Lean innovation – Getting to ‘Next’

by: Issues: May / June 2013. Tags: Strategy. Categories: Strategy.

Remember Blockbuster? Well then, surely you’ve heard about Kodak, that is its untimely and altogether avoidable demise? What caused those companies’ failures is the very thing that enabled others like Netflix to own the franchise in their industry: It’s called Thinking Lean. Readers will learn that Lean is more – much, much more – than reducing the head count, and is actually the platform for launching industry leadership.

The economy has been languishing for several years now, an economy that I call a “sleeping beauty.”  We know she will wake up at some point, and when she does, she will likely be terrific.  We just don’t know when that will happen.  In the meantime, we leaders and managers will try to wait it out.  We don’t invest for growth, innovate or really drive the business.  We wait for the economy to improve and then plan to act.

This is not a strategy with which I agree.  While the organization hunkers down, it also stagnates.  Star employees will leave for more interesting situations, customers get bored, and our competition likely isn’t sitting still.  We need to be driving to “Next.”

Yet, Next is a difficult place to get to, and the journey is fraught with doubt, failure, questions and expense along the way.  How do we know this is the right path for us?  How do we know what customers will want (especially tomorrow’s customers)?  Where will we get the resources?  Key concerns indeed.

Management thinkers Gary Hamel and Gary Getz[i] did a survey where C-level executives of Fortune 500 firms were polled and asked about the largest challenges they face in implementing strategy (strategies, to be very clear, that include significant growth and innovation targets).  The overwhelming response?  A lack of resources and short-term thinking.  They know what they want to do, but believe they don’t have the people, space, time or money to do it.  While the survey was done in 2003, its results are every bit as appropriate today.

 

Resources. That’s what Lean has to do with it.

Tell your team on Monday that you are launching a Lean initiative and some of them will update their resume.  People perceive Lean as being about cost cuts, headcount reductions, and other painful processes where we try and do more with less.  That’s the bad reputation that Lean is unfortunately labelled with most often. But that’s not what it is about.

For me, Lean is the enabler.  Lean is about value.  Value is the single-minded focus on driving what the customer wants, while we eliminate the processes, services and products from our portfolio the customers don’t care about.

Let’s flesh this out a bit.  We did a survey in 2011 with roughly 130 leaders and managers who were part of our Executive MBA programs at Queen’s University.  Over 70 percent of the respondents believed their businesses have too much complexity.  Looking further, over half of them agreed that their customers don’t understand or appreciate all of their available products or services.  So we say that we have too much complexity, and our customers don’t understand everything we are trying to provide them. 

Think about the menu board at your local Starbucks.  Most of us order one of four types of beverages – Coffee, Tea, Latte or Cappuccino.  Over the years, however, the menu at Starbucks grew increasingly complex, to the point where the poor baristas were struggling to make everything accurately and efficiently.  Starbucks has recently started to simplify their core offerings, but they still need to shut down the entire chain of stores periodically to support employee training[ii].

It’s as bad for customers too.  Think back to the first time you entered a Starbucks, probably with a friend or colleague who had been through the process.  You looked at the menu board, and the line of people around you, and felt anxious.  What if I get it wrong?  How do you pronounce that?  That thing is $4 – what if I don’t like it?   Anxiety?  Bad decision risk?  Absolutely.  Starbucks has done a great job creating a market around that ‘affordable indulgence’ category. But the complexity still creates issues. 

Your organization has some of this going on as well.  Most do.  These excess products or services that overlap each other are a result of a lot of things.  Think acquisitions and mergers, where they had a product like one of ours, and we left both running when we bought them.  We launch a new credit card for customers of our bank, but continue with legacy products.  Some long-time product offerings exist only because sales executives have successfully argued for years that they have customers that will leave if we discontinue that offering.

The challenge here is identifying the waste.  We can’t send our people forth and say, ‘Conquer the waste and complexity!’  We’ll get blank stares and calls for our replacement.  While I use Lean in my book as an enabler for innovation, I will save the how-to discussion for another paper. 

But Lean does two important things for us in our drive towards innovation.  The first is that it frees up resources – people, space, time, money – in our environment to apply to those innovation projects.  If we don’t have the people to implement the idea, there is no point in being more creative.  The second thing is more of a fundamental culture shift: When we start dealing with the complexity in our business, morale goes up.  We are eliminating the processes and products that waste time, that frustrate customers, and that don’t add value.  We free up the time for people to start thinking about Next.

 

Generating ideas

Where do the ideas come from?  That could be anywhere, as long as we are listening.  See Figure 1.  Your suppliers are a terrific source of ideas, and they want you to succeed – when your firm wins, they win through more business.  We used to do some business with 3M and representatives would visit from time-to-time, leaving products for us to try.  A lot of times we couldn’t do anything with the sample, but occasionally it solved an issue for us and we were able to put it in play.

 

Figure 1 – Idea Sources

A Board of Directors or Advisory Board should be able to generate ideas based on their experience or that of other non-competing organizations with which they work.  Two great sources of ideas are the people who build your products or provide your services (employees), and those people that use those products and services (customers).

R&D is always a source of ideas, but many firms don’t have significant R&D resources.  Our focus here is on a simpler means, and one requiring less heavy lifting.  The new knowledge coming out of Research and Development is essential, but I prefer not to lay responsibility for innovation at the feet of one department.  The key, however ideas are gathered, is to recognize the new doors and opportunities presented by a thorough review of the idea.

In 1985, management-guru and business professor Peter Drucker wrote Innovation and Entrepreneurship[iii], one of the earlier works connecting innovation and leadership.  Drucker talked about other sources of ideas beyond R&D, sources that required more awareness of what was going on around us than investment in a lab and PhD’s to run it.  Specifically, he used terms like:

  • The Unexpected
  • Incongruities
  • Process Need
  • Changes in Perception

This is where Lean and Innovation come together.  It is sometimes referred to as a recombination of existing elements — exaptation, or products and services from other industries that we bring together to make work in our business. 

Figure 2 – The Lean Innovation Framework

In Lean Innovation: Understanding What’s Next in Today’s Economy[iv], I devote two chapters to the Idea process. For the purpose of this article, I want to focus on what needs to happen after we have the idea (see Figure 2).

 

Refining ideas

When Reed Hastings launched Netflix in 1997, it looked a lot different than it does today.  In a classic example of a great idea evolving from a dissatisfying experience, Hastings started the DVD movie-by-mail business after being charged over $40 in late fees when he discovered an overdue copy of Apollo 13 in his closet[v].

At the time, the Internet was growing in popularity, as was on-line shopping and other transactions over the Web.  Connectivity speeds and bandwidth were increasing as well.  Amazon and other retailers were growing nicely, changing public perceptions about what could be done on the Internet.  Congestion, traffic and increasing fuel costs made staying home more appealing, supported by much improved home-entertainment systems with exceptional video and audio capability.

When Netflix was born, Hastings and his team had made some enhancements right away over the traditional movie rental model in the market dominated by Blockbuster. For example, Netflix offered thousands of titles, compared to hundreds in your local Blockbuster.  In the spirit of Lean, there were no physical store fronts, reducing the investment in real estate required by the company.  Given Blockbuster’s strategy of having a physical location within 15 minutes of 75 percent of the population, the investment required to compete on that level would have been extreme, indeed.  Distribution centers for DVD inventories popped up around the U.S. very quickly to reduce shipping time to customers.  DVDs arrived at your house with a pre-paid envelope in the package – when you were done with the movie, you simply dropped it back in a mailbox and forgot about it.

Still, there were issues, and customer adoption wasn’t what Hastings had hoped for.  One of the challenges faced early on was a perception by the customer that they weren’t being compensated for waiting for the DVD to arrive.  In the Netflix model, consumers selected DVDs on-line, and those DVDs were mailed to the customer.  When we selected a movie on a Wednesday, it could be Thursday or Friday (or later) before it arrived.  Customers, however, were initially charged the same rental rate as they would have paid when going to a Blockbuster location, yet they were forced to wait for the movie.  Call this version of the company Netflix 1.0.

Netflix 2.0 (my words, not theirs) arrived not long after, once Hastings and his team evaluated consumer feedback and the adoption rate of new subscribers.  The big change with Netflix 2.0 was the unlimited subscription.  For a flat fee of around $15, customers now could watch as many movies as they wanted through the month.  As well, viewers generally always had one or two movies from Netflix on-hand, changing the “movie night” paradigm to one where any night became movie night.

Netflix 2.0 also included a search algorithm on the Netflix website that helped customers find movies they would enjoy watching, based on past selections and other movies they had in their queue.  Similar in nature to the search process developed by Amazon, the algorithm added value for customers in a way the part-time help at Blockbuster never could.

The refinement of Netflix 1.0 to Netflix 2.0 (and from 2.0 to the current Netflix offering Video On Demand) is the primary reason the company is still here today.  Many of their initial customers rented exactly one movie from Netflix before returning to their original movie habits.  It wasn’t until the improved version of Netflix came along — one that allowed unlimited rentals, no late fees and ‘assistance’ selecting movies – that subscriptions really took off.  In fact, between 1999 and 2006, subscriber volumes increased by 50-88 percent per year.  Netflix continued to refine their model, as we will discuss later.

 

Why an innovation fails

The most significant reason an innovation doesn’t stick in the market is the failure to identify the appropriate target market for the idea.  Part of the appeal of an innovation is the ability of the idea to attract new customers.  Our challenge is to understand who those customers will be, as most existing customers will be satisfied with the current offering available to them.  One could argue that Hasting’s 1.0 version of Netflix targeted the wrong customer, the movie night ‘event’ customer who wanted the movie now.  That version of Netflix needed to be refined in order to seek the appropriate customers and market.

Before committing to his DVD-by-mail business, Hastings packaged up a couple of dozen CDs and mailed them from different locations in different packaging to himself, testing the durability of the media when transported through the post.  CDs and DVDs are made of polycarbonate, coated with aluminum and a protective barrier.  It is very uncommon for one of the discs to actually break in transit, but scratching can occur, which essentially destroys the movie.  Through this low-cost evaluation process, Hastings developed several packaging options and ultimately determined that this part of his business model would work fine.

 

What problem are we solving?

In determining how to refine our ideas, it helps to frame the situation with a question – What problem are we solving?  The idea connects to something, however abstract it may seem at this time.  Does it simplify the customer interface?  Does it eliminate a step in an on-line transaction?  Does it solve something customers have highlighted as an issue to us, or will it reduce errors below the line of visibility to the customer?  Once we identify the problem we are solving, we can decide how to break it down, how to experiment, or how to make it real and evaluate the idea.

Our Lean environment keeps us from pursuing the wrong strategy for too long.  The idea of unlimited resources allows people to pursue the wrong strategy for a long time, when the probability that we will get it right the first time is extremely low[vi].  Maintaining a focus on value will bring the experimentation back to what matters most – what the customer wants.

In all cases, it’s a collaborative process involving team members, employees, customers, and sometimes suppliers or competitors.  The 1.0 version of our idea has a place – to help the organization get to a 2.0 version that will really appeal to the market.  The 1.0 version should be tested, challenged, reviewed, bent, broken, tasted and turned, but if it gets launched, it’s a limited release to capture attention and input from Early Adopters.  It’s not a bad idea, but we need to make it better.  2.0 should be close on 1.0’s heels.

Refinement not only improves on the idea, but it prepares our organization for rolling out the idea itself, training employees how to deal with the idea and its related processes, and warming the team up to the change in company focus.  It reinforces a culture of innovation where we look after our current customers, though we are always thinking about who the next customers are and what they look like.  Refinement can prepare those customers for the idea too.  They’ve heard about the 1.0 version, maybe in a tech blog or company press release.  We use the testing and validation process to build momentum in the marketplace, getting it ready to launch.

 

The case for an innovation culture

Do you remember your first digital camera?  Ours was a Canon Digital Elph, with a 2.0MP processor in it.  It was small, heavy and the screen on the back was about an inch across, barely able to display the pictures we had taken.  When you turned the digital images into an actual printed picture through the local photo depot, you couldn’t print it larger than a 4” by 6” image, or it was grainy and of very poor quality.  Vibration was an issue, but it wasn’t evident until you developed your pictures.  We loaded many of the images onto our computers and e-mailed some of them, but bandwidth and Internet speeds were still young, so that was  cumbersome.  Such was the nature of early digital photography.

Consider the current state of the art.  Even photography enthusiasts and professionals have been using digital for years, and film and film cameras are virtually unavailable in all but the specialty stores.  Cameras now included in our phones, computers and tablets are superior to anything on the market 10 years ago, capable of taking stills and HD movies, and easily editing them in seconds.

 

Kodak didn’t get it

Given that Kodak was one of the founders of digital camera technology back in the early 1970s, we would expect them to be a major player in this market. Sadly, the company filed for Chapter 11 in January of 2012, and now one of the iconic brands of the last 100 years has just about vanished. How does that happen?  How does a company that develops Next in their industry fail to adopt it and direct the course of their firm and that of their competitors?

In hindsight, it is easy to question the leadership of the organization, who failed to seize the opportunity, failed to see the proverbial writing on the wall, and failed to adapt.  We often look at disruptive innovations like this and say that leadership was too focused on their existing markets, that current success and a focus on today’s customers kept them from seeing the prospect on the horizon.  In Kodak’s case, however, they were already threatened, as Fuji had begun making significant inroads in their paper and film business, a market Kodak had long owned.  There should have been more urgency around the conference room table in Kodak’s leadership meetings.  Perhaps hubris or even inertia, but without having been a fly on the wall in their executive chambers over the last 40 years, it is difficult to decipher.  What is clear, however, is that a culture of innovation in Kodak was virtually non-existent.

In the interest of clarity, we need to revisit an early discussion for a moment.  In my mind there is a big difference between innovation and research.  Kodak spent millions on what they called R&D, though it really wasn’t Research and Development.  They did the research, but how many of those concepts developed in R&D were actually brought to market?  In fact, a significant part of Kodak’s strategy (as they struggle to reinvent their business in the Chapter 11 proceedings) is to raise funds through the sale of thousands of patents and intellectual property.  There are so many things wrong with this picture that it’s tough to begin.  That they had the ideas but didn’t pursue them is unfathomable, especially considering the pressure they were under in the market.  That they believe a competitor may be interested in buying Kodak’s patents is very curious, as those competitors likely have their own technology, and are less interested in propping up a failing Kodak regardless.

In my model, innovation includes the implementation of an idea, its commercialization if you will.  R&D by itself generates the new knowledge, but that knowledge has little or no value until we bring it to market through its launch and adoption.  Innovation creates that value for the firm.  In telling their scientists and engineers to keep digital technology on the shelf, Kodak was stifling innovation.

At the time of its inception in the 1970s, the market was obviously not ready for digital picture technology.  Decent personal computers were still a dream, and there was no simple way to share or even store images.  Film technology and imaging was far superior, and digital was nowhere close to being a threat. 

Since we know how the story turned out, what would it have taken at Kodak to not only lead the charge as digital emerged over the next 20 years, but perhaps even accelerate it?  Where in the firm do we look for that inspiration?  The solution begins to appear when we circle back to our culture, but not culture alone, as there are other factors as well.  Within Kodak, there was no culture of innovation either, no curiosity or drive to see what the company was capable of doing.

Perhaps a more appropriate term of reference is fear – there was no fear at Kodak that something would come along and actually shake the foundation of their business.  How sad that the game-changing technology was within their four walls the whole time.  For me, a leadership perspective has a healthy dose of paranoia present in any long-term planning process. Once we realize that, the fear itself can be inspiring and can help drive the culture of the company towards innovation.

Let’s change industries (slightly) and look at the movie and DVD rental business again.  We spent some time earlier on Netflix, and how Reed Hastings and company refined their initial DVD-by-mail concept into a workable model and a multi-billion dollar business over a 10-year period.  The growth in that market came primarily at the expense of companies like Blockbuster, who hung on to their investment in retail locations, limited inventories, late fees and part-time sales help.  When DVD-by-mail rental appeared on the market, Blockbuster executives were quite public with their claim that the new business model would not appeal to consumers and that they would stick with their existing strategy.  Why wouldn’t they?  Blockbuster was very profitable at the time, growing its customer base and opening new stores all over North America, as more people invested in quality home entertainment systems and DVDs became broadly available.

Therein again is the challenge with disruptive innovations – the incumbent firm more often than not is unprepared to deal with the appearance of a new model, fails to adapt and begins saddling up the horses for its ride off into the sunset.  These firms may possess some culture of innovation, but it is typically cosmetic and ineffectual at best – in this case, new store layouts and décor, multi-day and weekly rentals, video games and member loyalty programs.  Look at us go now!

A firm with a genuine culture of innovation goes far beyond that – they look at the horizon for opportunities and threats.  They reward creativity and embrace challenges.  They take the approach that if something is going to threaten their business, it may as well be them that initiates and controls the innovation.  Such was the approach by Netflix when Video-on-Demand (VOD) emerged around 2005.  The firm had already leaned out the previous model of video rental with their Internet-based DVD business.  With VOD, however, Netflix recognized that the technology had the potential to replace their business model of relying on hard media on DVD.  Their options?   Netflix could continue to grow for several years, remaining profitable for the foreseeable future.  Hastings himself had built and sold a company prior to Netflix – perhaps now was the time to sell the business and move on to the next big thing.  Or, they could take the position that if someone is going to develop and commercialize the next innovation in home entertainment, it was going to be Netflix. And in a classic case of trial and error, that is what they did.

Initially launched to customers with Xbox and other gaming consoles, Netflix launched limited VOD availability in 2008.  Supporting technology was still developing, but feedback from Early Adopters helped them tune the process while they negotiated access to certain movies and television series.  Releases were never current, as the studios remained concerned over piracy and payment for anything digital.  Netflix encountered their share of turbulence along the way, most significantly with the failure of their Quikster initiative in 2011, where high pricing for VOD alienated many of the customers Netflix had worked so hard to cultivate over the years.  Evolution in the VOD market is occurring every day, with the networks themselves developing strategies, and Apple’s iTunes always on the threat board.  How it shakes out over the next five years is the territory of speculation, but I wouldn’t bet against Netflix in some form or other. The young firm embodies the spirit of an innovation culture, willing to cannibalize their own revenues in the pursuit of Next in their industry.  In effect, they were creating a new service life cycle while their current model was still growing.  How many of us as leaders would have the courage to do something similar?

As we look back over the last hundred years, we will see that only a handful of companies have truly reinvented themselves.  IBM no longer makes computers at all; 3M is a long way from the Minnesota Mining and Manufacturing days; Johnson & Johnson has evolved.  Are there many others?  With disruptive innovations, you don’t need to be the first mover, but you do have to move.  Had Kodak or Blockbuster reacted, they would both still be in the game.  These companies didn’t possess an innovation culture. 

I’m going to end with an interesting quote from a journal that may help put things in perspective:

Steve Jobs was the whiz-kid of the computer boom after designing the Apple computer at twenty-three.  But his vision of building a corporate counterculture in California’s Silicon Valley ended in 1985, when Apple’s management, responding to declining sales and poor morale, relieved him of his responsibilities.  Like all personal computer manufacturers, Apple was hard-pressed to fight IBM’s dominance of the market.[vii]

Oops.  We know now that this story wasn’t over.  Things change, constantly.  The executive teams that look for and lead that change with a clear view of what the customer wants will create new opportunities, markets and industries.  They will build a culture of innovation that embodies the way people in the firm think, talk and act.  They will become the icons in their field.

 




[i] Hamel, G., and Getz, G., “Funding Growth in an Age of Austerity”.  Harvard Business Review, p5, July-Aug 2004

[ii] Widely reported.  See for example, Grynbaum, M., “Starbucks takes a 3-hour coffee break,” New York Times, February 27, 2008

[iii] Drucker, P., “Innovation and Entrepreneurship”, Collins, 1985

[iv] Cross, B.L., Taylor and Francis Publishing, 2012

[v] Shih, W., Kaufman, S., Spinola, D., “Netflix”, HBS, 2007

[vi] Mangelsdorf, M.E., Good Days For Disruptors, an interview with Clayton Christensen.  SMR Spring 2009 pg 67

[vii] The 1980s: Maclean’s Chronicles the Decade.  Key Porter Books, 1989