Thursday, December 24, 2009

Margin of Safety: My most favorite insight of 2009

2009 was a year of severe economic depression. It is no surprise that I began to appreciate a concept called Margin of safety a lot more during 2009. What is Margin of Safety? And who was its father? Let’s explore these questions in this article.

Warren Buffett’s guru Benjamin Graham introduced the concept of “margin of safety” (MOS) in a seminal book “Security Analysis” published three quarters of a century ago (in 1934) in the middle of Great depression. Warren (who himself was born during great depression in 1930) explains MOS as follows: Our best ideas haven’t done better than others’ best ideas, but we’ve lost less. We’ve never gone two steps forward and then one back – may be just a fraction of a step back. Well, this last line, never going two steps forward and then one back, sums up what margin of safety means.

Most of us learn about MOS (or lack of MOS) early in our childhood when we play the game of snakes-and-ladders. We know that even if you have climbed several ladders and reached the 92nd position, the snake on 94th position can bring you back all the way down to 4th position. Perhaps Tiger Woods never played snakes-and-ladders when he was a kid. Perhaps he did but he climbed so many ladders in the past two decades without hitting a snake that he forgot that he is actually playing snakes-and-ladders.

Nassim Taleb calls the snake, especially the long snakes, “Negative black swan” in his bestselling book Black Swan and we saw earlier that being aware of the possibility of snake ahead is extremely important in innovation. We saw how Thomas Edison lost a decade worth of work in no time due to hitting upon a snake.

Incidentally, Benjamin Graham, like Tiger Woods, was also popular among girls. But he was wise enough not to create a brand out of his character. You and I may not consider anything wrong with having many girlfriends. Unfortunately, you and I don’t count that much when it comes to being a brand ambassador. Society counts and more importantly media counts.

Have you climbed too many ladders in the recent past? Then you better take a stock of the snakes ahead. And best is to avoid games with potentially long snakes. As Buffett’s partner Charlie Munger says, “Tell me where I am going to die, so I don’t go there.” And what if I can’t avoid “going there” like Tiger Woods? Then use Taleb’s suggestion and – Try to reduce snake-slide through redundancy, more insurance, more cash and less leverage.

Have a great 2010!

Tuesday, December 15, 2009

Thomas Edison and the patent paradox

With 1093 patents to his credit Edison has been an undisputed king of the patent world. At least a third of these patents have been related to incandescent lamps, generation and distribution of electricity. So one would expect that the electricity related patents might have been Edison’s greatest assets. Now, contrast this understanding with a remark from his biography Edison his life and inventions - Edison confesses that he has never made a cent out of his patents in electric light and power—in fact, that they have been an expense to him, and thus a free gift to the world. It is like Sachin Tendulkar saying all those centuries didn’t help India win. Is there some kind of paradox here? After all, aren’t patents supposed to create temporary monopolies? And if you have a few hundred, shouldn’t you be in a good position to beat competition? Then why didn’t Edison make any money in electricity business? Let’s explore the paradox which we call “patent paradox” in this article.

Now let’s start with the cynical proverb referred in Edison’s biography – A patent is merely a title to a lawsuit. How much money did Edison and his companies put in patent litigation? Upwards of two million dollars involving over two hundred lawsuits. That’s a lot of money, lawsuits and energy! The filament patent (part of light bulb) was the star attraction for legal battles resulting in over six thousand pages of legal record. So there was a lot of waste of paper too! The biography says - Every conceivable phase of ingenuity that could be devised by technical experts was exercised in the attempt to show that Edison had accomplished nothing new. Edison won but at a huge cost. Edison wasn’t dumb. So why did he go after patents? Let’s do a quick summary on what and why of patenting from patent FAQ at World Intellectual Property Organization.

What does a patent do?

It provides an exclusive right to the inventor without whose consent the invention can’t be commercially made, used, distributed or sold.

Why are patents necessary?

Patents provide incentives to individuals by offering them recognition for their creativity and material reward for their marketable inventions. These incentives encourage innovation, which assures that the quality of human life is continuously enhanced.

Nobody can deny the benefits patents offer to society. But how about the patent holder? Is everything hunky-dory for the patent holder?

Well, not really. Richard Tedlow, a business history professor at Harvard, points out three perils associated with patents in his book Giants of Enterprise. First, as we saw earlier they generate lawsuits. Second, a patent is a public document tipping off the rest of the industry to the company’s direction. Third, if a patent can be “invented around,” the information may cost the company dearly.

In technology based innovations, patents are essential. However, they are certainly not sufficient in keeping competitors at bay. As Peter Drucker pointed out a quarter of a century ago in his book Innovation and EntrepreneurshipBright ideas are the riskiest and least successful source of innovative opportunities. The casualty rate is enormous. No more than one out of every hundred patents for an innovation earns enough to pay back development costs and patent fees. A far smaller proportion, perhaps as low as one in five hundred, makes any money above its out-of-pocket costs.

What should systematic innovators do then? We will look at how one contemporary of Edison successfully resolved the patent paradox in the next article.

Monday, December 14, 2009

Edison’s Folly and understanding the exposure to negative black swan

What is the worst nightmare of an innovator? We may think it is a fear that the innovation may not take off. But we are wrong. The worst nightmare of an innovator is blowing up big time. Losing not only the investment made towards the innovation but much more. Falling so hard that you don’t get up again, ever. Hence, guarding against a possible “blow-up” is a critical piece of systematic innovation.

Before understanding how to guard against a potential blow-up, let’s understand a “blow-up” through a story commonly known as Edison’s Folly (given step-wise below).

1. By 1887, Edison had grown increasing bored with his electricity business as the business model was proven, competition intensified and legal battles became a norm. Edison developed interest in ore separation process as he saw the high price he had to pay for high-grade steel while building big electric generators and dynamos.

2. Edison starts experiments and files for 5 patents in 1887 improving the process of making high-grade iron ore from low-grade ore. He also writes his ideas in a magazine Iron Age. Mining experts dismiss the idea. A follow-up editorial labels the concept “Edison’s Folly”. Edison founds Edison Ore-Milling Company.

3. In 1889 he finds right kind of deposits on a mountaintop in the rural village of Ogdensburg on the northwest corner of New Jersey. He finds an investor Walter Mallory from Chicago and also puts in more than million dollars of his own money. He told his stockholders that “the sixteen thousand acres of land [at Ogdensburg] will supply the world with all of its ore requirements for seventeen years and the U.S. for seventy years!” Edison & Mallory purchase the land with stockholder approval.

4. Operation begins by fall of 1891. The mill and its machinery simply weren’t up to the task. The crushing rollers were not heavy or strong enough and often broke loose, endangering workers. Ore dust penetrated everything. The bulky steel conveyor system constantly jammed. In the following years nine workers were killed and many more seriously injured by loose, catapulting machinery.

5. Edison sells his electricity business to form GE and gets 12,000 shares. Sells the shares and puts most of the money into ore-milling business.

6. Plat shuts down due to depression in 1893. Edison goes back to his lab and during the idle time files more patents. By 1895 he is back at Ogdensburg armed with $250,000 and a box of new patents, drawings, and blueprints.

7. By 1898 the machinery starts to run dependably at last. A thousand tons of ore a day were being shipped out; if this volume could be continued and ore prices remained stable, the first operating profits might be just around the corner.

8. By 1899 the process matures further and Edison is able to offer a high-grade ore at $4.75/ton as against $7/ton of competition.

9. In 1898, two brothers had stumbled onto the great Mesabi Range in the northern Minnesota wilderness, hundreds of square miles of purest iron ore in the world. It needed only to be scooped from the ground and sent directly to the furnaces. By 1899 Mesabi starts delivering high-grade ore at $2.75/ton.

10. Edison finally closes the shop in 1900.

Nassim Taleb refers to the event such as “finding of high-grade ore in Mesabi” a negative black-swan. You can lose a decade worth of work in no time. We saw earlier that humans are very poor at predicting black swans. Question is – Was Edison aware of the exposure he had to a negative black swan? We don’t know. But I believe it is important for innovators to understand this exposure.

Warren Buffett when asked “What are the fundamental qualities of your successor?” has said, “I hope he is aware that 25 x 23 x 17 x 20 x … x 0 = 0; you had better be aware of introducing a zero in a series. In other words, we need someone genetically programmed to recognize and avoid serious risks.” Question is – is this quality, like Buffett says, really part of your genes? or can it be learned?

Related article: Pre-mortem: Tell me where I’m going to die, so I don’t go there.

William Denny and world’s first and pioneering idea management system

We looked at the evolution of a 50+ years old idea management system at Toyota. We also looked at benchmark data from idea management systems in India for the last few years. We observed that this benchmark data suggests that these suggestion systems are geared towards efficiency improvement only. Has efficiency improvement the only objective of idea management systems in the past? What were some of the oldest idea management systems like? What were the rules? What were the rewards? Let’s explore these questions with an example of a pioneering system introduced by William Denny of Scotland in his shipyard in 1880.

In Corporate Creativity, Alan Robinson and Sam Stern trace the history of idea management systems. About William Denny and his system, they write:

In 1864, at the age of sixteen, William Denny began a five-year apprenticeship in his father’s shipyard in Dumbarton, Scotland. He worked in the yard for twelve hours each day and upon returning home, studied for two more. In this way, he not only learned about shipbuilding but came to know well the workforce and the working conditions in the company.

On his twenty-first birthday, Denny was made a partner in the firm, and he soon set about overhauling the shipyard’s management practices, a project that would occupy him for twelve years. The systems he devised were described in a set of rules, a copy of which was distributed to every employee in the shipyard. These comprehensive rules were divided into five categories, one of which was “Rules for the awards committee to guide them in rewarding the workmen for inventions and improvements”.

This system was started in 1880 and quickly proved to be a success. To run it, he set up a two-people awards committee consisting of a member of engineering department and one person from outside the company, who also acted as a chairman. The rules were as follows:

An employee (exclusive of head foremen, officials of Awards Committee, and heads of departments) may claim an award from the committee on the following grounds:

1. That he has either invented or introduced a new machine or hand tool into their works

2. That he has improved any existing machine or hand tool

3. That he has applied any existing machine or hand tool to a new class of work

4. That he has discovered or introduced any new method of carrying on or arranging work

5. That he has invented or introduced any appliance for the prevention of accidents

6. That he has suggested some means by which waste of material may be avoiced

7. Or generally, that he has made any change by which work is rendered either superior in quality or more economical in cost.

Cash award from £2 to £15 were paid for each accepted idea, according to the committee’s estimate of its worth. If an idea was patentable, the rules stated that the company would give the inventor £15 and pay all expenses necessary to obtain a patent in inventor’s name. Other than the stipulation that the company should have free use of the idea, the inventor was free to pursue any other opportunities that might result from his patent. In 1884, a further incentive was added: award money would be doubled for any employee submitting five or more ideas.

By 1887, more than 600 ideas had been received, 196 of which had been accepted and award monies of £933 had been paid out. The company also built world’s first commercial ship model experiment tank in 1882. Dumbarton has a museum showcasing this tank and hosting exhibitions such as “Denny: innovation and experimentation”.

Sunday, December 13, 2009

Idea communication: The Edison way

In a previous article we looked at Thomas Edison’s method of innovation. As Edison’s innovation factory churned out incremental and radical innovations, Edison had to communicate his ideas to various stakeholders like the technicians in the factory, investors, patent officers, journalists and of course, potential users. What kind of methods did Edison employ in communicating his ideas? Let’s take a look in this article.

· Sketches: Henry Ford writes in Edison as I know him - If there is anything to be made or an experiment is to be conducted in a certain way, he draws a diagram in such clear, quick fashion that no further explanation is necessary. The speed with which Mr. Edison does all this is remarkable. He sketched the model of his first phonograph in less than five minutes.

· Analogies: We saw how Edison pursued the analogy of subdividing electric light so that it can be used like gas in small units (eventually turned out to be independent bulbs). Note that the analogy was not restricted to technical features alone. Edison established price points for electricity distribution based gas system comparison. On another occasion, Edison wondered, “Can we do to eye, what phonograph did to the ears?” (the innovation he worked on was motion picture camera).

· Use-cases: Edison invented phonograph in 1877. He articulated 10 possible uses of the phonograph in North American Review in 1878. They were: (1) Letter writing / dictation (2) Audio books (speaking to blind) (3) Teaching of elocution (4) Reproduction of music (5) Family record – sayings from members of family (6) Music boxes / toys (7) Clocks announcing going home, going for meals (8) Preservation of language (9) Education (10) Connection with telephone. Note that Edison suspended phonograph for almost 8 years in 1978 to focus on electricity.

· Prototypes: Demonstrating his prototypes was Edison’s pet method of attracting investments and publicity. Here is how he narrates his experience with Phonograph sometime in 1877 - That morning I took it over to New York and walked into the office of the Scientific American, went up to Mr. Beach's desk, and said I had something to show him. He asked what it was. I told him I had a machine that would record and reproduce the human voice. I opened the package, set up the machine and recited, 'Mary had a little lamb,' etc. Then I reproduced it so that it could be heard all over the room. They kept me at it until the crowd got so great Mr. Beach was afraid the floor would collapse; and we were compelled to stop. The papers next morning contained columns. (source: Edison his life and inventions)

Sunday, December 6, 2009

Idea management systems in India: Benchmark data from INSSAN

We looked at how idea management evolved at Toyota over 40 years from 1951 to 1989 cumulatively generating 20 million ideas. A natural question that comes to mind is: what is the industry benchmark?

I recently became a member of a 20 year old organization called Indian National Suggestion Scheme Association (INSSAN for short). This is a not-for-profit organization promoting and benchmarking employee suggestion schemes in the Indian industry. INSSAN bulletin for October 2008 – March 2009 (vol 20) gives the two tables shown above and below. This is the cumulative data for 18 organizations which shared their annual data on creative ideas coming from employees with INSSAN.

A few observations

· Scope of innovation: Impact of these suggestions is measured in “cost savings”. This is an important aspect of innovation. However, this means that the ideas entered in these systems are restricted to process improvements and not related to other 3 types of innovations (product, customer experience and business model). Perhaps these organizations use another mechanism for tracking these different types of ideas.

· Capacity of idea generation: On an average, number of ideas per person per year has improved from 3 in 2005 to 6 in 2008. For TVS Motors, this number is at 66 i.e. little over 1 idea per week per employee.

· Award per accepted suggestion at HAL, Bangalore is 80 times the average (HAL: Rs.7608, avg: Rs.93). Saving achieved per accepted suggestion is extremely high at HAL, Bangalore (Rs. 2.6 Crore) compared to average of Rs. 24,176. We don’t know whether this means that the standard of suggestions is very high at HAL or a few killer suggestions came this year.

· Idea acceptance rate: In case of, No of suggestions accepted out of number of suggestions received, a number of organizations (Maruti Suzuki, HAL, Godfrey Philips India, BEL) are at 100%. This is good as far as employee morale concerned. However, when the scope of innovation includes all types of innovations, this should look more like a funnel. For example, ex-CEO of P&G A G Lafley says in Game-Changer that for every 100 ideas that are received, 1 reaches the market. However, for every 2 ideas that reach the market, 1 succeeds. AG feels that the batting average (final success rate) shouldn’t exceed 70%. If it does, it would imply that employees are not taking enough risks. And that’s not good for innovation productivity.

Monday, November 16, 2009

Thomas Edison’s method of innovation

What was the most significant innovation of Thomas Edison? Some may say it was the distribution of electricity and incandescent lamp. Others may say it was the phonograph. I belong to Henry Ford club who believed that his method of innovation was as significant a contribution as his direct contributions such as lamp, phonograph etc. Let’s look at Edison’s method of innovation briefly through an example of electric distribution system.

1. Establish the need: In the summer of 1878, Thomas Edison was watching a gang of miners drilling for ore with heavy tools when he was seized by a vision – the idea of energy moving as electricity over a long distance.

2. Find anchors to hang your imagination: In the same year (1878), Prof. Barker of University of Pennsylvania suggested to Edison that he should subdivide the electric light so it could be got like small units like gas. Coal gas industry was an established industry by then supplying gas to homes and streets through underground pipes (e.g. see Austin’s coal gas plant which arrived in the city in 1873). Prof. Barker’s analogy provided a useful anchor for Edison. Around the same time, Edison visited the workshop of William Wallace and saw a generator system they had built to power their arc lamps – eight of them, in a row, all at once. Edison reported to New York Sun after a month, “I saw for the first time everything in practical operation. It saw that the thing had gone so far but that I had a chance. The intense light had not been subdivided so that it could be brought into private house”.

3. Know the known: Henry Ford writes Edison saying, “I started my usual course of collecting every kind of data. This time it was about gas: I bought all the transactions of the gas-engineering societies, et cetera, all the back volumes of gas journals, et cetera. Having obtained all the data, and investigated gas jet distribution in New York by actual observations, I made up my mind that the problem of the subdivision of the electric current could be solved and made commercial.” When Edison decided to focus on electricity project, he suspended the phonograph project.

4. Establish goals & use-cases: Edison established top two requirements as follows: "I realized that an electric lamp to be commercially practical must of necessity bear a general comparison with a gas jet in at least two points: first, that it must give a moderate illumination, and, second, that such a lamp must be so devised that each one could be lighted and extinguished separately and independently of any others. With this basic idea in mind we resumed our experiments at once”. Subsequently he wrote an 8-point memo that articulated requirements and use-cases of the entire electricity distribution system (see page 20, Henry Ford).

5. Iterate over experiments: Edison says, “When I am after a result that I have in mind, I may make hundreds or thousands of experiments out of which there may be one that promises results in the right direction. This I follow to its legitimate conclusion, discarding the others, and usually get what I am after.” In this case, he assigned the lamp experiments to his assistants Upton and Batchelor. Every experiment used to have a number. For storage batteries, Edison ran 5 series each with 10,000 experiments.

6. Demonstrate prototypes to stakeholders: Between October and December 1879 hundreds of carbon lamps were made and put into use not only in his lab but also on the streets and several residences at Menlo Park. On December 31, 1879, Edison and his gang made a public demonstration of his incandescent light bulb at Menlo Park. Special trains were run to Menlo Park by the Pennsylvania Railroad, and over three thousand people attended the demo (including public officials, financers, journalists etc).

7. Commercialize: This is how Edison established the commercial viability of electric lamp. Edison says, “The first year the lamps cost us about a dollar and ten cents each. We sold them for forty cents; but there were only about twenty or thirty thousand of them. The next year they cost us about seventy cents, and we sold them for forty. There were a good many, and we lost more money the second year than the first. The fourth year I got it down to thirty-seven cents, and I made up all the money in one year that I had lost previously. I finally got it down to twenty-two cents, and sold them for forty cents; and they were made by the million. Whereupon the Wall Street people thought it was a very lucrative business, so they concluded they would like to have it, and bought us out.”

8. Manage a portfolio: Edison always managed a portfolio of projects. For example, during 1880 to 1885, the peak of his lamp and distribution system project, he also filed patents related to magnetic ore separation, secondary batteries, telegraph and telephones and electric railway. His secretary estimated that in 1890 he was engaged in 72 different projects.

Source: Edison as I know him by Henry Ford.

Related articles:

  1. Thomas Edison, the father of systematic innovation: my favorite quotes
  2. Appreciating the promise of an underdog technology: Story of Henry Ford’s first meeting with Edison

Sunday, November 15, 2009

Appreciating the promise of an underdog technology: story of Henry Ford’s first meeting with Edison

Meeting with Thomas Edison on 11th August 1896 and hearing his words of encouragement was a turning point in the life of Henry Ford, the founder of Ford Motor Company. In 1890s Edison, pursuing electric cars, telling young Ford that gasoline cars hold more promise than electric cars was like Ken Olsen of DEC telling Steve Jobs that PCs hold more promise than mini computers in the 70s. How did Edison manage to see beyond electricity? Let’s explore this in this article.

In 1896, Henry Ford was working as a Chief Engineer with Detroit Edison Company with a salary of $125 a month. His boss Alex Dow approved of experimentation but did not like gas experiments. Ford mentions Alex saying, “Electricity, yes, that's the coming thing. But gas--no." It was a time when – as Ford recalls - all the electrical engineers took it as an established fact that there could be nothing new and worth while that did not run by electricity! It was to be the universal power. Edison, of course, was the torch-bearer of this universal power. It is in this context that Ford met Edison when Ford and Alex went to attend annual convention of all Edison companies at Manhattan Beach Hotel.

Even though Alex disapproved of gas experiments, he was the one to introduce Ford to Edison. Alex told Edison, “There's a young fellow who has made a gas car." Soon Edison and Ford got into a dialog. This is how Ford recalls the conversation:

"Is it a four-cycle engine?" he asked. I told him that it was, and he nodded approval. Then he wanted to know if I exploded the gas in the cylinder by electricity and. whether I did it by a contact or by a spark—for that was before spark plugs had been invented.

I told him that it was a make-and-break contact that was bumped apart by the piston, and I drew a diagram for him of the whole contact arrangement which I had on my first car—the one that Mr. Dow had seen. But I said that on the second car, on which I was then working, I had made what we today would call a spark plug—it was really an insulating plug with a make-and-break mechanism—using washers of mica. I drew that too.

He said that a spark would give a much surer ignition and a contact. He asked me no end of details and I sketched everything for him, for I have always found that I could convey an idea quicker by sketching than by just describing it. When I had finished, he brought his fist down on the table with a bang and said: "Young man, that's the thing; you have it. Keep at it. Electric cars must keep near to power stations. The storage battery is too heavy. Steam cars won't do either, for they have to have a boiler and fire. Your car is self-contained—carries its own power plant— no fire, no boiler, no smoke and no steam. You have the thing. Keep at it."

I find four things interesting in this story: (1) How most people get blinded by the technology-of-the-day (like Ford’s boss Alex) (2) Alex introducing Ford to Edison in spite of his grudge (3) The details into which Edison went questioning Ford (4) Edison’s ability to appreciate an underdog technology.

Ford quit his job on August 15, 1899, and went into the automobile business. Ford and Edison became lifelong friends.

Sources: Edison as I know him by Henry Ford and My life my work, Henry Ford’s autobiography.

Thomas Edison, the father of systematic innovation: my favorite quotes

I consider Thomas Edison the father of “systematic innovation”. Edison founded the first industrial research laboratory in Menlo Park in 1876 which he named “Invention Factory”. However, in today’s context, the name is a misnomer. What Edison started was actually an “innovation factory”. In the next few articles I will articulate my understanding of how Edison’s innovation factory worked. Let me start with a few of his quotes which I like and which I believe depict underlying principles of his method of innovation.

1. Anything that won't sell, I don't want to invent. Its sale is proof of utility and utility is success: This shows that Edison was first an innovator and then an inventor. Utility i.e. practical value of the things produced was of high importance to Edison. He used inventions and patents as a means to protect his product’s position from competition. As it turned out, patents alone are not the best form of competitive advantage. His biographers Dyer and Martin write - Edison confesses that he has never made a cent out of his patents in electric light and power—in fact, that they have been an expense to him. However, I believe that the 12,000 odd shares he got in General Electric after the merger of Edison General Electric and Thomson Houston in 1892 does indirectly show the value he received for his patents.

2. Great ideas originate in the muscles: Edison believed that experimentation was at the heart of innovation process. Ideas by themselves do not mean much. In fact, more refined ideas come about when you start experimenting with the ideas in crude form. Experimentation is hard work and perhaps that is why Edison said this.

3. Hell, there are no rules here. We are trying to accomplish something: Edison called his workers “muckers” – a word borrowed from British working class and meant “to fool around”. Similar to 3M, which called its innovators, “tinkerers”. Edison would set the broad direction of the experiments and assign it to a “gang” (his term). However, the “muckers” would “fool around” with the parameters the way they liked.

4. I have not failed. I just found 10,000 ways that won’t work: Edison distinguished between negative result of an experiment and failed experiment. Every new negative result means a new learning about what doesn’t work in what context. Edison would number all his experiments. For example, in the spring of 1884, he supervised 2,774 lamp experiments at Menlo Park.

5. I start where the last man left off: In 1878, Prof. Barker of University of Pennsylvania suggested to Edison that he should subdivide the electric light so it could be got like small units like gas. Edison says, “On my return home I started my usual course of collecting every kind of data. This time it was about gas: I bought all the transactions of the gas-engineering societies, et cetera, all the back volumes of gas journals, et cetera. Having obtained all the data, and investigated gas jet distribution in New York by actual observations, I made up my mind that the problem of the subdivision of the electric current could be solved and made commercial.” (source: “Edison as I know him” by Henry Ford)

6. To invent, you need a good imagination and a pile of junk: As mentioned in the wikipedia, Edison’s laboratory had "eight thousand kinds of chemicals, every kind of screw made, every size of needle, every kind of cord or wire, hair of humans, horses, hogs, cows, rabbits, goats, minx, camels in every texture, cocoons, various kinds of hoofs, shark's teeth, deer horns, tortoise shell ...cork, resin, varnish and oil, ostrich feathers, a peacock's tail, jet, amber, rubber, all ores ..." and the list goes on. Does your office have any pile of junk?

Wednesday, November 4, 2009

4 types of innovations: BusinessWeek classification

There are many ways to slice innovation. In this article we look at one such way which BusinessWeek uses while listing its 50 Most innovative companies. For example, it says that Apple is a product innovator, while Google is a customer experience innovator; IBM is a process innovator etc. This classification can help us answer questions like: What are we innovating around? How many levers are we turning?

There are 4 types:

· Process innovation: If Coffee CafĂ© Day uses a new and perhaps faster machine to make cappuccino, it is changing an internal process. Process innovation involves changing internal business processes and making them more efficient. Toyota is considered the role model of process innovation through its “continuous improvement” or “kaizan” methodology.

· Product/Offering innovation: When 3M offers Post-It notes or when SBI offers a new type of card called SBI gift card, it would be a product/offering innovation. It is about providing a new product or service to customers.

· Customer experience innovation: When a retail shop re-arranges the layout in its stores or when Intel runs an “Intel Atom inside” advertising campaign, they are trying to change customer experience. Visual merchandizing is a discipline that focuses on customer experience innovation in retail industry. Innovating a brand would fall under type of innovation.

· Business model innovation: When a company re-configures a value-chain by (a) creating a new customer and/or (b) by creating or eliminating a channel and/or (c) by re-defining a pricing model, it is doing a business model innovation. Tata Nano created a new customer (offering 4-wheeler to 2-wheeler owner). UFO Moviez eliminated the movie distributor in the value-chain. Google’s AdSense created a new way of monetizing Internet search.

In many organizations, these types of innovations happen in different departments. For example, delivery or product departments operationalize process innovation. New Product Development (NPD) or Business Development (BD) or Portfolio Management departments work on product/offering innovations. Brand managers work with customer experience innovations. Business model innovations are usually with strategy departments. Many of these departments speak their own language and usually don’t talk to the other innovators. It would be interesting to get a few representatives in a single room and see what concoction happens.

Related article: Joseph Schumpeter's 5 types of innovations (100 years old classification)

Future-proofing: A workshop with innovation leaders

Last week I facilitated a workshop Future-proofing: Making innovation engine fire and sustain held at Royal Orchid Park Plaza, Bangalore. We had 14 leaders from 9 organizations exploring together the topic of systematic innovation and how it can be operationalized.

We started with the question – Can we do to innovation what TQM did to quality? That means, can we systematically become better at managing innovation? Related to this broad question, we collectively thought of questions like:

  • How to create an environment of innovation?
  • Are there any systematic steps for innovation?
  • How do we predict timing of ideas?
  • How to identify innovative people?

We tried out Pain-Wave-Waste technique of sourcing ideas and we looked at how big ideas come about e.g. we looked at a story of creating a prepared mind and asked a question: Can we cook big ideas systematically? We looked at AdSense story and explored how we can bring experimentation to the heart of the innovation process. We looked at 4 types of risks every innovator should be aware of and how we can apply cost-impact matrix to select ideas. Finally, we also looked at how we can systematically create innovation sandboxes (additional examples: dynamic innovation sandbox, Tata Nano through sandbox lens).

At the end, we felt that each of us could start with a few steps in our respective organizations and make some progress step-by-step.

40 years, 20 million ideas: The Toyota suggestion system

As “innovation” buzzword gains popularity, various sub-areas start getting attention too. However, many of the sub-disciplines associated with “systematic innovation” are several decades old. One such sub-discipline is “idea management system”. In fact, the book “40 years, 20 million ideas” gives an excellent overview of how an idea management system evolved from 1951 till 1988 in Toyota. The book traces the origins (in 1950s), structures, processes, challenges in adoption and psychology of change and the role senior management played in making Toyota suggestion system work. It was a surprise to me to find out that idea management system came to Toyota from Ford when Toyoda and Saito visited Ford's River Rouge plant in Detroit in 1950-51.

During its first year (1951) there were 789 suggestions and awards totaling $2638. Both the quantity and quality of the suggestions were rather low. One reason apparently was that the employees thought “creative ideas” must be something like “big inventions”. Consequently, Shoichi Saito, father of the creative idea suggestion system, started emphasizing quantity and efforts were made to increase the number of suggestions. In fact, they replaced the formal kanji characters with hiragana alphabet in the logo to soften the stiff tone of the message. It took 20 years for that number to reach 100,000 ideas a year. Idea per person per year increased from 0.1 to 2.2 during the same time.

Yasuda-san writes – One factor responsible for increasing the number of suggestions at Toyota is the element of company culture called “on-site actual checks”. This means that before judging whether a certain idea will be successful, it is first tried out. To see whether something is suitable for customer, the first thing is t check out the customer’s actual situation. Failures are treated in a positive way, with absolutely no criticism. This minimizes the chances of rejection from the selection committee and helps keep the morale up for the employees submitting the suggestions.

Another factor that helped the suggestion system was a social club called Toyota GI (Good Idea) Club formed in 1974. It began as a social club by 13 people who had received annual gold prize for excellent suggestions. It was a voluntary group that received no subsidy from the company. The GI club began as a group of friends, but through training sessions, lecture meetings and other activities, it subsequently became a place for self-study for the purpose of making higher quality suggestions in the suggestion activities. As of 1988 the group had 1000 members.

This book is currently out of print. However, I hope it becomes available to others as it is the most comprehensive documentation on any idea suggestion systems I have seen. I found it in the Indian Institute of Management Bangalore library.

Tuesday, September 29, 2009

Letting a wave pass-by: story of Warren Buffett’s non-investment in Intel and Microsoft

In the past few articles on “strategy as surfing a wave” (see part 1, 2, 3 and 4), we looked at how a big wave like Internet hits people like Gorssman and Patrick. And how they surfed the wave. Well, do you really need to surf every wave coming? Can you choose not to surf a wave? How do wise men let a wave pass by? Let’s explore these questions using the story of Warren Buffett who chose to be a by-stander to both the PC and the Internet waves.

Let’s rewind to 1967 and zoom into the campus of Grinnell College which sat like a tiny radical island in the middle of the farming hamlet of Grinnell, Iowa. Its liberal-minded students tended to go into social services after graduation, and the school was focusing its funding on increasing its African-American enrollment. One of Grinnell trustees, Joe Rosenfield had become a friend of Warren and Susie Buffett. In October 1967 Warren attended a fund raising convocation and was moved by an electrifying speech by Dr. Martin Luther King, Jr. For the first time in his life, Warren felt in Susie’s words, “Perhaps there is more to life than sitting in a room making money”. After King’s speech, Rosenfield easily recruited Buffett to become a Grinnell trustee. Naturally, he went straight into the finance committee. And guess who the chairman of the committee was? An ex-Grinnell student Bob Noyce who at that time ran a company called Fairchild Semiconductors.

In 1968 Buffett showed up for a meeting at Grinnell College to find his fellow trustee Bob Noyce itching to leave Fairchild and start a new company. Joe Rosenfield and the college endowment fund each said they would put in $100,000, joining dozens who were helping to raise $2.5 million for the new company – which was soon to be named Intel, for Integrated Electronics. Out of regard for Rosenfield, Buffett signed off on a technology investment for Grinnell. As far as he was concerned, “We were betting on the jockey, not the horse”. It goes without saying that Buffett did not put any money from Buffett Partnership into Intel. Now, let’s fast forward 23 years to 4th July 1991 onto Bainbridge Island, a half-hour ferry ride from Seattle, where his friend Kay Graham dragged him to attend a party on a long holiday weekend.

And guess who were there at the party? Mr and Mrs Gates along with their son Bill Gates. It was the first time Buffett met Bill Gates. Buffett immediately asked Gates whether IBM was going to do well in the future and whether it was a competitor of Microsoft. Computer companies seemed to come and go, why? Gates started explaining. Buffett remembers, “We talked and talked and talked and talked and paid no attention to anybody else. He’s a great teacher and we couldn’t stop talking”. Gates told Buffett to buy two stocks: Intel and Microsoft. Buffett did not buy either – at least seriously. Why?

To get a glimpse of the answer, we need to understand two of the three pillars of Buffett’s business philosophy. The first one is “margin of safety”. It means having sufficient confidence in protecting your investment over long enough period. And why wouldn’t Buffett have confidence in the competitive position of Microsoft or Intel? There comes the second pillar: “Circle of competence” i.e. sticking to an area that you understand better than most others. In his own words, “I don't know what the world will look like in 10 years, and I don't want to play in a game where the other guy has an advantage over me."

In case you are wondering what the third pillar of Buffett’s philosophy is – It is “exploiting Mr. Market vagaries” i.e. exploiting the irrational behaviour of market investors. You may also want to check out: Warren Buffett and disruptive innovation. (source for Buffett stories: The Snowball by Alice Shroeder).

Monday, September 28, 2009

Innovation Sandbox: a low-cost grass-root level example

In the previous article A look at Tata Nano through dynamic innovation sandbox lens, we saw how Tata Motors created an innovation sandbox based on an insight from Tata Group chairman Ratan Tata. At the end we asked 2 questions: (1) How do we build innovation sandboxes when you don’t have a Ratan Tata or a Steve Jobs at the top? (2) Does every innovation sandbox have to be as expensive as Tata Nano? Let’s explore these questions using an example from a technology offshore center in Bangalore.

Let’s first understand the context a little more. This technology offshore center located in Bangalore is part of a global financial services firm. It has 1000 engineers responsible primarily of the maintenance of mature technology / products. Their day-to-day work involves fixing bugs raised by customer and adding new features whose design has been worked out by experts at the headquarters. The engineers and managers aspire to own products end-to-end. However, there is a huge chasm between the aspirations and perceived capability by their parent organization. Here is what happened starting February 2008.

There was a change of guard at the top of the parent company and in his welcome speech the new president mentioned “international trading” as a possible new area the company might enter. Video of this speech was available on the corporate intranet. A manager at the India offshore center, let’s call him Ajit, watched this video and “international trading” caught his attention.

In the next few days, he gathered 7-8 engineers together, some with business background, some with back-end technology knowledge like Oracle / mainframes and some with front-end expertise like .Net / user interface. Each of them decided to study implications of supporting “international trading” from their point of view. The group met once in two weeks for the next three months mostly studying the relevant systems and running small experiments and sharing the results.

In June 2008 India center got a call from onsite saying that they are kick-starting a project on “international trading” and checking if they have any inputs. With three months of solid experimentation the boys had more insights than what the onsite could believe. Pretty soon two of the engineers joined the team onsite in the conceptualization phase. The product went live this month. It is no surprise that one of Ajit’s team ended up owning a sub-system end-to-end.

Ajit is a middle manager (not a VP) and the sandbox they created with “international trading”, a “back-end” and “front-end” technology as constraints wasn’t expensive. In fact, all the experimentation happened by stealing time from the regular hours and more often putting in extra time. Ajit certainly played a key role in both identifying an opportunity and exciting a bunch of engineers around the opportunity.

What if the “international trading” project never got started? Well, unless you have a Ratan Tata or Steve Jobs with you, systematic innovation is a portfolio game. You need to ask, “Do we have a few such innovation sandboxes active with potentially high upside?”