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Why Big Companies Can’t Innovate

by Basil Peters on January 5, 2014 · 12 comments

When I was in grad school I co-founded a company that grew to become the second largest manufacturer of cable television headend equipment in the world. For the ten years after I graduated, I woke up every morning thinking of ways to out-innovate our two major competitors. We were a startup and they were both Fortune 500 companies. Ultimately, we succeeded because we were better at innovation. Today, the business I started in grad school is part of Cisco.

For over two decades, I’ve wondered about how our small startup was able to out-innovate our Fortune 500 competitors. Up until now, I didn’t really understand why that happens so often.

Like most startups we started in an under-served market

Our initial strategy, like a lot of startups, was to target a market segment that our huge competitors didn’t seem interested in. We initially focusing on building very economical and utilitarian products – Volkswagens to our competitors’ Chevrolets and Cadillacs.

Once we dominated the low end, the only place we could to go was up-market. We started building products in the Chevrolet class. That was when the upper end of our product line started to compete directly with our biggest Fortune 500 competitor. They had a 60 percent market share in the Chevrolet and Cadillac markets.

For several years we fought head-to-head over every order – our competitor using what we perceived to be every nasty sales trick in the book.

Around that time, the industry started to go through a period of revolutionary technological change. A fundamentally new technology, in our case fiber optics, gave us an opportunity to build a dramatically better and larger system. The engineers and entrepreneurs in us were fascinated by the opportunity.

After fighting it out against these much larger companies in the mid-range market, I was confident our more innovative design strategies would enable us to leapfrog the competition with a better product at the absolute upper end of the price and performance range. This was literally a “bet the company” strategy.

Trying to get the senior team onside – and failing

As the CEO, I could tell our team was far from confident about my ambitious goal. I thought the first crucial step was to develop consensus among our senior team.

For several weeks, I had discussions with my co-founder about how were going to develop this consensus. I spent several days developing an agenda for a two-day strategic planning retreat focused on this one objective. My plan was to demonstrate to our management team that we had consistently out-innovated our major competitor, beaten them on every cost performance measure that was important, and that we could pull off never-been-done-before innovation in technology to leapfrog their high-end products.

At the strategic planning retreat, through the afternoon and evening of the first day I worked as hard as I’ve ever worked to inspire confidence in the idea that we could out-innovate these two Fortune 500 companies. The conversation continued over a large investment in wine at dinner.

Despite my hard work, that evening the consensus was still that if we tried this, our much larger competitors would surely crush us.

The next morning, we started again over breakfast. I was hopeful that after sleeping on it, a few of the senior team would be willing to sign on to my goal. I wasn’t prepared for what happened next.

My co-founder, swayed by the persuasive arguments of the rest of the senior team, defected and joined the majority. I was completely alone. Nobody thought we could out-innovate these two enormous companies. Not one member of our senior team wanted to sign up to build the highest performance, most expensive product in the market.

Driving back with my partner, I asked what had caused him to lose faith. He said that after listening to the rest of the team, he also came to believe it was possible for us to actually out-innovate two giant companies who had dominated this upper end of the market for well over a decade.

I did what leaders often have to do

So I did what many CEOs have had to do before, and I went ahead anyway. For the next couple of years my first meeting every morning was with about 25 engineers who were executing the vision. To make a very long story short, we succeeded.

We knew we’d succeeded when we were selected by the largest cable company in the world at that time – Time Warner – to build a showcase new installation in New York. That was proof. We’d out-innovated our two major competitors – both Fortune 500 companies – again.

Soon after, our biggest competitor acquired our company. This was my first exit experience, and it literally changed my life. But one element that has stayed with me all these years was why such a large and well-funded company could be out-innovated by a little startup like ours.

Large companies are just bad at innovation  

The night after we signed the agreement to sell our company, we sat around a table with the senior executives from our new Fortune 500 owners. The most senior executive from the big company told me: “I’m so glad we’ve acquired your company because now I’ll be able to sleep at night.” He went on to say “You guys absolutely terrified us.”

For a few seconds, time stopped for me. I could not believe my ears. For the better part of a decade I had woken up every morning and prepared to do battle with this mighty Fortune 500 company. I just heard that we terrified them! How could that be?

As part of the transaction, I spent a year working inside the company who acquired us. It was even less fun than I imagined. But today, I’m glad that I did because I gained some insight into why we had succeeded in out-innovating them.

I was used to the fact that one of the competitive strategies our Fortune 500 nemesis used was simply to outspend us. In one case, they’d spent more than ten times what we’d spent to get to a similar level of product development. What shocked me was how casually they decided that they had failed and decided to scrap the entire project. During my year there, I kept trying to find someon who wanted to talk about why they’d failed and the things that were so obvious to me that they could have done differently. Nobody wanted to have the conversation.

In the end, I concluded that they were just shockingly bad at innovation.

 A decades-long puzzle

The question of why big companies are so bad at innovation has tortured me for decades. How can companies filled with smart people, deep experience, and seemingly infinite development resources be out-innovated by startups?

After my first exit I evolved from being an entrepreneurial CEO to being an investor and board member. What continued to surprise me over the following decades was how often I saw the same story play itself out over and over again. The small underfunded entrepreneurial companies regularly out-innovated their enormous, and infinitely better-financed, competitors. This didn’t happen just some of the time. It happened most all of the time.

Sure, I admit that a lot of smaller companies that weren’t good at innovation just died a natural death and were removed from the entrepreneurial ecosystem. That’s a natural normal Darwinian part of late 20th century economics.

I began to notice that when one of my investments succeeded, it was most often because their competitors were much larger companies.

At that stage in my career, I was still always surprised when a startup beat out a much larger company. But after I had seen this happen over and over again, I started to appreciate there was something more fundamental going on.

Each time I saw the same pattern I became more and more confident. I heard myself around the boardroom table assuring founders that they could beat out Fortune 500 companies.

Time and time again I told the story of not only how my own first company had beaten a Fortune 500 competitor by out-innovating them, but also recounted stories of other companies that I’d invested in who done exactly the same thing.

I also became more confident when I read that Josh Kopelman says, “Big companies suck at innovation and they know it,” And I’ve quoted him many times over the years.

But it still bothered me that I didn’t understand why this happened so consistently.

What it used to be like at big companies

I grew up in an era where everyone from my engineering graduating class wanted to go and work for one of the big companies. That’s where the really exciting projects seemed to be being done. That’s where we as undergrads perceived the innovation was happening. And that’s certainly where the big money was.

At that point we all thought that it was the big companies like 3M and Xerox that brought us the breakthrough innovations like Post-It Notes and photocopiers. The things that most of us labeled innovative seemed to have originated inside the large R&D facilities at these Fortune 500 companies.

Today, I see very few of the best and the brightest grads going to work in the big companies. It seems pretty obvious to me that the most innovative people are now choosing to work in startups and younger companies. I believe this is partly because it’s where they believe they have a better chance of creating some real wealth for themselves.

But, it’s also because most people now realize that the really interesting and innovative work today is more likely being done in startups, rather than large companies.

Maxwell Wessel on why big companies can’t innovate

Regardless of what I’d observed over all these years, I continued to be plagued by the question of why big companies can’t innovate. Until I read Maxwell Wessel.

Mr. Wessel is a member of Harvard Business School’s Forum for Growth and Innovation, a think tank devoted to developing the academic understanding of the innovation. He recently published a three-part blog series in the Harvard Business Review titled “Why Big Companies Can’t Innovate.”

In the first post in the series, Wessel argues that big companies are really bad at innovation because they’re designed to be bad at innovation. Successful mature companies do what they’re designed to do: create operational efficiency and deliver profit. Seasoned managers steer their employees from pursuing the art of discovery and towards engaging in the science of delivery. Such practices and policies minimize the types and scale of innovation that can be pursued successfully within an organization.

In the second post, Wessel offers four pieces of advice every executive should take into account if he or she wants to pursue transformational innovation. With the right approach, Wessel argues, big company innovation is possible. In the third and final post in the series, Wessel challenges big company executives who are passionate about innovation to commit to innovation not just in technology but in its business development and other aspects of its operations.

I highly recommend reading Maxwell Wessel’s three-part series in the Harvard Business Review and thank him sincerely for helping shed light on the place of innovation in the 21st century economy.

I’ll always be grateful to Maxwell Wessel for helped me finally understand why big companies just aren’t good at innovation.

This is a Golden Age for Entrepreneurs

I speak often to groups of entrepreneurs and investors about the fabulous opportunities that are available today to start, grow, and sell technology companies. I believe that history will call this period we’re now living through a Golden Age for Entrepreneurs.

The editor of Inc. Magazine recently wrote that I sounded vaguely Churchillian when I said, “Never before in history has it been so easy for entrepreneurs to create such valuable companies on so little capital and sell them so early for so much money.”

Today, most of my time is devoted to helping companies design and execute early exits. This is a great deal of fun and gives me a lot of personal satisfaction.

The wealth of opportunity for technology companies and the work I enjoy doing so much are possible because today’s innovation is not likely to be happened in the big companies. It’s happening in the startups and entrepreneurial young companies. And the big companies have never been more eager to acquire these companies at earlier and earlier stages – creating this huge shift towards early exits.

If we want our children and grandchildren to have good knowledge-based jobs and enjoy a standard of living anywhere nearly as good as the one that we’ve had, it’s important that we all better understand how changings in innovation and entrepreneurship are reshaping the 21st century economy.

{ 11 comments… read them below or add one }

Natalie Sweeney January 5, 2014 at 2:33 pm

Big companies can innovate. What you needed was an internal smuggler.

You see, the physics of big companies is to mitigate risk, reduce costs, stick to what is profitable. Innovators, whether entrepreneurs or intrapraneurs need to speak three languages. One of big vision, one of tiny little interesting steps, and one of toe the line. In order to get buy in, you need to first celebrate all of the wonderful merits of being a good corporate steward. For those who take this stewardship very seriously, tiny pieces of the innovation must be launched, and proven successful, in order to build upon the big vision. The language of big vision and what it can do for the organization needs to be a conclusion that execs come to once multiple pilots are successful. Not sold.

Further, failure is still seen as a horrible offense in the corporate world. Pilots need to fail under the radar, but successes celebrated with a modest “well who knew?” Wink wink nudge nudge.

If corporate language is English, and entrepreneurial language is Spanish, the language of us in innovation is both a mix of the two as well as a bit Jedi. “You don’t need to know market numbers (because the market doesn’t exist yet). This isn’t the big scary expensive technology you are looking for, it’s just a tiny little experiment pilot.”

Smuggling. Everyone needs to learn how if they want to change the world.

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Basil Peters January 7, 2014 at 5:56 am

Natalie,

Thanks for your outstanding comment and interesting perspective.

I like the smuggling analogy. Feels to me like you are saying that the innovators have to sneak the new ideas past the big company management. That correlates with my experiences.

But it sure sounds a lot more difficult than it is in a startup.

Basil

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nl7 January 13, 2014 at 8:47 am

Companies have internal cultures. At your small company, the culture was against you but the enterprise was small enough and your influence big enough that you managed to change the culture from one emphasizing nimble scavenging to one emphasizing grand triumphs.

At a big company, there are dozens of people with the power to actively resist big changes, and maybe hundreds or thousands of employees who have all been hired over the decades to do something other than the new plan. Those managers and executives were selected for their ability to run a unit that does X at a company that does Y, and they manage and hire people to help the unit do X for a company that does Y. If a CEO suddenly tells a unit that it needs to stop doing X and start doing A and the company will now do B, it goes against the decades of methods and experience. People selected for running a safe and conservative company were not selected for the ability to run a risky and chaotic strategy. Processes for quality assurance, regulatory compliance, legal review and expensing that make sense for a long-established manufacturer do not tend to track well to a nimble startup. People that were trained to carefully document everything and to loyally show up 9 to 5 are not the people who document only technical info and work sporadically 70 hours a week.

It would be faster for Xerox, IBM, or whoever to start a new venture with new people rather than trying to get old units to change their processes, goals, experience, and priorities. Better yet, they just keep chugging along at their business model until a competitor comes along and makes a tilt at them. If the startup works, they copy it or buy it. If it fails, then their methods are seen to be validated and the failure doesn’t show up as a loss on their balance sheet (unlike the strategy of creating an expensive innovative division that fails to innovate).

Big companies are culturally attuned to distribute. That’s a lot of compliance, administration, litigation, etc. Small companies tend to be less adapted to this world, but are culturally attuned to do interesting works of creation or die trying.

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nl7 January 13, 2014 at 9:10 am

I should point out the example of Saturn Corporation. GM took a concept car and eventually created a new brand and a new corporation – specifically calling itself a different kind of car company. It had a different HQ, in Spring Hill, TN rather than MI. It had special union work rules, still restrictive but much less so, and operated in RTW TN. They used an engineering concept that emphasized reliability and repairability, not American strength or Japanese economy (though it was economical). It had its own marketing, of course, but also its own retailer network, and even new sales personnel. They couldn’t use too many old car sellers, who were used to tough negotiations, tricks and gimmicks, etc., so they used many new people and trained them from scratch to enforce a friendly, all-smiles, no-haggle (i.e. predictable markup/margin) policy.

Despite general success, the rest of GM and the UAW remained jealous and suspicious of Saturn. Following the exit or sidelining of committed people at GM and at the UAW, internal politics at both determined to undermine and marginalize Saturn. UAW eventually took back the lightened work rules and the effort at collaborative working; other GM units got Saturn’s independence hemmed in or revoked. Saturn was increasingly an appendage of GM and lost much of its purpose and internal motivation. In the Great Recession, they finally killed off the undead Saturn.

So despite creating a very different company that met with lots of success and a committed core group of customers, as well as a sales model, shop floor model and engineering model that were all widely praised, the conservative forces managed to squelch Saturn. What looked like real change at GM and UAW was transitory and faded after the initial leadership was no longer around to guard the venture from its siblings. There was no change, because the culture at UAW was against weakening of work rules or moving to RTW states and the culture at GM was in favoring of a centralizing, conglomerating morass and against special rules for Saturn.

Auto industry is a weird example, because it’s expensive to compete and auto retailers have a bizarre quasi-cartel (witness dealer self-righteous opposition to Tesla direct sales). So startups are rarer (and mostly come in the form of foreign automakers poaching long abused US auto buyers). But it illustrates how difficult it is to change the culture at large institutions.

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Basil Peters February 6, 2014 at 10:54 am

Thank you for this insightful example.

While, I am not an expert in the auto industry, I think the Saturn is an excellent case study.

I’d add that this was a couple of decades ago, back when big companies were still a lot more innovative than they are today.

And, I think your insights also shows why the big companies are even less innovative today.

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Basil Peters February 6, 2014 at 10:50 am

Thank you for the excellent comment. You’ve provided some very valuable perspective.

I especially agree with your point: “If the startup works, they copy it or buy it.”

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Chrs Kenton January 15, 2014 at 2:47 pm

Great post, and great comment from Natalie. The two bits of wisdom that struck home for me: 1) No one wants to hear what went wrong. 2) Big vision can’t be sold. Adapting from failure and seeing the vision are two things that drive so much of the entrepreneurial spirit, and yet they’re anathema to big companies.

Big companies have the luxury of focusing on efficiencies and avoiding risk as long as their market is stable. Disruption forces them to respond, or risk massive failure. Kodak. Blockbuster. Any big newspaper… As the environment that enables entrepreneurs to build businesses faster and cheaper than ever, and to compete globally, disruption will only spread. Sooner or later, I suspect big companies will have to reframe their notion of risk from fear of internal operational failures to a broader fear of disruptive market failure. I believe that, but as of yet, I don’t have much evidence of any change in corporate behavior, other than obligatory hand-waving about Innovation!

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Basil Peters February 11, 2014 at 9:34 am

Thanks for your positive feedback, Chris.

Excellent point on “adapting from failure and seeing the vision”.

The most significant way I see big companies adapting is to acquire earlier and more often – which is very good news for entrepreneurs.

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Michael Zino January 16, 2014 at 12:03 am

They can innovate, but they do it slowly. In the early stage of a company, the founders and early employees are hungry for success. They want to succeed as hard as they want to breath. They are fighting for their survival daily. Once the company is growing and its exitense is no longer precieved at risk, “fat” is strarting to show in the way employees treat their own workplace. The individual can hide behind the collective, and the “hunger culture” simply disappears. In most cases, this phase is inevitable because the senior management also loses the appreciation it used to have to its short list of key employees of the early days. Anyway, I totally agree that the biggest threat for bigger companies are the restless and determined entrepreneurs, as lack of resources and finances ignites innovation even further. Applying the disruptive innovation pattern is most efficient when you are lean and agile.

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Revett February 19, 2014 at 3:12 pm

I built and sold a company in Calgary in the 1980s and 1990s. We sold to a big company. They then destroyed in two years everything we had built up over 12 years. What I learned completely supported your contention about big companies — and then some.

The company that acquired us fell in love with our culture while they were doing their due diligence. I think they paid a premium because of that, so I’m not complaining. One thing they made very clear was that they wanted me to help imbue the whole organization with our culture during the two years that I would work for them after the sale. But sadly the team that negotiated the purchase of my business was not the same team that subsequently took over operations. The last thing the latter wanted was anybody messing with their culture, which they thought was just fine. So naturally I got totally frustrated beating my head against a brick wall, to the point at which they fired me. (Again, no complaint: it just accelerated the performance bonus that was in place.) But my people were not used to a command-and-control environment; most of them became as frustrated as I had and within two years the purchaser had ‘grown’ my company from 250 people to 40.

They had the same problem with innovation. The team that bought us wanted to combine my team of people with theirs and with that of another business they were buying. They wanted to develop a “unique, focused, highly differentiated company that would be profitable and an attractive place to work”, but every time one of my people suggested trying a new way of doing anything, the buyer’s people balked on the grounds that they had always done it this way and were bigger and had more experience than us and so were better able to judge the best way. It didn’t matter what was suggested: every single idea was shot down by their experts.

My wife and I built another company from 2005 to 2012. Again we sold to a multinational. They were particularly interested in why and how we had beaten them off every time they had taken us on, even though they had tried every we’ll-give-you-the-first-year-free trick in the book. But again, once the sale was made, a different group of people took over and weren’t the slightest bit interested in why or how we had done anything. They had their way of working and it was just fine, thank you.

It is no surprise that so many large companies have trouble innovating.

Over the years I have developed several Basic Laws of Business. One of my favourites is: “When you are a small company, act like a big one. When you become big, act like a small one.” It’s the second part of that that gets ignored the most.

Love your articles, and love the comments! If you’d been around in 1997 I would have hired you like a shot. I’m sure I left a couple of mil on the table….

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Basil Peters March 3, 2014 at 1:32 pm

Thanks very much for this valuable contribution, Revett.

You clearly illuminate the differences between entrepreneurial organizations and large companies.

In your first exit, it sounds like there were some corporate development people who knew their organization needed a culture upgrade. My guess is that they underestimated how difficult it can be to change a well-entrenched culture.

You perfectly summarize why so many large companies have difficulty innovating.

Congratulations on two successful exits. I’m sorry I wasn’t around to see if we could have increased the price.

Any chance you have #3 in process?

Thanks for the excellent comment.

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