Technologies do not disrupt, business models disrupt: McKinsey’s Roth

Erik Roth heads the global innovation practice at McKinsey and Co. and is based in its Shanghai office. He is the firm’s leading expert on matters related to innovation strategy, business building, idea generation, portfolio and pipeline management, open innovation, R&D organization, and footprint optimization. He serves as an adviser to numerous CEOs and senior executives on innovation and R&D-related topics.

In 2004, along with Clayton Christensen and Scott Anthony, Roth co-authored Seeing What’s Next: Using the Theories of Innovation to Predict Industry Change. Prior to McKinsey, he was a core member of the team at General Motors Corp. (GM) that created OnStar (a GM subsidiary that provides a variety of in-vehicle services like hands-free calling, turn-by-turn navigation and remote diagnostics), and chief innovation officer at LG Electronics.

Roth spoke to Indrajit Gupta on the sidelines of a Nasscom summit on technology in New Delhi earlier this month. Edited excerpts from the interview:

What’s changed about what we know about innovation since the time you wrote ‘Seeing What’s Next’ with Clayton Christensen back in 2004?

Seeing What’s Next was very much an extension of the disruption theory, of what causes disruption. And that’s today well known. What we were trying to figure out was whether the theories have predictive value. And while (we) haven’t totally back-tested it, most of what we suggested has come through. One industry we got slightly off was education. We underestimated the political complexity. We thought it would shift a lot faster. Healthcare was in the same direction. There were a lot of factors that restrain the pace of change. Directionally, it felt more or less right. But at its core, it was about small companies attacking large ones. Since that experience, I’ve had the opportunity to work with a lot of large companies, who are acting small. The unique set of experiences that I have had have been working with and working inside large companies going through this transition.

First, it may be important for me to define what I see as innovation. Innovation, for me, is about products, services, processes and business models. And any organization’s ability to think holistically about all of them, rather than just about products. And that’s what has changed: that message has started to come out. And certainly today, digital business models get a lot more time and attention than back then when it was largely about innovation product.

Also, innovation has to be sustainable over time. Any company can have one-off wins, but the real challenge is how do you do it on a continual basis? The third element that is tied to that is how do you incrementally create value? This is where the differentiation between invention and innovation lies. Invention is about creating technology, but if you can commercialize that at scale and over time, that is the Holy Grail. You can argue that a large company should have an advantage doing that. After all, it has the resources, the investment potential and breadth. But for a lot of the reasons that have been well-studied before, it struggles.

We recently interviewed CEOs around the world, and we asked them this question: is innovation important? As many as 85% of CEOs said it was top of their agenda. What is even more interesting is that almost 80% of them admitted they were concerned that their business models were at risk. So they connected the idea that innovation and business model disruption are related. This is different from what it was 10 years ago.

We then asked them: how well prepared are you? Only 6% said they had the capability required to survive. That’s shocking. Only 23% said they were directly involved in making this change happen. Which is also interesting given what it tells us: that it is a top CEO level issue, there is no real good solution, but only a quarter of CEOs are taking action. Our interpretation is that they don’t know what to do. Innovation is a cross-functional, multidisciplinary, very squishy problem, which no one really owns. So a couple of years ago, especially after my experience at LG, driving a large-scale transformation, there is no playbook.

Look at the lists of the most innovative companies in the world, the same companies rise to the top. However, these companies innovate in fundamentally different ways. Google, Amazon and Apple, usually on top of most lists, have wholly different models. Google is a serial acquirer. Apple is fully integrated and Amazon is customer-centric, but it does a lot of incubation, small-scale experiments. What makes these companies successful? In the last few years, we’ve done a study where we interviewed over 3,000 executives and studied 500 companies looking inside out. The thing with the media lists is that they are outside in. If you look inside out, what are the markers of a successful innovator? Our article The Eight Essentials of Innovation is a high-level summary of what we found.

At a high level, none of what we found is surprising. But at a granular level, underneath those insights, there are nearly 120 practices we identified that are crucially important, things that do make a difference. We talk about eight essentials: aspire, choose, discover, involve, extend, accelerate, scale and mobilize. And each one has a serious question which is difficult to answer, yet is seemingly intuitive.

Let me take one: Is innovation absolutely critical to future growth? The term “absolutely critical” is the most important part of the question. We then translate that down to: How do we know whether or not it is absolutely critical inside your company? Is there a clear objective for inspirational goals? And this is where most CEOs tend to fail: the CEO might get very excited about innovation, talk about it, have the words to describe it, but it doesn’t go a lot further than that.

Then we ask a couple of more questions about your innovation objectives. How clear is it? If your aspiration is translated down to the average employee who is supposed to do something different, do they know what they’re supposed to do differently tomorrow? More often than not, the connections between the aspiration and what needs to be done differently to get to that, is missing. If you have an aspiration, you’ve got to ensure that there is a clear end point, clearly articulated and measurable. An aspiration which doesn’t have an end point and isn’t measurable, which can be translated into a bunch of KPIs (key performance indicators) that can be cascaded down the organization, you’ve already hurt your chances of success. I particularly like how (Procter and Gamble CEO) A.G. Lafley articulated his aspiration at P&G. He said three things: consumer is king, the next billion consumers and 50% of innovation should come from external sources. I am sure he spent a lot of time thinking about that in crafting aspirations that focus on what we need to do now—but also what it should be like when we get there.

Most often, I believe innovation is more a resource allocation problem rather than an idea problem. Ideas are nice and important, but honestly, I have never seen a company without ideas. The key question is whether you can mobilize resources effectively to reallocate time, dollars and people to go develop them.

If we agree that only business models die, and not businesses, are there ways to help prevent companies from dying?

It is true that business models disrupt, not businesses. Companies that die, their business models die. There could be a lot of reasons why companies die. But the ones that are truly well-managed and making the right kind of decisions, they are pursuing their success and that success takes them to a place that is no longer the primary lever of value creation, they were myopic or they didn’t realize the business model. That’s the classic disruption model.

That said, I think there is hope for a lot of companies. We did this study earlier on just how many business models are out there. There are fewer out there than what most people would like to believe. Disruption happens in waves. When a business model comes to the forefront in a given industry, it tends to get re-applied many, many times over. For instance, is Netflix a new business model? No. Companies that don’t have the ability to do pattern recognition are the ones that are at most risk.

Very often, much of the disruption is caused by cross-industry competitors, rather than direct industry entities. The new payments banks are a good example. Many of them aren’t traditional banks. How does that impact the innovation process inside a company?

Technology has made it easier. Banking is a good example. The cost of software has gone down. So has the cost of processes. The ability for someone with a strong customer relationship around transactions allows them to become a bank, almost overnight, thanks largely to IT. That’s a unique scenario. That type of scenario won’t be common across all industries. Take P&G. Are they susceptible to disruptors nibbling off bits of its business? Some of them are technology enabled. But it is more around a fundamental disruption of the value chain, rather than just the technology per se. There are some players who are coming direct to consumer. Is that new? I think not. Technology has enabled a better ability to reach that consumer. The same is true for the distribution infrastructure. Some people say that the Web has transformed the landscape. But getting something from the point of production to the person’s home is real tough. In India, that’s one of the greatest challenges here. I live in China and they’re rapidly solving that problem, but it isn’t completely solved. You need the whole operating model. So more modular the operating system is, the more likely it will be (for) more new entrants to change the dynamics of the supply chain.

But it isn’t just technology. Technologies do not disrupt, business models disrupt. It is about the commercialization and application of the technology that makes all the difference. I have seen some mind-bending technologies in the labs, which have never seen the light of day.

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