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Why Big Companies Can’t Innovate

by Basil Peters on February 15, 2014 · 13 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.

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