Guest Update 17 April 06

The Different Domains of Innovation

This week’s update was written by Tom Davenport, who is the Director of Research at Babson Executive Education and the holder of the President’s Chair in Information Technology and Management at Babson College.  His most recent book is called Thinking for a Living, published by HBS Press in September 2005.

Innovation is back in style. Many companies that had been cautious over the past several years and primarily focused on cost reductions are now turning their focus to innovation. There is ample evidence of this orientation. For example, 87% of senior executives in a 2005 survey said that generating organic growth through innovation is necessary for success in their industries, and 74% planned to increase spending on innovation in 2005.

Yet the mere desire for more innovation won't make it happen, and many organizations have poorly-managed approaches to innovation. In particular, they have too narrow a focus on innovation, and address only the product innovation domain. They do not manage an innovation portfolio in terms of how they source, fund, monitor, and assign responsibility for innovation. As a result, they will continue to have weak innovation results. In the 2005 study mentioned above, only 49% of the surveyed executives were satisfied with the financial returns on investments in innovation. In another 2005 analysis, undertaken by consultants Booz Allen and Hamilton, there was no correlation between spending on innovation and the overall financial performance of organizations.

In order to construct and manage an innovation portfolio, an organization must identify the types of innovation that are important to it, the key steps in the innovation process, and the primary responsibilities for managing it. Then it can begin to create a more formal approach for managing a broader, more comprehensive innovation portfolio. I'll describe each of the elements of such a portfolio.

Types of Innovation

What are the possible types of innovation that organizations can and should pursue? Unfortunately, most organizations focus only upon product innovation. In a 2003 study of companies' innovation sourcing strategies, two other researchers and I discovered that product innovation was far more likely to be addressed than any other type. 70% of the executives surveyed in the study said their organizations pursued product innovation, whereas the next most common responses (service and process innovation) were being pursued by only 20% of respondents.

Src: Linder, Jarvenpaa, Davenport, 2003

Types of Innovation Pursued by Companies

Product innovation is certainly important, and in some ways it offers the clearest economic payoff for innovation. Companies create products, take them to market, and sell them to customers. Yet there are important arguments for going beyond product innovation alone. First of all, an increasing proportion of sophisticated economies are based on services—over 70% in the United States, for example. Secondly, even in product markets, customers often buy products not just on the basis of the product's characteristics, but on the business model and processes by which the product is sold, and the services offered after the sale. Finally, companies are much more likely to produce effective and economically valuable products and services if they have innovative and high-quality management approaches.

IBM illustrates both the predominance of product innovation, and the emerging rise of other innovation domains. For several decades the company has vigorously pursued product and component research at its corporate laboratories such as Watson and Almaden. Despite the fact that half of its revenues derive from services, only in the last year has the company officially recognized services innovation as part of its innovation portfolio, creating the Services Research group at its Almaden Labs.

What does service innovation mean? For companies such as IBM offering business services, it means the development and testing of new ways to deliver services such as e-commerce, and new ways to help organizations change their cultures and processes. For organizations such as Bank of America that serve consumers, service innovation can mean identifying and testing new approaches to serve customers at the branch or point of sale.  For a company that performs detailed building services such as ServiceMaster, service innovation might take the form of industrial engineering-like attempts to streamline movements and reduce wear and tear on workers and equipment. Of course, just as product innovation takes a somewhat different form in each company, so will service innovation.

Organizations are increasingly prospering from a combination of product and service innovation. Apple's iPod, for example, would not have been nearly as successful without the availability of the iTunes content downloading service. When IT companies such as IBM and Hewlett-Packard announce new products, there is often a need for services to install, implement, maintain, or extract value from them.

Process innovation can take place in product or service firms. It usually involves either internal business processes, or those involved in delivering products and services to customers. Process innovation can involve revolutionary or breakthough improvement in broad, cross-functional processes (sometimes called business process reengineering), or can also entail continuous or one-time improvement in smaller processes, as in Total Quality Management or Six Sigma initiatives. Some companies focus their process innovation efforts in some areas more than others. Dell Computer, for example, is more oriented to manufacturing and supply chain processes than to any other type. Others, such as Raytheon, have a broad corporate program that addresses all processes with one approach (Six Sigma in Raytheon’s case). Most organizations should have a portfolio of process innovation initiatives underway at any given time, including both breakthrough and incremental innovations where necessary.

Managerial innovation involves the exploration and adoption of new approaches for managing people, technology, and other strategic business resources. There have been hundreds of new management ideas over the past several decades, yet most organizations are woefully haphazard or faddish in how they adopt and embrace particular ideas. Just as product innovation usually involves researchers and engineers, and process improvement has specialists such as Six Sigma "black belts," managerial innovation is usually driven by a type of individual called an "idea practitioner"—someone who identifies appropriate new management ideas and shepherds them through implementation.

Business model innovation may be the least well known of all the innovation domains. Business models are an organization's fundamental logic for going to market and making money. Business model innovation is critical because it is directly tied to an organization's economic fortunes. The concept became popular at the height of the e-commerce explosion, when many companies explored online business models for the first time. But e-commerce isn't the only form of business model innovation that companies can explore. Any company offering an expensive product for sale, for example, could explore the possibility of selling the same capability as an on-demand service (as many computer firms, including IBM and Hewlett-Packard) are currently doing.

Clearly there are other potential innovation types in addition to these, such as store design, architectural, and packaging innovation. Not all of these will be appropriate for all organizations at all times. Clearly some forms of innovation are going to be more important to a particular firm than others. However, a broad portfolio of innovation domains is desirable.

More Information:

1.      The Boston Consulting Group study is called "Innovation 2005."

2.      The Booz Allen study is from Barry Jaruzelski et al, "Money Isn't Everything," Strategy + Business 41, Winter 2005, p. 57.

3.      The source for the 70% of services statistic is: James Brian Quinn, Intelligent Enterprise: A Knowledge and Service-Based Paradigm for Industry. (Free Press, 1992).

4.      For more on Bank of America’s approaches to innovation, see Stefan Thomke, "R&D Comes to Services: Bank of America's Pathbreaking Experiments," Harvard Business Review, April 2003.

5.      On process innovation, see Thomas H. Davenport, Process Innovation: Rengineering Work though Information Technology (Harvard Business School Press, 1993).

6.      For more on idea practitioners, see Thomas H. Davenport and Lawrence Prusak, What's the Big Idea? Creating and Capitalizing on the Best Management Thinking (Harvard Business School Press, 2003).

7.      Click here if you have questions or comments for Tom Davenport.