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Forsake Start-Up Envy: Three Reasons Why Large Companies Should Out-Innovate Start-Ups

Jan 7 2014, 12:56pm CST | by

Forsake Start-Up Envy: Three Reasons Why Large Companies Should Out-Innovate Start-Ups

Photo Credit: Forbes
 
 

This is the first of a two-part series on how large companies can out-innovate start-ups. Part Two is available here.  An accompanying infographic is also available.

An executive recently left his job at a global advertising firm to take the No. 2 position at an online-media startup in the hills outside Los Angeles. To secure the position, he took a pay cut and joined immediately. He bunked with the founder in the back of the start-up’s warehouse office while his wife packed up their Chicago home and eventually set up house in Los Angeles. She didn’t need to bother. He is never home. He is working 18-hour days, seven days a week. He has a boatload of founder’s stock and is shooting for a golden exit.

The chief innovation officer of a Fortune 1000 company relocated to a Silicon Valley outpost far from her New York corporate headquarters. She now spends most of her time holding court with venture capitalists and entrepreneurs about stakes in hot start-ups. It is never clear who is courting whom in those meetings, though the general attitude in the Valley is that there is more dumb money than good start-ups. Her goal is not to maximize financial returns on her investments—even a 200 percent return would not be material to her corporation’s financials. Instead, she is essentially outsourcing her company’s innovation strategy to start-ups.

Do these stories sound familiar?

Like too many of their peers, these smart and savvy veterans were stymied in their efforts to get their companies to innovate. They resigned themselves to a conventional wisdom that has taken root in recent decades: that start-ups are destined to out-innovate big, established businesses.

In research for our new book, The New Killer Apps: How Large Companies Can Out-Innovate Start-Ups, however, Paul Carroll and I found that this conventional wisdom just isn’t true. Or, at least, it need not be. Yes, small and agile beats big and slow, but big and agile beats anyone—and that combination is more possible than ever.

There are three reasons why innovators at large companies should be optimistic about their ability to beat start-ups.

1. Start-ups aren’t all they’re cracked up to be.

Yes, Silicon Valley has the cachet, but Harvard Business School research shows that the failure rate for start-ups runs as high as 95 percent. Start-ups, as a group, succeed largely because there are so many of them, not because of any special insight.

What’s more, the National Bureau of Economic Research (NBER) found that start-ups shift rewards to financiers while saddling entrepreneurs with most of the risk. Entrepreneurs invest their time, reputations, and accumulated expertise for modest salaries and long hours in the hope of gaining huge rewards at “exit,” when the start-up goes public or is acquired. NBER researchers found, however, that start-ups rarely pay off for the entrepreneurs who slave away at them. Sixty-eight percent of companies that reached an exit (after a median time of forty-nine months from first venture funding) resulted in no meaningful wealth going into the pockets of the entrepreneurs.  These numbers add up to pretty long odds for corporate innovators looking to find greener pastures as an entrepreneur.

The story is not much better for strategic investors chasing start-ups through venture capitalists. Numerous studies, including a 2012 study by the Ewing Marion Kauffman Foundation and a more recent one by Cambridge Associates, show that venture capital has delivered poor returns for more than a decade. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested in venture capital.  Risk and reward have not been correlated.

Vinod Khosla, a billionaire venture capitalist and cofounder of Sun Microsystems, tweeted a revealing line from an executive at one of his companies in 2012: “Entrepreneurs really are lousy at predicting the future… VCs are just as bad.”

2. Large company scale is more valuable than ever.

In the context of today’s immense technology-enabled opportunities, large companies have growth platforms that would take start-ups years to build. Incumbents have products with which to leverage new capabilities such as mobile devices, pervasive networks, the cloud, cameras, and sensors. Social media can amplify their brand power and customer relationships. Large companies also sit on mountains of market and customer data and are therefore in the best position to extract knowledge from big data.

The possibilities are startling. And tapping into them isn’t optional. A perfect storm of six technological innovations—combining mobile devices, social media, cameras, sensors, the cloud, and what we call emergent knowledge—means that more than $36 trillion of stock-market value is up for what some venture capitalists are calling “reimagination” in the near future. That $36 trillion is the total market valuation of public companies in the ten industries that will be most vulnerable to change over the next few years: financials, consumer staples, information technology, energy, consumer goods, health care, industrials, materials, telecom, and utilities. Incumbent companies will either do the reimagining and lay claim to the markets of the future or they’ll be reimagined out of existence.

3. The roadmap for leveraging scale while avoiding innovation landmines is clearer than ever.

Since the start of the Internet boom some two decades ago, so many companies have looked to information technology to innovate that there’s now a track record showing what works and what doesn’t. The problems that have stifled innovation in large companies are now known and can be avoided. These problems are not inherent to bigness.

Having studied thousands of innovation efforts—both successes and failures—Paul Carroll and I have found that the distinction between companies that succeed at disruptive innovation and those that don’t boil down to six words: Think Big, Start Small, Learn Fast.

Think Big

By “think big,” I mean that successful innovators consider the full range of possible futures. They make sure they understand the emerging technology context, rather than assume that their current assumptions are right. They’re not too proud to explore their doomsday scenarios, including how new developments might drive them out of business. And, rather than just looking for incrementally faster, better or cheaper products, they dare to dream big. Successful innovators are willing to start from a clean sheet of paper to pursue “killer apps”—new products that might rewrite the rules of a category or entire industries.

As I extensively chronicled in my series on driverless cars, for example, Google didn’t just aim to make people better drivers. Its driverless cars aim to take human drivers out of the loop entirely. Google didn’t just aim to make slightly better cars, it focused on full automation—because full automation enables dramatically improved usage patterns and disruptive business models.

By contrast, those who fail typically think small. They assume that the future will be a slightly different version of the present. It’s human nature to see change as incremental and to think that our customers will stick with us, but incremental thinking can be very dangerous. For example, Microsoft, Motorola, Blackberry and Nokia all missed the smartphone because it didn’t fit with their own technology assumptions, and they couldn’t envision how it might challenge their own products.

Start Small

Successful companies “start small” after thinking big. Rather than jumping on the bandwagon for one potentially big product, they break the idea down into smaller pieces for testing. They don’t allow themselves to make decisions solely on intuition, or allow themselves to lock in on financial projections based on wishful thinking. They defer important decisions until they have real data.

Google’s early investments in its driverless car was not much more than car companies spent on Super Bowl ads during the same time, and on par with what it might take a car company to develop a new fender.

Those who fail typically think small—like Borders, Blackberry, Blockbuster, Kodak, Motorola, and Nokia—but then start big when they do finally move. Our research found that companies that should be innovating in the face of a disruptive technology tend to swing from complacency to panic. After ignoring opportunities because they can’t accept that they’re in danger, they finally see the disruption and make a last-chance, massive bet on a single idea—only to have it not pan out.

Learn Fast

Companies that “learn fast” take a scientific approach to innovation. They take the attitude that a demo is worth more than thousands of pages of business plans. They conduct extensive, inexpensive prototyping before they even get to the pilot phase—let alone the big rollout—so they can gather comprehensive information and quickly analyze both what’s working and what isn’t. They also don’t fall in love with their own ideas. The successes develop the institutional discipline to keep on asking the tough questions and are ready to set aside or alter projects based on what they learn, not what they hope.

Again, you can see this with Google, which has fielded dozens of cars for very public testing and learning, while othersexperiments are mostly hidden on their test tracks, except for very staged press events.

By contrast, thinking small and then betting big usually leaves neither the time nor the inclination to learn. The combination of thinking small, starting big and not learning fast is what killed Blockbuster. It ignored Netflix’s DVDs-by-mail model for years, then bet big on its own version before fully working out the economic and operational implications—and it turned out that Blockbuster’s business model couldn’t handle the loss of those hated late fees.

* * *

I am not arguing that there is no place for entrepreneurship or start-ups. Start-ups as a group will continue to be an economic engine driving innovation, jobs and wealth. But, any individual start-up, or even a small portfolio of start-ups, is far from a better bet for corporate veterans seeking better jobs or more successful innovation.

Rather than jumping from the frying pan into the fire, corporate innovators should consider staying put and focus on tearing down the barriers stifling their company’s  innovation efforts. Yes, small and agile start-ups look very attractive when viewed from the confines of a big and slow bureaucracy. Big and agile is an even more attractive position.

Just because large companies should out-innovate start-ups doesn’t mean, of course, that they will. In the companion piece to this article, I offer eight rules for how large companies can out-innovate start-ups.

This article is drawn from The New Killer Apps: How Large Companies Can Out-Innovate Start-Ups.

Source: Forbes

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