Getting Beyond the Innovation Fetish Innovate or Die? Sorry, that misses the point. There's actually an innovation glut. The real shortage is profits.
By Michael Schrage Reporter Associate Matthew Boyle

(FORTUNE Magazine) – Jennifer Brown, the executive vice president of e-business at Fidelity Investments, has a serious problem with innovation in her group. There's too much of it.

"We have more good ideas than we can handle," she confesses. "We have so many good ideas here--truly innovative ideas--that sometimes our people get a little frustrated that we can't act on most of them."

Too many good ideas? In a global marketplace filled with savvy, well-heeled, and aggressive competitors, ranging from Charles Schwab to E*Trade to Merrill Lynch? Don't management gurus like Peter Drucker and Gary Hamel insist that enterprises worldwide need to be even more innovative?

Yet Fidelity's embarrassment of innovation riches is not unique. E-business innovators at Schwab, eBay, Amazon, Travelocity, Microsoft, Enron, and IBM are also spinning out more good ideas than their companies have time and resources to implement. There's not a well-trafficked B2B or B2C site on the WWW that doesn't insist that it is committed to ongoing technical enhancement. "So long as we're being consistent with the brand, we're always innovating to make our site more appealing," says Toby Lenk, CEO of eToys, widely regarded as one of the best-designed e-tailing sites. "That's part of the price of doing business in this space."

What's apparently not part of the price of doing business, however, is charging customers for all that innovation. If one defines a business model as the resolution of the dilemma "What does a company charge money for?" vs. "What does it give away?" it's clear that e-businesses of all bandwidths think that innovation typically falls on the free side of the ledger. Think integrating a Web browser with your computer's operating system is innovative? So does Microsoft. That's why Internet Explorer was bundled into Windows free. Believe instant messaging and buddy lists represent an advance over e-mail? They're free on AOL. Think that helping customers design their own innovations is cool, even if there's no guarantee they'll use your products? So does GE Plastics, which spent more than $10 million developing an online Design Solutions Center and lets anyone in the plastics business use the thing--free, natch. Think "mass customization" represents the new new thing? That's what Yahoo offers in its free MyYahoo pages. Consider peer-to-peer file exchanges of music and software a "paradigm shift"? Think Napster and Gnutella--gratis.

Such is life in the thrall of today's innovation fetish. Spurred on by great strategists who insist on innovation uber Alles and aided by the information-is-free economics of digital media and the Net, companies are rolling out and giving away one innovative idea after another. In fact, there's even a whole subsector of technology built around giving away innovation. The "open source" movement--perhaps the most influential initiative in software today--is the apotheosis of these innovation economics, with myriad "freeware" subcults. "Many of the original [software] projects were developed by individual developers rather than corporations," says Tim O'Reilly of O'Reilly & Associates, the entrepreneurial publishing house serving the software development community, "but there are many corporations that have embraced the open source model. [Linux vendor] Red Hat is the most obvious example of a company that has made giving away all the code it produces a strategic part of its business model."

It remains to be seen, of course, if open source thrives as a viable, profit-inducing movement. What's undeniable is that its economics, and those of giveaway advocates from Yahoo to GE Plastics, are the ironic, perverse, paradoxical--but utterly predictable--result of today's innovation glut. The supply of digital innovation now overwhelmingly exceeds the demand. Over the past few years everyone in the world has rushed to adopt first, information technology, and second (and more important), the Web. With all these smart and not-so-smart people focused on one area, it's hardly astonishing that there are now simply more good ideas than the e-marketplace can effectively handle. As Fidelity's Brown ruefully acknowledges, the overwhelming presence of so many good ideas reduces rather than increases their vitality. "It's like drinking out of a fire hose," observes Steve Lazarus, managing director of ARCH Venture Partners and research chairman of the National Venture Capital Association.

At times like this, a cold economic reality kicks in: The more innovations there are, the less valuable any given innovation is likely to be. That doesn't mean innovation is unimportant, irrelevant, or valueless; it means that in an era of rising digital abundance it's more difficult for innovation to rake in the kind of premiums that so many innovators--and investors--expect. Rational markets don't pay top dollar during gluts.

Another thing that makes cashing in on innovation so difficult is that, as any good intellectual property lawyer will complain, the very digital technologies that make it faster, easier, and cheaper for innovators to innovate also make it faster, easier, and cheaper for imitators to imitate. In the e-world, today's innovation is tomorrow's imitation is next month's commodity. The Net is a fabulous medium for "fast followers"--firms such as Microsoft and AOL, which do a fabulous job of spotting an innovation trend and leveraging resources to make it their own. Markets know this. Wait a few months, and surely a rival will offer 80% of that bold innovation--with a twist of its own--for only 60% of the original innovator's price. When the distinction between innovation and value-added imitation is so blurry, many e-companies decide to give the innovation away and make their money elsewhere.

"That's exactly right," asserts Aaron Goldberg, VP and principal analyst at Ziff Davis Media. "There's a ton of innovation, but innovators are not [necessarily] creating [perceived] value. They offer feats of engineering, not things that excite Joe Six-Pack and Jane Wine-Cooler."

Of course, separating real, lasting innovation from the fad du jour has been a problem for years. Our new digital cornucopia has simply made the problem much more difficult. "We are mistakenly calling a lot of novelty 'innovation,'" claims Regis McKenna, the Kleiner Perkins partner who has worked with innovators ranging from Intel's Robert Noyce to Apple's Steve Jobs.

McKenna likes to distinguish firms that offer "technological innovation" from those that compete on "market innovations." Tech innovators like Intel, Microsoft, Cisco, and Sun get paid well for their innovations because they create the backbone of the new economy. But the Internet era's leading innovators--the likes of Amazon, eBay, AOL, and E*Trade--are market innovators that have created new distribution channels for various services. Market innovation is tough, says McKenna, because "everyone has access to the same tools." That's part of the reason it takes a lot of time to identify lasting market innovations. "Look at Wal-Mart," he says. "It took us 20 years to realize what they are. Starbucks had thousands of outlets before we knew [it was an innovator]."

Dot-coms, of course, are unwilling (and are now unable) to wait 20 years for recognition--and the riches that should surely ensue. So they have tried to cut through the clutter of our digital innovation glut with a noxious clatter of advertising and promotion. Internet-related B2B and B2C e-commerce companies spent tremendous amounts of ad dollars trying to establish brand leadership, with VCs who wholeheartedly endorsed this strategy happily providing the marketing cash. Yes, many of those dot-coms were "me too" and even "me three" imitators, but who could sort the winners from the losers in advance? Who could presume to tell the Microsofts from the Netscapes, the Palms from the Newtons, the Yahoos from the Mother.coms? In the absence of certainty, advertise!

This kind of short-term thinking betrays another problem with today's innovation fetish. University of Michigan management guru Karl Weick has made an observation about "retrospective sense making": organizations often don't know in advance exactly why they're doing what they're doing, but when they look back, they come up with reasons that make sense of all their past decisions. That is very true for what is and is not perceived as "innovation."

Consider two examples from Apple Computer. If its widely promoted multihued iMacs had been a marketplace flop, the idea of colored computers would have been contemptuously dismissed as a marketing gimmick. But since the machines were an enormous hit, Apple was heralded as an "innovator." On the other hand, there should be little question that, on a purely technical level, the handwriting-recognition software developed by Apple for its handheld Newton PDA in the early '90s was far more innovative than the Graffiti interface software used by 3Com's Palm. But it turns out that millions of people were willing to learn how to write in Graffiti, while few had the patience to wait for the Newton's flawed handwriting-recognition software to recognize their scribbling. To be sure, the Palm's one-button, one-touch PC synchronization interface played a big part in its popularity. But the fact remains that the less innovative technical solution that made more demands on the user became the undisputed market leader. Handwriting-recognition software languishes in technical limbo and marketing disrepute.

The cult of innovation at all costs has ignored the terrible difficulty of distinguishing lasting innovation from fleeting novelty. Who remembers Microsoft's "Bob" interface? If Time magazine's Man of the Year Jeff Bezos' Amazon.com doesn't make it, will it be described as a technology innovator but a business failure? A business innovator that failed? Or a faux business innovator that rose to prominence on the crest of a speculative bubble? Even now, after the company's been in business five years, each of those conclusions is feasible.

All this trouble with innovation has begun to sink in this year. Now that the exuberance of 1999 has given way to the crash of the tech-stock market, most e-companies don't even claim to compete on the basis of innovation. They are focusing far more on value capture than on value creation. That's why Amazon--even though it has publicly denied it--has conducted pricing experiments to see if its most loyal customers will pay a premium for convenience. That's why e-firms are exploring whether and how they can sell the information they collect about their customers. That's why, on average, the overwhelming majority of e-tailers have raised prices and instituted minimum-purchase requirements for free shipping.

"The reality is that part of waking up is finding ways to monetize the work the innovators have done," says Ziff Davis' Goldberg. In other words, e-market investors are now looking for new ways to make money rather than for new ways to make digital products and services. Coming up with tech innovations has become orders of magnitude easier than making money. Now, as far as the market is concerned, business-model innovation matters more than product and service innovation.

"This 'innovate or die' mentality makes me cringe," says James Faucette, who covers Palm for Pacific Crest Securities. "Innovation is cool as long as you can get someone to pay for it, which is why better-capitalized ideas win out over better ideas."

The venture capitalists now discount innovation when they do their due diligence. "Even if it's a great idea," says Redpoint Venture's Geoff Yang, "it will be difficult for us because we can't get a return on our capital, or we may not even be able to raise capital to prove out this idea. As a result, some of the most innovative ideas in the current market won't get the time of day."

Translation: Venture capitalists have tired of funding companies that create some value but fail to capture it for themselves. To be fair, for years the equity markets backed dot-coms on little more than the belief that value creation would eventually lead to value capture. What the overwhelming majority of those investors discovered is that most digital companies were better at innovation--whether invented or imitated--than at capturing the value of that innovation. That shouldn't have been surprising. This digital economy is nascent, and as a result it is fundamentally unclear which business models should be emulated. That's still an open question.

Ironically, the management book that has been perhaps most influential over the past few years is Clayton Christensen's The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. In his 1997 tome Christensen described the struggle that once-strong companies like Xerox and Sears faced when confronted by a disruptive technology assaulting their industry. The good news is that since then, everyone has become more attuned to both the threat of digital technology and the need to be a digital innovator. The bad news is that all this innovation in the marketplace has destroyed the ability of most companies to command a premium for innovation. Innovation for the sake of innovation isn't a core competence or even a key to competitiveness these days; it's an indulgence. After the glut, there's a new innovator's dilemma: It's the challenge of finding a balance between a culture that promotes innovation and one that builds a sustainable business.

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