All of which is interesting from the standpoint of tracking how ideas spread. Idea diffusion is one of the key things we talk about here, but that’s not what I want to talk about today. I’m interested in the analytical aspect of John’s post. He was talking about research findings that show that in Australian Biotechnology firms, using a Real Options valuation approach leads to better innovation results than using Net Present Value to evaluate potential projects. Firms using NPV actually had a negative return to innovation in their study – so the title of the post really should have been How NPV Kills Innovation. But then the idea wouldn’t have spread nearly as well.

The thing that concerns me about the study though is the use of tools in the first place. I recently read Innovation: The Missing Dimension by Richard Lester and Michael Piore. It’s one of the most insightful books that I’ve read in a while, and I recommend it strongly. Lester and Piore are reporting on the results of a massive number of case studies that they conducted in the cell phone, blue jeans and medical devices industries.

Their key finding is that to innovate succesfully, firms need to be good at both analytical and interpretive processes. Real Options and NPV are typical analytical processes that are used to evaluate potential new products. Lester and Piore argue that in addition to these types of tools, firms also need to be able to interpret the needs of their customers (which is essential the argument of Roberto Verganti in Design-Driven Innovation as well). Here’s how they describe it:

Analytical processes work best when alternative outcomes are well understood and can be clearly defined and distinguished from one another. Interpretive processes are more appropriate when the possible outcomes are unknown – when the task is to create those outcomes and determine what their properties actually are. These two ways of proceeding involve very different kinds of skills, different ways of working together, different forms of managerial control and authority, and, ultimately, different ways of thinking about the economy. The two processes are in fundamental opposition to each other, making it difficult for people to think about both of them at the same time. Yet the ability of businesses to think about these two approaches separately and to manage them simultaneously is the central challenge of product development.

That’s the real problem – analytical tools like NPV kill innovation, but we need them (or at least something like them) to innovate. The real achievement of Lester and Piore is to document how we need both analysis and interpretation in a wide variety of industries, and they include some suggestions for doing this successfully. The main one is to be aware of the necessity of both processes and how to use them effectively.

Interpretive processes are most important at the start of developing our new ideas. Design-driven tools are very effective early in the process, and they do lead to finding new competitive spaces. Disruptive innovations are most likely to arise from interpretive processes.

Because interpretation requires ambiguity and extended conversation, the biggest thing that managers need to do is to prevent shutting down discussion too early. This is the tendency in organisations dominated by analysis – they jump to a preferred option far too early.

The time to use analysis is once you have settled on the ideas that are best. This is the time to optimise things.

Innovation is filled with difficult contradictions to manage – incremental versus radical, short-term versus longer term, open models versus closed, and analytical versus interpretive. In most cases, firms need to find a balance between each of these oppositions. It is hard to do this, but the firms that are successful at finding these balances also tend to be the most innovative. And the most profitable.