Author: James Fahey

During last Tuesday’s debate between Mitt Romney and Barak Obama, both candidates touched on the topic of government investment in businesses.  The principal issue at hand was whether the government can (or should) create jobs.  However, although jobs are a very valuable aspect of investment or spending, the question of whether or not the government should invest in businesses is a much larger issue.

First, to be clear, the US federal government has long standing programs for subsidizing businesses.  These programs, ranging from farm aid to insurance for nuclear power plants, are designed to support industries that the federal government has decided are of national strategic importance.

Second, the US federal government rarely invests in business in the traditional sense of taking an ownership stake.  The government in America has moved steadily away from ownership of any business, preferring, instead, to guarantee loans (eg: Small Business Administration (SBA) loans) or to make grants for research and development projects (eg: Small Business Innovation Research (SBIR) grants), especially for small and mid-sized businesses.

Third, because the government is not investing for direct and immediate financial gain, which is the objective of most private or corporate investors, the American government measures success in other ways than capital gain, cash flow, or IRR.  The federal government invests to improve military and food security, to keep America competitive in emerging and dynamic technologies such as renewable energy and aerospace, or to create high-wage, high value-add jobs.

Investing Objectives

The US government is not, therefore, in the business of “picking winners” among businesses.  It deliberately spreads its resources widely in a range of industries and individual companies with the objective of having, in the long run, a net positive impact on American competitiveness, prosperity, and security.

We can assume, therefore, that a major component of “success” requires innovation and that innovation is both an objective and a by-product of the subsidies.

SBIR grants directly encourage commercial innovation by seeding small businesses experimenting with new technologies or techniques, resulting in an average of 7 patent filings per day.  In addition, insurance for nuclear power plants encourages innovation in the nuclear power industry by ensuring the survival of the industry, because private insurers are unwilling to cover all of the risks of nuclear plants and without insurance utilities would not build them.

Investing for Near and Long Term Returns

DARPA (Defense Advanced Research Projects Agency) is a government program that funds research with particular objectives and has produced, for example, the internet.  One model DARPA has used successfully is to lay out a project or a problem and offer a cash subsidy for research in that area, with various companies or research centers submitting competitive proposals for the subsidies.   In 2011, DARPA’s subsidies to small business research totaled just over $74M.  To qualify, those businesses must have fewer than 500 employees and be independently owned and operated.

In addition to looking for near term solutions and breakthroughs, the government also provides long term stimulus to innovation.  The government makes grants to academic institutions and public research institutes like  the National Institutes of Health (NIH) that conduct basic research, including research in healthcare, the natural sciences, and the social sciences.  The vast majority of this research has no immediate market value, so traditional market forces fail to provide incentives for businesses to invest in them.

The NIH received $30B in funding in 2011, resources that could never be matched by the private sector.

However, the results of the research paid for by the government often make their way into industry in unexpected ways.  Laser cutting tools, gene therapy, and non-stick surfaces on fry pans are commercial applications based on research originally funded by the government.

Contemporary cancer treatment is directly derived from research done at NIH 20-30 years ago, so the companies that make the instrumentation and chemical/biological products used in those treatments are direct financial beneficiaries of that research.

Some projects are simply too big for private enterprise.  When President Kennedy set the objective of going to the moon by the end of the 1960s, the government created a whole new agency, NASA, to take up the challenge.  From the outset, the implications for national defense as well private industry were understood as significant.  While no business was large enough to invest the billions of dollars it took to eventually reach the moon and we all paid for those visits through our taxes, private business spinoffs that use technologies developed for NASA now produce consumer and commercial products, including specialty materials and computing systems, that have generated billions of dollars in revenue over the last four decades.

Today, since the basic technologies for space launches are widely understood and can be produced economically and used (relatively) safely, private enterprise is taking over the industry, launching rockets with commercial, government, academic, and even private citizen payloads into orbit.  Earlier this month, SpaceX became the first commercial rocket launch company to resupply the International Space Station.

Rules and Regulations

Getting back to the debate.  Governor Romney has consistently argued that regulation gets in the way of private enterprise, and with it innovation.  And he makes a good point.  Evidence of this can be seen outside the US in countries where regulation of business is more pronounced.  In France and India, for example, laying off employees requires considerable red tape and cash layouts, a well intentioned set of rules that protects existing jobs and the individuals who lose them, but also compels companies to add new employees slowly and carefully, resulting not only in prolonged periods of high unemployment but also a reluctance to try new businesses because the financial obligations that come with failure are high.

Without a doubt, therefore, government has to consider unintended consequences of its regulations, and citizens have to evaluate the tradeoff between the intended benefits of regulation and the impact they have on business.  For example, when the EPA imposes rules on how toxic substances are handled, the rules may be well intended efforts to  protect homeowners, schools, workers, or natural resources such as lakes and streams, but the regulations may also impact the ability of the businesses using those substances to profitably conduct research or manufacture products.

There are, however, regulations that impose costs that businesses are willing to bear because business benefits from those regulations.  For example, intellectual property (IP) protection is a form of regulation that prevents one business from using the protected innovations of other businesses without permission.  Through laws that protect IP, the government ensures that innovative businesses can reap the benefits of their investments in research and development.  The cost of filing and defending patents is not trivial, but the financial consequences of not doing so make the costs worthwhile.  The government’s role in managing patents and providing a mechanism for businesses to defend those patents is indispensable, and companies and entrepreneurs will not set up businesses in countries in which the government does not offer adequate IP protection.

Similarly, an often underrated role of government in innovation lies in providing a predictable environment for the conduct of business.  Rule of law, public safety, and a stable political and economic structure are essential for businesses and entrepreneurs to take the risks that go along with innovation.  When social, political, and economic environments are unpredictable, businesses and individuals focus on survival rather than positive innovation because they do not know whether unanticipated, changing circumstances will allow them to make a return on the investments they make on improvements.

Government, therefore, plays a valuable role, directly and indirectly, in the innovation we see around us.  At the most fundamental level, government supports innovation by providing the social, political, and economic stability necessary for businesses to invest in new ideas.  In addition, government contributes to long term innovation by paying for basic research in healthcare, physical sciences, and social sciences and by taking on large projects that are beyond the scope of private industry.  Finally, the government primes the pumps of near term innovations by making grants to innovators in areas that are of national strategic interest and offering incentives in the form of prizes to student, academic, and business teams that compete to find solutions to problems that benefit the government and society as a whole.

There is no perfect model for innovation.

Don’t let anyone tell you that there is only one way to do innovation.  That’s like saying there is only one way to cook a meal.  Innovation comes from a complex mix of potential ingredients and one of the characteristics of innovation that makes it exciting is simply that you can pick and choose your ingredients and the quantities of your ingredients depending on the desired outcome.

Valve Software, a relatively small computer game company that always seems to be one step ahead of the curve, is famous for its lack of structure.  Internally, titles are not used; levels of authority and job assignments are worked out dynamically by the employees themselves.  Many fans of innovation would hold Valve’s approach as the ideal for creating opportunities for innovation because they see structure as antithetical to change and creative thinking.

Innovation can, however, survive in many climates.  In the early days of the internet, a large, highly creative media company in Japan (Hakuhodo) once assigned each employee on a team the task of coming up with 100 ideas for a new online service within 24 hours.  Together they culled through the results and the result was a popular online service modeled on a real-world service that combines Japanese new year greeting cards with sweepstakes.  A key difference: the online version included brand advertising.  The new online version generated fresh revenues for Hakuhodo and solidified its reputation as an innovator.

PepsiCo, too, has systematically sought innovative business ideas.  Two years ago, PepsiCo launched PepsiCo10, an incubator program in entertainment, mobile, retail, and sustainability.  The mix of categories fits both PepsiCo’s brand and the fast changing industries that affect its ability to do business competitively.  Last year PepsiCo10 went to Europe looking for entries and this year (2012) they have added Brazil and India, which shows additional systematic thinking about where and how innovation can help their business.

As it turns out, according to a survey conducted by IDG for CA Technologies, the more innovative IT departments are in companies that plan for innovation and implement programs that support the development and implementation of fresh ideas.  Keep in mind, IT is a corporate, line function, not the marketing department or the R&D department where creativity is expected and yet, as structured as the department may be, innovation thrives.

Drawing from IDG’s research, CA Technologies concludes: “Innovative organizations are more likely than their less innovative peers to emphasize experimentation and exploration…. [However,] Counter to conventional thinking, they also place more emphasis on planning and structure, indicating that they take a more mature approach to how innovation projects are managed and measured.”

Innovation is not just about technology.

Or engineering.

Anyone in the tech biz, given 5 minutes, can come up with half a dozen examples of “cool,” superbly engineered products that were commercial failures.  Just to make the point, here are a few:

• Xerox’s GUI interface (stolen by Apple, and then stolen from Apple by Microsoft, before it became a commercial success).
• Sony’s Beta video tape format.
• Sony’s Librie ebook reader.
• Netscape web browser.
• Apple’s eWorld.
• Second Life.
• Eight-track cassette players.
• Rotary engines.

These were all interesting technology implementations.  Most of them were ground breaking innovations and most of them were superbly executed from an engineering point of view.  But they were also commercial flops.

Brain power and imagination are not the problem when it comes to “cool” products that fail.  The engineers that I have met over the years, engineers working on products as diverse as DNA sequencers and eCard web sites, have been very bright people.

So why do some innovative products become game changers while others crumble in the face of less innovative existing competition?  To answer this question, we must first answer the question: What is a product?

A product is an object or a service provided by a business to a customer to solve a problem, a want, or a need at a price that the customer is willing to pay.

Simply put, successful products, especially products based fundamentally on technological innovation, are made up of a well balanced mix of:

• features and function
• price point
• quality
• perception – brand
• delivery or distribution, including advertising and promotion
• after sale service and support

Whether the innovative new product creates a new product category, disrupts an existing product category, or simply provides the manufacturer with a competitive advantage, all of the key elements of what makes a product must come together to make the product a commercial success.

Sony, for example, made the same mistake twice.  Famously, in the war over which video tape format would rule the consumer market, Betamax or VHS, Sony had arguably the better engineered product: betamax tapes and machines were smaller and the image quality they produced was better.  But Beta was also more expensive and, most importantly, Sony failed to convince content providers to make their movies available on the Beta format.  Consumers didn’t care whether or not the Beta format was better; they only cared which format had their favorite movies and TV shows.

That was in the 1970’s.  In 2004, Sony made the same mistake with the Librie, its pioneering ebook reader.  Sony had first mover advantage in a long anticipated product category, but Sony focused on the technology side of the product, especially the e-ink component, which was very cool and new at the time.  Unfortunately, Sony failed, once again, to provide content.  Consumers just won’t buy an eReader if little content is available or the material is not easily accessed or, worse, the material that is available is not the material consumers want to read, and the Librie suffered from all three of these content problems.

When an established and experienced consumer products company, such as P&G or Unilever, rolls out a new product, they carefully plan the entire package, including price, distribution, branding, and customer support.  Early stage tech companies often don’t feel they have the time and resources for such luxuries as market research and distribution planning, so they simply focus on the technology behind the product.  Technology is what the founders are familiar with and it provides the IP that the investors feel they are paying for.  The result is a higher than necessary failure rate.

Innovative technologies still need to be delivered as part of a complete product package, which means all the other pieces of what makes a product need to be taken as seriously as the technology that makes the product possible.

Yahoo!’s new CEO, Marissa Mayer, is making decisions that highlight the difference between satisfying short term financial investors and building a business.

In her announcements to and conversations with staff, she emphasizes product.

In her public presentations and in the company’s public filings, she emphasizes product.

In her musings about what to do with Yahoo!’s money (the $4B anticipated cash infusion from selling Alibaba comes to mind), she emphasizes product.

Yahoo! is just one of many companies that have, over the centuries, faded into nothing because they took a casual approach to product.  That thinking is dangerous enough if a company makes nuts and bolts or other basic goods, industries in which the products may not change dramatically, but customers might and competition from lower cost producers are certain to do so.  In high tech, especially in consumer high tech, however, sitting still and taking the gradual approach is not very different from tying concrete blocks to your investment dollars and tossing them into the nearest lake.

Kodak is a great example.  RIM and Yahoo! are better examples.

Ok.  Yes.  Investing a company’s money in building the business is risky.  Lots of companies have made bad decisions.  Microsoft, as recent write-offs have illustrated, has been less than brilliant.  HP screwed up with Palm, Compaq, and EDS.

But if you’re risk averse you shouldn’t be investing in tech stocks.

So the analysts who are downgrading Yahoo!’s stock based on Ms. Mayer’s decisions and direction are speaking to an investor community that shouldn’t buy any tech stock, let alone Yahoo!’s.  If you’re not risk averse and you’re willing to invest in tech companies, look closely at Ms. Mayer and Yahoo!.  It’s too early to predict success, but at least there’s a chance of it.

Yahoo!’s Board of Directors has brought in a stream of CEOs (five since Jerry Yang gave up the post in 2009).  In choosing Marissa Mayer, they clearly were not looking for someone who would turn the company into a cash cow.  If Yahoo!’s investors, current or potential, are not happy with the choice of CEO, they need to dump the Board and find a new strategy.  Ms. Mayer is close to ideal for the direction the company should take, and her focus on product is right on the money (pun intended).

The big question is: Can Marissa Mayer bring the company with her.  Yahoo! is, after all, made up of people even more than it is made up of money.  Money is relatively easy to move; people are harder.  Money creates the opportunity for innovation, but people are the actual innovators.

“How many first person shooters can we create per year?  How many can we play per year?”

In an interview published on July 5, 2012 in GameIndustry International, David Cage, author of Quantic Dream’s Heavy Rain, has called for more innovation in the games industry.  Cage believes the game industry will die “if it doesn’t try to be innovative.”

Cage is wrong in one respect.  The game industry will not die if it stays in its rut of big-boobed, muscle bound, blood-and-guts games.  Hollywood certainly has done well in the genre, why shouldn’t games?

Cage, however, is onto something in the games he develops.  Starting with Heavy Rain and continuing through Beyond, which is still in production, Cage’s games emphasize story line and depth of character.

Most games have some sort of back story.  For example, Blizzard’s World of Warcraft has a rich, carefully developed lore that some gamers study carefully and discuss at great lengths in online forums.  WoW’s lore heavily influences the visual, aural, and play-action content of the WoW universe.  Other games, such as Call of Duty, have a minimalist back story barely sufficient to support the play-action in the games.

Even in WoW, however, the characters, tellingly referred to as “toons,” have no identity independent of the player.  Races within WoW have traits that distinguish them from each other (Blood Elves, for example, are haughty and vane; Draenei are proud and spiritual) and these racial distinctions are manifest principally in the jokes that a player can get his toon to say.  Unfortunately, all Blood Elves tell exactly the same jokes, as do all Draenei.

Some movies, such as Terminator or Die Hard, can be the same way; they have a simple veneer of story to provide a vehicle for action or sex or both, and the characters tend to be simple and stereotypic.  Other movies, however, have complex story lines with characters who can elicit powerful emotions from the audience: sympathy, hate, or even simple curiosity.  The pregnant high school girl in Juno, for example, is as real as a classmate (or, in my case, a daughter – or at least a neighbor’s daughter).

Cage has enough regard for the characters in his games that he casts the actors who do the play-action and voices for his characters like a movie director, looking for expressiveness in voice, face, and body movement that fit the characters he wants to portray.  No one would call the people who populate his games “toons.”

When Cage calls for more innovation in gaming, he’s not simply talking about better controllers or more interactivity.  Undoubtedly, he would like better graphics to enhance his ability to communicate subtle emotions, but for now he is content with PS3 graphics.  He is not looking for technology innovation.  Cage wants more depth to the content.  He wants to shift the emphasis from male gaze and violence to plot and personality.  The testosterone filled shoot-em-up games will not go away, but if Cage has his way, perhaps the day will come when shoot-em-ups, instead of defining the medium, will simply be one of the many genres within the medium.

Don’t expect movies and movie theaters to go away either.  The couch potato will always want something he can sit down and watch without extending any more effort than it takes to reach for the dip.  You can, however, expect movies/games that have multiple story lines and multiple possible outcomes.  And game producers will demand that the players of their games, like readers of thoughtfully written books, understand the characters in the game and play them accordingly.  Imagine that: playing a character in a movie….

Adding to the diversity of genres available within the medium will attract more participants.  Think of it: GameStop will have to learn to service middle-aged men and women, and games, because successful play no longer depends on twitch reflexes, will move to tablets and e-book readers because those are the platforms used by the new generation of movie goers and book readers to consume – and interact with – their content.

Without variety innovation cannot take root.

Innovation has many, if you will, fertilizers.  Money helps.  Spare time helps.  An environment receptive to change is, of course, essential.  But variety is the seed from which innovation sprouts.

Variety can come from many sources:

1. Place
2. Culture
3. Perspective
4. Time
5. Experience
6. Training
7. Language
8. Process
9. Expectation

Change any of the above and you have the opportunity for innovation.  Mental alertness rises and the ideas for further change and (hopefully) improvement can be expected.

For example, simply having more than one place to work helps with concentration.  Research has shown that, contrary to the popular conception that having a fixed place to work is good for intellectual productivity, students learn better if they switch it up a bit and study in different places.  It helps, for example, if they sometimes study in their rooms, sometimes in the library, and sometimes in the kitchen.  The same applies to study times.  The increased focus (or the reduction of boredom) helps the students absorb their chemistry, language, music, and English literature lessons better.  (See the research of Dr. Robert Bjork of UCLA.)

The same applies to innovation.  Changing the work place, the work schedule, the content of the work itself, or any of the other variables listed above is a valuable stimulus to interest levels and will result in the introduction of fresh ideas.  Sometimes the “fresh ideas” are simply transfers of a practice that was picked up in a different context.  Sometimes the “fresh ideas” are true “ah ha!” moments in which the worker, with his mental alertness stimulated by the different context or content, has a breakthrough and comes up with a truly new and unique approach to a task or a problem.

Either way, innovation has sprouted and with a little encouragement can become part of the routine.

The Wall Street Journal has posted an article on off-the-wall business ideas (mostly apps) that are taken seriously and, in some cases, have a modicum of commercial success.  The premis is simple: A developer has a crazy idea (for a smartphone or iPad app, for example) that he or she thinks is a joke.  Other people, including investors, think the idea has merit, it gets built, and consumers buy it.

Take, for example, iPoo.  iPoo allows smartphone users sitting on toilets to chat with each other.  Sound like a joke?  It started off as one, but according to the Wall Street Journal, more than 200,000 people have downloaded it at $1.oo a pop.  That’s $200,000 in revenues for a project that probably took a few days to create.  Of the 25 reviews on iTunes, the sentiment is extraordinarily positive.  The poopooers mostly object on the grounds of inappropriateness, which probably means they shouldn’t be using it in the first place.  Thank goodness Apple let CellingNow sell it.

Of course, not all ideas are an immediate success.  TacoCopter will have to overcome FAA regulations to launch its home delivery service using remote control mini helicopters.  It will also have to overcome technical problems that caused its test copter to crash moments after its initial payload was loaded.  But it’s biggest problem is PR.  Steven Colbert (ab)used the concept in one of his routines and Wired.com said the business is “completely fake.”

But isn’t this where great ideas come from?  Crazy, off-the-wall ideas get refined and become real products.  iPoo has made a tidy profit for its creators (and given most of us a chuckle).  And who among us hasn’t dreamt of low altitude highways for consumers; why not for consumer products?

The best line in this particular article comes from Eric Kerr of Columbus, Ohio, who bears partial responsibility for spoof site Itsthisforthat.  Eric says, “Even if it sounds silly from the beginning, nobody knows what will work and what won’t work.  The best approach is to try it and see what happens.”

For those who want to read the original WSJ article, here’s the link.

One of the toughest balancing acts for a leader in an innovation driven organization is choosing what to keep and what to change.

On the one hand, change is at the heart of innovation and letting go of familiar and comfortable characteristics (style, function, or process) is an inevitable part of change.  On the other hand, customers, investors, and employees have expectations; stray too far from those expectations and you risk losing them.

The key lies in understanding what the customer really wants and improving on that.  Your product is not defined by what it does or how it works or what it looks like.  Your product is defined by what your customers expect to get from it.

The restaurant industry serves as a great example.  Any restaurant that considers itself in any way gourmet has to offer its own versions of the dishes on the menu.  Tomato soup that comes straight out of a tin can just won’t hack it with customers (or employees), and simply copying a recipe from another restaurant won’t do either.  The menu has to change several times per year, usually seasonally, and new items must mix the familiar with something unique.  Employees get bored (and sloppy) and customers get bored (and go elsewhere) if the dishes are always the same.

The better restaurants, therefore, must constantly innovate, finding new ways to prepare good food.

On the other hand, fast-food restaurants have to be perfectly consistent.  The menu in a McDonald’s restaurant is not very different today than it was 15 years ago, and it’s pretty much the same in New York as it is in Los Angeles.  Adding salads to the McDonald’s menu was such a big change, the company launched a massive advertising campaign to assure its success.

Gourmet customers are buying change and variety; they expect something different to be available each time they visit a restaurant and they expect it to taste very good.  Pleasant surprises are prized.  Fast food customers, on the other hand, are buying convenience and predictability. Surprises are generally avoided and good taste is a secondary concern.

Kodak (remember them?) assumed it was operating in a McDonald’s style market in which customers wanted predictability and reliability.  When the competitive market changed around it, Kodak waited too long to let go of its established products.  Ignoring the trend towards the handiness of digital cameras, including cameras built into cell phones, Kodak clung to its traditional film, chemicals, and paper businesses, assuming that digital photography would not catch up in the quality-cost-convenience mix.  After all, what could be easier than shooting your pictures, dropping off the film at the drug store, and getting beautiful prints back in a few days?

Undoubtedly, there are purists in the photography world who do not accept digital photography, like the purists in the audio world who prefer vinyl or tape over digital, but all amateur photographers and most professionals have switched to digital photography.

Why?  Kodak failed to recognize the implications of internet photo sharing services and home color printing.  Most importantly, they also misunderstood their customer base, which is more interested in fun and convenience than predictability and reliability.  The quality may not be quite as good as with film, but what is more fun and convenient than shooting a picture with your phone and instantly sharing it with a few hundred friends and acquaintances on the internet?  Even professionals, valuing the convenience of digital photography for editing and sharing with customers, have made the switch, compelling the manufacturers to improve quality quickly.  Kodak has yet to recover.

Blizzard Entertainment has been similarly inept in choosing what to keep and what to give up.  As Blizzard released a steady flow of updates to their popular game World of Warcraft, they lost subscribers.  Looking only at hard core gamers, Blizzard gave up the leveling experience and the opportunities to meet and develop new friends that had been inherent in the original game design.  As a result, many casual gamers have cut back on their WoW time.

Facebook, in an effort to innovate its way into a revenue model, has stumbled repeatedly, and predictably, over consumer privacy issues.  Some people abandoned Facebook altogether.  Others changed the way they use the service.  Almost everyone mistrusts Facebook’s updates to service and user agreements.

Neither of Blizzard nor Facebook has made as fatal a mistake as Kodak.  In the case of Blizzard’s World of Warcraft, brand loyalty and a considerable sunk investment of time will keep players coming back, so Blizzard has an opportunity to reprieve itself.  Facebook has severely damaged its brand and is vulnerable to a competitor who can make it easy and attractive to change, but Facebook users, like World of Warcraft players, have a considerable sunk investment.   The photos, posts, and connections built up on Facebook are hard to transfer to another service without violating Facebook’s IP.

Choosing what to keep and what to let go must, ultimately, be driven by what the customer expects and what alternatives are available.  Innovative product development should focus on enhancing customer satisfaction.  By all means, make the product faster or sexier or healthier or cheaper to manufacture.  Innovate as much and as fast as you can for competitive advantage and ROI.  But make sure you stay on top of what your customers expect from your product and innovate there first.  Sometimes that means letting go.