The Gnomes of Innovation

Innovate business models, not just products and services

Published: Friday, August 26, 2011 - 10:12

Few would argue with the proposition that a firm’s well-being depends upon its ability to innovate. Firms that lack the capacity to develop new and improved offerings which satisfy customer needs, together with improved means for realizing and providing those offerings, are not likely to remain in business very long. The economic health of any firm is a direct function of its ability to innovate.

Here in Canada, the innovation gap is particularly acute: Canadian firms have consistently lagged behind firms in developed countries when it comes to innovation, and during the last two years the country has slipped further in most key innovation indicators. Unless this situation is addressed, this will mean significant implications for the Canadian economy.

When a firm loses its capacity to innovate, it loses the entrepreneurial spirit it had when it was founded. Of necessity, all entrepreneurs must innovate. Because they are starting from ground zero, the entrepreneur must understand market needs, develop products and services to meet those needs, and then design and establish the means whereby the product or service will be realized and provided to the marketplace. Thus, for the entrepreneur, innovation is a creative act. More properly, innovation must be a continuously creative act—no product or service is forever, and a firm must continuously refresh itself anew through innovation to ensure relevance to the marketplace.

Even the best firms lose their way with innovation and must regroup to find their way once again. For example, in 2000 it became clear to Proctor & Gamble’s (P&G) top management that the firm’s internally focused approach to innovation and new product development was incapable of delivering against the growth targets the firm had set for itself. As a result, A. G. Lafley, CEO of P&G, embarked on a new innovation model, named Connect and Develop, designed to obtain at least 50 percent of the firm’s innovations from outside the company.

This initiative aimed at more clearly identifying customer needs and then establishing networks among external suppliers, technology brokers, and internal P&G technology entrepreneurs to generate a significant flow of product suggestions and proposals. By 2005, 35 percent of P&G’s new product launches, including Swiffer cleaning products, had their origins outside the company.

Behind every good innovation function lies an equally good marketing function. As W. Edwards Deming was wont to say, “No customer ever asked for anything.” What he meant was that it is always the supplier that innovates a product or service in response to a perceived need. Therefore, a key question that firms must address when it comes to innovation is, “Who will bring the need and the ideas forward?” If a firm lacks a capability to study and understand the marketplace, with a view to identifying needs that can be met, it will be incapable of innovating accurately, if at all. As my colleague Angelo Lyall pointed out in his Quality Digest article, “Strategy Made Simple it is the marketing function that gives purpose and accuracy to innovation, and without that function present in a mature way, firms will struggle with innovation.

However, the key reason why marketing is a vital driver of innovation is that firms should not just innovate products and services; they should innovate business models. A business model describes the rationale of how a firm will create, deliver, and capture value, thereby obtaining a return on its innovation investment. Business models include products and services, but more important, they identify how a firm will make money by defining such things as the firm’s value proposition, target markets and customers, value-chain structure, how revenues and margins will be generated, relationships with respect to collaborators, and competitive strategy. Because it is a business development and not an operational function, the marketing function will provide much of the key information, insights, and knowledge that a firm needs to build an effective business model.

Unfortunately, the situation with innovation in many firms is that it is all too often a hit-or-miss activity with respect to achieving profitable results. Even in firms that have a high intensity of innovation activity, or where product or service development is carried out in an accelerated fashion to speed the time to market, these markers are no guarantee that profitable innovation will be the result. Usually, this happens because a firm has failed to adequately think through and rationalize its innovation activities at the business model level.

In this respect, I am often reminded of the satirical critique of corporate performance that was served up in the second season of the TV comedy South Park, in the episode titled “Gnomes.” In that episode, the three-phase business model for the gnomes who go around stealing people’s underpants is the following:
Phase 1: Collect underpants.
Phase 2: ???
Phase 3: Profit.

The episode, which aired in 1998, was probably intended as a critique of the excesses of the dot-com bubble, which was at the time poised to burst. More generally, it is a take on the inadequacy of many business models, including that of the gnomes, who hoped to reap huge profits from the underwear they collected. There was just one flaw in their plan, however: The gnomes hadn’t fully thought through how, and if, they could obtain such profits from their venture!

Here’s a snippet from a transcript of that show, which highlights the foolishness of incomplete or missing business models:

[In the gnomes’ cave]
Gnome 1: This is where all our work is done.
Kyle: So what are you gonna do with all these underpants you steal?
Gnome 1: Collecting underpants is just phase one. Phase one: collect underpants.
Kyle: So what’s phase two?
[Silence]
Gnome 1: Hey, what’s phase two?!
Gnome 2: Phase one: We collect underpants.
Gnome 1: Ya, ya, ya. But what about phase two?
[Silence]
Gnome 2: Well, phase three is profit. Get it?
Stan: I don’t get it.
Gnome 2: (Goes over to a chart on the wall) You see, phase one: collect underpants, phase two—
[Silence]
Gnome 2: Phase three: profit.
Cartman: Oh, I get it.
Stan: No you don’t.
Kyle: Do you guys know anything about corporations?
Gnome 2: You bet we do.
Gnome 1: Us gnomes are geniuses at corporations.

Unfortunately, many firms’ approach to innovation is just as silly as the business model of the gnomes in South Park. It goes something like this:
Phase 1: Develop a new product.
Phase 2: ???
Phase 3: Profit.

Firm’s that pursue such an approach to innovation will struggle because they will lack a complete business model that describes how they will create, deliver, and capture value through an innovation—indicated by the question marks in Step 2 above. The absence of a complete business model that rationalizes the innovation, enabled and supported by sound market knowledge, incurs a high risk of failure or, at the very least, diminished profitability. Firms that innovate in this way have moved from the realm of calculated risk to uncertainty: Risk is the identification of variables and probabilities that can influence a desired outcome; uncertainty, in contrast, is a complete absence of knowledge about such variables and probabilities. Risk in a business model can be managed; uncertainty cannot.

In summary, if firms are going to innovate, as they must to sustain themselves, they should think not only about innovating specific products and services, but equally about the business models through which they will secure profitable performance from those products and services. Failure to do so will incur the risk of reduced profitability and impair a firm’s chances of gaining a competitive advantage.

About The Author

Stewart Anderson

Stewart Anderson is a partner with Anderson Lyall Consulting Group, a Toronto-based consulting and advisory firm that helps firms develop their competitive advantage. Anderson’s background and expertise includes competitive strategy and value chain engineering. He has advised companies in the manufacturing, service, and contract manufacturing industries. Anderson is completing his bachelor of arts in economics and he is a certified trainer in lean manufacturing principles and techniques.