Innovation and the Path Not Traveled

Southern Business Review, Summer 2009 by Townsend, William

The search for metrics to accurately and compre- hensively evaluate the value of innovation has occupied researchers and managers since Schumpeter (1934) identified it as an engine of organizational growth. The ability to quantify this value was limited for decades to direct monetary values (profit increases or cost reductions) and those related to R&D (ROsD expenditures, ROoD assets, patents, copyrights, etc.). While the limitations of these metrics were well known, the alternatives were limited. As a greater body of theoretical and empirical research developed on the impacts of innovation on the firm, a focused search began for an understanding of the underlying mechanisms and way to measure them in the organization. This explora- tion led to an understanding that innovation's value to an organization manifested itself in different ways. Observational and theoretical work identified several classes of innovation in organization that all produced value. Empirical research found that the value of innovation varied based upon other contextual criteria, such as industry sector, markets, customer relationship and previous performance.

As the understanding of the relationship between innovation and value evolves to a more contextually driven model, so too do the metrics used to capture it. The understanding of the range of value that innovation provides to the firm and increasingly sophisticated ways to capture it is progressively greater. The strict reliance upon cost reduction and R&D related metrics as the sole evaluative techniques has past. Empirical research confirms this gap between the aggregate value of innovation and the value assessed through traditional measurement. MonteiroBarata (2005) reports an often- discovered statistic in the analysis of innovating firms from two surveys of Portuguese manufacturing firms. While both the INDINOVA and SOTIP innovation research projects identified that only a fraction of the firms generating product and process innovation engaged in RO5D. While the percentage of firms producing innovations were fairly consistent between these studies (36% process innovation and 27% product innovation for the INDINOVA project, and 25.2 percent process innovation and 2 0. 7% product innovation for the SOTIP project) the number of companies engaged in internal R&D activities is 3 . 1 percent according to the SOTIP survey (p. 305).

Models of Innovation Valuation

Innovation is a localized phenomenon, defined within very specific contextual boundaries in an organization. Innovation valuation models do not necessarily transfer outside of the context in which they are found. This makes it difficult to establish a generalizable framework that can be abstracted and applied to other environments. An interesting statistic reported by Hipp and Grupp (2005) from the 1999 Mannheim Innovation Panel of German firms, reflects the localized nature of much innovation. Of the 1405 firms reporting an innovation in the past three years, 34 percent of manufacturing firms launched innovations that were new to the market and 57 percent produced innovations that were only new to the firm. This disparity in the level of novelty was even more pronounced in the services sectors. From the 1080 services sector firms with an innovation in the past three years, 16 percent created an innovation new to the market, while 77 percent produced an innovation new to the firm. (p. 525)

Pavitt's( 1984) work studying the sources of 2000 British technological innovations during the time period 1945-1980 revealed that an organization's industrial sector was a significant determinant in the type of innovations that a firm pursued. Firms in industries that were strongly customer- centric realized more new product or service based innovation, while firms in more production intensive sectors increased cost cutting process related technological innovation.

While this reinforces the idea that there is no single set of innovation measurement metrics that can be applied to all firms, it may be related to an underlying flaw in managing the application of the metrics. The sectoral variance in capturing different classes of innovation may be caused by only applying those metrics that have direct relevance to a current operational strategy.

The results developed by Pavitt (1984) may be caused by the decisions made on which innovation measurement metrics to use, rather than the overall potential value to the firm. It's like the joke about the man looking for his lost keys under a streetlight one night. When a passerby offers to help in his search, he asks, "Where do you think you dropped them?" The man responds "About 100 meters down the street." "Then why are we looking here?" the passerby asks. The man responds, "Because the light is better here." As managers, we seek out innovation where the light is better.

Innovation and the Value of Failure

The concept of failure has several connotations in the context of innovation value measurement. Failures in adequately capturing the value of the innovation by due to inadequate or incomplete application of the valuation metrics abound. Chesbrough (2004) discussed the need to measure and manage "false negatives" in the innovation process. He discusses "false negatives" as innovation efforts that have been terminated or abandoned by an organization which later show renewed value. The termination may be because the innovation relates to markets outside of those that the organization currently pursues. It may be because the innovation relates to a market that is currently undeveloped. In both cases, the organization finds renewed value in the "false negative" at a later point in time. Chesbrough highlights the need to regularly revisit the knowledge base created by terminated innovation to reevaluate the internal and external value of these ideas and to develop strategies to capitalize upon them.