(FORTUNE Magazine) – Gary Hamel says innovation is business's lifeblood--and he should know. Through Strategos, the firm he co-founded and chairs, he has consulted on strategy and innovation for the world's biggest companies--Dow Chemical, General Motors, IBM, Nokia, and Shell, among others. Hamel's theories on competitive innovation received widespread attention in 1996 after he co-wrote (with C.K. Prahalad) one of the biggest-selling business books ever, Competing for the Future. In 2000, Hamel published a follow-up--Leading the Revolution. He took time out from his vacation in London to explain why so many companies are inimical to innovation, what Mars learned from Dell, and what everyone else can learn from Starbucks.

The economic environment is still challenging for companies. Can they really afford to focus on innovation?

Many companies are reaching the point where it will be impossible to raise prices, grow the top line, or even significantly reduce costs without innovation. There are no strategies for creating wealth in the long term that are not driven by innovation. The challenge increasingly is not how you create entirely new businesses, but how to use innovation to reinvent the core of your company in a world where strategies die faster than they used to and where any company that's not constantly renewing itself is simply becoming irrelevant.

In other words, in order to remain resilient as a business, you really have to routinely innovate.

We need to do for innovation what W. Edwards Deming and others did for quality. If you asked managers 40 years ago where quality comes from, they would have said it came from either the inspector at the end of the production line or from an artisan who could make beautiful products. Deming sought instead to make quality a systemic capability, everywhere and all the time. He told companies to give ordinary employees the authority to stop a million-dollar production line. They thought he was nuts.

That very unconventional insight helped drive, I think, a lot of Toyota's success--the idea that there was a positive return to be made from investing in the problem-solving skills of every employee. If you ask people today where innovation comes from, you get an answer much like what people said back then about quality. They say it either comes from R&D or that once in a while somebody has a crazy idea and the courage to fight through the bureaucracy. Instead, I think the real returns come from harnessing the imagination of every single employee every single day.

You've said companies are toxic to innovation. Why?

Most large companies have a change model that is essentially borrowed from poorly governed Third World dictatorships. The only way you can change them is with a coup. When a company gets into trouble, the board changes the CEO. So many companies think they can only be run by geniuses. Ordinary employees have abdicated their responsibility for being agents of change. Most people's innovation impulses lie dormant as they wait for the great vision to come down from the top.

Does that help explain why innovation doesn't get more attention in large organizations?

To truly enhance the innovation capacity of an organization is going to take three to five years. It's tough. And if the average CEO expects a tenure of three to four years, why would he bother? It's much easier to take a restructuring charge that resets your performance bar, or to do a big deal, than to actually transform the company. By contrast, it's interesting that Jeff Immelt has refocused GE on innovation, because barring something unforeseen, he plans to be there a decade or more.

What else inhibits corporate innovation?

There are many myths about innovation. For example, people think it is always risky. But Starbucks got customers to prepay for their coffee. Nobody in the food-and-beverage industry had ever thought of getting people to pay weeks ahead using debit cards. But it certainly wasn't risky. The technology is well known. You can test it in two or three stores and off you go.

The second myth is that innovation is mostly about products. Where I live in Silicon Valley, most people do not look at Microsoft as an innovative company because they're thinking in product terms. But one of the most profound business innovations of the 20th century is Microsoft's business model, which allowed it to drive unheard-of economies of scale into software production. Every single component of a business model is open to innovation.

A third myth, at least as destructive as the first two, is that innovation is about big ideas. Of course, in the end you want an idea with the power to transform your core business. No idea ever started out as a billion-dollar one, yet large companies often start out asking for $100 million ideas. But imagine if somebody asked, in month six of eBay, "Do you have a $100 million idea here?" Nobody could have told you that. So instead we have to create a lot of low-cost experimentation. We need lots of $25,000 and $100,000 experiments.

That sounds hard. Who's done it well?

At W.L. Gore, if any employee can convince a group of their peers that an idea has merit and they are willing to spend time helping you with it, it suddenly becomes an official project. So Gore [best known for its Gore-Tex fabric] is constantly nurturing a lot of fairly small projects. At Google, employees can take up to 20% of their time to work on what are called Googlettes. They understand that a Google emerges out of hundreds of other business plans, most of them garbage. So they're trying to cultivate the same kind of experimentation inside the company.

Another myth is that innovation is only about the top line. But if you look at a lot of the most profound business-model innovation over the last few years, it's been focused on radical cost-structure changes. Think of JetBlue and Wal-Mart.

Do customers drive innovation?

Every industry on the planet is being reinvented from the customer backwards. Companies need to bring as much innovation to the demand chain as they brought to the supply chain. How do customers learn about this product or service? How do they pay for it? Acquire it? Use it? Experience it? And how do they build a relationship over time with the vendor?

What does a candy company like Mars have to learn from Dell? Well, go to the website for M&Ms, which is MMS.com. You can buy customized M&Ms in 21 different colors. My office is decorated in ivory, green, and crimson, and on the desk is a bowl of ivory, green and crimson M&Ms. The great thing for Mars is that they cost three times more per pound than the ordinary candies.