Distinguishing these four scenarios will help the corporate innovator decide on approach
By: Christian Vogt
Tags: Corporate Innovation, Innovation, Startup, Partnerships, Venture Capital

Distinguishing these four scenarios will help the corporate innovator decide on approach

Not every disruptive innovation needs to be spun out, not every sustaining innovation can be done inside. Here is how to tell.

Photo by Hans-Peter Gauster

Corporations are building out their “innovation toolboxes” to keep up with the pace of change around them. They are supplementing classic innovation disciplines like research and development with new disciplines that are more independent of the existing core business and more outside-in, embracing and building upon the innovation efforts of others. Cisco’s five-pronged approach to innovation is an example of what the new innovation toolbox could look like. So is SAP.iO’s three-part innovation model.

The new innovation disciplines are typically a combination of new-business incubation (“create”), corporate-startup partnerships (“partner”), and corporate venturing (“invest”). (Read on to understand why startup acquisitions, often named in the same breath, are better considered advanced stages of either corporate-startup partnerships or corporate-venture investments.) But while there is wide agreement on the types of innovation disciplines that corporations should establish, when and where each of these innovation disciplines is best put to use is still poorly understood. Every innovation discipline could, in theory, be applied broadly to innovation initiatives across the board. But this does not mean it should be. Every innovation discipline has a sweet spot. The funding, risk, and time to impact of an innovation initiative can differ tremendously depending on which innovation discipline is used, and good care should be taken in matching the two.

While there is wide agreement on the types of innovation disciplines that corporations should establish, when and where each of these innovation disciplines is best put to use is still poorly understood.

This is part one of a two-part article that establishes a simple framework to help corporate innovators decide which innovation discipline a given innovation initiative fits best. To abstract from the specifics of individual innovation initiatives, this first part defines four innovation scenarios that innovation initiatives can be grouped into. These scenarios will remind the well-read corporate innovator of the seminal theory of disruptive innovation as laid out in Clayton Christensen’s book “The Innovator’s Dilemma,” but they differ in a fundamental way that this part will elaborate on. Part two of the article then proceeds to identify the innovation discipline most suitable in each scenario, including the various roles that startup acquisitions can play.

In defining the innovation scenarios, the focus will be on what is most helpful and actionable to the process of matching innovation disciplines and innovation initiatives. Numerous frameworks have been suggested to add structure to the field of corporate innovation. Some separate short-term, mid-term, and long-term innovation. Others split core-business-related innovation from adjacent innovation. Still others attempt to gauge the potential and feasibility for each initiative. But while all of these frameworks may help a corporation prioritize innovation initiatives relative to each other, they tell little about how to execute on them.

More helpful and actionable to the matching process is the two-by-two framework shown here. It defines four innovation scenarios along two dimensions. The vertical axis shows the source of innovation: Is it the corporation itself that is innovating (“inside-out”), or is the corporation building upon the innovation of someone else (“outside-in”)? Corporations should seek to benefit as broadly as possible from the innovation that is taking place within their ecosystems, independently of who comes up with it, so covering both sources of innovation is important.

The horizontal axis denotes the degree to which the innovation is compatible with the way the corporation currently does business. In other words, would this innovation prosper within the corporation’s existing structures and processes? If the answer is “yes,” the innovation is compatible. If the answer is “no,” the innovation is incompatible. For example, Apple’s iPhone was a compatible innovation in the smartphone market. Even though the product marked a new era that saw market shares shift significantly between smartphone makers, the main disciplines needed to develop, market, and sell smartphones had not changed compared to the years prior. On the other hand, Uber created a model to hire rides that is squarely incompatible with the way traditional taxi corporations work: Its platform model neither has cars on the balance sheet nor drivers on the payroll. But software development is now a core competency, and additional capabilities such as new-market development to grow supply and demand in lockstep in new geographies are required. Even user behavior has changed with features such as ride pooling, dynamic fares, or integration of other forms of mobility such as electric scooters.

The degree to which an innovation initiative is compatible with the way a corporation currently does business is key to deciding how that initiative should be executed.

It is intuitively clear why the vertical axis plays an important role in deciding which innovation discipline to match a given innovation initiative to. The processes of organically innovating inside-out versus applying others’ innovation outside-in are fundamentally different, after all. The horizontal axis, in turn, is often overlooked, even though it is key to deciding how an innovation initiative should be executed. An innovation initiative that is compatible with the current way of doing business should leverage existing corporate functions as much as possible. If the initiative is inside-out, research and development is the right place to pursue the initiative, and downstream functions like marketing, sales, servicing, and support are also well aligned with what is needed. If the initiative is outside-in, these same corporate functions can work hand in hand with the external startup that has a solution. On the other hand, if the innovation initiative is incompatible with the way the corporation does business, the existing structures and processes of the core business would get in the way. Because making exceptions on an ongoing basis is not a sustainable proposition, the innovation initiative will need to be run autonomously from the corporation. For inside-out innovation initiatives, this will require an independent operating unit or a spin-out. For outside-in innovation initiatives, it will require obtaining a stake in the startup and taking a board seat.

It is worth spending a few words on why distinguishing between compatible and incompatible innovation is not the same as distinguishing between sustaining and disruptive innovation, the framework established in the book “The Innovator’s Dilemma.” The key difference is that the framework of compatible versus incompatible innovation was defined to help corporate innovators decide when an innovation initiative can be developed inside the corporation versus when it ought to be separated from the corporation, whereas the theory of sustaining versus disruptive innovation was defined based on how an innovation is brought to market. Although in many cases the disruptiveness of an innovation initiative aligns with the need to separate it from the structures and processes of the sponsoring corporation, there are prominent counterexamples.

One counterexample is, in fact, the main case study of disruptive innovation from the book “The Innovator’s Dilemma” itself — that experienced by the hard-disk-drive industry: Generation after generation, new hard-disk-drive technologies initially failed to appeal to incumbents’ main customer segments due to a higher costs per unit of storage capacity. But because they provided a better solution for the needs of a new customer segment, who valued form factor more than cost, the new technologies were able to enter the market via a niche. The niche allowed the new technologies to mature and, thanks to their cost curves being more favorable than those of the respective prevailing technology, to eventually catch up on cost per unit of storage capacity. Because the new technologies were at that point superior to legacy technologies in terms of both form factor and cost, they were able to take the mainstream market for hard-disk drives by storm.

Although in many cases the disruptiveness of an innovation initiative aligns with the need to separate it from the structures and processes of the sponsoring corporation, there are prominent counterexamples.

Time after time, the new technologies that shook the hard-disk drive industry were disruptive innovation at its finest. Still, every new hard-disk-drive technology was also compatible innovation, in line, at least to a significant extent, with the way hard-disk drives had been developed, marketed, and sold before. The fact that the companies that prevailed during each disruption were incumbents themselves, not new entrants, supports this observation. They were the incumbents that mustered up enough foresight to understand the long-term potential of the emerging disruptive technology. Consequently, disruptiveness is not a sufficient condition for having to separate an innovation initiative from the corporation. (Flash memory, the most recent innovation in computer storage and not a hard-disk-drive technology, is an innovation that is disruptive and incompatible. As predicted by the framework of compatible versus incompatible innovation, the leading hard-disk-drive makers have followed inorganic approaches to win in this new market: They have either acquired flash memory production capabilities or set up development agreements with third-party manufacturers.)

Another counterexample is electric-car maker Tesla. Tesla’s cars were a sustaining innovation in the auto industry because they were luxury cars, the industry’s most valuable market segment, whereas a disruptive innovation would have attacked the industry from the low end of the market or a niche. But the direct-to-consumer distribution model that Tesla adopted was squarely incompatible with the way distribution of cars had been done traditionally. There was good reason for this: After-sales maintenance accounts for the largest part of car dealers’ profit. Because electric cars have longer sales cycles and require less maintenance, it was evident that dealers would be incentivized to prioritize selling combustion engine cars over selling electric cars. In addition, as the time to charge an electric vehicle exceeds the time to refill a gas tank by orders of magnitude, Tesla was unable to work with gas stations either, but had to develop new infrastructure to charge electric cars. To address these obstacles, Tesla chose to integrate three elements of the value chain that were traditionally separate — manufacturing, dealership, and charging (alias gas) stations. The fact that traditional automakers have for a long time struggled to bring fully electric vehicles to market demonstrates that the nature of being sustaining does not necessarily imply that an innovation should be pursued inside the sponsoring corporation.

And the list of counterexamples goes on. The fact that Uber’s asset-light, software-first business model is highly incompatible with that of traditional taxi companies helps explain why taxi companies have been unable to recreate Uber’s success. And the fact that Apple’s iPhone is an innovation largely compatible with the way smartphones used to be developed and brought to market helps explain why Samsung, a player in the mobile-phone market well before the advent of the iPhone, has repeatedly been able to command the highest share of the smartphone market since the launch of the iPhone.

Part two of this two-part article will identify the innovation discipline most suitable in each innovation scenario, building upon the two-by-two framework established above. Part two will also explore the different roles that startup acquisitions can play, and what this implies in terms of whether an acquired startup should be integrated into the structures and processes of the corporation or kept separate as a new business unit.

Special thanks to Peter Borchers, Managing Director at pbo.vc and former CEO of Allianz X, for being a wonderful sparring partner in discussing the ideas presented in this article.