Counterparties: Why big companies are bad at innovating

July 19, 2012

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Today Nokia announced that it lost $1.7 billion in the second quarter, its fifth quarterly net loss in a row. Just a few hours before the announcement, the WSJ published a great piece revealing how, as early as 2000, the Finnish phone maker had designed a proto-iPhone – complete with a color touch screen and geo-location, gaming, and e-commerce capabilities. The phone, though, never moved into the mass production phase because of ”a corporate culture that lavished funds on research but squandered opportunities to bring the innovations it produced to market.”

While it’s not surprising that a lumbering, oversized multinational corporation failed on the innovation front, it’s clear that Nokia does not suffer from a dearth of ideas: It spent $40 billion on research and development over the past decade, almost four times what Apple spent over the same period. Nokia also developed and ultimately discarded not one but two operating systems, Symbian and MeeGo. Nokia’s deficiency lies in what Vijay Govindarajan and Chris Trimble call “the other side of innovation,” or the problem with executing new ideas, not just thinking them up.

If you believe Peter Thiel, this is also an affliction Google suffers from. At a debate at Fortune Brainstorm Tech this week, Thiel told Eric Schmidt that the $30 billion in cash Google has sitting idly on its balance sheet demonstrates that the company is “out of ideas” that are worthy of scaling up:

[T]he intellectually honest thing to do would be to say that Google is no longer a technology company, that it’s basically – it’s a search engine. The search technology was developed a decade ago. It’s a bet that there will be no one else who will come up with a better search technology. So, you invest in Google, because you’re betting against technological innovation in search. And it’s like a bank that generates enormous cash flows every year, but you can’t issue a dividend, because the day you take that $30 billion and send it back to people you’re admitting that you’re no longer a technology company. That’s why Microsoft can’t return its money. That’s why all these companies are building up hordes [sic] of cash, because they don’t know what to do with it, but they don’t want to admit they’re no longer tech companies.

After reading this exchange, Tyler Cowen noted that ”the revealed preference of our technological leaders is the best and most depressing argument for the great stagnation.”

At least some of tech’s big companies are trying to remain small or may have to downsize (see: Yahoo). Brad Stone wrote last spring about how Facebook’s Sheryl Sandberg believes that the Internet companies like Google that vastly expanded their staff during boom times “eventually came to regret the innovation-killing bureaucracy that resulted.” For that reason, she has favored automated systems, so Facebook can avoid increasing headcount. In capacity its new headquarters maxes out at 6,600 employees and it’s currently occupied by only a third of that total. – Peter Rudegeair

On to today’s links:

Slowing down
The world’s largest retirement community – “Disneyworld for adults” with 23,000 acres and 88,000 residents – Huffington Post

Beefs
“Krugmenistan vs. Estonia”: How a blog post ignited an international economic spat – Businessweek

‘Liebor’
Simon Johnson: The Fed thoroughly failed the financial system by missing the Libor scandal – Baseline Scenario

Alpha
The latest weapon in hedge fund divorces: bringing RICO cases against your spouse – New York Observer
Get used to generally crappy pension fund returns – Barron’s

Alien Equity
One-third of Bain Capital’s early investors were wealthy foreigners, most of whom invested through shell companies in Panama – LAT

EU Mess
A graph of euro doom – foreign capital’s flight from Italy and Spain – Telegraph
Spain’s 5-year debt costs hit new euro-era highs at an auction – Reuters

Defenestrations
Duke pins CEO swap on problems at nuclear plant – WSJ
“It seems odd to me that if these issues were burning issues, I never heard about them from anybody” – WSJ

Banks
Morgan Stanley’s earnings drop 50%, and the company plans to cut an additional 800 jobs by year’s end – Bloomberg

Bad News
Nobody seems to be talking about the looming $500 billion in cuts to Head Start, childcare and AIDS programs – Politico

Check in the Mail
The Postal Service is going to default on a $5.5 billion healthcare fund payment – NYT

Welcome to DC
“The astounding thing … was the extent to which unemployment went unmentioned” – American Prospect

Regulations
Blankfein: If there was an undo Dodd-Frank button, I wouldn’t push it – DealBook

Who Doesn’t
Rick Ross loves cheese – Bon Appetit

14 comments

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One key variable for big companies is that they are aligned in silo’d business units, whereas most game-changing innovations come from holistically, deeply integrated approaches.

If you look at the past 30 years of innovation, you see products that BEGAN life as one concerted effort, but over time were broken into piece part efforts, overseen by different teams in different divisions.

Hence, the effort becomes more about coordination and avoidance of internal co-option than break the bank re-think.

As to R&D, the seminal truth there is that specifically because most research efforts are unencumbered by the forced disciple of shipping and monetizing, you end up with lots of “concept cars” and no Mustangs.

Case in point, contrast Microsoft’s myriad of test the water endeavors with tablet and phone prototypes, and contrast that with Apple’s approach that it doesn’t exist until it ships.

Both companies are exercising lots of research and building lots of prototypes in the effort, but only one has a binary, all-or-none measurable.

Is it any surprise that only one of those companies generates a material portion of its revenues from products that didn’t exist 3 years prior?

Cheers,

Mark

Posted by hypermark | Report as abusive

NB: It was Alex Tabarrok, not Cowen, who posted on the “revealed preference” of tech companies.

Posted by Sunset_Shazz | Report as abusive

Nokia’s problem wasn’t executing new ideas, it was arrogance. Their management didn’t believe users would want anything besides their blackberry interface. They could have executed those early designs, they just were no better than Digital Equipment, whose CEO didn’t believe people would need or want personal computers.

In response to your comment, “if you believe Peter Thiel,…”, well, you shouldn’t. Very few of the companies he has invested in are no more “tech” than Google, the least of which are the two he is most famous for (PayPal and Facebook). If you go by hoarded assets, then Apple is the worts offender, as they have over $100B (and will probably announce next week that has grown by $10B or so). A large cash hoard is not proof a company is not a tech company, it just means they are incredibly successful and can’t figure out how to replicate that success on a similar scale (note to Thiel: it’s not easy to come up with ideas for products that generate 11 digits worth of revenue, let alone profit; certainly none of the companies he is involved with have even approached that figure yet).

As for Facebook’s dig about large companies, well, they have nothing to innovate anyway.

Posted by KenG_CA | Report as abusive

Google keeps improving search, maps, mail and other products. They’re doing the driverless cars, the glasses, also stuff like Wave that didn’t work so well. They’re trying hard to not get disrupted by Facebook, with Plus, and by mobile, with Android.

There’s an incumbent/insurgent dynamic, where the leader wants innovation that sustains and increases their edge, the insurgent wants innovation that disrupts the incumbent’s advantage.

Innovation that ties the incumbent into a complex eco-system, or otherwise offers increasing returns to scale/volume, favors the incumbent. Innovation that obsoletes the incumbent favors the insurgent.

Microsoft initially won against Apple because they were able to make Windows a sustaining innovation that would give business customers the WIMP GUI without changing their PCs, being unable to run Lotus 1-2-3 etc. And of course it was an IT buy at the time, and it didn’t matter if Windows was less slick than the Mac.

The iPhone/iPad, on the other hand, are consumer/end-user buys, that play into Apple’s brand, design, direct relationship via the Apple Store.

When it came to phones and tablets, Microsoft created a Windows tablet OS, instead of a brand new OS like Apple. Windows CE was just too early/didn’t raise the bar enough.

Obviously Google is a bit behind the curve on mobile and social and trying to leverage their existing franchise to get in the game.

Inevitably, after a big disruption, everyone asks why the big company didn’t see it coming. But it’s unreasonable to expect a big company to throw away all the advantages of incumbency. It’s culturally impossible, and even if they do see the writing on the wall and try something new, as Nokia did with MeeGo, they end up having no better shot than a well-funded startup.

Posted by streeteye | Report as abusive

You didn’t actually explain why big companies are bad at innovating. First, you said “Nokia does not suffer from a dearth of ideas”, then you quoted Thiel, who said Google is “out of ideas”. So, you’ve only established that companies which can’t innovate can have either too many or too few new ideas. The same applies to doorknobs, too.
I’ve consulted for 25 years to companies large and small, and I’ve found that large companies generally don’t innovate as much as small companies because the project managers have more to lose in established companies.
In a small company, if you don’t innovate, you won’t make sales next month or payroll the month after that. You innovate or you die. A lot of times, you die anyway.
In a large company, the established product lines keep money rolling in. There is often so much generated cash that it can be spent on R&D projects and not be missed. However, when it comes time for a manager to approve the budget that converts an R&D project into a new product, the stakes rise considerably. If the manager sticks his neck out and approves the project and it succeeds, he gets a small bonus. If it fails spectacularly, he gets fired. If he cancels the project before any significant money is spent on it, he still gets a paycheck, and there are plenty of other R&D projects in the works that might pay off instead.
When you do find a big company that innovates, you will also find that the guy in charge of the project is running scared and is willing to bet the farm.
This is not rocket science. This is simply incentives.

Posted by Wade_Kelman | Report as abusive

A bit of historical perspective, perhaps -

The conflict between the Valley’s creative innovators and the corporate suits in NYC, and in the local suites, dates from the 50′s, and William Shockley’s original founding of Silicon Valley. An unbroken sequence of rebellions against corporate stifling of innovation gave rise to many of the great tech companies, starting with those household names founded by ‘The Traitorous Eight’.

Can get started reading about it here -

http://en.wikipedia.org/wiki/Traitorous_ eight

Posted by MrRFox | Report as abusive

As companies grow functions split up, departments specialize managers form alliances and the process becomes both political and bureaucratic. When companies get truly big there is also the tendency for owners to treat employees more as a cost than as a source of profit and employees become more removed from owners and begin to view owner motives suspiciously as well. For this and other reasons you see the small companies innovate, the successful ones grow become big and as they mature lose the entrepreneurial spirit plateau and or slowly die.

Posted by Sechel | Report as abusive

As has been said above the article never actually addresses “why” large companies are bad at innovating. Tons of interesting points in both this and the linked articles but come on.

Posted by wmaustin5 | Report as abusive

Large companies are bad at innovating because they don’t have to. Once they become an incumbent, they try to sell what they are already making. The don’t want to take risks on new things because they don’t like risks, and they want to milk every product for as long as they can (that’s usually because some accounting person will throw up ROI babble and say it’s not worth investing in a disruptive product).

New companies have no choice but to innovate. If they don’t have something better, they won’t sell their product.

Apple was an exception to the large company rule. They killed the ipod mini at the height of its sales, and introduced something better, the ipod touch. Then they effectively killed that with the iphone (but they still sell amazingly lots of them), and they have cannablilzed sales of laptops with the ipad. I don’t think Nokia (while we’re on the subject, I have to admit to conflating Nokia and RIM in my earlier comment, which is understandably easy to do, as they both screwed up big time) falls into the category of a big company refusing to innovate to avoid risk or because they wanted to milk their current products, they just were incapable of reading the tea leaves. They thought because they were still selling lots of their outdated phones that that is what people wanted to buy.

Another reason why big companies are bad at innovating is that they are typically not run by the founders who have the vision for what products to sell. Instead, “investors” demand “professional” managers, who focus on formulas for success and not customer satisfaction. Instead of innovation, they rely on their sales channel, their brand name, marketing, and controlling costs. The last one is like eating sugar for energy, as it causes bad long term damage. Focusing on reducing costs puts employee income on a race to the bottom, which ends at the bottom. When leading companies pay as little as possible to cut costs, their competition does the same, and the result is that overall workers have less money to spend (that money instead gets shifted into cash hoards that accomplish nothing). As workers of even successful companies earn less, they spend less. Companies respond to declines in sales in their home markets by shifting their focus to new markets. Selling the same stale products, until some new company comes along and innovates, and takes away their business. The management is replaced, or the company is acquired, or it acquires the new company that takes their business away.

All because you put bean counters in charge of deciding what products to make.

Posted by KenG_CA | Report as abusive

The Fairchild Semi experience explains it IMO. They had a lock on all the production and all the ideas and all the people at the outset of the Valley as we know it. But management in NYC want to operate as a cash cow, avoid risk and investment – play fat, lazy and safe. The engineers in CA rebelled, fled and Fairchild effectively disappeared. From its human fragments arose Intel and other big names.

Xerox invented the mouse and the window-style format in use today. Management killed it, to the dismay of the Xe-techies, and to the delight of Steve Jobs, who took it over. Why take chances when the status quo is so good?

Doesn’t seem like much has changed. Not sure how realistic it is to think it ever will. Or that it should.

Posted by MrRFox | Report as abusive

Three reasons. First, established tech companies are loathe to introduce internal competition to their cash cow. That is the one place where I give Apple all the credit in the world.

Second, most big ideas start out quite small. But large companies can’t justify investement in small things, because they won’t budge growth. So they take a pass on many things that might grow the company significantly, because they are too small to bother with.

Third, large companies forget who the customer is. I consulted for Digital in the early 1990s, and internally they were too busy trying to sell ideas to each other to worry about their paying customers. I sat in hours-long meetings where the only consideration was how other parts of the company might accept their product ideas.

Posted by Curmudgeon | Report as abusive

What’s the chance Apple was simply lucky in basing the mobile experience on an app ecosystem at the right time in the development of the technology? Luck never seems to be the favored explanation of pundits…

And anyone who thinks the hardest part about search is building the engine is more than welcome to build one and see how it does! Thiel certainly has the money. Hint: like elevators, it’s the maintenance that generates the money.

Posted by AngryInCali | Report as abusive

Angry, the iphone was a success before they started the app store, that just made them more entrenched (and the app store itself was innovative). Apple’s biggest luck is the incompetence of their competitors.

btw, what are you angry about?

Posted by KenG_CA | Report as abusive

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