Creative Construction

by Gary P Pisano

  Large organizations are said to lack the DNA for innovation. This genetic metaphor is powerful because for natural species (like us humans), capabilities are deeply rooted in DNA. DNA explains why a cheetah runs faster than an elephant. And, in natural species, DNA is essentially immutable for the individual. Growing up in Westwood, Massachusetts, I dreamed of playing for the Boston Celtics. Unfortunately, my DNA (or, more precisely, the DNA I inherited from my parents) endowed me with neither great height nor much athletic prowess. And, no matter how many hours I practiced in the driveway, there was nothing I could do to change my DNA. This is where the metaphor breaks down. Natural laws, like those associated with genetics, govern natural phenomena. Organizations, of course, are not natural phenomena; they are completely man-made, designed and run by people. “Organizational DNA” is not immutable. Unlike you or me, organizations can manipulate their own DNA. Through systematically creating an innovation strategy, designing an innovation system, and building an innovation culture, organizations develop the capability for transformative innovation regardless of scale. If larger enterprises seem incapable of transformative innovation, it is because we design them and run them to be that way. Creative Construction examines how we can design and run them differently in order to better succeed at innovation.

  Small Is Beautiful Does Not Mean Big Is Ugly

  There is no doubt that entrepreneurial firms are a potent source of transformative innovation. Entrepreneurial firms have revolutionized countless industries, from software and semiconductors to beer and biotechnology. Whenever you see an industry transformed, you usually do not have to look far to see an Intel, an Apple, a Microsoft, a Genentech, a Netscape, an Amazon, a Google, a Netflix, or an Uber. Yes, many (many!) start-ups die. We only get to celebrate the few big winners, but as an organizational species, entrepreneurial firms are spectacularly successful innovators. When it comes to innovation, small can be beautiful.

  Does this mean, though, that big must therefore be ugly when it comes to innovation? I spend a lot of time in both entrepreneurial firms and very big companies as researcher and advisor. And, at first glance, the answer would seem to be yes. Instead of the creative focus, energy, and youthful enthusiasm of the start-up, I too often find endless hours of meetings, labyrinths of procedures and policies, and decision making mangled by byzantine organizational matrices. Whereas the start-up wants to be a Formula 1 race car (fast, agile, not very reliable, and sometimes pretty dangerous), the large enterprise emulates a freight train—predictable, boring, and rigid.

  You may have made the same observation or even experienced the difference directly by moving from a big corporation to a start-up or working in a start-up acquired by a big corporation. You might have worked in a successful start-up that, thanks to its success, became relatively large. I have come across many instances where the transition from Formula 1 race car to freight train happened relatively fast in the life of a company. One day, it was a nimble, hungry start-up aspiring to revolutionize an industry; a few years later, after it had $1 billion in annual revenue, it was a freight train barreling down a single track. But this observation raises a few questions. Is this state of organizational affairs inevitable? Are the innovation-stifling characteristics we commonly see in a larger organization inherent to its large scale, or are they simply the artifacts of conscious or unconscious design choices made by its leaders? Are successful young companies really doomed to become lumbering freight trains if they are fortunate enough to grow? Must big be ugly when it comes to innovation?

  Despite our perception about smallness and beauty and bigness and ugliness, it may be surprising that statistical evidence relating company size and innovation paints a far more nuanced picture.7 Big does not always mean ugly. Scale alone is not an impediment to innovative capacity. My own work on this topic compared the R&D productivity of large pharmaceutical companies to that of biotechnology companies from 1984 to 2004.8 At the time I performed the study, the conventional wisdom in the industry was that large pharmaceutical companies were less productive at R&D than smaller biotechnology companies (the same logic underpinning the Morgan Stanley analyst report). But my study—which traced the origin of every drug approved over a twenty-year period by the largest twenty pharmaceutical companies and more than 250 biotechnology companies—showed a “statistical dead heat” between the R&D productivity of both types of companies. So much for the hypothesis that big is ugly.

  But what about transformational innovation—the type that ushers in waves of creative destruction and leads to upheavals of entire industries? The evidence here is a bit clearer but still not completely without important wrinkles. In general, innovations that disrupt specific industries tend to originate from new entrants.9 I stress “tend” because there are important exceptions. Consider, for instance, that Intel revolutionized the semiconductor industry by inventing and commercializing the microprocessor. Intel, however, was already a semiconductor company; it was not a new entrant into the semiconductor industry when it invented and commercialized the microprocessor. Second, I stress “entrants” because there is a big difference between a new firm (a start-up) and a new entrant. Established firms can be new entrants if they diversify from one industry to another. Waves of creative destruction can originate from firms of any size. Large size does not prevent companies from being transformative innovators.

  Let’s consider some historical and more recent examples. In April 1964, IBM introduced the 360 line of mainframe computers.10 Prior to that time, every new machine required the development of a unique new operating system and hardware. There was little if any interchangeability between machines, even those made by the same company. This was becoming incredibly costly because everything had to be developed from scratch. It also made maintenance and support a major headache. IBM revolutionized computer architecture by creating common underlying software, like the operating system, and hardware that could be used across multiple machines. Today, we take this concept of modularity and interoperability for granted. In 1964, it was unheard of, and it completely revolutionized the computer industry. It triggered an explosion in demand for mainframes, and it created new markets for peripherals and software development. In 1964, IBM was neither a start-up nor a new entrant into the computer industry. It was already the largest computer company in the world and ranked number 18 on the Fortune 500 that year (its sales of $2 billion would be equivalent to approximately $15.5 billion today after adjusting for inflation).11 This is a great example of a large, dominant incumbent in an industry disrupting the very industry in which it competed. Most theories of innovation say this is not supposed to happen. But it did.

  Let’s take another example. In 1982, a team of scientists modified the genetics of a plant cell, an invention that laid the foundation for today’s genetically modified crops. Despite the controversy, it is hard to dispute the economic significance of this innovation. GMOs account for the vast majority of soybeans, corn, and cotton produced in the United States and transformed the agricultural seed industry. But this invention did not come from a start-up. It came from a team of scientists working at then-eighty-one-year-old Monsanto Corporation, a behemoth agricultural chemicals company (ranked number 50 on the Fortune 500 in 1982, with sales of $6.9 billion, the equivalent of $17.1 billion today). At the time, Monsanto was not even in the seed business, but today it is the world’s largest seed company. This is an example of a large player from one industry transforming itself and another industry through innovation.

  There are many other historical examples of large companies succeeding at transformative innovation. Think about 150-year-old Corning, which invented fiber-optic cable and the glass manufacturing processes critical to today’s computer, television, and phone displays. And, of course, Bell Labs almost single-handedly drove the transformation of the twentieth century with a series of inventions such as the transistor, the microwave, cellular communications, the laser, satellite communications, digital transmission and switching, so
lar cells, and the Unix operating system (among many others). Bell’s massive size did not seem to impede its capacity for innovation.

  Well, then, you may think, “History is fine, but times have changed. The day of the big lab is dead. We live in the age of entrepreneurs.” So, let’s move closer to the present: Apple. Everyone knows the story of how the iPhone completely redefined the market from mobile phones to mobile communications. It was both a classic Schumpeterian gale—destroying once-mighty incumbents like Nokia, Motorola, and RIM—and a brilliant act of creative construction. In 2007, the year Apple launched the iPhone, the company was no spring chicken: it was thirty years old. And it was no minnow either. Its sales of $24.6 billion put it at number 123 on the Fortune 500.12

  Amazon is another contemporary example of a huge company invading other industries. There are really two Amazon stories. The first is the classic start-up. This was the story of how Amazon.com brought us into the world of online shopping, at the expense of just about every brick-and-mortar retailer. The second story, though, is one of a still-young but relatively large company, which has continued to succeed at transformational innovation. In 2004, Amazon introduced one of the first cloud-based computing services and launched the cloud computing revolution. This represented a major business model innovation for Amazon, as selling web services is completely different from being an online retail business. Amazon’s revenues that year were $5.2 billion, and the company ranked number 342 on the Fortune 500.13 Amazon might have been young, but it was not small by any standard. Today, Amazon is a $178 billion company, and it continues to innovate and experiment with new businesses such as video streaming, content production, drone delivery, groceries, and health care.14

  Today, we see a number of large companies actively engaged in potentially transformative innovation. Alphabet (formerly known as Google) is a $90 billion enterprise (ranked number 27 on the Fortune 500).15 It dominates Internet advertising, of course, but it has also been a pioneer in autonomous vehicles. Honda, a giant auto company, is attempting to transform the corporate jet market by developing a low-cost, lightweight jet that can efficiently serve as an “air taxi.” It is too early to say whether these businesses will succeed, but they are certainly trying. If large enterprises are not supposed to pursue transformative innovation, it looks like these folks never got the memo.

  These examples—and probably many more you can think of—provide something akin to an “existence proof” that scale alone is not a showstopper when it comes to transformative innovation. But just because something is possible does not mean it is easy, either. It’s not. Innovating at scale takes work—work that is dependent upon thoughtful strategies and significant efforts that are distinct from those that tend to succeed in small enterprises.

  The Challenge of Creative Construction

  Building an innovative venture from scratch is hard. Many of you can personally attest to the brutally long hours, the harrowing moments when cash is short, and the stress of knowing that just one bad move can spell disaster for the whole enterprise. We celebrate entrepreneurs for good reasons. And yet, as tough as it is to build an innovative company from the ground up, the task of sustaining and rejuvenating an existing organization’s innovative capacities—what I call “creative construction”—is even tougher. Whereas entrepreneurship is like building a new house from the ground up (albeit on a tight budget), creative construction is akin to renovating a home while living in it. It takes real creativity to build something new out of something old. Creative construction takes leaders who constantly renew and rebuild their organizations’ innovative capabilities. They don’t buy the rhetoric that success—and the scale that it produces—must ultimately breed stasis. They don’t see their organizations, no matter how large, as immutable blocks of stone. They are not content to decline graciously and to die, as Schumpeter said it, as “old men die of old age.”

  Creative construction requires a delicate balance of exploiting existing resources and capabilities without becoming imprisoned by them. Johnson & Johnson (J&J) provides insight into why creative construction is so difficult, illustrating the extreme end of both the challenge and the opportunity created by scale. J&J is the world’s largest health-care company, with revenues of approximately $75 billion.16 It is, as of this writing, in the top 100 companies in the world by revenues and in the top 15 by market capitalization.17 It operates in more than sixty countries around the globe and employs 134,000 people.18 It spends $10.5 billion in R&D—through more than a dozen different R&D laboratories located throughout the United States, Europe, and Asia and also through more than one hundred external partnerships.19 The company competes across three major health-care sectors—pharmaceuticals, medical devices, and consumer health products—and operates more than 260 subsidiaries.20 It sells several thousand brands, and every year it launches more than a hundred new products.

  For J&J to maintain its historical rate of top line growth, it must generate about $3 billion–$4 billion of new revenue per year. If you consider that some portion of the company’s existing revenue base becomes obsolete or declines every year, the net incremental growth target becomes even higher. Over the next ten years, J&J needs to generate about $35 billion in net new revenue. To put this challenge in perspective, there are fewer than 5,000 companies in the whole world today with revenues greater than $1 billion per year.21 This means that J&J cannot just launch an innovation here and there and expect to grow. It has to generate a continuous stream of innovations over time.

  This challenge is tough enough, but it gets worse. (I feel like the medical technician turning up the dial on the treadmill.) J&J does not get to start with a blank slate. It has existing businesses, which generate all its revenue and profits, to support and defend. It cannot take its eye off them while pursuing new opportunities. Although it has a massive reservoir of resources and capabilities, many are honed to the requirements of those existing businesses and may not be suited to the new opportunities it wants to explore. Building new capabilities takes time and investment that must come from the existing businesses generating all the profits.

  The challenge gets even tougher when you consider the sheer complexity of an organization like J&J. Complexity is a much bigger problem for innovation than scale alone. Complexity is a function of the number of moving parts—such as different business units, different functions, different geographies, different processes, different technologies, and different people—that must be synchronized. And when you get to be the scale of a J&J, you have a lot of moving parts. Complexity makes innovation more difficult because innovation, by definition, involves change. In a complex organization, innovation in one part might require carefully synchronized changes across different business units, functions, and geographic markets. Add the common reality that not everyone in the organization may see the benefits of an innovation so positively, and you now have a system with serious frictions. Friction impedes mobility. Lack of mobility means lack of innovation.

  An example like J&J also highlights, though, the potential benefits of scale for innovation. Larger enterprises like J&J have massive financial resources to explore new opportunities. They can hedge highly risky technology bets through parallel experimentation in ways that start-ups can only dream of. They can build vast networks of external collaborators to explore a broad array of emerging technologies. They have incredibly deep reservoirs of technical talent and operational skills critical to bringing innovations to market. They have global distribution and a strong brand. They have the infrastructure, know-how, and processes to get an innovative new product into the hands of millions of customers around the world almost instantly. They have decades of experience working with regulatory and government authorities. You cannot underestimate how critical such complementary capabilities are to successful innovation. Many start-ups with spectacularly great technologies have failed because they lacked these capabilities.

  The example of J&J could be applied to countless other large ente
rprises that face the dilemma of scale that simultaneously is an incredible strength and an incredible liability with respect to innovation. Jeff Bezos, in his 2015 letter to Amazon shareholders, captures this dilemma succinctly: “Used well, our scale enables us to build services for our customers that we could otherwise never have even contemplated. But also, if we are not vigilant and thoughtful, size could slow us down and diminish our inventiveness.”22

  You do not have to be the size of J&J or Amazon to come face-to-face with this dilemma. The challenge of scale creeps into organizations relatively early in their life cycle. Young companies that have successfully launched their first major products and are growing rapidly face many of these same dilemmas: How much to invest in the existing product versus potentially new platforms? How do we leverage our existing capabilities without letting them hamstring us? How do we preserve our Formula 1 culture as we become a larger, more complex organization? The challenge of innovating at scale is to leverage these real strengths while figuring out ways to circumvent or eliminate the potential weaknesses.

  Why Most Innovation Initiatives Fail

  If you have worked at a large company, you may have lived through something called an “innovation initiative,” a major organizational change effort aimed at creating or rejuvenating an organization’s innovative capacities. These initiatives take many different forms, but they usually involve some combination of structural, process, and cultural change. They’re a typical response when a company’s growth has slowed and the CEO or another senior leader decides that innovation is the key to fixing this problem.

  If you have lived through one of these rejuvenation campaigns, you can attest to the hurdles involved. Becoming a reborn innovator is not like riding a bicycle. Once the innovation muscle has atrophied, it’s not a matter of just a bit of “exercise” to get back in form. You have to rebuild those capabilities from the ground up. You have to create entirely new organizational systems and build a new culture. There is a lot to figure out. How do you find new ideas? How do you stimulate creative thinking? How do you figure out which ideas to pursue and drop? How do you motivate people? How do you get people comfortable with all the uncertainties associated with innovation? This is tough stuff. But now consider that you have to do all this within an existing enterprise with existing systems and processes, current structures, and a deeply ingrained culture. Like any major organizational change effort, innovation initiatives are not necessarily going to garner universal support. Conflicts are inevitable. And now remember that you are going to undertake this massive organizational transformation, all the while keeping your existing businesses competitive and your finances healthy.