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Something new under the sunA special report on innovation l October 13th 2007

Innovation, long the preserve of technocratic elites, is becoming moreopen. This will be good for the world, argues Vijay Vaitheeswaran

alent of 100 miles-per-gallon using alter-native energy. The charitable arm of MrPage’s �rm has already taken hybrid pet-rol-electric vehicles, like the Toyota Prius,and turned them into even cleaner �plugin� versions which can be topped up froman electric socket.

Mr Khosla believes clean cars, using ad-vanced biofuels or other alternatives, willcome about only through radical innova-tion of the sort that Big Oil and Big Autosavoid. Risk and acceptance of failure arecentral to innovation, he argues, but the di-nosaurs typically avoid both. �Big compa-nies didn’t invent the internet or Google,and much of the big change in telecomsalso came from outsiders,� he adds.

Coming from almost anyone else suchtalk would sound preposterous. But MrKhosla and Mr Page are not ordinary busi-nessmen or armchair revolutionaries. MrKhosla helped to found Sun Microsystems,a path-breaking information-technology�rm, and he went on to become a partnerat Kleiner Perkins, a venture-capital com-pany that was an early backer of Ama-zon.com, America Online and many otherpillars of the internet economy. Mr Page’sGoogle is one of the internet’s biggest suc-cess stories. At 34 he is a multi-billionaire.

But these men are from Silicon Valley;and Silicon Valley is not America. It istempting to dismiss such breathless talk of

Revving upHow globalisation and information technology are spurring faster innovation.Page 3

Can dinosaurs dance?Responding to the Asian challenge. Page 4

A dark art no moreLike management methods before it, innovation is turning from an art into ascience. Page 6

The love-inThe move toward open innovation isbeginning to transform entire industries.Page 8

The fading lustre of clustersThe best thing that governments can do toencourage innovation is get out of the way.Page 11

The age of mass innovationWe are all innovators now. Page 13

The Economist October 13th 2007 A special report on innovation 1

1

Something new under the sun

�ACRISIS is a terrible thing to waste,�Vinod Khosla laments to Larry

Page. The two Silicon Valley luminaries arechatting one evening at the Googleplex,the quirky Californian headquarters ofGoogle. The crisis which Mr Khosla is con-cerned about is caused by carmakers’ ad-diction to oil and the consequent warmingof the planet. �The energy and car indus-tries have not been innovative in manyyears because they have faced no real cri-sis, no impetus for change,� he insists.

The two are plotting what they hopewill be the next great industrial revolution:the convergence of software and smartelectronics with the grease and grime ofthe oil and car industries. Mr Khosla iskicking around his plans for getting �chipguys� together with �engine guys� to de-velop the clean, software-rich car of the fu-ture. Such breakthroughs happen onlywhen conventional wisdom is ignoredand cross-fertilisation encouraged; �man-aged con�ict�, in his words.

Mr Page, co-founder of Google, had ear-lier hosted a gathering of leading environ-mentalists, political thinkers and energyexperts to help shape an inducement to getthings moving: the Automotive X Prize, tobe unveiled in early 2008. The organiserswill o�er at least $10m to whoever comesup with the best �e�cient, clean, a�ord-able and sexy� car able to obtain the equiv-

Also in this section

www.economist.com/audio

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Acknowledgement The author is grateful to the manythoughtful people who shared their views with him. In ad-dition to those mentioned in the special report, he wouldlike to thank John Denham, Kishore Mabhubhani, DevPatnaik, Ken Zita, Douglas Horn and experts at the WorldBank, OECD and World Economic Forum. Special thanks goto the generous organisers of two distinctive conferences,"Sci Foo" and Technology, Entertainment, Design (TED),which manage to capture the essence of innovation.

2 A special report on innovation The Economist October 13th 2007

2 revolution as just more hype from peoplewho are seeing the world through Googlegoggles. After all, go beyond the rare�ed airof northern California and the rules ofgravity are no longer suspended. The well-established industries which they mockstill move at their usual but reliably glacialpace, right?

Well no, actually. Rapid and disruptivechange is now happening across new andold businesses. Innovation, as this reportwill show, is becoming both more accessi-ble and more global. This is good news be-cause its democratisation releases the un-tapped ingenuity of people everywhereand that could help solve some of theworld’s weightiest problems.

The seditious scene from the Google-plex also captures the challenge thispresents to established �rms and de-veloped economies. For ages innovationhas been a technology-led a�air, withmost big breakthroughs coming out ofgiant and secretive research labs, like Xe-rox PARC and AT&T’s Bell Laboratories. Itwas an era when big corporations in de-veloped countries accounted for mostR&D spending.

North America still leads the world inresearch spending (see chart 1), but the biglabs’ advantage over their smaller rivalsand the developing world is being erodedby two powerful forces. The �rst is global-isation, especially the rise of China and In-dia as both consumers and, increasingly,suppliers of innovative products and ser-vices. The second is the rapid advance ofinformation technologies, which arespreading far beyond the internet and intoolder industries such as steel, aerospaceand carmaking.

What is innovation? Although the termis often used to refer to new technology,many innovations are neither new nor in-volve new technology. The self-service

concept of fast-food popularised by Mc-Donald’s, for instance, involved running arestaurant in a di�erent way rather thanmaking a technological breakthrough.However, innovation can involve plentyof clever gadgets and gizmos.

One way to arrive at a useful de�nitionis to rule out what innovation is not. It isnot invention. New products might be animportant part of the process, but they arenot the essence of it. These days much in-novation happens in processes and ser-vices. Novelty of some sort does matter, al-though it might involve an existing ideafrom another industry or country. For ex-ample, Edwin Drake was not the �rst manto drill for a natural resource; the Chineseused that technique for centuries to minesalt. But one inspired morning in 1859, Col-onel Drake decided to try drilling for oil inTitusville, Pennsylvania. He struck blackgold and from his innovation the modernoil industry was born.

The men in white coatsThe OECD, a think-tank for rich countries,says innovation can be de�ned as �newproducts, business processes and organicchanges that create wealth or social wel-fare.� Richard Lyons, the chief �learning of-�cer� at Goldman Sachs, an investmentbank, o�ers a more condensed version:�fresh thinking that creates value�. Both hitthe nail on the head, and will serve as thede�nition in this report.

According to popular notion, innova-tion is something that men wearing whitecoats in laboratories do. And that’s theway it used to be. Companies set up verti-cally integrated R&D organisations andgovernments fussed over innovation poli-cies to help them succeed. This approachhad successes and many companies stillspend pots of money on corporate re-search. But �rms are growing increasinglydisenchanted because the process is slowand insular. A global study across indus-tries by Booz Allen Hamilton, a consul-tancy, even concluded that �higher R&D

spending doesn’t ensure better perfor-mance in terms of growth, pro�tability orshareholder returns.�

Now the centrally planned approach isgiving way to the more democratic, evenjoyously anarchic, new model of innova-tion. Clever ideas have always been every-where, of course, but companies were of-ten too closed to pick them up. The moveto an open approach to innovation is farmore promising. An insight from a brightspark in a research lab in Bangalore or anavid mountain biker in Colorado now has

a decent chance of being turned into a pro-duct and brought to market.

So why does the generation and han-dling of ideas matter so much? �We �rmlybelieve that innovation, not love, makesthe world go round,� insists John Drydenof the OECD. Corny perhaps, but studiesdo show that a large and rising share ofgrowth�and with it living standards�overrecent decades is the result of innovation(see chart 2). Innovative �rms also tend tooutperform their peers. �We’re not discov-ering new continents or encountering vastdeposits of new minerals,� Mr Drydenadds. Indeed, the OECD’s experts believethat most innovation has been caused byglobalisation and new technologies.

Analysis done by the McKinsey GlobalInstitute shows that competition and inno-vation (not information technology alone)led to the extraordinary productivity gainsseen in the 1990s. �Those innovations�intechnology as well as products and busi-ness processes�boosted productivity. Asproductivity rose, competition intensi�ed,bringing fresh waves of innovation,� theinstitute explains.

That is why innovation matters. Withmanufacturing now barely a �fth of econ-omic activity in rich countries, the �knowl-edge economy� is becoming more impor-tant. Indeed, rich countries may not beable to compete with rivals o�ering low-cost products and services if they do notlearn to innovate better and faster.

But even if innovation is the key toglobal competitiveness, it is not necessar-ily a zero sum game. On the contrary, be-cause the well of human ingenuity is bot-tomless, innovation strategies that tap intohitherto neglected intellectual capital andconnect it better with �nancial capital canhelp both rich and poor countries prosper.That is starting to happen in the develop-ing world. 7

2Productive innovation

Source: Boston Consulting Group

US productivity growthOutput per hour, 1954=100

1954 60 70 80 90 2004100

150

200

250

300

Capital

Labour

Innovation

1Investing in ideas

Source: Booz Allen Hamilton database

R&D spending by region, 2006, %

North America43.7

Europe28.9

Japan21.5

Rest of Asia4.8

China & India0.6

Other0.5

Total:$478bn

1


IF YOU want a motorcycle, go to Chong-qing. Although this dusty central Chi-

nese city of drab o�ce buildings and per-petually grey skies is better known as thegateway to the enormous Three GorgesDam, it is also the two-wheeler capital ofthe world. Led by the region’s pioneers,China now makes half the world’s motor-cycles. But more important than the num-bers produced is the way these motorcy-cles are made�especially the waydesigners, suppliers and manufacturershave organised themselves into a dynamicand entrepreneurial network.

Unlike state-run �rms, the city’s priv-ate-sector upstarts, such as Longxin andZongshen, do not have big foreign partnerslike Honda or Suzuki with deep pocketsand proven designs. So they came up witha di�erent business model, one that wassimpler and more �exible. Instead of dic-tating every detail of the parts they wantfrom their suppliers, the motorcycle-mak-ers specify only the important features,like size and weight, and let outside de-signers improvise.

This so-called �localised modularisa-tion� approach has been very successfuland delivered big cost reductions andquality improvements, says John SeelyBrown, an innovation expert who used tohead the legendary Xerox PARC researchcentre. It is one example of the sort of busi-ness-model innovation which he insists isfar more radical than conventional pro-duct or process innovation.

China moves aheadExamples of these business-model inno-vations are now bubbling up from de-veloping economies to threaten the estab-lished global giants. In a report with JohnHagel, of Deloitte, a consultancy, Mr SeelyBrown argues that the activity of privateentrepreneurs means �China is rapidlyemerging as the global centre of manage-ment innovation, pioneering manage-ment techniques that most US companiesare struggling to understand.�

The emergence of Asian world-beatersexempli�es the two forces driving innova-tion. Globalisation and the spread of in-formation technology allow the creationof unexpected and disruptive business

models, like the one used by Chongqing’smotorcycle-makers. Other examples in-clude the design networks established byTaiwanese contract-producers in the tex-tile industry. Groups of innovative just-in-time suppliers abound in Asia, feedingWestern fashion and consumer-goodscompanies. They are often managed bysupply-chain experts, like Hong Kong’s Li& Fung. Unlike Japan’s keiretsu, whichbound companies and their suppliers to-gether with interlocking shareholdings,these �rms are free to leave their alliances.They stay together only if they continue tolearn and pro�t from the experience. Insome ways they resemble the nimble net-works of �rms that underpinned SiliconValley’s success.

Low labour costs may have given such�rms a head start, but that is a transitoryadvantage. India’s software innovatorswere once sni�ed at as merely low-cost o�-shoring and back-o�ce operations. But�rms like Infosys, Wipro and Tata Consul-tancy Services (TCS) have become worldleaders in business-software services. S.Ramadorai, TCS’s chief executive, says his�rm sees �innovation as a key enabler ofits productivity edge�. He points out thathis �rm has been investing in R&D for 25years and holds several dozen patents andcopyrights. Navi Radjou of Forrester Re-search, a technology consultancy, ap-plauds TCS’s �global innovation ecosys-tem� which brings together academic labs,

start-ups, venture-capital �rms, large inde-pendent software �rms and some of itsmost important customers.

Innovation is also changing thepharmaceuticals industry. Small biotech-nology �rms, using networked ap-proaches, are getting ahead of Big Pharma.This too opens the way for Asian competi-tors, like Ranbaxy and Dr Reddy’s Labora-tories. These �rms were once copycats,trampling on Western patents to makecheap generic versions of drugs. Butincreasingly they are shifting to process in-novation and even new drug discovery.

Such innovation can arise out of neces-sity. Entrepreneurs in China must competewith privileged state �rms with access tocheap credit as well as the local arms ofmultinationals. That makes China’s �thirdsector�, as Messrs Seely Brown and Hagelcall it, extraordinarily resourceful in tryingto reach global markets. India has beenless integrated into the world economy, somany of its innovative �rms have initiallyconcentrated on reaching �bottom of thepyramid� consumers. For instance, Selco,an Indian solar-energy pioneer, found thatbecause many of its customers were livingin remote areas, it had to set up local net-works of trained technicians to sell, installand repair its products, and provide cus-tomers with small loans.

Bigger namesMost of these Chinese and Indian innova-tors are not well known, but it is only amatter of time before some will be. Fransvan Houten, chief executive of NXP, aEuropean semiconductor �rm, is con-vinced of that. He says there are now over400 �rms designing chips in China. So farthey produce �very pragmatic, �t for use�designs, but he has no doubt they willquickly become world-class innovators.One company the big carmakers arewatching closely is India’s Tata Motors,which is developing a �people’s car� thatmight radically change the process of de-sign, manufacturing and distribution toachieve its target price of no more than$3,000. If successful in India, Tata will pro-duce a version of the car for export.

As the knowledge component of indus-tries continues to grow, it will lower even

Revving up

How globalisation and information technology are spurring faster innovation

1


2

ARE consumers in India and China toopoor to a�ord high-quality Western

goods? That used to be the old idea of do-ing business in these countries as �rmso�ered watered-down versions of theirproducts at reduced prices. Mr van Hou-ten, of chipmaker NXP, says Indian andChinese consumers are forcing multina-tionals to design sophisticated productsthat more closely meet their needs, andthis is making �rms operating in Asia bet-ter innovators.

By recruiting ingenious local engi-neers and designers in places like Banga-lore and Beijing, and paying closeattention to trends and practices in themarket, �rms are coming up with pro-ducts and services that can be sold inother parts of the world too. Nokia’s engi-neers are �nding that many Chinese andIndians access the internet mainlythrough their mobile handsets. Such cus-tomers’ requirements of their handsetsmay therefore be quite di�erent to thoseof Western users, many of whom havecomputers at home and at work.

GE’s research lab in China has comeup with a simpli�ed magnetic-resonanceimaging machine that costs a fraction ofthe one it sells in rich countries. The �rmnow plans to sell it worldwide. Wenda, aquestion-and-answer �knowledge com-munity� product developed by Google inChina to help overcome a lack of localcontent, was launched in Russia in June.

Unilever has long had a strong distri-bution network in India, but it has ex-panded its e�orts with a division called

Shakti, which provides Indian women’sself-help groups with business educationand the chance to earn a living sellingcheap sachets of Unilever products. Thee�ort has proved so successful that Uni-lever introduced a high-tech element: theShakti entrepreneurs now run kioskswith personal computers which villagerscan rent to send e-mails and browse theweb for things that can make a big di�er-ence to their lives, like market prices.

Alan La�ey, who ran some of Procter& Gamble’s Asian businesses before get-ting the top job at the American com-pany, says many Asian �rms beganimitating what foreign ones did but arenow �very innovative, especially withbusiness models�.

Mr La�ey sees Indian �rms shakingup the way foreign companies operate,and not only with back-o�ce serviceswhere many began. Hours after he ut-tered those words, Wipro, an Indian pio-neer of software services said it wouldopen a new development centre in At-lanta, Georgia, that will report to its head-quarters in Bangalore.

This is forcing P&G to innovate inother ways too. Mr La�ey uses the exam-ple of detergents in China, where thecompany is using a low-cost manufactur-ing method which he likens to Coca-Cola’s �syrup� model, which supplies aconcentrate to local bottlers. P&G pro-vides secret, high-value �performancechemicals� to Chinese partners, who addbasic ingredients and packaging beforedistributing the products.

Responding to the Asian challenge

Can dinosaurs dance?

further the barriers to entry in many busi-nesses. Yet the same democratisation of in-novation that empowers the new �rmscan be used to generate much greater inno-vation from within established compa-nies. Some multinationals are already do-ing this in Asia to keep up with their localcompetitors (see box).

The e�ects of the growing knowledge-component of innovation have becomeincreasingly clear in heavy engineering.Reinhold Achatz, of Siemens, claims theGerman giant has undergone a hiddenelectronics revolution. �We have moresoftware developers than Oracle or SAP,but you don’t see this because it is embed-ded in our trains, machine tools and fac-tory automation,� he says. Mr Achatz cal-culates that as much as 60% of his �rm’ssales now involve software. Some 90% ofthe development in machine tools is inelectronics and related hardware, and the�gure is similar for cars. A BMW, he says, is�now actually a network of computers.�

Flat out in GermanyThat may seem like an exaggeration untilyou step into the sleek new Hydrogen 7BMW saloon. Push the pedal to the metalon the autobahn and the car responds asevery BMW should; cylinders growling en-thusiastically as the ultimate drivingmachine races past slower vehicles. Butthis car is not like any other made byBMW. Press a button on the steering wheeland it seamlessly switches from burningpetrol to hydrogen.

The key to this advance, says UlrichWeinmann, of BMW, is smart software.Electronics have been in cars for decades,but those were isolated �dumb systems�,he adds. Now cars are crammed full of net-works of computers with smart softwarecontrolling and monitoring things. NewBMWs can even synchronise with Apple’siPhone, and download maps and direc-tions from Google while you drive.

The steady conversion of engineeringinto yet another knowledge-based indus-try forces the pace. �We are a quite matureindustry, but customers now expectchange faster,� adds Mr Weinmann. Thedemand for change is fastest in Asia. Sev-eral hundred new mobile phones arelaunched every year in China, and cus-tomers there now expect their new BMWsto be able to synchronise perfectly witheach new handset, he sighs.

New competitors are emerging fromunexpected quarters, which makes thingsdi�cult for established �rms. One of themis Elon Musk, a 36-year-old entrepreneur

who is challenging incumbents in not onebut two old-time industries. Mr Muskmade his fortune during the internetboom by selling PayPal, an online pay-ments system, to eBay for $1.5 billion. Henow heads Space Exploration Technol-ogies, known as SpaceX. This is a start-upo�ering private space launches. Earlier thisyear, it �red a rocket into space, the �rst tobe designed, paid for and launched en-tirely with private money.

SpaceX is the vanguard. Many private-sector newcomers, fed up with the over-bearing ways of NASA and the big defence

contractors, are working furiously to com-mercialise space. In September the X PrizeFoundation and Google decided to fuel the�re by announcing a $30m prize for the�rst private-sector team to land and oper-ate an unmanned rover on the moon. PeterDiamandis, the foundation’s chairman,believes the old guard is no longer able toinnovate. �Real breakthroughs require riskand the ability to absorb failure, and largeorganisations are incapable of such risktaking,� he says.

Mr Musk is not waiting to win anyprizes. Besides SpaceX, he has also started


2 Tesla Motors, which has devised an elec-tric sports car capable of accelerating fromzero to 60mph (100kph) in four secondsand has a top speed of over 130mph. Moreimpressively, thanks to its advanced lith-ium-ion batteries and lightweight carbon-composite construction, the Tesla Roadsterhas a range of 200-250 miles from an over-night charge. The �rst cars to be producedon a larger scale are expected to hit theroad next year. They will cost a pricey$100,000 or so, but Mr Musk’s �rm has al-ready started work on a new factory to pro-duce a family car which the companyhopes to sell at half the price.

Larry Burns, in charge of R&D for Gen-eral Motors (GM), is impressed by Tesla’stechnology, but points out that the �rm’sinitial output of just a few hundred cars istri�ing compared with global car produc-tion of some 60m vehicles a year.

He is right, but Tesla and others are thethin end of what could be a big wedge. Be-sides the innovative process lowering thebarriers to entry, much key intellectualproperty involved in carmaking nowa-days is no longer guarded in-house by thelikes of GM and Ford: they now outsourcemost aspects of making a new car (exceptengines) to global parts suppliers and out-side �rms that put together large sections,or �modules�. That makes it much easierfor newcomers to buy any bits they need.

Manufacturing is integratingEven more important, the cost of launch-ing a new car company has dropped dra-matically. When Toyota and GM

launched, respectively, Lexus and Saturnas semi-independent new companies,they had to spend billions of dollars. Nowan upstart would need just a few hundredmillion. Paul Horn, the outgoing head ofresearch at IBM, believes that the car in-dustry is but one example of �the decom-position of the vertically integrated busi-ness model: car �rms were once veryintegrated, but now don’t make anything�they’re integrators in a ‘value net’.�

Mr Musk, mindful that he has yet to seea return on his investment, agrees the costsof entry are much lower, but gives warn-ing that it will not be easy to take on the in-cumbents: �The last successful car start-upin America was 100 years ago.� Even so, heis convinced that the time has come to trybecause of a fundamental �technologydiscontinuity�: the shift from the internal-combustion engine to electric drive.

The proportion of electronics thatmakes up the cost of a new car has shot upfrom very little to perhaps a quarter. By

2010 experts think it could approach half.Thanks to recent advances in batteries andpower electronics (made possible by inno-vations to power mobile phones and lap-top computers), Mr Musk thinks most carswill become electrically powered. �In 50years, we’ll look back on the internal com-bustion engine and see it as a giant anach-ronism, like the steam locomotive.�

And again Asia could take the lead.Robert Lutz, GM’s head of product de-velopment, says investment in and enthu-siasm for clean technologies in Asia is sogreat that cars powered by fuel cells(squeaky-clean devices that use hydrogento make electricity) are likely to take o� inChina before they do in the United States.

There is reason to believe he might beright. Just as villagers in Africa and Bangla-desh have gone straight from no phones tomobile phones, developing countriescould leapfrog with other innovations.

Developing countries already havehigher levels of �early stage� entrepreneur-ship, with more people engaged in thingssuch as starting new ventures�often be-cause the necessity for doing so is greater(see chart 3). Tim Jones of Innovaro, a Euro-pean innovation consultancy, points outthat Africa is about to take the lead in usingmobile phones for payments and remit-tances, thanks to the introduction ofschemes like the M-PESA money-transferservice introduced by Vodafone and Citi-group in Kenya. These allow people tosend money using text messages.

Some people reckon that, as the natureof innovation changes, so it is speeding up.But that’s not obvious. Other periods haveseen bursts of dramatic technological pro-gress: the arrival of the telegraph, for in-stance, was just as disruptive as the in-ternet is today.

Visit Wal-Mart’s headquarters in Ben-tonville, Arkansas, and you will be greeted

by a large plaque in the lobby which says:�Incrementalism is innovation’s worst en-emy! We don’t want continuous improve-ment, we want radical change.� These arethe words of Sam Walton, the �rm’s foun-der. And to his credit, Walton did radicallychange the general store with his innova-tive approach to low cost, high-volume su-permarket retailing. But ask Linda Dill-man, a senior o�cial at the �rm, aboutinnovation at Wal-Mart today and she con-cedes that radical thinking was easierwhen the �rm was young. Meg Whitman,eBay’s boss, says the same. She concen-trates on incremental improvement with-in the online auctioneer while looking out-side to acquire radical ideas by buyingstart-up companies, including ones inother markets that imitate eBay.

Ideas at double speedMany executives feel the heat is on andthat they must innovate faster just to standstill. One reason is that product cycles areundeniably getting shorter. Gil Cloyd,chief technology o�cer at Procter & Gam-ble (P&G), the world’s biggest consumer-products �rm, studied the life cycle of con-sumer goods in America from 1992 to 2002(before the internet’s full impact was felt)and found that it had fallen by half. That,he concludes, means his �rm now needs toinnovate twice as fast.

3M, an American company famous forinventing the Post-it sticky note, also be-lieves the world is moving much faster.Andrew Ouderkirk, one of the �rm’s cele-brated inventors, thinks that is in part be-cause many things that his company usedto do in-house are now done by outsiders.To keep up, 3M carries out �concurrent de-velopment�, which involves talking to cus-tomers much earlier in the process to try toshorten development times.

Even the �rm that laid down the �rstlong-distance telegraph lines thinks to-day’s innovation frenzy is unprecedented.Mr Achatz, of Siemens, is adamant that in-novation is happening much quicker andthat �access to information is so fast nowthat it allows much faster product-de-velopment cycles.� His �rm is convincedthat there will be an explosion of medicalknow-how thanks to the advance of in-formation technology into medicine.

Perhaps managers at �rms everywhereshould be both far-sighted and paranoid inequal measure as they scan the horizon forunexpected competitive threats. Somecompanies are trying to organise them-selves with management techniques toface just such a disruptive future. 7

3The necessity of invention

Source: Global Entrepreneurship Monitor 2006

*Purchasing-power parity

Early-stage entrepreneurial activity

GDP per person at PPP*, 2006, $000

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trep

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0

5

10

15

20

0 10 20 30 40 50

UnitedStates

Britain

Australia

Denmark

France

Japan

Czech Republic

China

Indonesia

Thailand

MalaysiaIndia

Germany

CanadaArgentina

1


�WHAT matters gets measured.�That is one of the basic tenets of

corporate strategy taught at businessschools. As driving growth through inno-vation is today at the top of corporateagendas you would expect to �nd manag-ers treating it like a science. After all, manu-facturing philosophies such as �total-qual-ity management� (a process of continuousimprovement) and �Six Sigma� (whichuses statistical methods to eliminate varia-tions and defects) were quanti�ed andwidely deployed a long time ago, oftenwith good results.

Yet innovation remains a frustratinglyfuzzy notion. Many bosses think it is essen-tially a creative process. Some anoint�chief innovation o�cers�, bring in con-sultancies or set up secret �skunk works�to tease out the ideas they fear their ownbureaucracy might squash. One senior ex-ecutive maintains that innovation simplycannot be de�ned exactly, but that �likepornography I know it when I see it.�

The wrong measureJorma Ollila, non-executive chairman ofboth Nokia and Royal Dutch/Shell, arguesthat it is a mistake to measure innovationby the number of patents issued by a com-pany or the extent to which new technol-ogies are introduced. He suggests that themost fertile area of innovation today can

be found in management.One reason why bosses might not want

to be too obsessive about creativity is thatgenerating ideas is the easy part. Exploit-ing them has always be harder. As ThomasEdison, one of America’s greatest inven-tors, put it, genius is 1% inspiration and 99%perspiration. But many managers are re-luctant to take the same hard-nosed ap-proach they use in other parts of their busi-ness and apply it to fragile creative types.

If any �rm has an analytical approachto innovation it should be Google. Afterall, the �rm’s superstars are its software en-gineers. It is so obsessed with data that itposts nerdy tip sheets on statistical-qualitymeasurement above the urinals at theGoogleplex. And yet managers sound likemumbling teenagers when they are askedhow they approach innovation.

Marissa Mayer, the company’s �am-boyant head of �user experience�, declaresthat Google is not merely a search enginebut �an innovation engine� that needsconstantly to reinvent itself��just likeMacs and Madonna�. As 3M and someother �rms do, Google grants its engineerspermission to spend 20% of their paid timeon pet projects unrelated to their daily job.She points to a few examples of new pro-ducts that have emerged this way, such asGmail, but cannot provide any real evi-dence that allowing sta� to take time o�

from their normal jobs contributes more tothe �rm than it costs.

It is a question that even Eric Schmidt,Google’s chief executive, cannot answer.Surprisingly, he declares that trying tomeasure his �rm’s innovation processwould choke it o� altogether. Tim Brown,head of Ideo, a design consultancy, con-curs: �A lot of innovation is anti-Six Sigma.You want a lot of variance.�

Fuzzy logicNot surprisingly, Je�rey Immelt, chairmanof GE, strongly disagrees. His �rm has longbeen a champion of Six Sigma. Mr Immeltreckons that �operational excellence� isthe crucial part of innovation, not thefuzzy ideas-generation bit. He suggests that�passion and vision� might make up just20% of the process.

Larry Keeley of Doblin, a innovationconsultancy, has followed this debateclosely for decades and insists the answeris clear: �Creativity is maybe 2% of the in-novation process. It’s a vanishingly smallcomponent, and it’s the part you can ac-quire from outside the �rm.�

Despite di�culties trying to de�ne it,the innovation process is steadily becom-ing a practical science to be measured,taught and managed. Clayton Christen-sen, a professor at Harvard BusinessSchool and an expert on the subject, insists

A dark art no more

Like management methods before it, innovation is turning from an art into a science

1


2 that �innovation simply isn’t as unpredict-able as many people think. There isn’t acookbook yet, but we’re getting there.�

The Haas business school at the Uni-versity of California at Berkeley has al-ready gone so far as to revamp its entirecurriculum to concentrate on innovationmanagement. Berkeley is home to some ofthe leading experts on the subject, includ-ing Henry Chesbrough (who popularisedthe notion of �open innovation�) and An-naLee Saxenian (whose recent book �TheNew Argonauts� analyses Silicon Valleyand related innovation clusters). RichardLyons, now of Goldman Sachs, led the re-vamp at Haas in his previous job. He isconvinced that all managers can be taughthow to nurture innovation.

The rough outline of how this might bedone is emerging. But there is no one-size-�ts-all strategy. Bosses have to appraise thestrengths and weaknesses of their �rmshonestly and continuously to take accountof rapidly evolving competitive threats.But cut through the clutter of PowerPointpresentations and faddish slogans, and anumber of things become clear.

All that jazzFor a start the debate over creativity versusexecution should be put to rest: �rms needto do both. But that does not mean theyhave to do it all themselves. On the con-trary, the double act is best managed witha loose and open approach during thewild and woolly idea-generation phase,and a tighter, more concentrated one toturn ideas into products or services. JohnKao, author of �Jamming: The Art and Dis-cipline of Business Creativity�, likens theprocess to playing jazz: there is no �xedscore in any given improvisation, but thatdoes not mean there are no underlyingprinciples either.

P&G is a good example of an inward-looking �rm that has embraced creativityand openness with some success. But MrLa�ey, its chairman, makes clear this is nomystical process. He argues that even aprocess that is open to fresh thinking fromthe outside, as P&G’s is, can be run thesame way as a factory: �It is possible tomeasure the yield of each process, thequality and the end product.�

On the �ip side, a �rm known foremphasising execution over creativity isGE. Its focus on the practical application ofnew ideas, rather than invention itself,goes all the way back to its founder, Edi-son. Indeed, he commercialised but didnot invent the light bulb.

GE’s strength is not in breakthrough in-

ventions but, to use Mr Immelt’s words,�in turning $50m ideas into billion-dollarideas.� His way of doing that is a highlystructured process that involves a mix ofmanagement training, increased exposureto outside ideas (for example, his �rm isstarting a venture capital fund to get �earlyvisibility� of clever inventions) and con-tinuous funding for the development ofnew ideas. He also emphasises that the ac-ceptance of failure is an integral part of thee�ort, as long as it is �fast failing�.

It is the last bit of Mr Immelt’s processthat points to one of the biggest thoughtsemerging from innovation research in re-cent years: neither idea generation nor exe-cution is as important or as tricky as the �l-

tering process that links the two. HaroldSirkin, of the Boston Consulting Group, isthe co-author of �Payback�, a book on in-novation strategy. He sco�s that ��rmshave too many ideas and too much em-phasis on creativity�more ideas merelychoke the funnel even more.� In fact, themore ideas a �rm comes up with, the moreimportant it is for bosses to decide early onwhich of them to kill o�. This is to avoidheading down countless and costly deadends. As Ron Adner of Insead, a Frenchbusiness school, puts it, �Innovation is aloser’s game, as we know most initiativesfail. But the truly innovative companiesknow how to deal with losing.�

That is why failing fast and learningfrom those failures is so important for com-panies. Niklas Savander, of Nokia, argues

that given today’s accelerating pace ofglobal innovation �rms �need really harshdiscipline to weed out ideas quitequickly�we are working at fast failing, butare not there yet.� He thinks his own com-pany’s legacy as a hardware manufac-turer�a capital-intensive and slow-mov-ing sector compared with software orservices�is holding it back.

Turf wars are another obstacle to fastfailing. Employees in one part of a com-pany often reject ideas and advice from adi�erent part. Mark Little, GE’s head of re-search, confesses that getting his bo�ns tokill o� unviable projects is the hardest taskhe faces: �Like a dog with a bone, peopledon’t want to give them up.�

Even if �rms can overcome the stigmaof failure, how exactly are bosses to knowwhich potential innovations to kill? MrChristensen, author of �The Innovator’sDilemma�, believes he has cracked thecode. He says it can require unlearningsome of the things that managers often ac-cept as golden rules. The chief one is thebelief in listening and responding to theneeds of your best customers.

Siren songsThis seemingly sensible strategy can be adangerous siren song, Mr Christensen ar-gues. His in�uential book shows howeven successful �rms can get into troubleby trying to please their best customers.Because there may be only a handful ofhighly pro�table, high-end buyers whowant and can a�ord more features and bet-ter performance, �rms can invest heavilyin trying to deliver what this elite groupwants even though the resulting productsmay end up beyond the reach of the ma-jority of their customers.

That, argues Mr Christensen, allowsupstarts to enter the market and o�er infe-rior (although perfectly adequate) technol-ogies and products at much cheaper pricesand push incumbents into ever smallerniches�and ultimately out of business al-together. He cautions this �disruptive� in-novation is not the same thing as �radical�or �breakthrough� innovation, althoughthe notions are often con�ated. In hisview, personal computers disrupted IBM’smainframe computers and Digital Equip-ment’s mini-computers, as did Nucor’shighly e�cient mini-mills to US Steel’sblast furnaces.

Now Chinese and Indian �rms arepoised to disrupt established companieseverywhere in much the same way, he ar-gues. Their impact, he says, will be evenmore traumatic because both countries

1


2

BERKELEY seems like a �tting place to�nd the godfather of the open-innova-

tion movement basking in glory. The Cali-fornian village was, after all, at the veryheart of the anti-establishment movementof the 1960s and has spawned plenty ofradical thinkers. One of them, Henry Ches-brough, a business professor at the Univer-sity of California at Berkeley, observeswith a smile that �this is the 40th anniver-sary of the Summer of Love.�

Mr Chesbrough’s two books �Open In-novation� and �Open Business Models�have popularised the notion of looking forbright ideas outside of an organisation. Asthe concept of open innovation has be-come ever more fashionable, the corporateR&D lab has become decreasingly rele-vant. Most ideas don’t come from there

(see chart 4 on next page).To see why travel to Cincinnati, Ohio�

which is about as far removed culturallyfrom Berkeley as one can get in America.The conservative mid-western city ishome to P&G, historically one of the mosttraditional �rms in America. For decades,the company that brought the world Ivorysoap, Crest toothpaste and Ariel detergenthad a closed innovation process, centredaround its own secretive R&D operations.

No longer. P&G has radically altered theway it comes up with new ideas and pro-ducts. It now welcomes and works withuniversities, suppliers and outside inven-tors. It also o�ers them a share in the re-wards. In less than a decade, P&G has in-creased the proportion of new-productideas originating from outside of the �rm

from less than a �fth to around half. Thathas boosted innovation and, says its boss,Mr La�ey, is the main reason why P&G hasbeen able to grow at 6% a year between2001 and 2006, tripling annual pro�ts to$8.6 billion. The company now has a mar-ket capitalisation of over $200 billion.

IBM is another iconic �rm that hasjumped on the open-innovation band-wagon. The once-secretive company hasdone a sharp U-turn and embraced Linux,an open-source software language. IBM

now gushes about being part of the �open-innovation community�, yielding hun-dreds of software patents to the �creativecommons� rather than registering themfor itself. However, it also continues to takeout patents at a record pace in other areas,such as advanced materials, and in the pro-

The love-in

The move toward open innovation is beginning to transform entire industries

have a large pool of domestic customers�many of whom have only just begun con-suming and do not have the same highexpectations as Western customers typi-cally have. Chinese and Indian companiescan practise on their domestic customerswhile they improve quality to the pointthey can begin to export. South Korean�rms have already gone through much thesame process with consumer-electronicsand cars�and in the process have fright-ened many of their Japanese rivals.

Snap, and it’s too lateIn a sense, Mr Christensen’s managementmyths echo a sentiment expressed by Ed-win Land, the inventor who founded Po-laroid. �People who seem to have had anew idea have often simply stopped hav-ing an old idea,� he said. Alas, his succes-sors at Polaroid did not pay attention. The�rm stuck by its successful old idea for�lm-based instant photography and stub-bornly ignored the disruptive potential ofdigital imaging until it was too late. Polar-oid went bust in 2001.

Mr Christensen’s alternative innova-tion strategies include watching out fornew technologies or new business modelswhich are designed to attract customerswho may not be using your product todaybecause it too expensive or too compli-cated. Sony’s early transistor radios weretinny compared with RCA’s big home ver-

sions, but teenagers who never had radiosloved these cheap devices.

He also thinks it is better to make thingssimpler and easier for the bottom and mid-dle of the market, as personal computersdid, rather than add needless bells andwhistles for the handful of top customerswho can a�ord and demand them. And hesays companies should act decisively toco-opt or pre-empt disruptive ideas them-selves, even if it threatens their core busi-nesses in the short run.

Executives at USSteel, a traditional inte-grated steel-�rm nervously eyeing thethreat from new mini-mill technology,nearly built a cheap and cheerful mini-millthemselves to compete against the upstartNucor. However, recounts Mr Christen-sen, those aspiring innovators within US

Steel were forced to halt the pro�table pro-ject by bean counters, who argued that itwas cheaper just to produce more steelfrom the �rm’s existing blast furnaces(since their capital costs had been paid forand steel could be produced for merely themarginal cost of cranking out an extratonne). That short-term thinking scup-pered the giant �rm’s best chance for re-inventing itself.

Peter Drucker, an eminent manage-ment guru, argued decades ago that inno-vation and entrepreneurship are �pur-poseful tasks that can be organised�are inneed of being organised� and should be

treated as part of an executive’s job. Is there a risk that with too many rules,

�rms could lose out to serendipity? Ask MrLa�ey how he intends to keep P&G’s edgeif innovation becomes less ad hoc and heimmediately points to Toyota’s embrace oftotal-quality management as a model.Many �rms have studied the Japanese car-maker’s legendary methods, as P&G’s ri-vals are even now studying its innovationmodel, but none has really been able tocopy it. That is because Toyota’s real edge isthe strong culture which drives its unre-lenting quest for quality.

Bill Reinert, a senior Toyota o�cialbased in North America, explains it thus:�What’s discontinuous about our �rm isthe very long view of management. Thatvision has pushed us from being a closedcompany to one with continuous informa-tion �ows, both into the company andwithin it, about market, regulatory andgeopolitical trends.�

A symbol of this is Toyota’s Prius hy-brid-electric car. It was a risky bet on anunproven technology, but it has been ahuge success. It was a long-term vision,says Mr Reinert, that overcame the �rm’sinnate caution. And in the future the com-pany is going to have to make similar betsagain. �We are convinced that we are en-tering a disruptive future, and we want tobe ready for it,� he says. He is not alone intaking that view. 7

1


2 cess racks up some $1 billion a year in li-censing fees.

Since an army of programmers aroundthe world work on developing Linux es-sentially at no cost, IBM now has an ex-tremely cheap and robust operating sys-tem. It makes money by providing itsclients with services that support the useof Linux�and charging them for it. Usingopen-source software saves IBM a whop-ping $400m a year, according to Paul Horn,until recently the �rm’s head of research.The company is so committed to opennessthat it now carries out occasional �onlinejam sessions� during which tens of thou-sands of its employees exchange ideas in amass form of brainstorming.

Mr Chesbrough, of course, heartily ap-proves. He gives dozens of other examplesof �rms doing similar things, ranging fromClorax, a household products �rm to AirProducts, an industrial gases company. MrChesbrough reckons that �IBM and P&G

have timed their shift to a high-volumeopen-business model very well� and thatif their competitors do not do the samethey will be in trouble.

Not everyone is impressed. KennethMorse, head of MIT’s EntrepreneurshipCentre, sco�s at IBM’s claim to be an opencompany: �They’re open only in markets,like software, where they have fallen be-hind. In hardware markets, where theyhave the lead, they are extremely closed.�

Open costsDavid Gann and Linus Dahlander, of Lon-don’s Imperial College, are also sceptical.They argue that �rms have always beenopen to some degree and that the bene�tsdi�er depending on their line of business.Those using older technologies, for in-stance, may bene�t less. They also pointout that the costs of open innovation, inmanagement distraction or lost intellec-tual-property rights, are not nearly as wellstudied as its putative bene�ts.

Yet another critique comes from capi-tal-intensive industries, where productstake a long time to develop and remain onsale for years. Toyota’s Mr Reinert laughswhen asked about open innovation. Withthe billions of dollars his �rm spends onresearch and on equipping its factories�not to mention a �ve-year product-de-velopment cycle�he suggests it would befoolish to open up and allow rivals to stealits edge. �Eventually even Google willhave to make something tangible, andwhen they do they will protect it�just likeTesla Motors, which does not have anopen model,� he adds.

GE’s Mr Immelt observes that his �rm isa leader in a number of �elds, such as mak-ing jet engines and locomotives, which re-quires �doing things that almost nobodyelse in the world can do� and where intel-lectual-property rights and a degree of se-crecy still matter. Mark Little, his head ofresearch, is even more sceptical and saysoutside ideas �don’t really stick well here�.He professes great satisfaction with theoutput of GE’s own research laboratories.�We’re pretty happy with the hand we’vegot,� he adds.

Horses for courses, perhaps. Boostersof open-innovation agree that there areperils. One of them is that it is not easy towork with outsiders. Corporate culturescan sometimes clash and some outsidersare not used to working in a business envi-ronment. For example, P&G has a �co-in-vention� lab with BASF, a German chemi-cals giant with its own strongcorporate-culture. Bo�ns from the Ameri-can government’s prestigious Los Alamosnational laboratory also sit in on some ofP&G’s research-planning sessions. Theconsumer products �rm believes that thebene�ts of working with people from suchdiverse organisations are worth the e�ort.

For one thing, patents are becomingmuch less important nowadays thanbrands and the speed at which productscan be got to market. It is true that some ofthe rising stars in developing economiesare beginning to take out more patents, butmany of their innovations are still keptquiet as trade secrets. So �uid are theirmarkets, and so weak the historical patent-protection in them, that bosses often preferto keep things in the dark�and come upwith the next innovation as necessary to

stay ahead of the competition. Even in developed markets, the accel-

eration of innovation is making patentsless relevant. What is more, say brand ex-perts at P&G (which claims not even tocount patents any longer), the dizzyingpace of change today confuses consumerswith a ba�ing array of choices. Such �rmsare increasingly turning to trusted brandsto simplify things for their customers. An-drew Herbert, head of Microsoft’s researchcentre in Cambridge, England, puts it thisway: �Our brand hides a tremendousamount of innovation.�

Open innovation also appears to keepcorporate bureaucrats on their toes, mak-ing companies better at competing. Thecombination of exciting new technologiesand juiced-up management processes has,according to Mr La�ey, helped P&G to re-duce its rate of failed product-launchesfrom eight out of ten to just half.

Unilever’s David Duncan insists thathis �rm�one of P&G’s biggest competi-tors�is much better connected to its cus-tomers than it was. �Twelve years ago,when I joined, we were very closed, verti-cally integrated and owned most of thevalue chain�even the chemicals and soft-ware we used,� he says. Now it is muchmore receptive to ideas and services fromthe outside, even posting challenges on theinternet for people to come up with newideas. But he too confesses that there canbe di�culties: �it’s like the �rst time youused Google; it was scary and a bit tricky,but soon you see that it’s great.�

So how do you know if open innova-tion will work for a particular company? Itmay well depend not just on what a com-pany does but also on how it is perceivedin the market. Hal Sirkin, of the BostonConsulting Group, suggests that ratherthan see �rms like P&G and IBM as trulyopen innovators, it is better to view themas �beacons�. They have enough world-class experts working for them to attractoutsiders who have brilliant ideas. Such�rms are �open� in the sense that they arenow casting a very wide net in their searchfor ideas. However, once they have cap-tured the essence of those ideas, argues MrSirkin, �they control them and the processof getting them to market.�

At your serviceOn a summer day in east London, a ware-house was taken over by a company eagerto make a splash. It was decked out to looklike a cool New York loft. The Ministry ofSound, a London nightclub, was hired for aparty afterwards. The event was packed

4People power

Source: IBM “The Global CEO study 2006”, based on

interviews with 765 CEOs and business leaders

Most significant sources of innovative ideas% of respondents selecting up to three choices

0 10 3020 40

Employees

Business partners

Customers

Consultants

Competitors

Associations, tradeshows, conference boardsInternal sales andservice units

Internal R&D

Academia


2 with journalists. At last the stars took to thestage�a group of besuited Nokia execu-tives there to announce a dramatic changein corporate strategy.

Nokia, a Finnish company, makes mo-bile-phone handsets which are used bynearly a billion people around the world.However, it now wants to be a services�rm. Why? Niklas Savander, of Nokia, ar-gues that the mobile-phone business �ismoving so rapidly, thanks to the democ-ratisation of the internet, that we must in-novate or die.� Providing people with de-vices alone is not enough, the companyhas concluded.

With half of the value and most of theinnovation in a mobile-phone handsetnow made up of software, �the leap to ser-vices is not so great as it seems,� he adds.Nokia is now rolling out Ovi, a brandedservice o�ering users networked gaming,music downloads and other services fromtheir handsets.

Visionary companies need to do evenmore than that, argues a report by C.K.Prahalad and Venkataram Ramaswamy,two academics at the University of Michi-gan. They think �rms should cultivate anetwork that includes consumers in which�personalised, evolvable experiences arethe goal, and products and services evolveas a means to that end.� That sounds �u�yenough to have come straight from theSummer of Love.

Yet despite the dangers, some compa-nies have successfully brought consumersand others into the innovation process.Lego, the Danish maker of children’sbuilding blocks did it; and it helped revivethe company. In�uenced by research doneat MIT on how children learn, Legolaunched Mindstorms, a robotics kit thatallows people to design their own robotsand other devices. Numerous websiteshave popped up as users�including manyadults�come up with all sorts of ways ofputting together the kit to make thingsranging from intruder alarms, sorting ma-chines and even the controls for small un-manned aircraft.

Eric Von Hippel, of MIT, has long advo-cated user-driven innovation. He says youcan see it all around you. Users who feelpassionate about certain products often�ddle around with them because they failto provide exactly what they want. It mightbe a mountain bike, a kayak or even a car.He reckons open innovation misses thepoint if it is not inspired by users, becausecompanies are then �just talking about amarket for intellectual property rights, it’sstill the old model.�

Mr Von Hippel thinks that �rms that areclose to their lead users can come up withmuch better designs for new products andget them to market faster. This advice ap-pears to contradict what Harvard’s MrChristensen says, but in fact the two thesesare compatible. Mr Christensen’s point isthat �rms should not uncritically cater tothe demands of their most pro�table cur-rent customers. They must question thosedemands or they could end up doing littlemore than gold-plating their current o�er-ings; like Mr Von Hippel, he thinks �rmsshould keep a closer watch on new anddissatis�ed users, who are much morelikely to be the source of disruptive ideas.

Invented on FacebookMr Von Hippel adds that networks ofhyper-critical users can even help �rmsquickly �lter out bad ideas and thus en-courage the process of fast failing. Thecraze for social networking sites, like Face-book and MySpace, could be useful. SinanAral, of the Stern business school at NewYork University, argues that how peoplerelate to the products they use (somethingoften discussed on such sites) reveals a so-cial structure and preferences. That canhelp �rms understand more about theircustomers and how to market productsmore e�ectively.

User networks operate in many busi-nesses. OnStar, a mobile-information sys-tem widely launched by GM in 2000, wasinitially meant only to provide safety andemergency services for drivers. But motor-ists wanted it to do more, and they pushed

GM to innovate. Now OnStar can check if acar is working properly, open the doors fora driver who accidentally locks the keys in-side and even locate the nearest pizzaplace. GM’s Larry Burns believes OnStarhelps to improve his �rm’s brand loyaltybecause it keeps the company in constanttouch with its customers.

Richard Lyons, of Goldman Sachs, of-fers the most compelling argument for�rms to think hard about recruiting usersto speed up and improve their innovatione�orts. In rich countries about four-�fthsof economic activity now involves ser-vices, but pro�t margins are eroding. He ar-gues in a new paper that �commoditisa-tion often occurs even faster in servicesthan in physical products�, because inno-vations are easier to copy, patents can pro-vide less protection, up-front costs arelower and product cycles are shorter.

For a business that uses open and net-worked innovation, it matters less whereideas are invented. Managers need to focuson extracting value from ideas, whereverthey come from. Unfortunately govern-ment planners, who are often obsessedwith national innovation policies and theneed to create clusters like Silicon Valley,have not learnt this lesson. History alsoshows that countries that come up withnew technologies are often not the onesthat commercialise or popularise those in-ventions. Richard Halkett, of Nesta, a Brit-ish research body devoted to innovationpolicy, jokes that the right policy for gov-ernments should be �never inventedhere�. He may be right. 7

1


THE scene in Salzburg earlier this yearwas one that Joseph Schumpeter, an

economist obsessed with innovation, andMr Drucker, the management expert,would surely have approved of. Severaldozen government o�cials and academ-ics from around the world gathered atSchloss Leopoldskron, a spectacular ro-coco palace located on the shores of anidyllic lake. They came not for the fresh Al-pine air, hearty Austrian fare or even thehills alive with music. It was for a confer-ence organised by the Salzburg GlobalSeminar, a non-government organisation,to discuss what they could do to turn theireconomies into innovation powerhouses.

Holding such a meeting in the heart ofEurope seemed only �tting�and not justbecause the two great theorists of innova-tion both hailed from the region. After all,it was a European, France’s Georges Do-riot, who invented venture capital duringhis time teaching at Harvard. And it wasanother Frenchman, Jean-Baptiste Say,who coined the word entrepreneur twocenturies ago to describe the plucky up-start who �shifts economic resources outof an area of lower and into an area ofhigher productivity and greater yield.�

And yet the star of the show was Amer-ica. Everyone wanted to learn how SiliconValley was created and how it has man-aged to keep its edge despite variousbooms and busts. And Asia also made itsmark, with innovation gurus from placeslike Singapore bragging about how manybillions of dollars they are spending ontechnology parks, tax breaks on foreign in-vestment and scholarships for their brightyoung things to go to MIT and Stanford.

Out of steamSo what about Europe? The blunt answeris that the European Union (EU) is some-thing of an also-ran when it comes to inno-vation. That does not mean the region hasno innovative companies�it certainly hasthem in some areas, especially retail and �-nancial services with �rms like Zara, aSpanish fast-fashion chain, and DirectLine, a British online insurer. But thesetend to be exceptions. It is not much of anexaggeration to say that, aside from mobiletelephony, Europe has not come up with a

globally disruptive innovation in de-cades�although Skype, an internet-tele-phony �rm that is now part of eBay, oncelooked like it might qualify.

Europe’s innovation malaise is the re-sult of a complex mix of factors. Someplaces, like Ireland, Finland and parts ofScandinavia, do better than others. AndCambridge, England, can reasonablyclaim to have created Europe’s best inno-vation cluster, albeit one that falls far shortof Silicon Valley. The main thing holdingback continental Europe is that it is a lousyplace to start a new company. It can cost alot of money and it takes too long to set upa business (see chart 5).

Last year, venture capitalists invested

only about 6.4 billion ($9 billion) in theEU, while their American counterpartssplashed out some $45 billion on new ven-tures. The link between venture capitaland innovation is a strong one. SamuelKortum and Josh Lerner, two Americanacademics, have shown that �a dollar ofventure capital could be up to ten timesmore e�ective in stimulating patentingthan a dollar of traditional corporateR&D�. They scrutinised 20 manufacturingindustries between 1965 and 1992, andfound that the amount of venture-capitalmoney in a sector dramatically increasedaccording to the rate at which businessesin that sector took out patents. From 1982to 1992, they calculated that venture-capi-tal funds amounted to just 3% of corporateR&D but 15% of all industrial innovations.

It is true that patents have become lessimportant in some industries and so theymay be an imperfect proxy for all innova-tion. And in some cases venture-capitalfunds will follow rather than create inno-vation. Nevertheless, patents are stillwidely used and Messrs Kortum and Ler-ner successfully validated their resultswith other measurements too.

But surely innovation and entrepre-neurship are not the same thing? Follow-ing the most useful de�nition�that inno-vation brings fresh thinking to themarketplace that creates value for a com-pany, its customers and for society atlarge�someone who opens yet anothercorner café may be a successful entrepre-neur but not much of an innovator.

The fading lustre of clusters

The best thing that governments can do to encourage innovation is get out of the way

5Waiting to start

Source: World Bank “Doing Business” project

Number of days required to start a business

0 5 10 15 20 25

Japan

Germany

Britain

Italy

France

United States

Denmark

Iceland

Canada

Australia

1


2 The ones worth paying attention to area special type of entrepreneur who em-braces new ideas. These are the peoplewho are able to carry out the �creative de-struction� that Schumpeter marvelled at.In Europe they are thin on the ground: toomany Europeans opt for comfortable jobsworking for Siemens or Electricité deFrance than the risk and bother of startingspeculative new companies.

This is worrying for Europe. Nationalchampions and incumbents are not dis-ruptive innovators: upstarts are. From 1980to 2001, all of the net growth in Americanemployment came from �rms youngerthan �ve years old. Established �rms lostmany jobs over that period and dozens fello� the Fortune 500 list.

Big corporations have been dying o�and disappearing from stockmarket indi-ces. Most of the dynamism of the worldeconomy comes from innovative entrepre-neurs and a handful of multinationals(like GE, IBM, 3M, P&G and Boeing, all ofwhom have stayed on the Fortune 500 listfor over 50 years or so) and which con-stantly reinvent themselves.

Carl Schramm, president of the Kauf-man Foundation, which studies entrepre-neurship and innovation, says that �for theUnited States to survive and continue itseconomic and political leadership in theworld, we must see entrepreneurship asour central comparative advantage. Noth-ing else can give us the necessary leverageto remain an economic superpower.�

The trouble with dirigismeAmerica’s economy is not a free-marketparagon, to be sure. The internet and re-lated industries have all bene�ted from thespill-over e�ects from government fund-ing of universities and from militaryspending. However, it is wrong to thinkthose factors alone explain America’s dy-namism. The Soviet Union spent lavishlyon its military and space programmes dur-ing the cold war, but because its economicsystem was ossi�ed there were few spill-over e�ects. The unintended bene�ciarywas Israel, arguably the most entrepre-neurial economy on earth, because itsmany Russian émigré scientists now formthe core of a vibrant high-tech sector.

What is more, Europe itself spends a lotof money on higher education and has anumber of top universities with leadingacademics and researchers who produceexcellent papers and win Nobel prizes. Theproblem is that their ideas tend to stay intheir ivory towers. Part of the explanationis that innovation is still seen as being dri-

ven by government spending in R&D,when in fact most of it is now in servicesand business models. Companies that out-perform their peers put a much bigger em-phasis on business-model innovation (seechart 6 on next page).

The EU has an o�cial target to raise gov-ernment R&D spending to 3% of GDP andthere is much angst over patents�an ob-session that Japanese planners share. Thelatest edition of �Science, Technology & In-novation in Europe�, an annual report byEurostat, the statistical arm of the Euro-pean Commission, reveals exactly what iswrong. It is chock full of �gures, brokendown by region and industry, of researchspending, patents �led, scientists em-ployed and other important-soundingvariables. The problem is that these are allinputs into the innovation process, notoutputs. There is only a cursory discussionof venture capital and no attention paid atall to entrepreneurship�the most power-ful way to turn ideas into valuable pro-ducts and services.

The world is spikyAnother problem is that EU o�cials, likegovernment bureaucrats everywhere, areobsessed with creating geographic clusterslike Silicon Valley. The French have pouredbillions into pôles de compétitivité; and Sin-gapore, Dubai and others are doing muchthe same. There are dozens of aspiringclusters worldwide, nicknamed Silicon

Fen, Silicon Fjord, Silicon Alley and SiliconBog. Typically governments pick a promis-ing part of their country, ideally one thathas a big university nearby, and provide apot of money that is meant to kick-start en-trepreneurship under the guiding hand ofbenevolent bureaucrats.

It has been an abysmal failure. Thehigh-tech cluster in and around Cam-bridge, England, is the most often-citedcounter example. Hermann Hauser, ofAmadeus Capital, a leading British ven-ture capitalist (who, curiously, also hailsfrom Vienna), is an optimist: �Silicon Val-ley is still the lead cow but Cambridge isthe best in Europe.� Perhaps, but that isfaint praise. The main problem, arguesGeorges Haour, of IMD, a Swiss businessschool, is that Cambridge su�ers from thePeter Pan complex: �inventors never wantto grow up, they are happy with modestsuccess.� One veteran of the city’s start-upscene even argues that its success came �inspite of, not because of� government anduniversity support.

Experts at Insead looked at e�orts bythe German government to create biotech-nology clusters on a par with those foundin California and concluded that �Ger-many has essentially wasted $20 billion�and now Singapore is well on its way todoing the same.� An assessment by theWorld Bank of Singapore’s multi-billiondollar e�orts to create a �biopolis� reck-oned that it had only a 50-50 chance of suc-cess. Some would put it less than that.

Diana Farrell, of the McKinsey GlobalInstitute, argues that the real problemholding back innovation in many de-veloped countries is too much govern-ment in the form of red tape and marketbarriers. She points out that planning re-strictions have prevented the expansion ofAhold and other highly e�cient retailersin France. Closing hours in several EU

countries also act as an inhibitor. The insti-tute’s studies of Japan and South Koreasuggest the heavy hand of government iseven more sti�ing in those countries: out-side a small, highly competitive group ofexport industries (cars, electronic goodsand steel), ine�cient, coddled domesticsectors are slow to adopt new technologiesor business practices.

Pedro Arboleda, of Monitor Group,summarises his consultancy’s years of re-search into this matter thus: �Companies,not regions, are competitive. So the ques-tion for government is: how to attractmany competitive �rms?� That throwscold water on cluster-mad politicians. Italso points to what are sensible prescrip-

1


2

JOHN KAO is an innovation guru de-scribed as �Mr Creativity� by this news-paper a decade ago. Now he is concerned

about America losing its global lead andbecoming �the fat, complacent Detroit ofnations�. In his new book, �InnovationNation�, he points to warning signs, suchas America’s underinvestment in physicalinfrastructure, its slow start on broadband,its pitiful public schools and its frostinesstoward immigrants since September 11th2001�even though immigrants providedmuch of America’s creativity. The rise ofAsia’s innovators is a �silent Sputnik�, heargues, invoking a cold war analogy. WhatAmerica needs, he reckons, is a big push byfederal government to promote innova-tion, akin to the Apollo space project thatput a man on the moon.

Curtis Carlson puts it in starker terms:�India and China are a tsunami about to

overwhelm us.� As head of California’sStanford Research Institute, Mr Carlsonknows the strengths of Silicon Valley from�rst-hand experience. And yet here he isinsisting that America’s information tech-nology, services and medical-devicesindustries are about to be lost. �I predictthat millions of jobs will be destroyed inour country, like in the 1980s when Ameri-can �rms refused to adopt total-qualitymanagement techniques while the Japa-nese surged ahead.� The only way out, heinsists, is �to learn the tools of innovation�and forge entirely new, knowledge-basedindustries in energy technology, biotech-nology and other science-based sectors.

It is natural to be sceptical of such dourarguments and calls for government ac-tion. After all, the United States still leadsin innovation. Whether it is by traditionalmeasures, like spending on research and

the number of patents registered, or lesstangible but more important ones, like thenumber of entrepreneurial start-ups, lev-els of venture-capital funding or the pay-back from new inventions, America is in-variably at the top of the league. Indeed,the Council on Competitiveness recentlyconcluded in a report that, by and large, theoutlook is bright for America.

Yet the same council’s innovation taskforce also gave warning that other coun-tries are making heavy investments thatthreaten to erode America’s position. Itwould like a big push in four areas: im-proving science, engineering and mathseducation; welcoming skilled immigrants;bee�ng up government spending on basicresearch; and o�ering tax incentives tospur �US-based innovation.�

These are mostly sensible recommen-dations because they focus on those

The age of mass innovation

We are all innovators now

tions to promote innovation.First of all, stop spreading money

around trying to clone lots of Silicon Val-leys. Steven Koonin, chief scientist at BP

and formerly the provost of the CaliforniaInstitute of Technology, thinks EU coun-tries anyway spread research funds toothinly. American o�cials, he says, �haveno problem making big awards, so theycan achieve scale.� His own �rm has justdone that, setting up a $500m research alli-ance run by the University of California atBerkeley to look into advanced biofuels.

However, there is an even more impor-tant factor than money: culture. Nokia’ssuccess was not the result of far-sightedplanning or subsidy by the government ofFinland. One Nokia executive con�des:�The biggest boost to our �rm was the de-regulation that followed the second worldwar and the government’s avoidance ofprotectionism.� One of the most innova-tive things Nokia did was to spot that thehandset could also be a fashion accessory.And coming from such a small and openmarket, it was forced to think globally.

Secondly, governments keen to pro-mote innovation need to look out for mar-ket distortions and over-regulation thatcan be stripped away. Entrepreneurs canface an uphill battle legally, and not justculturally, in many countries. The bank-

ruptcy code in many places is excessivelyburdensome, even banning some failedentrepreneurs from running a companyfor years. Contrast that with America’sChapter 11 bankruptcy proceedings,which quickly re-deploy both the bank-rupt �rm’s physical assets and the creativeenergies of its leaders.

In India an overbearing system knownas the �Licence Raj� choked the creativityout of most sectors of the economy for de-cades, through a mix of over-regulation,petty corruption and centralised planning.But the bureaucrats in Delhi did not under-stand computer software well enough to

regulate it. And by the time they cottonedon, innovators in Bangalore and other cor-ners of India had created a world-class in-dustry. A similar story may be unfoldingin China. Adam Segal, of the Council onForeign Relations, an American think-tank, has studied high-technology �rms inBeijing, Shanghai, Guangzhou and Xian.His research shows that smaller �rms inthe private sector are likely to be more in-novative than bigger ones reliant on gov-ernment largesse.

Even in Africa, where chaotic and cor-rupt rule can impede growth in myriadways, extraordinary innovators are start-ing to �ourish wherever they are notchoked o� by bureaucrats or fat cats. JohnDryden, of the OECD, observes that �free-dom from legacy� (in the shape ofstranded assets, like �xed-line telephonyor centralised power grids) has liberatedAfrican entrepreneurs and allowed themto leapfrog with technology�from havingno electricity to solar cells, for instance.

Stewart Brand, an internet pioneer andco-founder of the Global Business Net-work, a scenario consultancy, is convincedthat if you want to see the next wave ofconsumer innovation, �look to the slumsof South Africa, not Japanese schoolgirls.�So where does that leave the present Goli-ath of innovation, the United States? 7

6Innovating the business

Source: IBM “The Global CEO study 2006”based on interviews with 765 CEOsand business leaders

*Based on operatingmargin growthover five years

Priorities of underperformers v outperformers*% of emphasis

0

20

40

60

80

100

Underperformers Outperformers

Businessmodel

Operations

Product/services/markets

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framework conditions and bits of infra-structure that the market would not pro-vide on its own. Where such prescriptionstend to go awry is when they argue for spe-ci�c subsidies or tax breaks for favouredindustries (like supporting only �US-based� innovation in today’s world ofglobal creative networks). After all, theSchumpeterian forces of creative destruc-tion must be allowed to work their magic.

Resilience in the face of those disrup-tive forces gave Silicon Valley the edge overits nearest high-tech rival, Boston’s Route128 technology corridor. Both clusterswere riding high until the personal com-puter and distributed-computing changedthe market. Firms went through wrench-ing change, but those in northern Califor-nia, like Hewlett-Packard and Xerox,emerged stronger than those near Boston,like Digital Equipment and Wang�whichno longer exist. As Berkeley’s AnnaLeeSaxenian has shown, Silicon Valley’schampions were nimble and networkedbut those on Route 128 were brittle, top-down bureaucracies.

Where the magic happensSergey Brin, who co-founded Google withMr Page, insists that �Silicon Valley doesn’thave better ideas and isn’t smarter thanthe rest of the world� but it has the edge in�ltering ideas and executing them. Thatmagic still happens and attracts peoplefrom around the world who are �bold, am-bitious, determined to scale up and able toraise money here actually to do it.� Mr Brinpoints to Elon Musk as an example.

Mr Musk moved from South Africa toeventually settle in California to make hisfortune. His equation for success is: �talenttimes drive times opportunity�. Unlikemany countries, America is never satis�edwith the status quo. �There is a culture herethat celebrates the achievements of indi-viduals�and it is too often forgotten in his-tory that it is individuals, not governmentsor economic systems, that are responsiblefor extraordinary breakthroughs,� he says.

That explains why the best innovationpolicy is probably one that does the least.Liberty is a powerful force. In the past, asMr Brin notes, innovation was dominatedby elites�the �wealthy gentlemen tinker-ers�, for example�who had privileged ac-cess to information, money and markets.

He is right. The history of innovation is�lled with elites and centralised processes.But look closer and you �nd that ordinarypeople have always silently played a role.In �A Culture of Improvement: Technol-ogy and the Western Millennium�, Robert

Friedel shows how countless small e�ortsby individuals, from all rungs on society’sladder, contributed to the astonishing ad-vances that we enjoy in today’s post-mod-ern, post-industrial societies.

Imagine how much better �rms andcountries could innovate if they could har-ness the distributed creative potential ofall these innovators-in-waiting. The key,Mr Friedel observes, is freedom: �Technol-ogy and the pursuit of improvement areultimate expressions of freedom; of the ca-pacity of humans to reject the limitationsof their past and their experience, to tran-scend the boundaries of their biologicalcapacities and their social traditions.�

To put it the other way round, domi-neering bosses and governments maynotch up some success, but history showsthat it will at best be limited and may stag-nate. �You can ordain the money but not

the brilliance and free-thinking,� saysIdeo’s Mr Brown. �Creative people like tochallenge constraints and authority.�

As industries become more knowl-edge-based and more �rms turn to openand user-led innovation models to keep astep ahead of disruptive innovators, gov-ernments will have to think more carefullyabout what, if anything, they can do tokeep their economies competitive. Oftenthat will mean a lighter touch. As WilliamWeldon, chairman of Johnson & Johnson,a health-care giant, observes: �Innovationis no longer about money, it’s about the cli-mate: are individuals allowed to �ourishand take risks?�

Stewart Brand, an internet pioneer, hasfamously argued that �information wantsto be free.� So surely the knowledgeworker, the creator of that information,also needs the same freedom. Companiesand governments can �nd an innovator in-side everyone; they just need to liberatethem. Moreover, the rising tide of inven-tions that make one country wealthybene�ts others that bring those cleverideas to market or simply make use ofthose products, processes and services.

In an age of mass innovation the worldmay even �nd pro�table ways to deliversolutions to the 21st century’s greatestneeds, including sustainable clean energy,a�ordable and universal healthcare forageing populations and quite possibly en-tirely new industries. The one natural re-source that the world has left in in�nitequantity is human ingenuity. 7

....................................................................Vijay Vaitheeswaran and Iain Carson are the authors of�Zoom: The Global Race to Fuel the Car of the Future�,published by Twelve (Hachette Book Group USA), 2007

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