Business Strategy, Internet Industry, Product Management

Thoughts on Innovation At Established Companies

I spent two plus year working in an innovation group at my prior job and in earlier roles I’ve lead many new product efforts. These experiences have taught me about why many corporate innovation efforts fail. I’m not going to name the places where I’ve worked in this piece. While every organization has its specific challenges, this piece focuses on what I see as common challenges to that any organization pursing innovation.

There’s been much written on why companies miss disruptive shifts in their markets. Clayton Christensen’s The Innovators Dilemma is the seminal work in the genre. As much as I think The Innovators Dilemma is mandatory reading and its recommendations are strong, there are a series of more practical issues which that work and others in the genre do not address.

Venture Capital Exists For a Reason

Many new innovative products are financed through venture capital funding new companies. Venture capital is well structured for financing new innovations and established corporations are not.

One of the primary reasons is the power law nature of returns for new innovations.  Power law distributions have much fatter tails than the “normal” distribution. The main implication of the power law is home runs generate more return than the rest of the fund. Venture funds take a portfolio approach. If they invest in 50 companies, then the odds the home run are greater. To increase the size of their portfolio, venture investors almost always co-invest with other funds, broadening their portfolio.

Except for the largest corporations, it’s not possible to establish a broad enough innovation portfolio to have a decent chance of a home run as it takes too much money. Looking at venture funded companies, in general, it takes at least $50M in funding to get them to cash flow positive. For the home runs, levels of investment are often much much higher to fuel the growth necessary to capture the opportunity.

An established company running an innovation effort typically either does not have the level of funds available or is unwilling to spend it. As a venture funded startup goes through its Series A, B, C, etc financing rounds, its financial statements are showing a sea of red ink. Venture investors expect this. For a public company, this level of spending means lower earnings per share which for most companies is not tolerable.

The other alternative is boot-strapping, using a small amount funds up front and using profits to grow the business. We love a great bootstrap story but there really are not that many of them that generate large scale returns. Boot-strapped businesses, because they are capital constrained, tend to grow slower. With in an established company, the slower growth of a boot-strapping will often result in executives thinking it’s too small a business to be worthwhile.

Long Time Scales

The other area where established companies struggle with innovation efforts is the time frame of returns. Venture investors assume, on that average, returns are years away which is why their investment funds have 10 year lifetimes. Venture investors will set aside money for follow-on investment rounds knowing that it takes years and follow-on investment to build a strong business.

Most established companies lack this level of patience and typically expect to see large returns much quicker which typically is not possible. Even an exponential growth rate doesn’t yield big numbers early on. The returns of the new business always seem puny and irrelevant when compared to the firm’s existing businesses.

Risk Aversion

Startups by their very nature move fast and are willing to take risks. If a startup can not show progress and achieve milestones, it will be unable to raise the next round of funding. The greatest risk is not being able to raise the next round.

By contrast, established corporations, particularly publicly traded ones, are risk minimization machines. There are many high paid professionals whose job it is to reduce risk regardless if it reduces speed. Considering there’s more to lose, this is a rational mindset. But for innovation efforts, it can become a serious obstacle.

This obstacle rears its head when there’s risk of lawsuits or regulatory concerns. A start-up will see a 25% risk of a lawsuit or regulatory action as preferable to the 100% certainty of ceasing to exist if it doesn’t make progress. Extreme examples are Uber or Airbnb. It’s inconceivable to me that any established company could have built those businesses because of the risks involved. YouTube is another example. The risk of being sued for copyright infringement is too large for an established company to take on a nascent product.

Option To Give Up

One of greatest impediments to innovation efforts at established companies is that it’s too easy to give up. Being a risk minimization machine, an established organization will at some level see giving up as a good thing when obstacles and risks arise. Those employees working on the innovation efforts will be moved to some other project. The senior executives are spared the discomfort of having to explain a reduction in profitability or a new lawsuit on an earnings call. For the startup, giving up means shutting down or at least a pivot, both of which are painful.

The Technology Myth

At the core of innovation efforts is the belief that new technology is what will drive future business success. The problem with this belief is not that it values technology, but rather that it discounts all the other pieces that go into building a successful business. The ignoring all the activities a business must get right is a primary factor in dramatically underestimating just how much funding it takes to turn one of these ideas into a real business. The technology is the cheap part. Turning an early stage product into a real business which includes productizing it, marketing it, selling it which all gets expensive.

What Works Better

Given all these challenges, established firms are most likely to be successful with innovations that are connected or adjacent to their existing businesses. The first reason is there’s leverage from the existing business which both plays to the firm’s existing strengths and lowers some of the costs. In adjacent business, many of the assets of the company are valuable such as the brand, the sales and support operations and the channels to market.

The second reason is that executive leadership will be able to recognize the value being created. The most innovation famous story, one which has reached the level of myth in the technology world, is Xerox Parc which in the late 1970’s invented the future of computing but failed to see the value and commercialize it. Malcolm Gladwell has a great essay on Xerox Parc titled the Creation Myth.  Gladwell tells us there’s one innovation from Parc where Xerox recognized the value:

Meanwhile, the thing that they invented that was similar to their own business—a really big machine that spit paper —they made a lot of money on it.” And so they did. Gary Starkweather’s laser printer made billions for Xerox. It paid for every other single project at Xerox PARC, many times over.

This outcome is partially because Xerox could readily understand the value of laser printing because it was similar to their core copier business and partially because printers was a smaller leap to turn into a real business since many of the activities needed to be the copier business are also useful for the printer business.

The underlying goal of most innovations efforts to create a continuous pipeline of profitable new businesses. Note that a pipeline of profitable business is not what the professional venture investors try to achieve.  Rather they focus on the power law and look for the home runs. Pure innovation is not repeatable or predictable.  For better or worse, established firms want a repeatable process for new sources of profits.

The repeatable process for new sources of profits is a system for successfully moving into adjacencies. Cisco does this via acquiring smaller companies and then leveraging its salesforce, customer relationships and brand to increase the value of the acquired product. Acquisition is not an easy model as most acquisitions fail but Cisco has built strengths in acquiring and integrating so it can achieve a high success rate.

Amazon is another great example. Amazon started in books and has systematically expanded to new categories to the point where it covers a huge portion of the retail landscape. These category expansions leverage all the strengths that Amazon has built including its world class supply chain, fulfillment capabilities and strong brand. One of Amazon’s biggest flops was outside its core competencies, the Fire Phone. Amazon has also been successful at consumer electronics, most notably Alexa.

If you read this far, what I want to leave you with is that innovating is an unpredictable endeavor where failure is much more common than success. Established firms are on the whole not suited to this pursuit in areas disconnected to their core business. Even if an innovation effort discovers a great new technology, the constraints that established firms have mean they are unlikely to successfully commercialize it. Instead, established firms should build a system to move into adjacencies where they are most likely to be successful and can leverage their existing strengths and capabilities.

Product Management

Prioritization for Product Managers

At Product Camp Silicon Valley 2018, I presented on the topic of Prioritization.   Prioritization is at the heart of what Product Managers do. In the talk, I looked at frameworks for prioritization, stepped back to talk about the big picture of value creation which is what product managers are trying to achieve with their prioritization choices and then talked about practicalities of prioritizing effectively.

Product Management

Product Manager’s Guide to Dealing With Sales People

I spoke at Silicon Valley Product Camp 2016 on “Product Manager’s Guide to Dealing With Sales People”  This was my third year speaking at Product Camp and it’s always a pleasure to share what I’ve learned with the Product Management community.

Talk Description:

If your product is sold to enterprise customers, Sales is a key constituency for Product Management.  Effectively managing your relationship with sales people, whether they be account executives, sales engineers, or account managers, is an important component of being a successful PM.  In this presentation, I’ll address how to get competitive intelligence from sales, deal with common problems and create a roadmap that helps the sales teams.

Business Strategy, Product Management

My Product Camp 2015 Presentation

I spoke on “Overcoming the Barriers to Building Great Products” at this year’s Silicon Valley Product Camp.  In this presentation, I look at how great products generate superior financial returns even though they have equivalent or lesser functionality to their competition.  I then present a hypothesis that building a great product requires making decisions that run counter to the quantifiable ROI requirements that almost every business endorses.

Internet Industry, Product Management

The Problem With Uber’s Surge Pricing

Uber’s surge pricing causes a ton consternation among for its customers and while surge pricing is a theoretically correct economic response to a shortage, in practice it makes for service that doesn’t meet the all the needs that Uber is trying to fulfill. The idea behind surge is pricing is sound on paper: when there’s more demand than supply, the price should rise so that market clears. The alternative is a shortage which would mean long waits for an Uber, similar to how its difficult to get a taxi in a period of high demand. The problem with surge pricing is that it forces the customer to be in a spot market for transportation. A spot market is where a transaction is made for immediate fulfillment or in simpler terms, an Uber ride can only be bought when you need it and the price fluctuates so there’s no way of knowing in advance (say a day or even an hour before) how much you’ll pay.

Consumers do not like spot markets in general and most of the time, their transportation needs are predictable rather than of the moment. The number of commodities that the average consumer buys at spot prices is quite small. Ones that come to mind are gasoline and food products like milk, fruits, vegetables, and meat. The amount of complaining when gas prices rise is a good indicator of how much people dislike spot markets. There’s less complaining about food because there are many of substitutes. If the price of beef is high, one can always buy chicken or pork instead.

When it comes to transport, people avoid spot markets. When was the last time you walked into the airport and bought a ticket for plane departing in an hour? The problem with walking into the airport and buying a ticket is that the price could be very high. If there are few seats left, a flight that is usually $400 could be $1000. Since most of us rarely need to fly on short notice, we avoid the spot market and make a reservation in advance. If fares are high the weekend we want to fly to Vegas, maybe we go the next weekend or decide to take a road trip instead.

With Uber, we have none of these options since we don’t know what the price is going to be till right when we need the service. Say I bought an airline ticket for 4 weeks from now. I know 4 weeks in advance that I need transportation to the airport on a particular day and time, but if I want to take Uber, I have no idea what that will cost. If I open the Uber app and see it’s 3x surge pricing, I likely don’t have enough time left to take the bus instead. The same problem exists if I need to be a work at 9am tomorrow and my plan is to take is to take Uber. For much of most peoples transit needs, they know in advance when they will need transportation. That foreknowledge should be useful in making sure that supply and demand are balanced but with Uber, it’s not used at all.

With Uber, the riders are only one-half of the equation. If surge pricing worked as intended, drivers would see the high prices, start driving and increase the supply. For the supply to meaningfully increase, the number of drivers has to be elastic meaning that high prices need to actually significantly increase the supply. Uber drivers have a similar problem to riders in that they don’t know what the rates will be in advance. If an Uber driver is sitting at home in their underwear and watching re-runs on TV then 3x surge pricing might motivate them to put on some pants, get in the car and starting driving. However, if they made other plans or just decided to sleep in, then 3x surge has no effect on their willingness to provide rides. If they had known that it was going to be 3x surge pricing maybe they would not have agreed to go to brunch or stayed out late the night before but with Uber’s current system it’s all guess work. An experienced driver might know when surge pricing is likely and plan accordingly but if it’s unpredictable (either in time or amount), then potential increase in supply is limited to drivers who happen be sitting around doing nothing.

I don’t have access to data on how surge pricing affects supply. Uber certainly has this data but even under heavy criticism, they’ve never (to my knowledge) made any specific claims about how effective surge pricing is at increasing the number of drivers. Even without the data one could presume that if surge pricing was effective at bringing in drivers that surges above 1.5x would be rare as most people would not pass up the chance to earn 50% more than usual. In some geographies, 2x and greater surges are a common event.

New Year’s Eve is surge pricing at its most extreme. On NYE 2013, some riders were paying $500 for rides. Every business that is part of people’s New Year’s Eve festivities, especially bars and restaurants, raises prices on New Year’s Eve which makes sense because demand is so high and supply is fixed so it certainly makes sense that an Uber ride will cost more. Personally, I’m not a huge fan of New Year’s Eve and there’s an amount of income that would at least get me to consider driving for Uber on NYE. However, with the current surge pricing system, I don’t know what I’d make. While some revelers wouldn’t want to pre-plan what time they go home, I suspect many would prefer to book their ride in advance especially if it gave them certainty on the cost. I’m not going to give up my NYE’s because the earning potential might be good but is unknown and I suspect there are many people like me. Predictability would increase supply and make consumer better off.

Allowing reservations and still keeping an element of dynamic pricing so that supply and demand balance isn’t an easy problem. However if ride-sharing services are going to fulfill their vision of enabling people to not own cars, Uber or its competitors will need to create a method where prices are known in advance for transport needs known in advance. While surge pricing might be economically efficient in a purely economic view, that’s too narrow a way to look at the problem. From a product point view, there are customer needs not being met. If Uber can’t figure out how to tell people what it will cost them to get from point A to point B a week now, somebody will come into the market and meet that need.