Why Innovation is Less Risky Than You Think

One of the most common excuses I run across for not innovating is risk aversion. Organisations don’t innovate because they’re risk averse, or so they say.

But is innovation really so risky? Yes, a new idea might not work. But in many cases, not innovating is even riskier. Here is how Peter Drucker puts it in his classic book Innovation and Entrepreneurship:

Entrepreneurship, it is commonly believed, is enormously risky. And indeed, in such highly visible areas of innovation as high tech – microcomputers, for instance, or biogenetics – the casualty rate is high and the chances of success or even of survival seem to be quite low.

But why should this be so? Entrepreneurs, by definition, shift resources from areas of low productivity and yield to areas of higher productivity and yield. Of course, there is a risk they may not succeed. But if they are even moderately successful, the returns should be more than adequate to offset whatever risk there might be. One should thus expect entrepreneurship to be considerably less risky than optimization. Indeed, nothing could be as risky as optimizing resources in areas where the proper and profitable course is innovation, that is, where the opportunities for innovation already exist. Theoretically, entrepreneurship should be the least risky rather than the most risky course. (emphasis added)

This is the point that Clayton Christensen, Stephen Kaufman and Willy Shih make in their article Innovation Killers (link to pdf). They illustrate it with this great diagram:

When we assess the potential risk of innovating, it is normal to assume that things will continue as they currently are. In a stable environment, it might be safe to assume that taking the ‘do nothing’ option will result in stable returns.

Drucker’s point is that if you are in an industry that is primed for innovation, then even if things seem stable, assuming continued safe returns is extremely dangerous.

Then how can we tell if our industry is primed for innovation?

Drucker addresses this in the book (and there is a short summary in this HBR article as well) – he identifies seven drivers of innovation opportunity. These are things that change the environment. Drucker contends that these can be identified through analysis, and that regularly conducting such analyses is a central part of the discipline of innovation.

The seven drivers are:

  1. Unexpected Occurrences: Drucker stresses that we should look for outcomes in our business that surprise us. These can be positive surprises. He talks about Macy’s department store in the 1950s identifying an unexpected surge in appliance sales relative to clothes. This actually reflected the start of a major shift in consumer behaviour. Or the surprise can be negative, like the failure of the Edsel. In both cases, you have to identify the surprise and learn from it. Macy’s identified the surprise, but didn’t act. It was Bloomingdale’s that took advantage of the change in behaviour. On the other hand, Ford did learn from the Edsel, which led to the extremely successful introduction of first the Thunderbird, and then the Mustang.
  2. Incongruities: these are differences between expectations and results, or between beliefs and reality. A great example of this is in the shipping industry. For a long time, it was assumed that the best way to drive down costs was to reduce the time it took to get between ports. However, this is an incongruous belief. The real problem in shipping is when the ship is idle. So the best way to increase returns is to get in and out of port as quickly as possible. Recognising this incongruity is what led to the invention of containerization – which almost immediately led to a 60% reduction in shipping costs.
  3. Process Needs: these arise from problems within a production process. Photography provides a good example. When it was invented, it quickly became very popular. However, a big impediment to amateur photography was the need for the use of heavy glass plates. George Eastman saw this process problem, and worked to replace the glass plates with cellulose film. Doing so is what led to a market-dominant position for his company, Kodak, within 10 years of the introduction of his lightweight camera.
  4. Industry and Market Changes: here are some of the examples Drucker used in 1985:

    In a similar fashion, changes in industry structure have created massive innovation opportunities for American health care providers. During the past ten or 15 years, independent surgical and psychiatric clinics, emergency centers, and HMOs have opened throughout the country. Comparable opportunities in telecommunications followed industry upheavals—in transmission (with the emergence of MCI and Sprint in long-distance service) and in equipment (with the emergence of such companies as Rolm in the manufacturing of private branch exchanges).

    You can see similarly structural changes now driven by the internet in a wide range of industries.

  5. Demographic Changes: these are usually fairly predictable, but often ignored. For example, how many of you are still not considering the enormous opportunities provided by the increase in ageing consumers that we are currently going through? This is the best innovation opportunity ever.
  6. Changes in Perception: here is Drucker again:

    All factual evidence indicates, for instance, that in the last 20 years, Americans’ health has improved with unprecedented speed—whether measured by mortality rates for the newborn, survival rates for the very old, the incidence of cancers (other than lung cancer), cancer cure rates, or other factors. Even so, collective hypochondria grips the nation. Never before has there been so much concern with or fear about health. Suddenly, everything seems to cause cancer or degenerative heart disease or premature loss of memory. The glass is clearly half empty.

    Rather than rejoicing in great improvements in health, Americans seem to be emphasizing how far away they still are from immortality. This view of things has created many opportunities for innovations: markets for new health care magazines, for exercise classes and jogging equipment, and for all kinds of health foods. The fastest growing new U.S. business in 1983 was a company that makes indoor exercise equipment.

  7. New Knowledge: these are opportunities that arise through invention – and often this is the only one of these drivers that we consider.

Obviously, these drivers often overlap. The main point is to use them as tools to identify the areas that we should be thinking about.

If you do this, you are on your way to practicing innovation as a discipline, rather than as a lottery. And if you do that, innovation can be much less risky than doing nothing.

Student and teacher of innovation – University of Queensland Business School – links to academic papers, twitter, and so on can be found here.

Please note: I reserve the right to delete comments that are offensive or off-topic.

13 thoughts on “Why Innovation is Less Risky Than You Think

  1. Good prompter on this Tim. It is strange how risk has become so attached to innovation in everyones mind.

    In product development the risk is managed, accepted, built in, what is it 9 out of 10 products fail. Is that not risk?

    The level of M&A activity that fails to obtain the synergies or enhancing aspects calimed at the point of takeover and ‘return’ is far lower than forecasted and aso much of what is taken over gets spun out, sold off or closed. This has risk.

    When organizations embark on new drug discovery, invest in plant that needs 5 to 10 year planning, that has ‘acceptable risk’ yet innovation somehow seems top of mind in risk.

    Perhaps it is the very defintion of innovaton as it deals with all of the above- creating something new, so it has this tag.

    Risk can be ‘factored in’ but chasing something new and different must have risk.

    I always use the yin and yang of risk balanced with opportunity and that is what innovation provides.

    • It’s a tricky thing – in part because on average we’re not very good with the numbers around risk to start with. That makes it hard to assess accurately. Consequently, just saying no to new ideas seems safer.

  2. Good article, Tim. The key risk is insularity and a focus on what is happening inside the company rather than outside. It leads to an over-emphasis on incremental efficiency. Often it isn’t a lack of resource that impedes innovation, it’s the lack of top management bandwidth and attention. They see the next quarterly report coming, and need things to say, forgetting that innovation is a great story.

    The other way to de-risk innovation is to have a solid portfolio approach, like the 3 Horizons model you referred to recently. Within each horizon, there will also be different levels of risk. It works in investment, it works in innovation.

    • Thanks Kevin. I’m going to address the bandwidth/attention issue a little bit in my next post.

      And your suggestion about the benefits of a portfolio approach here is exactly right.

  3. Tim,

    great post!

    Although something was bothering me. If the innovation path is so obviously better than why isn’t everybody doing it?

    I think you actually pointed it out. Identifying what is the opportunity is the challenge. Your shipping example shows this. And Kodak’s decline shows it, too.

    thanks for the post.

    • Thanks for the comment Frank. I think the other part of the issue is that innovation isn’t obviously better. That’s the point of the DCF curve illustration. Everyone assumes a particular future, and if that assumption is correct, then you can afford to skip innovation. But that assumption is faulty.

  4. I think the core idea behind this post relates nicely with your more recent post on uncertainty. If you do innovate, the outcome is (more or less) uncertain. If you don’t innovate, the outcome is much more predictable. But the more predictable outcome does not necessarily correspond with the more advantageous outcome. In fact, it’s usually the opposite. I think Peter Schiff said it best: “Take away the freedom to fail, and you have obliterated the freedom to succeed.”

    • Dealing with uncertainty has ended up being one of the core themes that I’ve written about Beyon. It’s central to innovating successfully. So as with all the core themes, I end up coming at the idea from multiple angles, and fairly regularly! The Peter Schiff quote is excellent.

Comments are closed.