

aggravated the innovation process—employees were pumping more

and more ideas into an already badly broken system.

Even the strongest dose of the best analgesic on the market won’t

help mend a broken bone. Likewise, companies can’t just import the

latest fads in innovation to cure what’s ailing them. Instead, they need

to consider their existing processes for creating innovations, pinpoint

their unique challenges, and develop ways to address them. In this

article, we offer a comprehensive framework—“the innovation value

chain”—for doing just that.

The innovation value chain is derived from the findings of five large

research projects on innovation that we undertook over the past

decade. We interviewed more than 130 executives from over 30

multinationals in North America and Europe. We also surveyed 4,000

nonexecutive employees in 15 multinationals, and we analyzed

innovation effectiveness in 120 new-product-development projects

and 100 corporate venturing units.

The innovation value chain view presents innovation as a sequential,

three-phase process that involves idea generation, idea development,

and the diffusion of developed concepts. Across all the phases,

managers must perform six critical tasks—internal sourcing, cross-

unit sourcing, external sourcing, selection, development, and

companywide spread of the idea. Each is a link in the chain. Along the

innovation value chain, there may be one or more activities that a

company excels in—the firm’s strongest links. Conversely, there may

be one or more activities that a company struggles with—the firm’s

weakest links. (See the exhibit “The Innovation Value Chain: An

Integrated Flow.”)

The Innovation Value Chain: An Integrated Flow

Viewing innovation as an end-to-end process rather than

focusing on a part allows you to spot both the weakest

and the strongest …

Our framework asks executives to take an end-to-end view of their

innovation efforts. It discourages managers from reflexively

importing innovation practices that may address a part of the chain

but not necessarily the one that the company needs to improve most.

It centers their attention on the weakest links and prompts executives

to be more selective about which practices to apply in their quest for

improved innovation performance.

The innovation value chain can also help managers realize that a

perceived innovation strength may actually turn out to be a weakness:

When managers target only the strongest links in the innovation

value chain—heeding popular advice for bolstering a core capability

in, say, idea generation or diffusion—they often further debilitate the

weakest parts of the chain, compromising their innovation

capabilities overall.

Think Innovation Value Chain

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To improve innovation, executives need to view the process of

transforming ideas into commercial outputs as an integrated flow—

rather like Michael Porter’s value chain for transforming raw

materials into finished goods. The first of the three phases in the

chain is to generate ideas; this can happen inside a unit, across units

in a company, or outside the firm. The second phase is to convert

ideas, or, more specifically, select ideas for funding and developing

them into products or practices. The third is to diffuse those products

and practices. Let’s examine the activities and challenges associated

with each.

Idea generation.

Executives understand that innovation starts with good ideas—but

where do these concepts come from? Managers naturally look first

inside their own functional groups or business units for creative

sparks; they usually find they have a pretty good sense of what’s close

at hand. The bigger sparks, they discover, are ignited when fragments

of ideas come together—specifically, when individuals across units

brainstorm or when companies tap external partners for ideas.

Cross-unit collaboration—combining insights and knowledge from

different parts of the same company in order to develop new products

and businesses—is not easily achieved. Decentralized organizational

structures and geographical dispersion make it hard for people to

work across units. Managers at Bertelsmann, the large German global

media company, took a staggering three years to catch up with

Amazon in launching an online bookstore, in large part because of

their company’s decentralized makeup. Bertelsmann’s autonomous

publishing houses, book and music clubs, and distribution and

multimedia divisions could not and did not collaborate on this new

business opportunity.

Companies also need to assess whether they are sourcing enough

good ideas from outside the company and even outside the industry—

that is, tapping into the insights and knowledge of customers, end

users, competitors, universities, independent entrepreneurs,

investors, inventors, scientists, and suppliers. Many companies do

this poorly, resulting in missed opportunities and lower innovation

productivity. Sony, for example, had an impressive track record

throughout the 1980s for developing new-to-the-world products such

as the Walkman and PlayStation. But by the 1990s, the company’s

engineers were becoming increasingly insular. As CEO Sir Howard

Stringer recalled in a 2005 New Yorker article, the engineers started

to suffer from a damaging “not invented here syndrome,” even as

rivals were introducing next-generation products such as the iPod

and Xbox. As a result of their belief that outside ideas were not as

good as inside ones, they missed opportunities in such areas as MP3

players and flat-screen TVs and developed unwanted products—

cameras that weren’t compatible with the most popular forms of

memory, for instance.

Idea conversion.

Generating lots of good ideas is one thing; how you handle (or

mishandle) them once you have them is another matter entirely. New

concepts won’t prosper without strong screening and funding

mechanisms. Instead, they’ll just create bottlenecks and headaches

across the organization. In many companies, tight budgets,

conventional thinking, and strict funding criteria combine to shut

down most novel ideas. Employees quickly get the message, and the

flow of ideas dries up. When Stewart Davies became head of R&D at

BT in 1999, the UK telecommunications group was in financial

trouble. Davies reviewed operations within R&D and recalled being

staggered by the inventiveness—and the frustration—of the people he

met. There was no shortage of good ideas at the company, he

concluded. But inadequate commercial skills and a shortage of seed

money for high-risk projects made it difficult for anyone to move

forward with ideas for new technologies.

Other companies have the opposite problem: Managers don’t apply

their screens strictly enough. The organization overflows with new

projects of varying quality (often underfunded and understaffed) and

no clear sense of how the initiatives fit into the overarching corporate

strategy. For instance, in 1999 the UK media company Emap

earmarked approximately £100 million to create a digital division to

develop Internet-based offerings for its magazine and radio

businesses. Worried that it was falling behind its competitors, the

company aggressively invested in whatever digital business ideas

were put forward, with little regard for business cases or budgets. By

2000, Emap had 43 separate businesses focused on online media

offerings, with projected revenues in excess of £100 million. In

reality, revenues never rose above £20 million. Most of the businesses

shut their doors; and the division reported losses of £60 million in

2001 and £17 million in 2002.

No matter how well screened or funded, ideas still must be turned

into revenue-generating products, services, and processes. Concepts

that have been selected for further development often go nowhere

because they’re languishing in a part of the organization that’s too

busy doing other things or that fails to see their potential. For

instance, to address the burgeoning demand for energy-efficient

lighting, consumer appliances, and heating systems, General Electric

invested in a small energy-management services business in Canada

in the 1990s. Despite the business’s early successes in winning

contracts and some market share, there was no natural home for it

within the product-focused GE. The business struggled along as a

misfit for a few years before being shut down, and GE missed an

opportunity to gain early-mover advantage in a growing industry.

Idea diffusion.

Concepts that have been sourced, vetted, funded, and developed still

need to receive buy in—and not just from customers. Companies

must get the relevant constituencies within the organization to

support and spread the new products, businesses, and practices

across desirable geographic locations, channels, and customer groups.

In large companies with many subsidiaries and organizations, such

diffusion is far from automatic. At Procter & Gamble in Europe, for

instance, the focus several years ago was on extensive product and

market testing to prove “superior total value,” and the company

placed ultimate authority for launching new products on the

shoulders of its national brand managers. These policies led to

painfully slow rollouts. Because of P&G’s rigorous market-test

requirements, managers launched Pampers diapers in France an

astonishing five years after the product was first introduced in

Germany. Meanwhile, Colgate-Palmolive, noticing P&G’s early

success in Germany, launched a me-too line of diapers in France,

gaining dominant market share there, two full years before P&G

introduced Pampers in that country.

Focus on the Right Links

When executives view their companies’ innovation processes as a

value chain, engaging in a link-by-link analysis, they may be surprised

by what they learn. The managers we’ve worked with are often quick

to tout their particular innovation strengths: “We’re really creative.”

“We’re very good at developing products fast.” Perhaps—but these so-

called innovation strengths can actually lead to weaknesses in the

process if they’re not complemented by equivalent strengths in other

areas. Consider the computer hardware manufacturer we referred to

earlier. At any point in time, there were at least 50 very good ideas for

new products and businesses floating around the company. But

because managers did not screen the ideas properly—funding the best

ones and killing the others—few ideas took hold, and new ones just

kept coming. The engineers at the firm became increasingly

frustrated, seeing their creative talents go to waste. The

brainstorming sessions that senior management implemented to help

mend fences with the engineers only contributed to the problem. By

failing to recognize the weak link (idea selection) and focusing more

time and resources on an already strong link (idea generation), the

management team undermined the company’s overall innovation

efforts.

Similarly, it doesn’t matter how great a company’s idea-selection

process is if only a few good concepts are on the table or if the

subsequent development process is weak. It’s also a waste of time and

money to develop state-of-the-art capabilities for rolling out products

or services when there’s nothing worthwhile to diffuse.

A company’s capacity to innovate is only

as good as the weakest link in its

innovation value chain.

In short, a company’s strongest innovation links are simply no good if

they prompt the organization to spend money with little hope of solid

returns or if the attention paid to them further weakens other parts of

the innovation value chain. Managers need to stop putting all their

effort into improving their core innovation capabilities and focus

instead on strengthening their weak links. Indeed, our research

suggests that a company’s capacity to innovate is only as good as the

weakest link in its innovation value chain. (See the exhibit “Which

Innovation Strategy Is Right for You?”)

Which Innovation Strategy Is Right for You?

There are many excellent innovation perspectives, as this

small sample of published works indicates. The

innovation value …

Organizations typically fall into one of three broad “weakest link”

scenarios. First is the idea-poor company, which spends a lot of time

and money developing and diffusing mediocre ideas that result in

mediocre products and financial returns. The problem is in idea

generation, not execution.

By contrast, the conversion-poor company has lots of good ideas, but

managers don’t screen and develop them properly. Instead, ideas die

in budgeting processes that emphasize the incremental and the

certain, not the novel. Or managers adopt the “1,000 flowers”

approach, letting ideas bloom where they may but never culling them.

The need is for better screening capabilities, not better idea

generation mechanisms.

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Finally, the diffusion-poor company has trouble monetizing its good

ideas. Decisions about what to bring to market are made locally, and

not-invented-here thinking dominates. As a result, new products and

services aren’t properly rolled out across geographic locations,

distribution channels, or customer groups. For such companies, the

real upside lies in aggressively monetizing what it has already been

able to develop, not in paying further attention to idea generation or

idea conversion.

Here’s a closer look at the three typical weakest-link scenarios and

some possible best practices that would be appropriate for managers

to adopt.

Fixing the Idea-Poor Company

Why do some companies experience a shortage of good new ideas?

Our research indicates it’s partly due to inadequate networks.

Managers fail to forge quality links with others outside their

company. Or people prefer to talk to their immediate colleagues

rather than reach out to counterparts in other departments or

divisions. These companies need to build external networks as well as

internal cross-unit networks to generate ideas from new connections.

Build external networks.

There are two fundamentally different approaches to building

external networks, each of which fulfills different objectives. The first

approach is to develop a solution network, geared toward finding

answers to specific problems. This is what A.G. Lafley mainly has

built at P&G. In-house product developers translate customer needs

into technology briefs that include descriptions of the problems to be

solved. The technology briefs traverse the company’s external

network—which comprises technology scouts, suppliers, research

labs, and retailers worldwide—to see whether someone, somewhere

can offer solutions to the problems posted. (For more details about

P&G’s external solution network, see Larry Huston and Nabil

Sakkab’s “Connect and Develop: Inside Procter & Gamble’s New

Model for Innovation,” HBR March 2006.)

Likewise, the pharmaceutical company Eli Lilly has spearheaded

InnoCentive (www.innocentive.com), a solution-seeking Web site

that Lilly, P&G, and other companies use to find answers to specific

technical or scientific problems. The companies post questions—for

instance, “How can we protect fatty acids from oxidation?”—that any

of the more than 10,000 engineers, chemists, and other scientists

registered at the site can tackle. The individual or group offering the

best acceptable solution gets a financial reward; the winner of the

fatty acids challenge received $20,000.

The second approach is to build a discovery network geared toward

unearthing new ideas within broad technology or product domains.

This is what Siemens, the Germany-based electronics and

engineering company, has done in Silicon Valley. Since 1999, it has

sited a 15-person scouting unit in Berkeley, California. Members of

the Technology-to-Business (TTB) Center cultivate personal

relationships with scientists, doctoral students, venture capitalists,

and entrepreneurs as well as government labs and corporate research

centers. Through these relationships, they learn about emerging

technologies and business ideas. Their real value as scouts, though,

lies in their ability to match emerging technologies to specific

Siemens businesses. For instance, TTB scouts learned about

technology for optimizing the quality of service on computer

networks from a Columbia University doctoral student. They were

able to deliver that knowledge to the appropriate parties—first to

Siemens’s telecommunications division, and then, after that industry

experienced an unrelated downturn, to the company’s factory

communications division. That group aspired to meet the customer

need for guaranteed real-time traffic over wireless local area

networks (WLAN). As a result of TTB’s diverse external network,

Siemens was able to release the first-ever WLAN product with real-

time guarantees and take a leading place in that market.

The objective of discovery networks should be to learn, not to tell.

Consider how Intuit developed its Simple Start edition of QuickBooks

in 2003. Developers wanted to observe the owners of one- or two-

person businesses: Exactly how did they manage their accounts? How

did they handle their payables and receivables? Intuit created a fact-

finding process: A ten-member development team visited with small

business owners in 40 “follow me homes,” where the developers

experienced firsthand the business problems facing users. Many

customers didn’t need or want certain higher-end accounting

functions in their software, the developers learned, so the team set

out to simplify QuickBooks. They tested six successive stripped-down

versions of the software in the follow-me-homes before arriving at

the Simple Start edition—which proved to be a best seller for Intuit.

Whether managers are developing solution networks or discovery

networks, the key metric for them to keep in mind is diversity, not

number, of contacts. The goal here should be to tap as many unique

sources of information and ideas as possible as opposed to interacting

with many similar contacts.

Build internal cross-unit networks.

A complementary approach to generating new ideas from outside

companies is to build cross-unit networks inside organizations. After

all, employees who don’t know one another can’t collaborate on new

ideas. And the occasional cross-functional brainstorming session

won’t do the trick: It unfairly assumes that people who are unfamiliar

with one another will be able to work together to generate ideas on

demand. What’s needed is an ongoing dialogue and knowledge

exchange between people from different units.

P&G has done this for years, resulting in many successful cross-

fertilized product and business creations. Take, for example, the

company’s development of Olay Daily Facials. The idea was to make a

face cream that was an excellent cleanser and moisturizer. Experts

from P&G’s skin care, tissue and paper towel, and detergents and

fabric softeners groups joined together, and their combined

knowledge about surfactants, substrates, and fragrances helped P&G

create and launch a highly successful new product.

These kinds of collaborations don’t happen by chance; they are the

result of well-established organizational mechanisms. P&G has

developed 30 communities of practice. Each comprises volunteers

from different parts of the organization and is built around an area of

expertise (such as fragrance, bleach, analytical chemistry, or skin and

hair science). The teams solve specific problems that are brought to

them, and they participate in monthly technology summits with

representatives from P&G’s ten business units. The company has also

posted an “ask me” feature on its intranet, where employees can

describe a business problem or need. Their questions or concerns get

pushed out to 10,000 P&G employees worldwide and are ultimately

funneled to those people with relevant expertise. At a more

fundamental level, P&G promotes from within and moves people

across countries and units. As a result, its employees build extensive

personal cross-unit networks.

Fixing the Conversion-Poor Company

Why do companies find it difficult to convert good ideas into

products and services? Most companies have no shortage of formal

systems for managing ideas. The number and diversity of people

involved, however, can create a risk-averse and bureaucratic process

that grinds execution to a halt. As one senior executive in a financial

services company told us, “If I want to get a new idea to market

quickly, I take personal control of it, and I steer it through the system.

If I want to kill an idea, I send it through the formal process.” Two

innovation practices can go a long way toward addressing the idea-

conversion problem—multichannel funding and safe havens.

Most companies have no shortage of

formal systems for managing ideas. The

number and diversity of people involved,

however, can create a risk-averse and

bureaucratic process that grinds

execution to a halt.

Multichannel funding.

In conversion-poor companies, innovation stalls when, say, the boss

doesn’t like a particular new idea or doesn’t consider it good enough

to supplant an existing initiative that’s already accounted for in the

budget. That’s usually the end of it; another potential line of business

or method for improving corporate performance falls by the wayside.

A multichannel funding model, however, opens up different options

outside the boss’s immediate purview—from small discretionary pots

of seed money all the way to full-scale venture funds.

Consider the success of Shell Oil’s GameChanger unit: It was set up in

1996 to fund the development of radical ideas that might lead to

entirely new businesses, and it has been a great success over the past

decade. Today it operates across all the major divisions of Shell

(exploration and production, retail, and chemical) and has an annual

seed-funding budget of $40 million. Leo Roodhart, a corporate-level

executive, oversees the 25-person unit. Shell employees submit their

ideas to the GameChanger Web site. Unit members review all ideas,

and, over the course of six months to a year, the proposals go through

various rounds of vetting, prototyping, and funding. Employees take

time away from their day jobs to explore their ideas further, and they

are compensated for their efforts. As proposals turn into business

plans, employees may receive between $300,000 and $500,000 in

initial funding from GameChanger. Project milestones are formally

set up, and clear deliverables and progress reviews are required at

each stage. Ventures that achieve “proof of concept” (about 10% of all

original submissions) leave GameChanger at that point and are either

moved into one of the divisions (where most projects go) or into Shell

Technology Ventures, a corporate spinout vehicle.

Since GameChanger was formed, some 1,600 ideas have been

submitted. The flow of proposals is constant, and the unit has built up

a track record of success: forty percent of all development projects in

the exploration and production business started out as GameChanger

ventures.

Safe havens.

Some companies are better than others at building safe havens for

their emerging concepts. Such havens can be critical to the successful

conversion of good ideas into profitable products or businesses.

Consider the situation at a UK technology company we’ll call Tenco.

Frustrated by its anemic top-line growth, the firm in 2000

established a separate unit focused on developing new business ideas

that were clearly relevant to Tenco’s overall strategy but that would

probably stagnate in the line organization. Of the 13 ventures the unit

was responsible for sheltering, nine went on to become viable

businesses with combined annual revenues in excess of £100 million.

Tenco’s executives saw their role as shielding these new businesses

from the short-term thinking and budget constraints that pervaded

the rest of the organization, but without isolating them. On the one

hand, the management team built a governance structure that kept

the new businesses close to the mainstre