CompensationCultureLeadershipRewardStrategy

Enabling organizations to play the high-risk, high-reward sport – Innovation

posted by Ravi Arora July 13, 2016

Today, on July 13, 2016 I have completed one year of my monthly posts on Innovation. It has been an exhilarating journey for me as I attempted to introduce new ways of comprehending innovation. I tried to unearth new insights on why innovation even today remains one of the most desired but evasive subjects. Today is my 13th post and I am using it to reflect back and summarize my views of last 12 months.

Start with resolution:

I have come to conclusion that the starting point for Innovation is ‘resolution’ – Resolution to innovate – something specific – that one feels strongly about. Resolutions are very popular because of new-year. Unfortunately this popularity is negative because most new-year resolutions are not fulfilled. The reason for this failure is simple – people do not put the required efforts and forget their resolutions. My observation on innovation resolutions in most established companies is similar – either companies do not make or those who make, rarely accomplish their resolutions to innovate. As innovation practitioners, we need to change this trend. We would like more managers to make resolutions to innovate and do their best to fulfill them and not forget them.

Once a resolution has been made for a specific innovation or a basket of innovations, there are three choices (a) Share the resolution openly with the relevant/interested people upfront like it is shared in the Promissory Note (b) Don’t share the resolution immediately but decide a date or a milestone when it will be shared – similar to Death-will, which is read only after a specific milestone (death of the person). (c) Never share the resolution with anyone. This option is most undesirable. Not sharing the innovation resolution with the relevant people is the main reason for failing to accomplish them. On the other hand, resolutions made in Promissory notes and Death-will are shared with the relevant people and are fulfilled.

Play it hard:

One needs to put in efforts to fulfil the resolution. Depending upon what the resolution is, chance or luck could be a factor that has influence on the outcome. Innovations have a higher dependence on luck and therefore instead of calling ‘Innovation resolutions’, I prefer calling them as ‘Innovation bets’. Now, the moment we replace ‘resolution’ by ‘bet’, it gives a feeling that one could accomplish them by spending less efforts and relying more on luck. There is a reason behind this feeling – Lottery is an extreme case of a bet where one has to put zero effort in winning. Lottery is 100% chance, although some people believe in numerology and put some efforts in making a choice of which lottery number to buy.

There are other bets like a sports bet (horse racing or car racing or F1) in which the bettor needs to spend some effort in deciding the bet. Information about the past trends and current situation are important inputs in making predictions and thereby making a choice for the bet. There are some sports where one can change positions (modify the bet) while the game is being played. But even here, like lottery, there is no role for the bettor in winning (Let us ignore match fixing for this discussion!).  This little extra involvement in analyzing past data to make predictions and then make the informed choice for placing or modifying the bets creates excitement and engagement for the bettor. Ability to make the prediction is an important skill to make choices for the innovation bet.

On one other extreme are a set of people who claim to be in the business of making predictions and giving advice but are not involved thereafter. Those who make predictions on the basis of their past experience but do not contribute much (or spend effort) in accomplishing the predictions are like advisors. Unfortunately there are people who predict the future without using past experience and are also not all involved in making the predictions true are like palmists. If the palmists were confident about that their predictions, I am sure they would have found a way of buying stakes in the future fortunes of people.

Can you think of a sport where the bettor’s involvement is high not only in making choices for the bet but also in winning it? Innovation is one such sport in which one starts by predicting the future using all the information and knowledge available about the customer, technology and other factors. These predictions are then used by the innovator in placing innovation bets. Unlike other situations of betting discussed before, the bettor the innovation sport is not a meek spectator but is actually on the steering wheel to navigate and complete the innovations and win the bet! This involvement and responsibility of the bettor in winning is the uniqueness of our innovation sport.

We think we play this sport but actually we don’t:

Is Innovation sport played often by people in organisations? Perhaps no. Why? There are a large number of people who don’t want to play this sport because of its inherent risk as compared to other corporate sports. There is another equally large set who think that they are actively engaged in the race to scale new heights for their organisation and innovation is part of the work ethic. I would like to delve deeper into the second set of people and highlight that their thinking is quite misplaced:

  • Companies use the SII (Standardization, Improvement and Innovation) model to sustain and improve their competitive position. This model is undoubtedly very useful and gives quicker visible outcomes. Unfortunately, it also works as a trap due to its vicious nature. Let me explain – Companies follow this SII model in sequence – they focus on Standardization and then on Improvement. Every Improvement warrants new Standardization. Improvement also keeps the leadership satisfied and excited and the cycle between S and I continues. Is there an end to Improvement? No! Does the rule of diminishing returns apply on improvements? Yes! Carrying out improvements continuously keeps everyone so busy and satisfied that most don’t reach the last ‘I’ (innovation)! Occasionally, upon self-reflection, such companies realize that they are not doing much on innovation. They also acknowledge that they are still in the Improvement phase and not yet ready to focus on Innovation. In my view, the solution to this problem is the reversal of the model: Make it IIS. This change (The first ‘I’) will ensure that regardless of the situation, a minimum focus and effort is always given to innovation.
  • Quite a few companies follow the PDCA method to identify and execute improvement projects. The PDCA method over the years has been perfected to identify and deliver Improvements. PDCA supports the SII model discussed above and was designed to drive Improvements and Innovations. Unfortunately, the PDCA hasn’t been effective for delivering innovations. The main reasons are (a) ‘Rotating the PDCA cycle’ is the language of practitioners on this subject and it encourages managers to identify projects that have shorter cycle-time thereby making the rotation fast and visible. Innovation projects have longer lead times and cannot rotate the PDCA cycle as fast. (b) The first step of PDCA i.e. ‘P’ decides if the project will lead to innovation or improvement. Unfortunately, there is no Check that looks at the Plan to separate innovation projects from improvement projects. As a solution to this problem, I have proposed to change PDCA and make it PCDCA.  The check after Plan has been introduced to generate feedback if the Plan is not likely to result in innovation. This change will get enforced if we change SII to IIS as discussed above.

The above models are just the means to deliver the expectations of leaders, which managers use to deliver improvements. Changing SII to IIS and PDCA to PCDCA will happen only if there is an explicit demand from business leaders to innovate. How do senior leaders manifest this demand? The only way for them is to take some risks! The demand to innovate can be best manifested in the Long term (LT) plans of the company. Unfortunately companies focus on Short term plans or annual plans but rarely prepare or review the Long term plans. Companies who prepare LT plan need to clearly spell out the innovation bets, which we discussed earlier.

Lack of patience discourages us to play this Longer term sport

LT plans, wherever made, are usually forgotten, not deliberately but due to the immense focus on annual plan. Gurus of Strategic management have advised that the most effective way to focus on LT plans/goals is to break the LT plan into shorter journeys/segments with appropriate milestones and measures. These journeys and measures should then be embedded into short term or annual plans. Can we do the same for innovation bets that would be listed in the LT Plan? Typical measures for Short term plan are Revenue, cost, customer satisfaction, new customer acquisition, market share, employee satisfaction etc. In order to bring Innovation into annual plan, I suggest a new measure called ‘Our share of future innovations’ into the short term or the annual plan. ‘Our share of future innovations’ represents the share of future innovations that the company will deliver as per the LT Plan. This is a very good lead measure for ‘future market share’ and ‘share of future profits’.

Will this sport make companies profitable?

The ‘share of future profits’ reminds me of an analysis that I did to find out why are most profitable companies not necessarily the most innovative and vice versa? The reason is very simple and I am sure you would agree. The list of most profitable companies is drawn from the real numbers reported in Profit loss statements. On the other hand, the list of most innovative companies is drawn on the basis of the difference between their Market Cap and the NPV of their cash flows. The perception of shareholders is the source of this difference (or premium) in market cap. What builds these perceptions? Product innovations have the most influence on shareholders and customers followed by service innovations. Unfortunately, process innovations, which is one of the hallmarks of established companies and contributes greatly in sustaining and improving the profits have almost no impact on raising this perceptions and hence the market cap. Why? The impact of product and service innovations on the Profit-loss statement can be easily reported through measures like ‘Revenue/Profit from new products’ but impact of process innovations cannot be reported. Why? This is because all the ERP systems capture the ‘actual revenue’ and ‘actual cost’. Therefore Revenue from new products gets captured and reported effortlessly and without any audit related issues. Process innovations usually lower the costs and cycle time. The same ERP systems capture the actual (reduced) costs. Since is no method in the ERP system to capture cost savings from process innovations, they do not get reported and highlighted. Established companies and Process innovations will get their due share if ERP companies and accounting professionals together could find a solution to this.

This sport needs perseverance but not obstinacy

Let me now come back once again to the innovation sport that starts with bets. I discussed earlier that there are two sets of people who do not play this sport. The first set of people, as discussed before don’t play this sport because of its inherent risk as compared to other corporate sports. The risk element in innovation is in the execution or implementation. Execution is most difficult part of Innovation. It needs perseverance, focus and sustained resources. From the organisations’ point of view, the resources are always limited and therefore it is fatal to overspend resources on any particular innovation… especially if is a dead wood. Overspending on an innovation project due to negative perseverance of project team is what I call it as Obstinacy. Organisations need to keep a watch on the team’s transition from Perseverance to Obstinacy.

What does one do to avoid obstinacy? Obstinacy kicks in because failures are not accepted in companies and the measurement system penalizes all types of failures. Managers are hence reluctant to declare their projects as failed. We want companies and managers both to willingly play the Innovation sport. To enable this, companies need to have a mechanism of identifying creative failures, celebrate them and kill projects which could transition into obstinacy. We need to extract precious lessons from all such projects.

Rewards to managers to play this risky sport:

Let me end by making one final point on rewards. Organisations thrive on having a defect free operations.  They aspire to grow linear year after year and meet the expectations of shareholders. Senior leaders and managers are rewarded for achieving predicted outcomes with zero deviation. Organisations have rewards in the form of bonuses for successfully achieving the annual results. In many cases, the external complexity (increasing VUCA) makes it difficult to achieve the stretched results as compared to previous year. Increasing intensity of VC backed start-ups has become a threat to almost all established businesses.

Organisations get outstanding results from innovations but should the returns from innovations be equitable to all employees? Fully? What is the reward for people to play this risky game when they can happily play other safer games? One might say that there are people who enjoy taking risks and are passionate about innovation projects. I don’t think this is an acceptable organizational design. The only way to encourage leaders and managers to play this risky game would be a very high upside for being successful in accomplishing the high impact innovation bets.

Innovation bets have longer duration and there is no established method today to reward people (compensate) for making, engaging and winning innovation bets. We need to redesign our compensation that is equally aligned to the Long Term strategy (that includes innovation bets). This modified system should reward people adequately for taking bets, navigating through known and unknown risks, roadblocks and ultimately realizing them.