Innovation

Factors determining rate and direction

The economic effects

BIBLIOGRAPHY

Innovation is here defined as the process by which new products and techniques are introduced into the economic system. Successful innovation results in the capability of doing something that could not be done before, or at least not so well, or so economically. In Schumpeter’s terms (1912), innovation results in the establishment of a new production function—a change in the set of possibilities that defines what can be produced and how.

In economic theory a sharp conceptual line is drawn between changes in the quantity of capital or labor used with already known techniques and practices, and changes to new ways of using capital and labor. Of course, changes in the inputs of the various factors of production, for example, increases in the amount of capital per worker, generally involve some changes in technique used, if not the utilization of a previously unknown way of doing things. Cutting with a power saw is not exactly the same process as cutting with a handsaw. Changes from one well-established technique to another that are the routine and obvious consequence of changing factor supplies or costs (such as switching from a coal furnace to a gas furnace because of lowered gas prices, or installing a long-available automatic machine in response to rising labor costs) would not be considered innovations. By contrast, the discovery and use of a new energy source, or design and use of a machine based on a new principle would be innovations, since they result in the establishment of a new capability.

However, it obviously is impossible to draw a fine line between changes in technique that are innovations and those that are not. Many of the changes in technique stimulated by the steadily rising cost of labor relative to capital that we have experienced in the United States for at least the past century have involved changes to ways of doing things quite different from those used before. The saving of labor often has required the designing of new machinery. While the degree to which the change in design or technique was more or less routine has varied from case to case, the design or use of anything that has not been produced or applied before is at least slightly risky and requires some imagination. Generally the term “innovation” is reserved to denote a change which requires a significant amount of imagination, represents a relatively sharp break with established ways of doing things, and thus essentially creates a new capability. But these qualifiers are not precise. Innovation clearly is a matter of degree.

Factors determining rate and direction

Invention and innovation

It is useful to distinguish between the conception of a new product or means of production and the practical implementation of that conception; in much of the economic literature the term “innovation” is reserved for the second of these two stages (see Ruttan 1959). In this article we shall view the process of innovation more broadly as involving the invention and development of new products and processes as well as their introduction to the economy. However, even defining innovation narrowly, analysis of the determinants of innovation must take invention into consideration.

Schumpeter has stressed that often innovation can occur without the presence of anything that we would identify as a technical invention. Thus, the opening up and utilization of a new source of raw materials is an innovation; it introduces a new capability to the economic system. This is so whether it is the result of an invention that enabled a previously uneconomic ore source to be tapped economically or of the initiative of an imaginative entrepreneur who seized a long-available opportunity that others had neglected. Further, even when a new conception is involved, the underlying invention need not be technical in the sense of a product or machine; rather it may be a new managerial concept (like statistical quality control or time-motion analysis) or an organizational concept (like the self-service supermarket). However, innovations based on technological advances have constituted a very large share of the innovations we have experienced, and the rate and direction of innovation obviously is affected by the rate and direction of the invention and development of technically new products and processes.

Social scientists have only begun to understand the determinants of technical invention, but it is clear that at least two variables play an important role in influencing what kinds of inventions are made: the state of technical knowledge and the perceived payoffs from successful inventions in different fields (see Nelson 1959).

In recent years there has been a tendency to view technical knowledge and formal scientific knowledge as being inseparable; certainly such inventions as the transistor and nylon were in large part the result of closely preceding scientific research and probably would have been impossible without the knowledge provided by modern science. However, it is clear that a large number of inventions have not been dependent for their conception and successful development upon closely preceding advances in formal science (Schmookler 1962; Gilfillan 1935). Thus, while the design of the gas refrigerator rests on the principle that expanding gases absorb heat, this was known long before the refrigerator was developed; and the development of the automatic cotton picker seems to have required no scientific concepts or data that were not known more than a century ago. It also appears that even when a particular design is closely dependent on recent advances in science, there often is an alternative design not resting on these advances that would accomplish roughly the same objective. Thus, while there certainly are exceptions, the role of formal science in influencing efforts to invent new products and processes seems to be more that of a reference book used to find solutions to problems than that of a spur to specific inventive efforts.

On the other hand, the data suggest that perceived needs have a strong effect on the kinds of problems focused on by inventors and organizations engaged in inventing. In particular, as the size of an industry grows relative to other industries, and as the amount of new equipment purchased by that industry increases, inventors appear to be drawn by the expanding opportunities and potential payoffs to work on problems related to that industry (Schmookler 1962). Less clearly, it also appears that changes in the relative scarcity of different factors tend to stimulate inventors to try to economize on the more scarce factor (Habak-kuk 1962). Changes in both relative size of industries and relative scarcity of factors seem to stimulate reasonably rapid inventive response. Thus, as a first approximation, it seems fruitful to view conditions of perceived return as determining what problems inventors try to solve, and the state of scientific and other technical knowledge as determining how they go about solving them.

In recent years a growing share of the patented inventions made in the United States has been made in corporate R & D laboratories; the relative role of the private, free-lance inventor clearly is much smaller today than in 1900. However, despite many predictions to the contrary, many of the most significant technical inventions still come from private inventors or small companies, although this differs from field to field (see Jewkes et al. 1958; Schmookler 1959).

From invention to first practical use

Inventions, of course, have no impact upon the economic system unless they are brought into practice. The stock of unexploited inventions is one part of the set of possibilities for innovation open to potential entrepreneurs—individuals who are in a position to try to introduce something new to the economic system [seeEntrepreneurship.]

It is sometimes convenient to conceive of the decision to try to introduce a new product or apply a new process as essentially occurring after the technical development is complete; this is the primary reason for the sharp conceptual distinction between invention and innovation that occurs in some of the literature. However, the use of the corporate R & D laboratory suggests that today at least (and probably a century ago also) a large part of the development work on a process or product (if not the original conception) occurs within the firm which subsequently tries to rise or market it (see the case studies in Jewkes et al. 1958). Further, it is clear that the early versions of new products and processes often have serious technical difficulties. Generally a considerable amount of development work remains to be done after a product or process is first introduced. The studies of learning curves by Hirsch (1952) bring this out clearly. Thus, in most cases development and innovation are tightly linked decisions, and the image of the entrepreneur as the chooser among an autonomously supplied set of complete, unexploited inventions is misleading.

Of course the fact that something has been invented does not mean that it will be, or should be, applied, even if all the technical development is complete. Whether it is, or should be, depends on how well it stands up in competition with existing products and processes, at existing conditions of supply and demand. The use of atomic energy for the production of power is economic in parts of Europe where the demand for power is great and the costs of mineral fuels are high, but not, at present, in the United States. And, when demand is not expanding, it is not economic to introduce a new process that requires new equipment until the old equipment has deteriorated to the point where the total costs (including the costs of buying the new equipment) of the new process are less than the variable costs of using the old. Thus, the time to bring even a potentially economic invention into use depends strongly on economic conditions, and very often there is a considerable lag between invention and first practical use (see Gilfillan 1935).

At the present time it is not clear what is the effect of market structure—the average size of firms and the degree of competition—upon the speed with which firms respond to new technical possibilities (for a theoretical discussion see Fellner 1951; Schmookler 1959). Mansfield’s studies (1963) suggest that large firms tend to be the innovative leaders when the innovations are expensive to adopt and require large-scale operations to be economic, but perhaps not otherwise.

From early use to general use

Just as there is a lag between invention and first use, there also is a lag between early use and widespread use. If new productive capacity is required, it takes time for it to be expanded and labor hired. If the product replaces older products, it takes time for the older products to depreciate to the point where a switchover is economic. And, most important, it takes time for the potential consumers to learn about and appreciate the merits of the innovation.

Several studies have shown that the growth path of a new product or process can be approximated by a logistic curve: the growth is slow at first, then becomes quite rapid, and finally slows down as market equilibrium is reached (see Rogers 1962). Griliches (1957) and Mansfield (1961) have found that the speed with which equilibrium is reached is a function of the advantages of the new product over the old and the cost of purchasing it. Many sociological studies have identified other variables that determine the speed of diffusion and have begun to come to grips with the decision mechanisms involved [for a review of the literature see Rogers 1962; see alsoDiffusion, article onthe diffusion of innovations].

The economic effects

Innovation and potential output

The most important economic effect of innovation is to increase the capability of the economic system to provide wanted goods and services—its potential output. In this article we shall call the effects of innovation upon the potential output of an economy technical progress.

It is useful, but not precise, to distinguish between innovations that create new or substantially improved final goods and services and innovations that increase the output of established goods and services which a given amount of labor and capital can produce. Perhaps the most dramatic impact of innovation has been in the creation of new and potentially better final goods and services. The improved standard of living that we have achieved since 1900 is in considerable part due to such innovations as the automobile, radio, and antibiotics. Although less dramatic, the role of innovations in increasing the productivity of capital and labor in production of existing goods and services may have been even more important. These innovations have been organizational as well as technological; they have included improvements in job-scheduling techniques, factory and warehouse layout, and mechanisms of labor-management relations, as well as new machinery and materials. Compared with 1900, the American economy is capable of producing not only a wider and more satisfactory range of final products and services but also much more of all kinds of products.

Unfortunately, given the present state of economic analysis, there is no practical way of measuring the contribution to improved well-being of innovation which results in really new goods and services. However, it is possible to get some qualitative feel for the role of innovation in increasing productivity.

While only a few studies have attempted to measure carefully the productivity advances that have resulted from specific innovations, the results of these studies are quite impressive. For example, Enos’study (1962) of the effects of various technological developments in catalytic cracking suggests productivity increases of several hundred percent. Griliches’study (1958) of the effects of the introduction of hybrid corn also shows very great increases in productivity. In addition, the numerous histories of technology (for example, Habakkuk 1962) provide strong qualitative evidence of the tremendous impact of various innovations upon productivity.

While case studies can provide a qualitative feel for the over-all contribution of innovation, it is very risky to generalize from such a small sample. To assess the over-all contribution of innovation, an aggregative approach is needed.

There are a number of studies which have attempted to quantify the contribution of innovation and of other factors in our over-all economic growth (for example, Solow 1957; Denison 1962; Nelson 1964). These studies have tried to relate the growth of real Gross National Product (GNP) to such variables as growth of man-hours worked, growth of the stock of plant and equipment, rising educational attainments, and changing composition of output and employment—as well as to improved technology. These studies have all tended to show that growth of man-hours worked and of capital of unchanged quality together account for about half of the growth we have experienced, and that since 1900 the output a given quantity of labor and capital can produce has more than doubled. But the relative contribution of the other factors is extremely sensitive to the particular assumptions of the model and to the techniques of estimation. While the case studies of innovation mentioned above suggest that innovation has been an extremely important factor, the aggregate growth models are unable to specify, save under very restrictive assumptions, how much of the over-all increase in productivity has been due to innovation and how much is due to rising educational attainments and other factors. [SeeAgriculture, article onproductivity and technology; Capital, human.]

When the interaction among the various factors which jointly contribute to growth is considered, it is easy to understand why it is so difficult to isolate the importance of any one of them. It is clear that the contribution of innovation to the improved ability of the economic system to meet the material wants of society cannot be considered in isolation from the role of other factors. New capital equipment and highly trained and educated manpower were often required to achieve the benefits of new technology. But on the other hand, technological innovation certainly has played a role in determining the kinds and costs of capital equipment that could be built and the type of technological information and patterns of technological thinking that were imparted to the students who became the nation’s trained manpower. Further, if technological advances had been less rapid it would have been impossible to have achieved the growth of the capital stock we have experienced without sharply declining rates of profit on new physical investment; thus the rate of growth of the capital stock probably would have been slower.

Because of interactions such as these it is impossible to determine precisely, given the present state of our economic understanding, the over-all contribution to economic growth that innovation has played. But clearly that contribution has been large.

Innovation and effective demand

Increased potential output can be used to meet more fully the private and public wants of society, but this need not occur automatically. If increased potential output is to be realized, effective aggregate demand for goods and services must grow in pace with the increased ability to supply them. If aggregate demand grows too slowly (or too rapidly), depression (or inflation) is the result.

There are many determinants of the rate of growth of aggregate demand; the rate of innovation is one of them. Indeed Schumpeter (1939) has placed innovation at center stage in his theory of the determinants of fluctuations in the rate of economic activity, as well as in the leading role in his theory of long-run economic progress. While the quantitative effect is difficult to measure, it is clear that rapid innovation raises the profitability of new equipment and hence spurs business investment and that retardation of innovation reduces the profitability of new investment and hence shifts the demand curve for investment downward (see Fellner 1956). If private savings are not particularly sensitive to changes in the rate of return these savings can earn, and if government fiscal and monetary policies are not particularly responsive to the state of over-all demand-supply balance in the economic system, then fluctuations in the rate of technological progress, by stimulating fluctuations in business investment, can cause business cycles. Thus Schumpeter associates the boom in the mid-nineteenth century with railroad and steel innovations and the boom of the 1920s with innovations in the automobile, chemical, and electrical industries. Conversely, periods of depression, such as the 1870s and the 1930s, can be blamed on a falling off of investment opportunities associated with a lack of major innovation. While it is probable that the Schumpeterian theory overstresses one-way causation (it is clear that there is a feedback from demand to innovation) and ignores the effectiveness of modern fiscal policies, Schumpeter’s analysis does have considerable plausibility.

The implications appear paradoxical. Productivity grows at a faster rate when technological advance is rapid than when it is slow; hence, demand must grow more rapidly if it is to keep pace with a probably growing labor force plus the growth of productivity. However, an economy with rapid innovation may not require as expansionary a fiscal and monetary policy to keep employment high as an economy with a slower rate of technological progress and slower growth of productivity; for an economy with little innovation may not be able to sustain a high investment rate.

However, given modern fiscal and monetary policies, there is no reason why we must be dependent upon rapid technological progress and high investment demand to keep demand growing in line with potential output, or why fluctuations in innovation must cause severe business cycles. Changes in taxes and public spending, together with changes in government monetary operations, can compensate for large fluctuations in investment demand. The relationship between innovation and aggregate demand, stressed so strongly by Schumpeter and probably of major importance in the pre-World War ii world, is not of major significance, save as a guide for fiscal and monetary policy in a world which has learned from Keynes and taken his lessons seriously.

Innovation and economic structure

Beneath the changes in aggregative economic activity and performance we have experienced, there have been dramatic shifts in the composition of GNP and in the allocation of the nation’s human and material resources. These changes in composition have been essential aspects of the process of economic growth and, in particular, of the way in which technological change affects the economic system. These shifts have permitted the society to gain maximum benefits from new technological advances. At the same time, however, the necessity of making these shifts has imposed serious social costs.

The changing composition of output and employment that the United States has experienced since 1900 has been the result of interaction between changing patterns of demand and changing relative costs. While even without technological advance there would have been a shift in the composition of output and employment, it is difficult to avoid the judgment that in the absence of technological change the shift in the composition of output and employment would have been significantly smaller. Technological change certainly has played a major role both in shifting demand patterns—by changing the spectrum of available products and services, and changing relative costs—by creating new and more productive techniques (see Terleckyj 1957).

The shifting of the allocation of resources is an essential part of the process by which society takes maximum benefit from the new opportunities presented by technological advance. If an economy has freedom to reallocate its resources, it has a choice between taking the benefits of the technological advance primarily in the form of increased output by the initiating industry, or by shifting labor from that industry so as to increase output in other industries. In general, when new or improved products have been developed, society has chosen to shift labor and resources into their production and away from production of close substitutes. When technological advance has led to increased efficiency in producing existing products, the result in general has been lower prices and increased output of these products. In these cases where price has been quite sensitive to cost reduction and demand quite sensitive to changes in price, employment has increased. In the cases where price has not been particularly sensitive to cost reductions or demand not particularly sensitive to price reductions, labor has been released. There are many examples of both cases and both Kendrick’s (1961) and Salter’s (1960) data show that instances of the former have been about as frequent as instances of the latter. Where the industry is young and its products are just being introduced to the economy (as automobiles during the 1920s), rapid technological change tends to spur increases in employment. When the industries and their products were well established (as agriculture during the 1950s and 1960s), more often than not rapid technological change tends to cause cutbacks in employment.

In addition to causing changes in the composition of output and employment, innovation may change the balance between the rates of return to the different factors of production—particularly between labor and capital—by changing their relative marginal productivities (see Hicks 1932). There is a considerable body of economic thought relating to the effect of innovation on the relative returns to, and relative shares in national income of, labor and capital. While it is possible for an innovation to increase the marginal productivity of both labor and capital in the same proportion, it also is possible for the effects of innovation to be unbalanced: to raise the marginal productivity of capital more than the marginal productivity of labor and thus stimulate a substitution of capital for labor (labor-saving innovation) or vice versa (capital-saving innovation). It even is possible for an innovation to reduce absolutely the marginal productivity of one factor or another.

At the present time it is not possible to judge whether on balance innovation has been capital-saving, labor-saving, or neutral. In fact, the shares of capital and labor in the United States in 1960 were not drastically different from what they were in 1929, and probably not much different from 1900. But, of course, innovation is not the only factor which affects relative shares, and while neutral technological change is consistent with the data, other explanations are consistent as well. For example, it is possible that innovation has tended to be labor-saving, but labor’s share did not fall because the rising capital-labor ratio we have experienced has sharply increased the relative returns to labor (in technical language—the aggregate elasticity of substitution is less than one). Indeed, several recent studies suggest that this may be the correct explanation (see Brown & De Cani 1963). But at present we cannot hold this conclusion with any real confidence.

Richard R. Nelson

[See alsoIncome distribution, article onFunctional share; Patents; Productivity; Research and development, article onindustrial research and development; and the biography ofSchumpeter.]

BIBLIOGRAPHY

Blaug, Mark 1963 A Survey of the Theory of Process-innovations. Economica New Series 30:13-32.

Brown, Murray ; and De Cani, John S. 1963 Technological Change and the Distribution of Income. International Economic Review 4:289-309.

Denison, Edward F. 1962 The Sources of Economic Growth in the United States and the Alternatives Before Us. New York: Committee for Economic Development.

Enos, John L. 1962 Invention and Innovation in the Petroleum Refining Industry. Pages 299-322 in Universities-National Bureau Committee for Economic Research, The Rate and Direction of Inventive Activity. Princeton Univ. Press.

Fellner, William J. 1951 The Influence of Market Structure Upon Technological Progress. Quarterly Journal of Economics 65:556-577.

Fellner, William J. 1956 Trends and Cycles in Economic Activity. New York: Holt.

Gilfillan, S. Colum 1935 The Sociology of Invention: An Essay in the Social Causes of Technic Invention and Some of Its Social Results. Chicago: Follet.

Griliches, Zvi 1957 Hybrid Corn: An Exploration in the Economics of Technological Change. Economet-rica 25:501-522.

Griliches, Zvi 1958 Research Costs and Social Returns: Hybrid Corn and Related Innovations. Journal of Political Economy 66:419-431.

Habakkuk, H. J. 1962 American and British Technology in the Nineteenth Century. Cambridge Univ. Press.

Hicks, John R. (1932) 1964 The Theory of Wages. New York: St. Martins.

Hirsch, W. Z. 1952 Manufacturing Progress Functions. Review of Economics and Statistics 34, no. 2:143-155.

Jewkes, John; Sawers, David; and Stillerman, Richard 1958 The Sources of Invention. London: Macmillan; New York: St. Martins.

Kendrick, John W. 1961 Productivity Trends in the United States. National Bureau of Economic Research, General Series, No. 71. Princeton Univ. Press.

Maclaurin, William R. 1949 Invention and Innovation in the Radio Industry. New York: Macmillan.

Mansfield, Edwin 1961 Technical Change and the Rate of Imitation. Econometrica 29:741-766.

Mansfield, Edwin 1963 Size of Firm, Market Structure, and Innovation. Journal of Political Economy 71:556-576.

Nelson, Richard R. 1959 The Economics of Invention: A Survey of the Literature. Journal of Business 32: 101-127.

Nelson, Richard R. 1964 Aggregate Production Functions and Medium-range Growth Projections. American Economic Review 54:575-606.

Rogers, Everett M. 1962 Diffusion of Innovations. New York: Free Press.

Ruttan, Vernon W. 1959 Usher and Schumpeter on Invention, Innovation, and Technological Change. Quarterly Journal of Economics 73:596-606.

Salter, W. E. G. 1960 Productivity and Technical Change. Cambridge Univ. Press.

Schmookler, Jacob 1959 Technological Progress and the Modern American Corporation. Pages 141-165 in Edward S. Mason (editor), The Corporation in Modern Society. Cambridge, Mass.: Harvard Univ. Press.

Schmookler, Jacob 1962 Changes in Industry and in the State of Knowledge as Determinants of Industrial Invention. Pages 195-232 in Universities-National Bureau Committee for Economic Research, The Rate and Direction of Inventive Activity. Princeton Univ. Press.

Schumpeter, Joseph A. (1912) 1934 The Theory of Economic Development: An Inquiry Into Profits, Capital, Credit, Interest, and the Business Cycle. Harvard Economic Studies, Vol. 46. Cambridge, Mass.: Harvard Univ. Press. → First published as Theorie der Wirtschaftlichen Entwicklung. An abridged edition was published in 1964 by McGraw-Hill.

Schumpeter, Joseph A. 1939 Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. 2 vols. New York and London: McGraw-Hill.

Solow, Robert M. 1957 Technical Change and the Aggregate Production Function. Review of Economics and Statistics 39:312-320.

Strassman, Wolfgang P. 1959 Risk and Technological Innovation: American Manufacturing Methods During the Nineteenth Century. Ithaca, N.Y.: Cornell Univ. Press.

Terleckyj, Nestor E. 1957 Factors Underlying Productivity Advance: Some Empirical Observations. American Statistical Association, Business and Economic Statistics Section, Proceedings [1957]: 300-309. → Includes one page of discussion.

Universities-National Bureau Committee for Economic Research 1962 The Rate and Direction of Inventive Activity: Economic and Social Factors. Edited by Richard R. Nelson. Princeton Univ. Press.

Innovation

Innovation is the basic driving force behind entrepreneurship and the creation of small businesses. When an individual comes up with an idea that has not previously been explored, or a niche that larger businesses have not been able to exploit, he or she may be able to turn that idea into a successful business venture. "Ideas are the fuel that keep entrepreneurial fires blazing," I. Satya Sreenivas wrote in The Business Journal. "Savvy entrepreneurs realize the fact that ideas can originate from anywhere at anytime, and a random idea could be more worthwhile than a well-researched project."

Of course, not every new idea has the potential to become a successful business. And in many cases, individuals with good, marketable ideas fail to come up with the capital needed to turn their ideas into reality. But innovation is still a necessary first step for small business success in many instances. Moreover, entrepreneurs cannot afford to stop innovating once they have established a successful business. Innovation applies not only to new business and product ideas, but also to the internal workings of a company. Successful business owners continually innovate with regards to internal systems and processes in order to create and sustain a source of competitive advantage. "The global economy requires that companies generate an unending stream of new products, systems, technologies, and services," Claus Weyrich wrote in Electronic News. "And innovation has to be applied to things other than products."

According to Weyrich, sustaining innovation in a business organization requires an understanding of the company's core competencies, an innovative corporate culture, and a systematic approach. He described three phases in the innovation process: 1) the invention phase, in which ideas are generated; 2) the implementation phase, in which the best ideas are selected and developed further; and 3) the market penetration phase, in which ideas are exploited for commercial gain. This process is an ongoing one, with feedback used to close the loop.

Analysts agree that companies of all sizes need to place innovation into a broader context than just traditional research and development. The process of innovation needs to be managed in a structured way. "Companies need to establish a seamless innovation process—an enterprise-wide exchange of ideas that will ensure that the information and expertise required to create, market, and service breakthrough products is available and accessible to those who need it," Chemical Week contributor Ken Cottrill explained. "If all the people able to extract value from a new product or technology are in the information loop, there is a smaller chance that opportunities will be squandered." Making use of the information resources available within a company allows employees to benefit from "corporate memory." They are better able to focus on innovation because they know where others have been before them.

Innovation is something that takes time, quite literally. To be innovative, people need time to clear their minds, to read about interesting and unrelated fields, and to ponder these things in a non-urgent environment. According to a Harvard Business Review study entitled "Creativity Under the Gun," people are rarely creative when they are under deadline. "When creativity is under the gun, it usually ends up getting killed. Our study indicates that the more time pressure people feel on a given day, the less likely they will be to think creatively." What is needed to jumpstart the process of innovation is time away from the day-to-day pressures of multitasking. Managers should avoid extreme time pressure when possible and should try to structure work for others so that they too may avoid working under deadline at least part of the time. Part of any program designed to stimulate innovation must be a measure of free time. After all, complex cognitive processing takes time.

It is important to include the whole company in the innovation process, because the germ of an idea can come from anywhere, and the best ideas often grow out of a combination of functional areas. Establishment of a network structure can provide a framework for this desired innovation. A network structure includes cross-functional groups within the company, cross-links between the various groups, and can even include linkages with external parties such as customers and suppliers. "Companies of all sizes can adopt this approach to innovation," said Cottrill. "There is no standard blueprint for these networks, because they are shaped by a company's business goals and organizational structure. However, the individuals who make up these groups are unified by a common mission and are in regular communication."

Small businesses face a number of obstacles on the road to effective innovation, the most obvious being limited financial, knowledge, and manpower resources. They also have some advantages over larger firms when it comes to the flexibility, a characteristic that is important for the successful implementation of an innovation fostering process. In fact, one of the most important factors in promoting company-wide innovation is the support of owners, managers, and those in positions of authority. "A corporation's synapses may be buzzing with creative ideas and initiatives, but without support from the top echelons, this effort can lose momentum, and innovation becomes stifled," Cottrill stated.

see also Managing Organizational Change

BIBLIOGRAPHY

Amabile, Teresa A., Constance N. Hadley, Steven J. Kramer. "Creativity Under the Gun." Harvard Business Review. 1 August 2002.

Cottrill, Ken. "Networking for Innovation." Chemical Week. 25 February 1998.

Pisa, Regina M. "Formally Foster Innovation and Inevitable Change." Boston Herald. 1 February 2006.

Sreenivas, I. Satya. "First Idea May Not Be the Best." The Business Journal. 3 November 1997.

Weyrich, Claus. "The Meaning of Innovation." Electronic News. 16 February 1998.

                                Hillstrom, Northern Lights

                                  updated by Magee, ECDI

Innovation

Innovation is the act of developing a new process or product and introducing it to the market. It is essentially an entrepreneurial act, whether it takes place in a start-up firm, a large organization, a not-for-profit, or a public-sector agency. Innovation means change: sometimes radical change, such as the development of the computer, and sometimes incremental change, such as the modification of existing computer software. In either case, managers must develop processes to encourage and guide the changes taking place.

Sources of, and opportunities for, innovation in organizations are described below. Finally, the management principles underlying an innovative organization are identified.

INNOVATION MODELS

Business innovation has certain parameters and can be divided into categories based on company objectives. Three of the most common classifications are industry, revenue, and enterprise. Industry innovation involves production methods and products themselves. Some successful companies achieve industry innovation by moving into new markets or producing complementary goods, finding new ways to profit on their existing business and resources. Other companies choose to invent new delivery methods, eliminating intermediaries. Still others create entirely new types of industries to sell in and create new customer bases.

Revenue innovation refers to new methods in pricing and value models that companies can use to improve their profits. This can work many different ways, such as using new legislation, new customer demands, and new resources to raise revenues. Anything that can be used along the production chain to decrease costs and change pricing plans can be considered revenue innovation.

Enterprise innovation is a wide category involving companies venturing into new areas, often involving vertical integration up and down the supply chain, where businesses begin to create their own products or begin plans to supply themselves with necessary resources. Enterprise innovation can also work through methods of concentration, where companies outsource or drop various stages of production to focus on others.

SOURCES OF INNOVATION

Innovation generally stems from the purposeful search for opportunities. Management guru Peter Drucker identified that opportunities for innovation exist both within and outside a company or industry. Opportunities internal to a company include unexpected events, incongruities in processes or between expectations and results, process needs, and changes in the marketplace or industry structure. Opportunities external to a company include demographic changes, changes in perception, and new knowledge.

Incongruities. Incongruities result from a difference between perception and reality. Federal Express was able to capitalize on consumer dissatisfaction with the U.S. Postal Service and demonstrate that individuals and companies were willing to pay a premium for overnight delivery of packages and documents.

Likewise, Southwest Airlines provided a dramatically different approach to airline service. Its low-fare, no-frills, first-come-first-seated approach has garnered devoted customers. Southwest Airlines has remained profitable for thirty-five straight years (as of 2008), even during the economic downturn following the terrorist attacks of 2001, when many airlines struggled to remain in business.

Process Needs. Process needs innovations are those that are created to support some other process or product. The development of the ATM (automatic teller machine) and

now Web-based and Internet banking options allow individuals to do their banking when the bank is closed and without relying on tellers being available. This has freed tellers from performing many routine functions such as cashing checks and has improved both efficiency and profit margins for banks.

Market and Industry Structure Changes. Industry structures change in response to growth and changes in the marketplace. One of the most dramatic changes can be seen in the health care industry. The rise of HMOs (health maintenance organizations) and the decline of the traditional fee-for-service plans have impacted the health-care industry as a whole. The development of the personal computer also had a far-reaching impact on the computer industry as a whole. Until the personal computer, manufacturers of large mainframe computers, terminals, and software developed for specific uses within a firm dominated the computer industry. With the adoption of the personal computer and advent of the laptop computer, the composition of computer sales and marketing changed dramatically.

Demographic Changes. Demographic changes are shifts in the makeup of the population. Increases in the Hispanic and Asian populations in the United States create opportunities for new products and services, such as cable television stations targeting these audiences. Innovations in prepared meals and takeout food are meeting the needs of busy two-income families and single-parent families.

Changes in Perception. Americans have become more health conscious and we have seen the rise in popularity of stores such as GNC which cater to the demand for vitamins and other supplements. Similarly, stores such as Whole Foods provide organic produce, meats, dairy, and fish free from additives to satisfy a growing market demand for chemical-free products.

New Knowledge. New knowledge or technology is one of the strongest forces for innovation. Many companies, of all sizes and levels of sophistication, now have a Web presence on the Internet with the capability of connecting their products with customers nearby or on the other side of the globe. No longer are consumers limited to the daytime hours for their activities; online stock trading, shopping, and banking are examples of services that are accessible at any time of day or night via the Internet. Other opportunities are being explored in the fields of genomics and nanotechnology. These technologies and systems will develop even further as consumers continue to demand new and innovative products and immediate access to information, goods and services.

MANAGING INNOVATION

Innovation must be seen as a process occurring within an organization, not a single event. This process can be managed. In general, the process follows five stages: (1) idea generation, (2) initial screening, (3) review, (4) seeking sponsorship, and (5) sponsorship and commercialization. At each of these stages the organization's culture must be designed to support the innovation process.

Idea Generation. Idea generation requires a supportive organizational culture. Ideas, and the people who develop them, are fragile, and if the organization does not support them, they will not develop. A supportive culture requires that the organization allow for experimentation and failure. In other words, not every idea will be commercially viable, but mistakes are to be learned from and learning should be celebrated. W.L. Gore is a company that celebrates learning and innovation. Each plant is kept small and everyone in the company is allowed to experiment with the products. In addition to the familiar GoreTex polymer coating, the company also manufactures products for the medical industry, NASA, and industrial use. The company operates internationally and holds hundreds of patents.

Initial Screening. The screening process can be made easier by assigning a facilitator from outside the organization who can help guide the initial idea through the organization's systems, as well as act as an advocate for the idea. At this stage, the idea is evaluated and possibly revised before being sent on to a group to review for further development.

Review. At this stage, the idea should be sufficiently developed to present to a group within the organization who will make a decision about funding further development. 3M has a long-standing process such as this. The Post-It notepads are probably the best-known illustration of the effectiveness of the process. Although no uses for the adhesive were initially found, the researcher was allowed to continue to spend time developing the product. The review process did not initially continue direct funding, but by allowing the researcher time, the company indirectly funded the development of a very successful product.

Seeking Sponsorship. In most organizations, an idea needs a sponsor to continue to move forward. The sponsor must be convinced of the value of the idea to the organization. Effective champions frequently are managers who know how to navigate the corporate structure for support and resources. In addition, they are effective at putting together a cross-functional team to help develop all aspects of the new idea. Both 3M and W.L. Gore have instituted systems that facilitate this process.

Sponsorship and Commercialization. At this stage, the champion or sponsor takes the project forward through the final phases of corporate approval to commercialization. Many organizations, including Dow Corning, PepsiCo, 3M, and Black & Decker, spend a great deal of time interacting with customers at this stage. Customer input can help with final design issues, with searching out new uses for a product, and with simplifying processes. According to N. Radjou as quoted in Industrial Management, “Customers seek innovations that enhance their life cycle experience with a product—not the product-centric improvements in functionality and reliability that R & D engineers focus on.” Utilizing consumer input can help companies focus their creativity on the products and improvements that will most satisfy consumer needs and wants.

DISRUPTIVE INNOVATION

Disruptive innovation is a type of innovation that reinvents a market or creates an entirely new system, product, or business concept. It is disruptive because it causes the entire industry to react, either by making innovations of their own or by copying the first innovation to stay profitable. Some types of disruptive innovation create entirely new industries that force all other industries to react, such as the adoption of a new technology or new product. Recent examples of disruptive technology include:

1. Peer-to-peer networking software
2. Audio and video compression technology
3. Personal computers
4. Steel mini-mills
5. E-commerce
6. Cell phones

Other potential disruptive technologies include renewable energy sources and advances in biochemistry. Disruptive innovation will always have certain identifiable effects on the companies that develop them and the surrounding business. Those looking to foster or create disruptive innovations can depend on several key pieces of advice:

• Expect growth from disruptive innovation. Whatever type of innovation a company attempts, whether it affects the way business is done or produces a new type of business completely, it will place that company ahead of its competitors. In order to fully capitalize on the innovation, the company should create processes to keep their ideas sustainable. Some disruptive innovations are simply vast improvements on older designs, which require excellent marketing and integration into existing processes. Other disruptive innovations are breakthroughs into new fields that will rocket companies into prominent positions, which they must then learn to maintain by designing ways to steadily produce or use their discovery. A company can enter into an unexplored field and then use more innovations along the way to refine and market their ideas.
• As previously mentioned, disruptive innovations will either create markets that did not exist before or transform the lower ends of existing markets. In the first case, companies have a serious advantage—their competitors will, in the beginning, lack the means to enter the new market. The new company must concentrate on making their product or offering their service and marketing it to the correct people, because a new market means an entirely new set of customers. The second type of disruptive innovation will occur at the lower end of some existing market, transforming a process that has already been in place. This will allow the innovating company to grow within its own industry, pushing it ahead of its old competitors through new ways of doing business.
• Opportunities go through several phases before they become full innovations. Some companies have a system in place to help ideas move through the business until senior management accepts them and forms plans to implement the innovation. Unfortunately, these systems can hamper the development of true disruptive innovation. Disruptive opportunities, once fielded by a company's process, are usually stripped of their unique qualities and made to fit into a preexisting expectation that the company has for useful creativity. To truly create disruptive innovations, a company must learn to accept potential ideas even if they may appear outlandish.
• When forming a new product, businesses should attempt to market it to the proper consumers. This does not necessarily mean trying to appeal to their existing customers, but focusing on locating customers who would profit by their innovation. Innovative products can fail if not marketed to the correct audience. Customers should not be asked to accept completely new products without good reason.
• Innovation requires decisions concerning product integration. Companies can choose to be involved in every part of their new product's creation, or they can choose to specialize in one particular part of the supply chain. Choosing the correct activities to specialize in allows the company to maximize benefits from the innovation process.
• Disruptive innovations cannot be expected to grow into international businesses overnight. Managers encouraging innovation should aim for profitability before growth. Profitability, though it may take trial and error, will ensure success in the long-term, while growth can easily collapse on itself if not accompanied by sustainability.

Companies can seek disruptive innovation in other areas beside products. Services and supply chain methods can also be subject to disruptive ideas. Companies can attempt transporting their old products in new fashions, as the band Radiohead famously did in 2007 by allowing their fans to download their album In Rainbows from their Web site, at whatever price the music-buyer thought was fair. They can also try to reinvent old processes in such ways that they appeal to new customers.

EMPLOYEE INNOVATION

Employees can be a reservoir of potential ideas, innovations, and new ways of thinking; companies just have to find a way to tap into them. Even in companies that encourage employee innovation, employees can feel restricted by the heavy company process involved in developing an idea. Expression should be encouraged by companies looking for internal innovation, but how? GovLeaders has some ideas, in the form of five 2008 suggestions designed to foster employee input:

• Managers should get to know every employee. If managers know their employees, they can know how to encourage each person to develop their own unique ideas. Motivation can often depend on knowledge of what is important to employees.
• Employees should be challenged to improve processes. If employees are asked specifically to look at the operations they are involved in, they will be much more likely to notice areas of possible improvement. Managers can implement plans to ask employees for improvement ideas at regular intervals.
• There is a mechanism that some companies use called “Employee for a Day.” This involves employees taking regular turns in running through their business process from the outside, following a product or service naturally from start to completion. This way people can see problems they may not have normally noticed.
• Reward systems can be implemented specifically to award employees who improve the operation process in some way. “Idea” awards can build enthusiasm for new ideas and encourage an atmosphere of creative solutions and healthy competition.
• How will employee ideas make any difference? In order to profit from their employees' ideas, companies need a system to implement employee ideas. The employee who created the innovation process should, as much as possible, oversee its implementation so that a healthy sense of ownership can be developed. Managers, after all, will usually have enough to deal with without managing someone else's ideas.

SEE ALSO Futuring; New Product Development

BIBLIOGRAPHY

Anthony, Scott. “Radiohead's Disruptive Innovation.” Harvard Business Publishing, 2007. Available from: http://conversationstarter.hbsp.com/2007/10/radioheads_disruptive_innovati.html.

Bate, J.D., and R.E. Johnston, Jr. “Strategic Frontiers: The Starting-Point for Innovative Growth.” Strategy and Leadership 33, no. 1 (2005): 12–18.

Costin, H., ed. Readings in Strategy and Strategic Planning. Fort Worth, TX: The Dryden Press, 1998.

Christiansen, Clayton M, Raynor, Michael E., and Athony, Scott D. “Six Keys to Building New Markets by Unleashing Destructive Innovation.” Harvard Business School, 2003. Available from: http://hbswk.hbs.edu/item/3374.html.

Francis, D., and J. Bessant. “Targeting Innovation and Implications for Capability Development.” Technovation 25, no. 3 (2005): 171–183.

Frohman, A.L. “Building A Culture for Innovation.” Research-Technology Management 41, no. 2 (1998): 9–12.

Henry, J., and D. Walker, eds. Managing Innovation. London: Sage Publications, 1991.

“IBM's Three Types of Business Model Innovation Strategies.” Unitedbit.com, 2008. Available from: http://www.unitedbit.com/ibms-three-types-of-business-model-innovation-strategies/.

Jacobson, Don. “The Link Between Motivation and Innovation.” GovLeaders.org, 2008. Available from: http://www.govleaders.org/motivation.htm.

McDermott, B., and G. Sexton. Leading Innovation: Creating Workplaces Where People Excel So Organizations Thrive. Herentals, Belgium: Nova Vista Publishing, 2004.

Radjou, N. “Networked Innovation Drives Profits.” Industrial Management 47, no. 1 (2005): 14–21.

Stefik, M., and B. Stefik. Breakthrough: Stories and Strategies of Radical Innovation. Cambridge, MA: MIT Press, 2004.

Tidd, J., J. Bessant, and K. Pavitt. Managing Innovation: Integrating Technological, Market and Organizational Change. Chichester, UK: John Wiley & Sons, 1997.

Verloop, J., and J.G. Wissema. Insight in Innovation: Managing Innovation by Understanding the Laws of Innovation. Boston, MA: Elsevier, 2004.

Von Stamm, B., and N. Nicholson. Innovation: How to Create and Develop New Business Ideas. Norwich: Format Publishing, 2005.

Yapp, C. “Innovation, Futures Thinking and Leadership.” Public Money and Management 25, no. 1 (2005): 57–60.

INNOVATION

As a relatively new way of conducting business, e-commerce itself is a technological innovation. Within the e-commerce industry are also multiple and varied examples of businesses using innovative ideas to attract new customers and increase sales. For example, the decision by Lands' End Inc. to add to its World Wide Web site "Your Personal Model," an application that allows users to create a 3-D model of their body shape and then suggests appropriate clothing, was an innovation that attracted new customers. In many cases, the simple act of creating an Internet-based company—such as eBay, Amazon.com, or Yahoo!—is also an innovation.

The world's largest online retailer, Amazon.com, is the result of an innovative idea aggressively pursued by 30-year-old founder Jeff Bezos. In 1994, Bezos moved to Seattle, Washington, to take advantage of the anticipated surge in Internet use many analysts were predicting for the mid-1990s. Bezos perused roughly 20 different products, including magazines, CDs, and computer software, that he deemed appropriate for sale on the Internet. Eventually, Bezos decided to pursue books, believing that the electronic searching and organizing capabilities of an online site could help to organized the industry's sizable and varied offerings. At the same time, the small size of most books would simplify distribution efforts. Bezos also believed that customers would be more likely to make their first online purchase if the risk was minimal; an inexpensive object like a book might prove less intimidating than something more costly, like computer equipment.

After building one of the first viable online retail operations, Bezos continued to use innovative ideas to build his customer base. His "associates" program, established in July 1996, permitted individual Web site owners and operators to offer links to Amazon from their site. In return, the associate earned a commission any time a user clicked on the link to Amazon and purchased a book. Within two years, this associates program secured 30,000 members. Another major innovation was the one-click shopping technology developed by Amazon in 1997. According to Electronic Business writer Marc Brown, Amazon.com developed the technology in an effort to reduce the number of sales lost to customers frustrated with online checkout processes that included completing lengthy personal information forms. "Amazon.com captures the buying impulse immediately by storing this information in a database, assigning the customer a unique I.D., and storing the I.D. in a cookie on the customer's computer. The next time the customer visits, the I.D. is automatically read and used to locate the customer's record." Thanks to the one-click innovation, for which Amazon secured a patent in October of 1999, any returning Amazon.com customer is able to make a purchase simply by clicking on the "Buy Now" icon located next to each product.

Another key e-commerce innovator is Pierre Omidyar, founder of eBay.com. When Omidyar's girlfriend, a Pez candy dispenser aficionado, expressed her desire to interact with other nearby collectors, the 31-year-old Omidyar created Auction Web, a basic online auction site that permitted sellers to post items for sale by describing the object, setting a minimum bid, and selecting the auction's length, which could extend from three to ten days. Buyers were able to bid on an object at any time during the auction, and the highest bidder won the right to purchase the object for the bid price. Omidyar stipulated that payment and delivery were to be handled by the buyer and seller. Despite the fact that the site offered no search engine, no guarantees of any type regarding the merchandise sold, and no dispute resolution services, it attracted an immediate following. Eventually, Auction Web evolved into eBay, which became the world's largest online auction site, with more than 22 million registered users and roughly 8,000 product categories.

Leading Internet portal Yahoo! also has at its roots a single, innovative idea. After finding it difficult to keep track of his growing list of favorite sites with the new Mosaic software that allowed users to browse the fledgling World Wide Web, David Filo sought the help of his friend, Jerry Yang. Together, Yang and Filo created a program that would allow sites to be grouped together by subject. The partners then posted their categorized site list, dubbed "Jerry's Guide to the World Wide Web," on the Web. After receiving email from Web users across the globe about the usefulness of the list, Filo and Yang decided to catalog the entire Web, using several layers of categories and subcategories. What was initially an organizational tool for Web site classification eventually grew into a top Internet destination, with more than 100 million monthly visitors, by the year 2000.

FURTHER READING:

"An Amazonian Survival Strategy: The E-Tailer is Long on Web Savvy, Short on Profits. The World is Full of Companies with the Opposite Problem. Will the Two Tango?" Newsweek, April 9, 2001.

Brown, Marc E. "'One-Click Shopping' Still Risky to Implement." Electronic Business, May 2001.

Govidarajan, Vijay. "Strategic Innovation: A Conceptual Road-map." Business Horizons, July 2001.

Hazleton, Lesley. "Jeff Bezos: How He Built a Billion-Dollar Net Worth Before His Company Even Turned a Profit." Success, July 1998.

Jaffe, Sam. "Online Extra: eBay: From Pez to Profits." BusinessWeek Online, May 14, 2001. Available from www.businessweek.com.

Schlender, Brent. "How A Virtuoso Plays the Web: Eclectic, Inquisitive, and Academic, Yahoo's Jerry Yang Reinvents the Role of the Entrepreneur." Fortune. March 6, 2000, F-79.

SEE ALSO: Affiliate Model; Amazon.com; Bezos, Jeff; eBay Inc.; Filo, David; Omidyar, PierreYahoo!; Yang, Jerry