CM: When we talk about innovation, are we speaking about it differently than when we considered innovation in the Industrial Age? Does it mean something different today?
Christensen: Anybody who purports that innovation today is different or innovation is new or innovation is more important, they really don't have a sensible perspective on how business works.
But, just as a broad generalization, you can divide the factors that affect what an organization can accomplish into three groups: Organizations have resources, organizations have processes, and organizations have business models or a profit model. And you can have innovations to create new and better resources, new and better processes, or different business models. So if you're looking for a taxonomy of how to define what innovations are, to me that's about the most cogent taxonomy that I can think of. You have innovations to create new resources, new and different processes, or new and different business models.
CM: When we speak of business models, people are resources?
Christensen: Yes, well, people are resources to an organization. Products are resources. Brands are resources. Technologies are resources. Cash is a resource. And most of what people think of as innovation are efforts to create new and better resources.
And developing better, more capable employees or management talent is an innovation. So when people think about innovation, they generally are thinking about how do I create new and better resources?
But there's a lot of innovation that occurs in the process column, and there is a process that corresponds to every resource. So you can look at a company's management talent and say, "Boy, they've got good resources in their management talent," but you really can't say whether the company is capable of developing even better management talent unless you look at the process by which they create that resource.
CM: It seems that frequently when we speak to consultants today about innovation, we are talking about how it relates to business models …
Christensen: The creation of new and different business models is really the highest leverage point of innovation. These are really new formulas for how to make money. And, generally, it entails what I call a disruptive innovation, and that is creating a business model that can simplify, make something more convenient and affordable, so that a whole new population of people can now afford to own and use a product who historically weren't able to do that. And it's the creation of new business models that is generally the source of greatest growth in an industry, and that's the type of innovation that most companies ignore, but is really the most important.
New innovations emerge at the intersection of technical disciplines that never intersected before. Or a new innovation — a breakthrough innovation — occurs where you apply a technology to a market where it's never been applied before. The principle is that breakthrough innovations rarely occur within a technical discipline or within a market, but almost always where you create a novel intersection between markets.
CM: An example would be, say, eBay?
Christensen: Yes. And let's look at 3M. If you crawl inside its R&D organization, the reason they are so innovative and productive is that they actually have processes to create these novel and unconventional intersections between technologies and between technologies and markets.
So these folks who came to see me had come out of an intersection of several disciplines where they had developed a technology that relied a lot on their polarization capability. They could take a sheet of plastic and stretch it and heat-treat it so that it would reflect any wavelength of light that they chose. They could tailor the plastic red or yellow or blue or to reflect all light or reflect no light. And they had laminated these sheets of plastic together and then built a gift bag out of it, and they brought this gift bag to me and it was just gorgeous. I mean, I just can't describe how beautiful it was. If you looked it straight on, it was yellow. If you turned it a little bit, it was pink.
As I got excited about what a great technology this was, I said, "This has just got to be selling like gangbusters, you guys." And they said, "Well, there's really not a market for it, unfortunately." I said, "What do you mean, there's not a market for it? The gift wrap and gift bag business has got to be several billion dollars in value." And, yeah, it is, but the problem is that the gross margins are only 30 percent, and it turns out that this marvelously innovative technical organization has to interface with a company that has never innovated in terms of business models.
So to commercialize the technology, they've got to demonstrate that this business is going to generate gross profit margins of 55 percent, or else they won't invest to commercialize the technology. It's not a natural response, right? Because if I went back to 3M, they're embedded in a financial structure, and Wall Street examines — or Wall Street evaluates — 3M's financial performance based on gross margins, which, historically, they've tried to maintain at 55 or higher percent. So what if 3M just decided, "All right, we're going to be innovative in business models and we're going to create a different organizational structure out there whose overheads are so low that they can make attractive bottom-line profits at a 30 percent gross margin"? But because Wall Street looks at gross margin rather than bottom-line profit, the Wall Street analysts would probably hit 3M as headed in the wrong direction.
So it's not a natural thing for operating managers to create new and different business models, because of the scrutiny — I'll call it the perverse scrutiny — that Wall Street imposes on them.
CM: Is Wall Street getting savvier about innovative companies and, perhaps, giving them a wider berth, or is that likely to happen in our lifetime?
Christensen: It's less savvy. And the reason is that about 10 percent of the equity that's held on Wall Street is in hedge funds, but a hedge fund's average holding period of stock is less than 60 days. So the hedge funds trade and trade and trade. About 30 percent of the trading volume in the stock market is hedge funds. And with the holding horizon at 60 days, they don't care what innovations are going on in the company. Their time horizon doesn't extend out even to contemplate short-term innovations.
The average mutual fund, their holding period of the stocks in their portfolios is only 10 months, on average. So their holding period, too, doesn't even extend out long enough to consider the effect of even short-term innovations, let alone long-term ones.
And, so, in many ways, managers who, for some reason, have decided that they need to focus on maximizing shareholder value, they're really pursuing a goal that's impossible to achieve, because the money on Wall Street has become so short-term-oriented that innovation and shareholder short-term stock price maximization are just … they're orthogonal. You almost have to say, "Let Wall Street do what it wants, because it has no interest in or perspective on our company beyond a year." Because innovations don't pay off, shorter than a year.
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