Clayton Christensen : Assessing Your Organization's Innovation Capabilities

copyright and permissions Assessing Your Organization's Innovation Capabilities by Clayton M. Christensen Leader to Leader, No. 21 Summer 2001 Thought Leaders Forum: Clayton M. Christensen Clayton Christensen is a professor of business administration at the Harvard Business School, and is author of The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail. (6/2001) More on Clayton M. Christensen This article appears as "Coping with Your Organization's Innovation Capabilities" (Chapter 17) in Leading for Innovation. Read more. Order from Amazon.com. From Leader to Leader, No. 21 Summer 2001 • Table of Contents • From the Editors • Resources Additional resources for this article The amount of information available to managers and the amount of work required to sort the important from the less important is increasing dramatically. arnings are all about us that the pace of change is accelerating. The amount of information available to managers -- as well as the amount of work and judgment required to sort the important from the less important -- is increasing dramatically. The pervasive emergence of the Internet is exacerbating these trends. This is scary news -- because when the pace of change was slower, most managers' track records in dealing with change weren't that good. For example, none of the minicomputer companies such as Digital, Data General, and Wang succeeded in developing a competitive position in the personal computer business. Only one of the hundreds of department stores, Dayton Hudson, now Target, became a leader in discount retailing. Medical and business schools have struggled to change their curricula fast enough to train the types of doctors and managers that their markets need. The list could go on. In most of these instances, seeing the innovations coming at them hasn't been the problem. The organizations just didn't have the capability to react to what their employees and leaders saw, in a way that enabled them to keep pace with required changes. When managers assign employees to tackle a critical innovation, they instinctively work to match the requirements of the job with the capabilities of the individuals they charge to do it. In evaluating whether an employee is capable of successfully executing a job, managers will look for the requisite knowledge, judgment, skill, perspective, and energy. Managers will also assess the employee's values -- the criteria by which the person tends to decide what should and shouldn't be done. Unfortunately, some managers don't think as rigorously about whether their organizations have the capability to successfully execute jobs that may be given to them. Often, they assume that if the people working on a project individually have the requisite capabilities to get the job done well, then the organization in which they work will also have the same capability to succeed. This article offers a framework to help managers confronted with necessary change understand whether the organizations over which they preside are capable or incapable of tackling the challenge.  An Organizational Capabilities Framework hree classes of factors affect what an organization can and cannot do: its resources, its processes, and its values. When asking what sorts of innovations their organizations are and are not likely to be able to implement successfully, managers can learn a lot about capabilities by sorting their answers into these three categories. Resources Resources are the most visible of the factors that contribute to what an organization can and cannot do. Resources include people, equipment, technology, product designs, brands, information, cash, and relationships with suppliers, distributors, and customers. Resources are usually things, or assets -- they can be hired and fired, bought and sold, depreciated or enhanced. Resources are not only valuable, they are flexible. An engineer who works productively for Dow Chemical can also work productively in a start-up. Software that helps UPS manage its logistics system can also be useful at Amazon.com. Technology that proves valuable in mainframe computers also can be used in telecommunications switches. Cash is a consummately flexible resource. Resources are the things that managers most instinctively identify when assessing whether their organizations can successfully implement changes that confront them. Yet resource analysis clearly does not tell a sufficient story about capabilities. Processes Organizations create value as employees transform inputs of resources into products and services of greater worth. The patterns of interaction, coordination, communication, and decision making through which they accomplish these transformations are processes. Processes include not just manufacturing processes, but those by which product development, procurement, market research, budgeting, employee development and compensation, and resource allocation are accomplished. Processes are defined or evolve de facto to address specific tasks. This means that when managers use a process to execute the tasks for which it was designed, it is likely to perform efficiently. But when the same seemingly efficient process is employed to tackle a very different task, it is likely to prove slow, bureaucratic, and inefficient. In contrast to the flexibility of resources, processes are inherently inflexible. In other words, a process that defines a capability in executing a certain task concurrently defines disabilities in executing other tasks. When managers employ processes designed to address one problem to tackle different tasks, an organization manifests slow, inefficient, and bureaucratic behavior. One of the dilemmas of management is that by their very nature, processes are established so that employees perform recurrent tasks in a consistent way, time after time. To ensure consistency, processes are meant not to change -- or if they must change, to change through tightly controlled procedures. The reason good managers strive for focus in their organizations is that processes and tasks can be readily aligned. The alignment of specific tasks with the processes that were designed to address those tasks is, in fact, the very definition of a focused organization. It is when managers begin employing processes that were designed to address one problem to tackle a range of very different tasks that an organization manifests slow, inefficient, and bureaucratic behavior. Values The third class of factors that affects what an organization can or cannot accomplish is its values. The term values carries an ethical connotation, such as those that guide decisions to ensure patient well-being at Johnson & Johnson or that guide decisions about plant safety at Alcoa. But in this framework, values have a broader meaning. An organization's values are the criteria by which employees make decisions about priorities -- by which they judge whether an order is attractive or unattractive, whether a customer is more important or less important, whether an idea for a new product is attractive or marginal, and so on. Employees at every level make decisions about priorities. At the executive tiers, they often take the form of decisions to invest or not invest in new products, services, and processes. Among salespeople, they consist of day -- to -- day decisions about which customers to call on and which to ignore, which products to push and which to deemphasize. The larger and more complex a company becomes, the more important it is for senior managers to train employees at every level to make independent decisions about priorities that are consistent with the strategic direction and the business model of the company. A key metric of good management, in fact, is whether such clear and consistent values have permeated the organization. Clear, consistent, and broadly understood values, however, also define what an organization cannot do. A company's values must by necessity reflect its cost structure or its business model, because these define the rules its employees must follow for the company to prosper. If, for example, the structure of a company's overhead costs requires it to achieve gross profit margins of 40 percent, a powerful value or decision rule will have evolved that encourages middle managers to kill ideas that promise gross margins below 40 percent. This means that such an organization would be incapable of successfully commercializing projects targeting low -- margin markets -- even while another organization's values, driven by a very different cost structure -- might enable or facilitate the success of the very same project. The values of successful firms tend to evolve in a predictable fashion on at least two dimensions. The first relates to acceptable gross margins. As companies add features and functionality to their products and services in an effort to capture more attractive customers in premium tiers of their markets, they often add overhead cost. As a result, gross margins that at one point were quite attractive at a later point seem unattractive. Their values change. One of the bittersweet rewards of success is that as companies become large, they lose the capability to enter emerging markets. The second dimension along which values can change relates to how big a customer or market has to be, in order to be interesting. Because a company's stock price represents the discounted present value of its projected earnings stream, most managers typically feel compelled not just to maintain growth, but to maintain a constant rate of growth. For a $40 million company to grow 25 percent, it needs to find $10 million in new business the next year. For a $40 billion company to grow 25 percent, it needs to find $10 billion in new business the next year. The size of market opportunity that will solve each of these companies' needs for growth is very different. An opportunity that excites a small organization isn't large enough to be interesting to a very large one. One of the bittersweet rewards of success is, in fact, that as companies become large, they literally lose the capability to enter the small, emerging markets of today that will be tomorrow's large markets. This disability is not because of a change in the resources within the companies -- their resources typically are vast. Rather, it is because their values change. Those who engineer mega-mergers among already huge companies to achieve cost savings, for example, need to account for the impact of these actions on the resultant companies' values. Although their merged research organizations might have more resources to throw at innovation problems, they lose the appetite for all but the biggest market opportunities. This constitutes a very real disability in managing innovation.  The Capabilities to Address Sustaining or Disruptive Technologies ne of the most important findings in the research summarized in The Innovator's Dilemma relates to the differences in companies' track records at making effective use of sustaining and disruptive technologies. Sustaining technologies are innovations that make a product or service better along the dimensions of performance valued by customers in the mainstream market. Compaq's early use of Intel's 32-bit 386 microprocessor instead of the 16-bit 286 chip was an example of a sustaining innovation. So was Merrill Lynch's introduction of its Cash Management Account. Disruptive innovations, on the other hand, bring to market a new product or service that is actually worse along the metrics of performance most valued by mainstream customers. Charles Schwab's initial entry as a bare-bones discount broker was a disruptive innovation, relative to the offerings of full-service brokers. Early personal computers were a disruptive innovation, relative to mainframes and minicomputers. PCs were disruptive in that they didn't address the next-generation needs of leading customers in existing markets. They had other attributes, of course, that enabled new market applications to coalesce, however -- and from those new applications, the disruptive innovations improved so rapidly that they ultimately could address the needs of customers in the mainstream market as well. In a study of sustaining and disruptive technologies in the disk drive industry, my colleagues and I built a database of every disk drive model introduced by any company in the world between 1975 and 1995 -- comprising nearly 5,000 models. For each of these models, we gathered data on the components used, as well as the software codes and architectural concepts employed. This allowed us to put our finger right on the spot in the industry where each new technology was used. We could then correlate companies' leadership or laggardship in using new technologies with their subsequent fortunes in the market. We identified 116 new technologies that were introduced in the industry's history. Of these, 111 were sustaining technologies, in that their impact was to improve the performance of disk drives. Some of these were incremental improvements while others, such as magneto -- resistive heads, represented discontinuous leaps forward in performance. In all 111 cases of sustaining technology, the companies that led in developing and introducing the new technology were the companies that had led in the old technology. It didn't matter how difficult it was, from a technological point of view. The success rate of the established firms was 100 percent. The other five technologies were disruptive innovations -- in each case, smaller disk drives that were slower and had lower capacity than those used in the mainstream market. There was no new technology involved in these disruptive products. Yet none of the industry's leading companies remained atop the industry after these disruptive innovations entered the market -- their batting average was zero. The Innovator's Dilemma recounts how dynamics like those we observed for disk drives -- the interplay between the speed of technology change and the evolution in market needs -- precipitated the failure of the leading companies to cope with disruptive innovations in a range of very different industries. Why such markedly different batting averages when playing the sustaining versus disruptive games? The answer lies in the resources-processes-values (RPV) framework of organizational capabilities described earlier. The industry leaders developed and introduced sustaining technologies over and over again. Month after month, year after year, as they introduced improved products to gain a competitive edge, the leading companies developed processes for evaluating the technological potential and assessing their customers' needs for alternative sustaining technologies. In the parlance of this article, the organizations developed a capability for doing these things, which resided in their processes. Sustaining technology investments also fit the values of the leading companies, in that they promised higher margins from better products sold to their leading -- edge customers. On the other hand, the disruptive innovations occurred so intermittently that no company had a routinized process for handling them. Furthermore, because the disruptive products promised lower profit margins per unit sold and could not be used by their best customers, these innovations were inconsistent with the leading companies' values. The leading disk drive companies had the resources -- the people, money, and technology -- required to succeed at both sustaining and disruptive technologies. But their processes and values constituted disabilities in their efforts to succeed at disruptive technologies. Large companies often surrender emerging growth markets because smaller, disruptive companies are actually more capable of pursuing them. Though start-ups lack resources, it doesn't matter. Their values can embrace small markets, and their cost structures can accommodate lower margins. Their market research and resource allocation processes allow managers to proceed intuitively rather than having to be backed up by careful research and analysis. All these advantages add up to enormous opportunity or looming disaster -- depending on your perspective. Managers who face the need to change or innovate, therefore, need to do more than assign the right resources to the problem. They need to be sure that the organization in which those resources will be working is itself capable of succeeding -- and in making that assessment, managers must scrutinize whether the organization's processes and values fit the problem.  Creating Capabilities to Cope with Change manager who determined that an employee was incapable of succeeding at a task would either find someone else to do the job or carefully train the employee to be able to succeed. Training often works, because individuals can become skilled at multiple tasks. Processes are not as flexible as resources -- and values are even less so. Despite beliefs spawned by change-management and reengineering programs, processes are not nearly as flexible as resources are -- and values are even less so. The processes that make an organization good at outsourcing components cannot simultaneously make it good at developing and manufacturing components in-house. Values that focus an organization's priorities on large customers cannot simultaneously focus priorities on small customers. For these reasons, managers who determine that an organization's capabilities aren't suited for a new task are faced with three options through which to create new capabilities:  Acquire a different organization whose processes and values are a close match with the new task.  Try to change the processes and values of the current organization.  Separate out an independent organization and develop within it the new processes and values required to solve the new problem.  Creating Capabilities Through Acquisitions Unfortunately, companies' track records in developing new capabilities through acquisition are frighteningly spotty. Managers often sense that acquiring rather than developing a set of capabilities makes competitive and financial sense. Unfortunately, companies' track records in developing new capabilities through acquisition are frighteningly spotty. Here, the RPV framework can be a useful way to frame the challenge of integrating acquired organizations. Acquiring managers need to begin by asking, "What is it that really created the value I just paid so dearly for? Did I justify the price because of the acquisition's resources -- its people, products, technology, market position, and so on? Or was a substantial portion of its worth created by processes and values -- unique ways of working and decision making that have enabled the company to understand and satisfy customers and develop, make, and deliver new products and services in a timely way?" If the acquired company's processes and values are the real driver of its success, then the last thing the acquiring manager wants to do is to integrate the company into the new parent organization. Integration will vaporize many of the processes and values of the acquired firm as its managers are required to adopt the buyer's way of doing business and have their proposals to innovate evaluated according to the decision criteria of the acquiring company. If the acquiree's processes and values were the reason for its historical success, a better strategy is to let the business stand alone, and for the parent to infuse its resources into the acquired firm's processes and values. This strategy, in essence, truly constitutes the acquisition of new capabilities. If, on the other hand, the company's resources were the primary rationale for the acquisition, then integrating the firm into the parent can make a lot of sense -- essentially plugging the acquired people, products, technology, and customers into the parent's processes as a way of leveraging the parent's existing capabilities. The perils of the ongoing DaimlerChrysler merger, for example, can be better understood through the RPV model. Chrysler had few resources that could be considered unique in comparison to its competitors. Its recent success in the market was rooted in its processes -- particularly in its product design process and in its processes of managing its relationships with its key subsystem suppliers. What is the best way for Daimler to leverage the capabilities that Chrysler brings to the table? Wall Street is pressuring management to consolidate the two organizations so as to cut costs. However, if the two companies are integrated, it is very likely that the key processes that made Chrysler such an attractive acquisition will not just be compromised. They will be vaporized. This situation is reminiscent of IBM's 1984 acquisition of Rolm. There wasn't anything in Rolm's pool of resources that IBM didn't already have. It was Rolm's processes for developing PBX products and for finding new markets for them that was really responsible for its success. In 1987 IBM decided to fully integrate the company into its corporate structure. IBM soon learned the folly of this decision. Trying to push Rolm's resources -- its products and its customers -- through the same processes that were honed in IBM's large-computer business caused the Rolm business to stumble badly. This decision to integrate Rolm actually destroyed the very source of the original worth of the deal. How much better off they would have been had IBM infused some of its vast resources into Rolm's processes and values! Financial analysts have a better intuition for the worth of resources than for processes or values. DaimlerChrysler, bowing to the investment community's drumbeat for efficiency savings, now stands on the edge of the same precipice. Often, it seems, financial analysts have a better intuition for the worth of resources than for processes or values. In contrast, Cisco Systems' acquisitions process has worked well -- because, I would argue, it has kept resources, processes, and values in the right perspective. Between 1993 and 1997 most of its acquisitions were small companies that were less than two years old: early-stage organizations whose market value was built primarily on resources -- particularly engineers and products. Cisco has a well-defined, deliberate process by which it essentially plugs these resources into the parent's processes and systems, and it has a carefully cultivated method of keeping the engineers of the acquired company happily on the Cisco payroll. In the process of integration, Cisco throws away whatever nascent processes and values came with the acquisition -- because those weren't what Cisco paid for. On a couple of occasions when the company acquired a larger, more mature organization -- notably its 1996 acquisition of StrataCom -- Cisco did not integrate. Rather, it let StrataCom stand alone, and infused its substantial resources into the organization to help it grow at a more rapid rate. Creating New Capabilities Internally Too often, resources are plugged into fundamentally unchanged processes -- and little change results. Companies that have tried to develop new capabilities within established organizational units also have a spotty track record. Assembling a beefed-up set of resources as a means of changing what an existing organization can do is relatively straightforward. People with new skills can be hired, technology can be licensed, capital can be raised, and product lines, brands, and information can be acquired. Too often, however, resources such as these are then plugged into fundamentally unchanged processes -- and little change results. For example, through the 1970s and 1980s Toyota up -- ended the world automobile industry through its innovation in development, manufacturing, and supply-chain processes -- without investing aggressively in resources such as advanced manufacturing or information processing technology. General Motors responded by investing nearly $60 billion in manufacturing resources -- computer-automated equipment that was designed to reduce cost and improve quality. Using state-of-the-art resources in antiquated processes, however, made little difference in GM's performance, because it is in its processes and values that the organization's most fundamental capabilities lie. Processes and values define how resources -- many of which can be bought and sold, hired and fired -- are combined to create value. Unfortunately, processes are very hard to change. Organizational boundaries are often drawn to facilitate the operation of present processes. Those boundaries can impede the creation of new processes that cut across those boundaries. When new challenges require people or groups to interact differently than they habitually have done -- addressing different challenges with different timing than historically required -- managers need to pull the relevant people out of the existing organization and draw a new boundary around a new group. New team boundaries enable or facilitate new patterns of working together that ultimately can coalesce as new processes -- new capabilities for transforming inputs into outputs. In their book Revolutionizing Product Development, Steven C. Wheelwright and Kim B. Clark call these structures heavyweight teams. Not just Chrysler but companies as diverse as Medtronic in cardiac pacemakers, IBM in disk drives, and Eli Lilly with its new blockbuster drug Zyprexa have used heavyweight teams as vehicles within which new processes could coalesce. Creating Capabilities Through a Spin-Out Organization The third mechanism for creating new capabilities -- spawning them within spin-out ventures -- is currently in vogue among many managers as they wrestle with how to address the Internet. When are spin-outs a crucial step in building new capabilities to exploit change, and what are the guidelines by which they should be managed? A separate organization is required when the mainstream organization's values would render it incapable of focusing resources on the innovation project. Large organizations cannot be expected to freely allocate the critical financial and human resources needed to build a strong position in small, emerging markets. And it is very difficult for a company whose cost structure is tailored to compete in high-end markets to be profitable in low-end markets as well. When a threatening disruptive technology requires a different cost structure to be profitable and competitive, or when the current size of the opportunity is insignificant relative to the growth needs of the mainstream organization, then -- and only then -- is a spin -- out organization a required part of the solution. Just as with new processes, business based on new values needs to be established while the old business is still at the top of its game. Merrill Lynch's retail brokerage business, for example, is today a very healthy business -- and the firm's processes and values for serving its clients work well. The disruption of on-line brokerage looms powerfully on the horizon -- but any attempt Merrill management might make to transform the existing business to succeed in the next world of self-service, automated trading would compromise its near-term profit potential. Merrill Lynch needs to own another retail brokerage business, which would be free to create its own processes and forge a cost structure that could enable different values to prevail. It must do this if it hopes to thrive in the post-disruption world. How separate does the effort need to be? The primary requirement is that the project cannot be forced to compete with projects in the mainstream organization for resources. Because values are the criteria by which decisions about priorities are made, projects that are inconsistent with a company's mainstream values will naturally be accorded lowest priority. The physical location of the independent organization is less important than is its independence from the normal resource allocation process. In our studies of this challenge, we have never seen a company succeed in addressing a change that disrupts its mainstream values absent the personal, attentive oversight of the CEO -- precisely because of the power of processes and values and particularly the logic of the normal resource allocation process. Only the CEO can ensure that the new organization gets the required resources and is free to create processes and values that are appropriate to the new challenge. CEOs who view spin -- outs as a tool to get disruptive threats off their personal agendas are almost certain to meet with failure. We have seen no exceptions to this rule.  A Structural Framework for Managing Different Types of Innovation he framework summarized in the figure can help managers exploit current organizational capabilities when that is possible, and to create new ones when the present organization is incapable. The left axis in the figure measures the extent to which the existing processes -- the patterns of interaction, communication, coordination, and decision making currently used in the organization -- are the ones that will get the new job done effectively. If the answer is yes (toward the lower end of the scale), the new team can exploit the organization's existing processes or capabilities to succeed. As depicted in the corresponding position on the right axis, functional or lightweight teams are useful structures for exploiting existing capabilities. On the other hand, if the ways of getting work done and of decision making in the mainstream business would impede rather than facilitate the work of the new team -- because different people need to interact with different people about different subjects and with different timing than has habitually been necessary -- then a heavyweight team structure is necessary. Heavyweight teams are tools to create new processes -- new ways of working together that constitute new capabilities. FITTING AN INNOVATION'S REQUIREMENTS WITH THE ORGANIZATION'S CAPABILITIES Note: The left and bottom axes reflect the questions the manager needs to ask about the existing situation. The italicized notes at the right side represent the appropriate response to the situation on the left axis. The italicized notes at the top represent the appropriate response to the manager's answer to the situation on the bottom axis. Return to reference The horizontal axis of the figure asks managers to assess whether the organization's values will allocate to the new initiative the resources it will need in order to become successful. If there is a poor or disruptive fit, then the mainstream organization's values will accord low priority to the project. Therefore, setting up an autonomous organization within which development and commercialization can occur will be absolutely essential to success. At the other extreme, however, if there is a strong, sustaining fit, then the manager can expect that the energy and resources of the mainstream organization will coalesce behind it. There is no reason for a skunk works or a spin-out in such cases. Region "A" in the figure depicts a situation in which a manager is faced with a sustaining technological change -- it fits the organization's values. But it presents the organization with different types of problems to solve and therefore requires new types of interaction and coordination among groups and individuals. The manager needs a heavyweight development team to tackle the new task, but the project can be executed within the mainstream company. This is how Chrysler, Eli Lilly, Medtronic, and the IBM disk drive division successfully revamped their product development processes. When in region "B" (where the project fits the company's processes and values), a lightweight development team, in which coordination across functional boundaries occurs within the mainstream organization, can be successful. Region "C" denotes an area in which a manager is faced with a disruptive technological change that doesn't fit the organization's existing processes and values. To ensure success in such instances, managers should create an autonomous organization and commission a heavyweight development team to tackle the challenge. Functional and lightweight teams are appropriate vehicles for exploiting established capabilities, whereas heavyweight teams are tools for creating new ones. Spin-out organizations, similarly, are tools for forging new values. Unfortunately, most companies employ a one-size-fits-all organizing strategy, using lightweight teams for programs of every size and character. Among those few firms that have accepted the "heavyweight gospel," many have attempted to organize all development teams in a heavyweight fashion. Ideally, each company should tailor the team structure and organizational location to the process and values required by each project.  The Danger of Wishful Thinking The capabilities of an organization also define its disabilities. anagers whose organizations are confronting change must first determine that they have the resources required to succeed. They then need to ask a separate question: Does the organization have the processes and values to succeed? Asking this second question is not as instinctive for most managers because the processes by which work is done and the values by which employees make their decisions have served them well. What the RPV framework adds to managers' thinking, however, is the concept that the very capabilities of an organization also define its disabilities. A little time spent soul-searching for honest answers to this issue will pay off handsomely. Are the processes by which work habitually gets done in the organization appropriate for this new problem? And will the values of the organization cause this initiative to get high priority, or to languish? If the answer to these questions is no, it's okay. Understanding problems is the most crucial step in solving them. Wishful thinking about this issue can set teams charged with developing and implementing an innovation on a course fraught with roadblocks, second-guessing, and frustration. The reasons why innovation often seems to be so difficult for established firms is that they employ highly capable people and then set them to work within processes and values that weren't designed to facilitate success with the task at hand. Ensuring that capable people are ensconced in capable organizations is a major management responsibility in an age such as ours, when the ability to cope with accelerating change has become so critical..  Copyright © 2001 by Clayton M. Christensen. Reprinted with permission from Leader to Leader, a publication of the Drucker Foundation and Jossey-Bass. Print citation: Christensen, Clayton M. "Assessing Your Organization's Innovation Capabilities" Leader to Leader. 21 (Summer 2001): 27-37. This article is available on the Drucker Foundation Web site, http://drucker.org/leaderbooks/L2L/summer2001/christensen.html.