C.K. Prahalad is one of the most influential management thinkers and writers in the world. He is the Paul and Ruth McCracken Distinguished University Professor at the Ross School of Business, University of Michigan. He is the coauthor (with Gary Hamel) of Competing For the Future, a management classic, and the author of The Fortune At the Bottom of the Pyramid: Eradicating Poverty Through Profit, which The Economist named as the best book of the year (2004). C.K. Prahalad’s latest book is The New Age of Innovation: Driving Co-Created Value Through Global Networks. This interview is based on the book.

Stephen Bernhut: In The New Age of Innovation, you write that co-creation of value and global access to resources and talent are emerging as the two pillars of innovation. Can you describe the forces shaping their emergence?

C.K. Prahalad: If you look at what has really changed and what are the key drivers of change in the nature of innovation — both the nature and the sources of innovation — there is connectivity around the world. For the first time, more than 3 billion people are already connected, and 4 billion will be connected through cell phones and PCs of some kind, in the next 5 years. That is the first time in human history. The second…there is a tremendous convergence of technology and industry, making new things possible. For example, if you look at a cell phone today, it’s literally a telephone, computer, map, calendar, watch, TV, radio…there is a tremendous convergence taking place. That’s not only in digital technology, but also in food and pharma…we can go down the list. The third is the tremendous drop in the cost of digital technology. Today I can buy an 8- gigabyte memory stick for $30.00…it will go down to $5.00. Essentially, storage and computing and communications are becoming so low-cost, there are such dramatic improvements in quality and price, that technology does not differentiate between the rich and the poor any longer. So everybody can have access to technology. Then there is the emergence of social networks, be it Facebook, MySpace and others. So, there are 4 fundamental drivers that are changing the way we think about writing creation and innovation, and actual globalization has been going on for the last many years.

SB: What do you mean by value co-creation?

CK: The traditional view of consumers and manufacturers was that one produced and the other consumed, so the consumers were fairly passive. Then when you look at a whole bunch of self-service innovations, whether it’s at the gas station or airport, essentially the consumers become part of the production process. So they are still part of the production process when they go to an ATM or gas pump, but still it is a firm-centric view and we are just part of the process. We are very oriented towards company-centric processes. When you start looking at what is happening in Google and Apple and so on, Apple produces the device, but it does not make any of the components, it does not produce any of the music; but it allows each one of us to create our own playlist. Google allows us to create our own page. Essentially, what these companies are trying to do is to say you create your own experience. That means I, the consumer, working with a Google platform or Apple platform, can create my own experience. It is different from the company orchestrating a piece of that experience for me. Here, I am involved in creating my own experience; that is true in the case of video games, true in NetFlix and Amazon. You produce a platform within which I create my own experience. This is an active involved consumer, and therefore a very different process of creating a relationship between the consumer and me. What is the benefit? The benefit is you start knowing a lot more about me. Therefore you can suggest — as a company — new movies or songs, knowing my interests. So a lot of analytic understanding of individuals’ expectations, individuals’ behaviour, allows me to be much more focused on helping serve one consumer at a time. Co-creation assumes that I share some information, I share my skills, beliefs, information and priorities, and the company responds back by helping me improve an experience by suggesting alternates, but making sure I get what I want. That is what I like to call co-creation, which is two joint problem-solvers collectively creating value, rather than the company creating the value and exchanging it with consumers.

SB: What physical/virtual medium would you use to get to my key preferences?

CK: For example, think about what has happened in many cases already. For example, I buy 5 books from Amazon, so they see a pattern of what I buy. They may not be smart enough to know that I might have bought all the books as gifts, but at least as a starting point they can suggest similar books that other people have bought and therefore what new books they can recommend; it happens already. The same thing can be done. NetFlix can look at the kind of movies that I order, and after a period of time they say, ‘If you like Nature or Adventure, it seems that these following 3 movies may be of interest to you.’

SB: Would Amazon represent the best example of value co-creation?

CK: Not necessarily. This is just one example where everybody knows that it’s happening, and most people experience it. To use Google, Apple or Amazon is because everybody is familiar with it, but there are a lot of places where it is happening. Let me give you two very unlikely places. One is OnStar. OnStar is what GM has done. It’s a telematic view of the world. You press a button in a GM car, and it takes you to a human voice. They can give you directions and tell you whether your car is doing well. If you get in an accident they can call the police, can call the ambulance. This is something that is already happening with five million cars in the United States. OnStar is a very co-created personalized experience. For example, I can give permission to OnStar, if I want to, and they can tell me which route to take, given that there are blizzards in Pikes Peak. The same thing with Medtronic. If something goes wrong with my heart, if I have a pacemaker, they can detect it remotely and give me advice on what I should do. You can have a very highly personalized experience because each person’s heart is different and the problem is different. The same thing is happening in auto insurance, where you only pay for use of the car, and the rates that are charged depend on your driving habits, where you drive, what kind of car you drive, and what time of the day you drive. If you look at the book (New Age of Innovation), the first two chapters, we consciously avoided using Google and Apple. We have companies which are doing tutoring remotely, Bridgestone Tires, shoes, insurance, so that we communicate to the reader that this is happening all across the board; it is not something that is unique to high-tech businesses. You can transform any business using a different way of thinking about innovation, which is what we call N=1 and R=G. The fundamental drivers are very active everywhere.

SB: How do you determine the cost of acquiring a customer?

CK: Let me be clear…one customer experience does not mean more cost…that’s a very traditional way of thinking. For example, what is the cost of going to Google search for you? Google costs you nothing. What about Apple, the cost for you to buy one song? What about NetFlix to get one movie…is it any more than going to Blockbuster? Buying a book on Amazon, is it cheaper than going to a bookstore? In that sense, co-creation and N=1 may dramatically alter the cost in favour of the consumer, and increase the profit for the company, both at the same time. It’s very counter-intuitive. It’s the same old debate that we have, ‘Can you have high quality and low cost?’ What we learned, you can have very high quality with low cost — it’s not either/or. Can you have highly-differentiated products and low cost — the answer is yes, that’s called mass customization. What we are saying is innovation and efficiency can both co-exist.

SB: How is the customer of today different than the customer of three or four years ago?

CK: I think 3-4 years is a very good timeframe to look at. Today, all consumers, especially younger consumers, think and act very differently. The best example of how much has changed in 4 years is the Presidential race in the United States. Four years ago nobody thought of using the internet and text messaging to mobilize millions of people. But if you look at Barack Obama’s campaign, it demonstrated the power of digital technology, how young people want to be contacted, mobilized, and how to create teams and [thematic] communities around the country. He can send a message to 5 or 6 million people instantaneously. That is all because of the new technology and the ability of younger people to consume information and act on the technology. Think about these people becoming active consumers. Will the old way of serving them work, or do you have to build a new way of serving them; that’s the question? If we ever needed a dramatic illustration of how much the world has changed, I think the last election is a perfectly good example. The Republicans had no clue of what was going on.

SB: What are the key enablers of an innovation culture?

CK: The social infrastructure or social architecture of a company — the values, beliefs, skills, performance metrics — are very very important. In other words, moving to this way of thinking about innovation…not seeing it as an episodic one big idea, but as continuous, iterative, interactive innovation. That requires a different skillset on the part of managers, and a different set of behaviours. Actually, for a very well-established company, the real challenge is how to mobilize inter-generational differences. A young group of people who are consumers manage people who do not understand fully the technology bias, and the bias for action using new facilities that are available because of these new technologies. That is a fundamental problem. The second is, almost all established companies do not look at IT as a strategic weapon….they look at it as back-office, a cost that they cannot avoid. But increasingly, if you look at all the examples, including UPS, FedEx, Dell…their entire business model is built on the IT architecture that they’ve built. Without IT, UPS cannot function. For example, UPS gives routes to trucks that allow them to make only right turns, not left turns, because left turns mean you have to wait at red lights and you waste time. They load the trucks in such a way that the last in is first out…they load it in the way that you’re going to go to the customers and deliver…it’s all a [repeat] program. They do it not for one truck, but for all the trucks in the United States. This cannot be done without clear algorithms, clear IT architecture, a lot of data, and the capacity to real-time manage their data. That is their business model, and the same thing with FedEx. It is not only for the Googles of the world. Simple logistics companies like FedEx and UPS are also changing. Take it one extra step…FedEx is now saying that it makes no sense to send a big packet from, say, Montreal to Windsor. “We’ll take it, but it makes no sense. Why don’t you send all the materials that you want — to be printed, packed and sent to Windsor — electronically, to my Kinko store. We will print it, bind it, and send it to the address in Windsor. That way it is only 4 miles of driving, rather than an aircraft and truck coming from Montreal to Windsor.” That cannot be changed without the IT backbone. Otherwise you’ll not know who sent the package, where it should go, whether you have the obligation to print and bind it, or just print it, or none of the above. The reason why they send the package is because they want to send a hard copy, so the question is how can you disintermediate all the problems of running trucks and aircraft. A lot of these business models are already incorporating many of the things we are talking about.

SB: It’s fair to say that when we think of innovation, or at least “innovative” we think of a product. But as you write, process innovation is an enabler of product innovation. How so?

CK: That’s right. When you start thinking about how you innovate, just doing the old way, doing it a little bit faster doesn’t help. In other words, if everybody focuses on reducing cycle time rather than asking a more basic question, the very nature of innovation and value-creation is not changing. Therefore, reducing cycle time in the old way of doing it is like improving the buggy wheel.

SB: You mentioned that the emergence of the new pillars of innovation highlights a generation gap. How does a manager bridge generations?

CK: There are many ways. A generational gap does not necessarily mean that if you’re 50-years-old, you can’t get it. All that it means is we have to do some hand-holding and introduce the new technology to 50-year-olds; not in terms of how to be part of the Facebook crowd, but how are these new tools being used by young people. So part of it is practice, part of it is getting a visual understanding. Part of it is creating teams…group where some are quite savvy with the technology, mixed with others who may be a lot more deeply involved in the business but do not necessarily know the technology that well. It is how you create teams, how do you legitimize people saying ‘I don’t get it, I won’t understand it’…how to provide training and help and support…those are the kinds of things that need to be done. In other words, assuming everybody would know this without help, support and training, would be the first wrong step. Provide training, make sure it is something they’ll feel comfortable with, and make it unobtrusive. If somebody is not willing to say “I don’t know, I don’t get it,” just make sure they get training unobtrusively at home.

SB: You also write that the traditional sources of sources of competitive advantage – access to capital, physical location and other factors – will become “table stakes.” Why?

CK: In order to be able to continuously create unique experiences. If you think about it, creating unique personalized experiences…that range of requirement can be quite large. Some of them may be very sophisticated consumers, and therefore they are willing to participate and co-create effectively. Some of them may just want to get what is available on the shelf; so you have to cater to both extremes. The real challenge is to be able to accommodate a wide range of options that are available to consumers, and that are targeted to individual levels of expertise and the propensity to co-create. In other words, I’m not assuming everybody wants to spend time co-creating everything that they consume. Sometimes I just want to go and get a cup of coffee and run out of Starbucks. Sometimes I want to go sit there and read the newspaper. Sometimes I want to go sit there and have a meeting. Sometimes I just want to go sit there, listen to music and read a book for 4 hours. Starbucks should accommodate all of us. The same person can do any of the above at different points in time. The question is, “How do you create robust platforms that allow for infinite variations in the level of engagement that consumers want at different points in time?” That, I think, is the real challenge.

SB: What are the principles on which that platform is built?

CK: One is the real-time configuration of resources. That means I want a Hindi song now…Apple should be able to provide me the Hindi song now. That means, of all the suppliers of songs, they should be able to locate and deliver 8 songs for me now. That means a real-time configuration of resources. It is not a predetermined supply chain, but a web of vendors who are activated on a customer-request basis, so you must reconfigure the resource space, real-time, to be able to deliver what I want. That, I think, is one requirement…so there’s no latency or not too much. Even if I’m ordering a shirt…it cannot take 6 months, it has to take 3 days to come from Hong Kong.

Second, is a very event/prevent view of the world, not a transactions-based view. Traditionally, we record all the transaction sales, but we never ask the question what are the events and therefore what are the likely requirements. If there is a car that crashes, then recording that as an event means that I have to get support immediately, whether doctors, ambulance or hospitals…all that I have to do. So, OnStar needs to have the ability to look at various types of events and predict. That means to have algorithms ahead of time, on what does it take — as soon as an event happens — for us to get all these services that are required to help. Those two will be, I think, fairly high on the list.

SB: These are tough economic times, especially so for a Small-Medium-Sized Enterprise. How can the SME sector innovate to establish competitive advantage or reinvent itself?

CK: There are two questions. One is, what can manufacturing companies do? The other is what can small and medium enterprises do? Let me take the second one first. The new way of thinking about innovation is very helpful to small and medium-size enterprises, because they don’t have to have all the resources inside. What they need is an extraordinary ability to form networks; that means exploiting R=G. They don’t have to own these companies, but they have to learn how to influence them and how to get privileged access to their knowledge base on products or services that other companies can provide. If you can provide the intellectual architecture for providing service, a small company can effectively behave like a large company, without the resources. A small company that figures out how to provide unique services and unique co-creation, and can co-create opportunities, this is great. This is a good way to do it.

SB: Can they be more successful by becoming part of a global value chain?

CK: Create a global value chain. Joining a global value chain does not require a lot of resources; it requires a lot of imagination and the ability to connect all of that through the point of view about how to serve. That, I think, is what makes it very entrepreneurial. A small company with the capacity to collaborate can overcome the deficiencies in investment capacity. The basic argument is that collaborative capacity and the capacity for integration may be more important than investment capacity. That’s the first premise. Small and medium enterprises don’t have to feel abandoned. It’s not about how much R&D dollars you have.

The second part is that the manufacturing industry may have to ask a different question. “If we want to survive and prosper, are we going to focus on cost efficiencies of the product, or are we going to look at the efficiency of delivering unique experiences that go beyond product?” Product may be a subset of the experience, but not the total experience. In other words, we don’t sell tires on a price basis, we sell usage on safety…that’s a very different way of thinking about the company than saying we make the best tires and they’re low cost. What I would say is that manufacturing companies should take a leap-frog approach. They should not necessarily say I am going to out-compete Chinese in cost of production, but instead that I am going to out-compete them because I have a deeper connection with my consumers, and I’m going to turn all arms-length transactions into long-term relationships. If I start providing tires on a usage basis, and I charge on a usage basis, it’s very hard for the customer to just disengage…I sell the tire and one year later I come and see you. But, if every month I’m giving you an itemized list of how many miles you drove and the road conditions, and therefore how much it costs, that is not a relationship you can easily break. How to convert transactions into relationships may be a more interesting question for manufacturing companies. And it’s up to the manufacturer to sustain the relationship.

SB: Does the current difficult economic climate constrain a company from being innovative?

CK: If companies are smart, they can use the crisis as a way to move to the next phase. Crisis always allows more degrees of freedom for companies to move. There are two reactions. One is a knee-jerk reaction of cutting costs. The other is a way to change and transform the business. I’d much rather companies use the crisis to transform the business rather than just cut costs.

SB: Thank you very much.

CK: You are welcome.