In 1942, Joseph Schumpeter created a new consciousness concerning the role of innovation in economic growth. He declared that the fundamental impulse that sets and keeps the capitalist engine in motion comes from new and value creating activities; creating value for society as a whole. These new and value creating activities help the capitalist enterprise create new consumers, new goods, new methods of production or transportation, new markets, and new forms of industrial organization.
…resulting in an unfortunate overuse of the word innovation, leading to anything new being dubbed as an innovation
Over the years, people have forgotten Schumpeter’s original assertion concerning the benefits of innovation – new and value creating. There is an excessive focus on the new and a concomitant overlooking of value creating, resulting in an unfortunate overuse of the word innovation, leading to anything new being dubbed as an innovation.
Both as a word and as an activity, innovation has a positive connotation. We assume that anything and everything hailed as an innovation creates a positive benefit for society. This is a dangerous assumption and as the recent financial crisis demonstrates is definitely counterfactual.
In their book Animal Spirits, George Akerlof and Robert Shiller discuss how several activities and products touted as innovations, but with suspicious value creating credentials, precipitated the financial crisis. Gillian Tett reinforces this point-of-view in her post-mortem on the financial crisis, turning Schumpeter’s concept of creative destruction on its head to describe instead a process of destructive creation, where allegedly innovative financial instruments created a snowball effect of unmanageable negative consequences.
Using innovation indiscriminately as an adjective to describe something new, rather than to convey the new and value creating potential of a business initiative is not limited to the financial world alone. Consider ethanol, which generated significant buzz as an alternative that could help break the dependence of both developed and growth economies on traditional fossil fuels.
Without a doubt, consumers stood to benefit from ethanol’s cleaner fuel technology and lower environmental footprint. On the face of it, because it was made from something so simple and abundant as corn, it seemed like the ultimate win-win.
But was it an innovation? For many it was, on account of its novelty and environment friendly promise. However, with time it soon became clear that new it was, but value creating it wasn’t. The reason being that because the U.S. industrial food system is so heavily dependent on corn, diverting corn for fuel sent food prices skyrocketing, thereby offsetting any potential value creating benefits of ethanol. If this significant offsetting feature had been considered at the outset, would ethanol still have been called an innovation?
Olestra is another telling example. Like ethanol, Olestra represented a significant technological development – a fat substitute that tasted like fat but with no weight gaining side effects, because its molecules are too big for the body to digest and pass right through the digestive tract leaving no calories behind. If ever there was a compelling story for guilt free indulgence, this was it.
But as the Americans like to say, there is no such thing as a free lunch. Olestra may not have gone to people’s hips, but it certainly did get to their stomachs and cause other health problems. As one of the organizations lobbying against Olestra stated – why in the world would anyone want to eat a chemical that inhibits the absorption of vitamins and causes diarrhea and abdominal cramping?
For a business initiative to be truly innovative, it must be both new and value creating
What at first blush sounded like a dieter’s dream, junk food that doesn’t go to your hips, soon showed up significant downsides. In addition to acting as a laxative as it journeys through the body, Olestra also snares disease-preventing agents like fat-soluble vitamins and drags them out of the body. It was these negatives that led countries like UK and Canada to ban the product.
All of which leads to a potent but simple question, when is an innovation not an innovation? For a business initiative to be truly innovative, it must be both new and value creating. If innovation is to be used in this spirit and not merely as a label for anything new, it must pass the following litmus tests.
Fundamentally, innovations are about asset creation. These assets can be tangible or intangible. Consider any of the past or current innovations – ATM’s, MRI, iPhone -all of them created assets. The financial innovations that created products, better known by their acronyms, like CDO (collateralized debt obligations of asset-backed securities), fail this test.
Fundamentally, innovations are about asset creation
Credit risk, by definition, is a liability. No amount of packaging and reselling it can convert it into an asset. Furthermore, moving credit risk around in an economic system by selling it and reselling it to a variety of interlinked organizations does not create value; it erodes it.
Is there mutuality of benefits; do both producers and consumers benefit?
Gillette promotes its Fusion Power shaving system as better than a Mach 3 – a result of 8 years of shaving innovation and 20 patents. Since Gillette would like to benefit from this innovation, wet shaving enthusiasts have to shell out more money for the Fusion Power razor and shaving cartridges than they did for Mach 3. But is it only Gillette that benefits? Not really, the shaver benefits as well, in both real and perceived ways.
Both Apple and Pandora have introduced innovations in the personal music listening space. The process through which they create value for music lovers is very different – iTunes vs. the music genome project. However, both are very transparent. There is no ambiguity or doubt about how Apple and Pandora create and deliver value.
But that was not the case with Enron or the dot-com companies. The innovations in natural gas trading and gas-fired electrical generation systems that allowed Enron to miraculously book ever growing profits were hardly transparent. Valuation systems followed by analysts to forecast and monetize eyeballs in the case of dot-com companies were not transparent either.
Two blades are better than one, three better than two, and five better than three. Gillette’s positive that an average wet shaving enthusiast can handle this level of complexity. Gillette and the wet shaving army get it – more is better. True innovations are easy to understand and don’t need an advanced college degree.
True innovations are easy to understand and don’t need an advanced college degree
Contrast this with the financial initiatives labeled as innovative responsible for ushering in the current financial crisis. They were not simple to understand.
In fact, Tett is spot on in her assessment when she states that these innovations became so intense that they outran the comprehension of even skilled bankers and regulators. Bernanke too echoes this sentiment when he alluded to complexity and opacity of financial innovations being at the heart of the current financial crisis.
Quackery and fraudulent patent medicines were well and alive in 19th century USA. Theatrical performances and fire and brimstone selling pitches, more befitting religious sermons, usually accompanied the selling of these products. Not difficult to understand why? The extra sizzle had to compensate for the lack of steak!
The word innovation is a merit badge and should be used selectively
The original developers of credit derivatives wanted us to believe that their creations would promote market completion, or more perfect free markets. Perhaps, but not when they are not traded on the free market! In the case of both Enron and the financial innovations in question, the claims far exceeded the benefits. Far from creating freer markets, they created opaque trading worlds for concentrating risk that promised much more than they could ever deliver.
The word innovation is more than just a label. We need to remind itself that at its heart, innovation is not just something new, but something that is both new and a key driver of economic prosperity. Hopefully, this will lead to more discipline in its usage. The word innovation is a merit badge and should be used selectively. Not every new product or service is worthy of it.
Gaurav Bhalla is a strategy, innovation, and marketing professional with global experience, having worked on three continents and with companies in over 20 countries. He is also owner and CEO of Knowledge Kinetics. The company focuses on the practice of customer-driven innovation and value co-creation.
Gaurav previously was the Global Innovation Director, at Kantar-TNS, one of the world’s largest market information and insight companies. Additionally, he held positions in corporate strategy, brand management, sales management, and market research at companies such as Nestle, Richardson Vicks, and Burke.
Dr. Bhalla holds a BA (Hons.) degree in Economics and Mathematics from Delhi University, an MBA with a concentration in Marketing and Finance from the Indian Institute of Management, Ahmedabad, and a PhD in Business from the University of Kansas.
He has published research papers in leading technical journals dedicated to marketing, marketing research and statistics, and has presented before professional and academic societies in the USA and abroad. Dr. Bhalla has also served as an adjunct professor at Duke University’s Fuqua School of Business. He is currently associated with the University of Maryland’s Smith School of Business as a member of the Department of Marketing’s Corporate Advisory Board.