(Business 2.0 Magazine) -- With its sleepy train station and rolling green hills, the hamlet of Oberkochen makes an unlikely epicenter for Germany's optical-engineering industry. It's also the site of one of the most remarkable mergers in history.

Like Germany itself, Carl Zeiss (Charts) - a 160-year-old optics maker famed for its microscopes and camera lenses - was split into separate East and West German entities after World War II. The two companies reunified in 1991, and after years of being weighed down by its former Soviet Bloc half, Zeiss has emerged as one of the most innovative companies in Europe.

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Its secret?

A fanatical research and development method that funds only the most commercially viable projects. "Innovation is about more than invention," says CEO Dieter Kurz. "It is about creating something useful that gives the company an advantage."

Having nearly gone broke in the mid-1990s, Zeiss now earns an astounding two-thirds of its revenue from products less than five years old. Last year the company's net profit nearly doubled to a record $193 million, while sales climbed 4 percent to $2.8 billion - about 10 percent of which was poured back into research. Here's how an innovation makes it through Zeiss's tortuous R&D gauntlet.

1. Zeiss's 1,600 R&D employees bring hundreds of new ideas, such as a heads-up display system for cars in 2004, to its annual innovation conference.
2. Twenty to 30 of the concepts are presented to the Zeiss "ideas board," which spends three months selecting the eight to 12 best inventions.
3. The ideas board spends six months analyzing risks and conducting research with potential customers--such as car-parts makers for the driver information system.
4. That research is presented to the Zeiss venture board, which green-lights two or three projects, each of which is assigned a budget and a manager.
5. Each manager assembles a team, which spends as long as a year creating a prototype. It then finds possible partners, such as auto-parts subsidiary Siemens VDO, to test the prototype.
6. The vetted products are again presented to the venture board, which decides how many get the nod. The automotive display was approved in 2005; the product will be made by Siemens VDO and hit the market in 2007.

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