The year end issue of The Economist includes a provocative column - Big and clever: Why large firms are often more inventive than small ones. The column addresses a fundamental question that those studying innovation have been wrestling with for years: “Are big companies the best catalysts of innovation, or are small ones better?”
The column is based on a recent study - Scale and Innovation in Today’s Economy - by Michael Mandel, chief economic strategist of the Progressive Policy Institute.
“Conventional wisdom these days says that small is better when it comes to innovation and putting new ideas into practice,” writes Mandel at the beginning of the report. “Large enterprises are typically thought of as hidebound defenders of the status quo, dominating by market power and brute force rather than technological and innovative prowess. . .Yet reality is far more complicated than this simple small versus big distinction. . . After 20 years where startups have rightly dominated the innovation headlines, we will show that the pendulum may be swinging back. As a result, there are reasons to believe that scale may be a plus for innovation in today’s economy, not a minus.”
There is little question that small, entrepreneurial start-ups are almost always the ones that bring to market highly disruptive innovations. They excel at creative destruction, the term that economist Joseph Schumpeter popularized almost seventy years ago to describe the process of transformation that accompanies disruptive innovation.
Entrepreneurs have sharp incentives to break into a market with a disruptive new idea that attacks the dominance of established companies. They are highly motivated to bring to market new products which offer significantly improved designs and/or lower costs, and thus gain competitive advantage and market share from the established leaders in their segment of the market.
But, in what has become known as the Schumpeterian Hypothesis, Schumpeter also believed that large companies in concentrated markets have more incentives to innovate. By investing in new products or processes, the company can sell them to their already large customer base and reap greater rewards faster. Moreover, in a highly competitive market, startups will have trouble holding on to the gains from their innovations because they will be quickly imitated by rivals, while large companies with greater market power will be able to better protect and hold on to the gains from their innovations.
So, which is it? Are large companies at a disadvantage because start-ups can move much faster in bringing new ideas to market, or is their scale an incentive for investing in innovation? Mandel summarizes the economic research evidence in two words: It depends.
He writes that “the link between scale and innovation is highly dependent on the economic environment.” He believes that the current US economy favors big companies over small ones because in today’s environment, three key forces are driving innovation: large-scale ecosystems; globalization; and the vast, systemic challenges posed by business and societal problems that technology now enables us to address.
We generally think of large companies as being good at operations and incremental innovations, which require them to excel at management discipline, detailed information analysis and project management. But managing the kind of disruptive innovations that change the rules of the game requires a different management style based on identifying a brand new idea, moving quickly to establish an early market presence, and continuous market experimentation to refine the offerings and establish the company’s strategy. This latter management style is more suitable for fast moving, risk taking startups than for larger, more established companies which have existing products and customers to support and protect and are often caught in what Clay Christensen called The Innovator’s Dilemma.
But, the kind of innovation that Michael Mandel writes about in his article is a mixture of disruptive and incremental. It favors large companies because of their ability to address complex systemic problems, manage the large-scale ecosystems that solving such problems requires, and bring their solutions to market all round the world. The problems are typically not based on new inventions, so it is hard think of them as representing disruptive innovations, but their scale and scope puts them in a class way beyond incremental. This kind of complex systemic innovation leverages lots of known ideas and makes them work together to help address important problems.
Mandel cites health, energy and education as examples of large-scale integrated systems in dire need of reform. “Conventional venture-backed startups don’t have the resources to tackle these mammoth problems. Only large firms have the staying power and the scale to potentially implement systemic innovations in these industries.”
Looking at my own recent work, most of the problems being addressed as part of IBM’s Smarter Planet and Smarter Cities initiatives require systemic, innovative approaches to their design, development, management and continuous evolution. Equally challenging are the digital money and digital payments initiatives I am involved in my work at Citi.
No company, no matter how large, profitable or technically savvy can possibly address such problems on its own. They require the formation of large-scale innovation ecosystems. Mandel cites the ecosystems surrounding the iPhone, Android and 4G mobile networks as examples. One of the major challenges to the successful transition to universal digital money and payments will the formation of digital money ecosystems that include companies from a variety of different industries as well as public sector institutions. “These ecosystems require management by a core company or companies with the resources and scale to provide leadership and technological direction,” writes Mandel. “This task typically cannot be handled by a small company or startup.”
Such ecosystem leadership requires companies that are global in scope. “[G]lobalization puts more of a premium on size than ever before. A company that looks large in the context of the domestic economy may be relatively small in the context of the global economy. . . most large companies today are global-facing, and concerned with their ability to compete in global markets, to negotiate with suppliers and to find customers. What matters is scale relative to the size of the global economy, not relative to U.S. markets.”
But, it is not enough to be large for a company to succeed at complex systemic innovation. As is often the case, the most important and hardest transformations are cultural ones. In order to to tackle highly complex, global business and societal problems companies need to embrace an open, distributed style of leadership so they can effectively manage all their ecosystem relationships. In particular, they must embrace a collaborative style of innovation, where many of the best new ideas, perhaps the most disruptive ones, will come from startups, universities and open source communities, as well as from clients, business partners and even competitors.
Large companies that make the successful transition to an open, collaborative style of innovation will emerge as effective ecosystem leaders. Such companies will find that their scale is a major asset for the kind of complex systemic innovation that will be increasingly important in the decades ahead.