Why startups innovate while big companies incrementally improve

Innovation happens at companies large and small, but truly disruptive innovation usually happens at startups. Why don't we see more innovation from the big companies? Microsoft spends more than $6.5 billion a year on R&D. IBM spends $5.8 billion, HP spends $3.6B, and Oracle spends $1.9B. Apple spends over $700 million. That is a LOT of money.

How can a little startup that spends 1,000 times less money on R&D be more innovative? Because they have nothing to lose and everything to gain. It is the only way they can survive. Big companies protect their base...their cash cows, by making incremental improvements to existing products. Small companies need to create a new base, a new market, by disrupting the market with better, faster, cheaper products.

It is the classic Innovators Dilemma. Successful market leading companies sometimes fail when faced with simpler, cheaper, less functional products that disrupt the market. The market for these products is viewed as small or ill defined. Your existing customer base has no interest in the inferior product, they want more features and performance at a reasonable price. But, at some point the market doesn't care about all the new features. They want something simpler and cheaper that can do a very specific task. This is the inflection point where the disruptive technology on the low end overtakes the market leader.

Why don't big companies set aside a portion of their R&D money for disruptive start-up like projects? Some companies do this, but with little success. The reasons go beyond money. Big companies put their best people on the most important profitable businesses, not skunk works projects. Sales people at big companies have big quotas. They are going to sell the well known product that generates the best commissions. Creating new markets for new products takes lots of time and a whole different selling process. Big companies are not set up to handle this.

Why not  just acquire the successful start-ups? The venture capital business is tough even for experienced professionals. Take a look at this quote from the NVCA:

"Since the beginning of 2004, venture capitalists have put nearly $350 million into no fewer than 79 start-ups that had something to do with Internet search, according to the National Venture Capital Association, an industry group."  "Still, recent history suggests that gaining traction is going to be difficult. Of dozens of search start-ups that were introduced in recent years, none had more than a 1 percent share of the United States search market in November, according to Nielsen NetRatings, a research firm that measures Internet traffic."

Rather than spend $350 million trying every possible approach to find the next big thing in search technology why not acquire the most promising start-up for $50 million? This is essentially what has been happening over the past 4 or 5 years. There haven't been any significant IPOs, so most exits have been small acquisitions. Microsoft acquired 22 companies in FY 2006, mostly in the $30M to $50M range. Google and Yahoo have made selective acquisitions as well. YouTube at $1.65 billion is a point off the curve.

What about the "fast follower" strategy? This is actually a pretty good strategy for a large company that can move quickly, but most can't do it. Apple is a good example. Apple didn't invent music downloads, and they didn't invent MP3 music players. But, the iPod and iTunes followed fast enough to be a winner. Google didn't invent search either. But, again they followed fast enough, and added a few innovations, and displaced the market leaders. For more on the "fast follower" strategy see "Innovate or Imitate...Fame or Fortune".

It all makes sense. Big companies should incrementally improve their existing products to optimize profits. Startups should try to innovate and disrupt the market. Not just better, faster, cheaper, but totally new ways of doing things that disrupt the market leaders. The fast follower approach is a reasonable compromise for a large company with a good brand name. If a company can't lead in either of these three strategies...they might be in the valley of the walking dead.

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Comments

[Lloyd Budd]

set aside a portion...: of employee time? Google's "20 percent time" seems like a great idea, but most pepole that I speak to suggests that like all jobs there is more work than 100% of their time let alone 80% and the time is seldom used for exploration.

[Don Dodge]

Lloyd, Every startup I ever worked with consumed 100% of my waking hours. There was no way to carve out 20% of my time to focus on anything not directly related to getting the next release done. Big companies have so many people that no one can keep track of what they are really doing. Perhaps Google has graduated from start-up to big company.

I was suggesting something different. Take 20% of your R&D people and focus 100% of their time on new innovative, disruptive projects. Take 20% of your sales and marketing people and focus them on building new markets.

It is an interesting idea that has had a few amazing successes. IBM set up a separate small skunk works, in a small facility in Boca Raton to develop the original PC. Apple did something like this with to develop the Mac while the rest of the company focused on the Apple III. Microsoft set up a self directed group to build the Xbox, and did it again to develop the Zune.

All of these products were innovative and by most measures very successful. Maybe it should be done more often.

[Lloyd Budd]

Don, I got what you were suggesting. I was looking forward to your thoughts on 20% (distracted) time and appreciate the insights in your response. Thank you.

[Thomas Meloche]

I've been reading Darwin's "On the Origin of Species" the past few weeks and I think his ideas are applicable to your article. Think of innovation in business as variation in a species. Some innovations improve the chance for survival and some don't.

Startups have several advantages over large companies in testing variation:

1. There are more of them, so many more different variations can be tested.

2. Small innovations actually help a small business survive.

#2 is essential, and it is why I believe many small businesses seem to innovate more than large businesses (I am not convinced that they do, but I am convinced that their innovations survive better). Innovation in a small business has a better chance of succeeding than innovation in a large business because small business actually notice when an innovation is helping them survive. The small innovation may be the difference between making payroll and not making payroll because it led to a key sale this month!

The small business thrives on the one new additional customer hooked by a new innovation. The large business doesn't even notice it has a new customer. In the small business the successful innovation can continue to be fostered and enhanced while in the large business it may be discarded and not recognized as having survival value.

I've worked in small and large businesses and I've seen a lot of innovation in the large businesses. However, I also noticed that most of the large business innovation never saw the light of day.