Innovation and Entrepreneurship (book by Drucker)

Innovation and Entrepreneurship

Peter F. Drucker

Innovation & Entrepreneurship

 This book was originally published in 1985. Despite being 30 years old, the book’s currency shows clearly the classic value of Drucker’s insights. It also shows that a large number of books basically re-package the content of this book to discuss innovation and entrepreneurship. Drucker provides both a definition and a rational for studying innovation and entrepreneurship together. Innovation is the specific tool of entrepreneurs, the means by which they exploit change as an opportunity for a different business or a different service….Entrepreneurs need to search purposefully for the sources of innovation, the changes and their symptoms that indicate opportunities for successful innovation.* The key concepts here is “exploit change” and “search purposefully”.

 

At the time of the book, entrepreneurs were commonly equated with small business. As the book makes clear, most small businesses startups are not entrepreneurial because they do not exploit change. Some small start-ups are based on change, but so are many efforts by large business. Drucker spent a lot of time with entrepreneurs and concluded that entrepreneurship was not a personality trait, but a learnable set of behaviors. There was an identifiable theory of innovation and entrepreneurship. While innovation may involve risk, many cases of failure were due to the failure to follow the principles described in the theory. …people who need certainty are unlikely to make good entrepreneurs…But anyone who can face up to decision making can learn to be an entrepreneur and to behave entrepreneurially…and its foundation lies in concept rather than intuition. A key part of this theory is the perspective taken on change. Traditional economic theory seeks to maximize the return on resources and seeks to stabilize the environment. An alternate theory of the economy assumes that there is a “dynamic disequilibrium” that is always creating change. This may be caused by changes in demand or supply. Innovators are one source of change and often their most “disturbing” action is to create new kinds of demand. In a more current context, the advent of smart phones created demand for many kinds of services and accessories. …the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.

 

INNOVATION

People often equate innovation with technology, but there has been significant social innovation over the last 200 years that was a prerequisite for the technological innovation that followed. Universities, hospitals, and commercial laws are examples of prerequisite social innovations. Innovations have been common in many non-technical domains. In Drucker’s view, the most risky innovations are technical, so the idea that innovation is risky may result from the common practice of equating innovation and technology. Drucker identified seven sources of innovation and makes the point that innovators need to systematically search for innovative potential from these sources.

 

The unexpected

No other area offers richer opportunities for successful innovation than unexpected success. In no other area are innovative opportunities less risky and their pursuit less arduous. Yet the unexpected success is almost totally neglected; worse, managements tend actively to reject it. For example, the chairman of Macy’s once told Drucker that the biggest problem that they had was growing appliance sales. Macy’s identified itself with fashion and most of its leaders came from a fashion background. Appliances had higher margins than fashion, but the managers saw that as a problem – it was not the core business. Bloomingdales recognized that consumers were changing, supported the increasing demand for appliances and changed their entire approach to marketing to serve this emerging consumer group; they created an approach based on “life style”. In a similar way, the steel industry rejected the mini-mill concept even though the dominant integrated mill was usually a money losing proposition. The unexpected success is a challenge to management’s judgment. “If mini-mills were an opportunity, we surely would have seen it ourselves,” the chairman of the big steel company is quoted as saying when he turned the mini-mill proposal down. Managers focus their attention on problems – not things that are going well. A medical laboratory supply company introduced some new equipment to the market. Early sales to the clinical market were good, but soon orders were coming from industrial and academic labs that exceeded the clinical demand. Nobody at the company noticed or took any action to understand or serve this market. Some years later, another company took those customers away by paying attention to them. Thus the unexpected success is not just an opportunity for innovation, it demands innovation. It forces us to ask, What basic changes are now appropriate for this organization in the way it defines its business? ….The unexpected success is an opportunity, but it makes demands…. It demands seriousness and support on the part of management equal to the size of the opportunity. And the opportunity is considerable.

 

Unexpected failure also can also be a source of opportunity. When a well-planned innovation’s execution fails, it may signal a real change in the marketplace. Perhaps customers have changed their values and perceptions; while they still buy the same “thing”, they are actually purchasing a very different “value.” New segments may be appearing or old ones dividing. Companies often blame these failures on irrational customers, but this is a mistake. The customers usually are perfectly rational, but they are expressing a new rationale. That new rationale may require new products and services that are probably not being offered yet. Faced with unexpected failure, executives, especially in large organizations, tend to call for more study and more analysis. But…this is the wrong response. The unexpected failure demands that you go out, look around, and listen. Failure should always be considered a symptom of an innovative opportunity, and taken seriously as such.

 

A third source of “unexpected” innovation is the unexpected event. For example, IBM engineers in the 1970s were asked if personal computers had a future and their detailed analysis showed that such computers would be really expensive for what they could do (speed, memory, etc.) and thus of little interest to consumers. Consumers did not know about this analysis and uptake of small computers was fast. IBM responded to this very rapidly and for a while dominated the market. Drucker asked IBM people how they had been able to see the opportunity that others did not. And I always get the same answer:”Precisely because we knew that this couldn’t happen, and that it would make no sense at all, the development came as a profound shock to us. We realized that everything that we’d assumed. Everything that we were so absolutely certain of was wrong. Innovations that capitalize on unexpected events tend to arise from companies already in the domain of the change. IBM was a computer company. Large format book stores were introduced by major retail companies (not independent book sellers who knew books, but not retail). Minimills were created by people in the steel industry.

 

Seizing opportunity based on an unexpected situation is something best suited to established companies. They have connections to customers and markets that allow them to create expectations and consequently know when they are not met. However, it is also worth observing that many competitors in a market will observe the same events and only a few perceive that there was a meaningful event. Drucker comments at numerous places in the book that managers need to pay more attention and think more deeply.

 

Incongruities

An incongruity is a discrepancy…between what is and what “ought” to be, or between what is and what everybody assumes it to be….an incongruity is a symptom of an opportunity to innovate….Incongruities do not…usually manifest themselves in the figures or reports executives receive and pay attention to. They are qualitative rather than quantitative.  Most incongruities are well known but ignored. People in an industry know about them. An example of an incongruity was the assumptions about ocean freight that were wide spread in the 1970s. Ships were being designed to sail faster and faster, yet the most important loss of time in the shipping cycle was loading and unloading. Adoption of the containerization of freight yielded a greater than 75% decrease in port times, but the adoption of containerization came many years after rail-truck containerization occurred. This is an example of an economic incongruity.

 

A more important incongruity often occurs between why a customer buys a product and why the seller thinks the customer buys the product. The book cites the example of stockbrokers at major brokerages who assume that customers invest to get rich. Edward Jones (a brokerage) realized that many customers invest to preserve their wealth; the actual product they are buying is peace of mind. Producers and suppliers almost always misconceive what it is the customer buys. They must assume that want represents “value” to a producer and supplier is equally “value” to the customer. This means that producers attempt to innovate in ways that customers don’t value and misdiagnose the situation when their offerings are rejected – even if the offering was once acceptable.

 

A final type of incongruous opportunity arises from gaps in a process. The book cites the example of the OM Scott company that became prominent in the lawn care industry thanks to the spreader. Fertilizers were developed, tested and marketed using scientific data, yet consumers had no way to control the application of the fertilizer. By introducing the spreader, the consumer could spread the fertilizer as scientifically as it had been developed and they could gain the value they sought (healthy looking lawn) with less uncertainty and effort.

 

Process Need

The insight here is that many things are bought to help someone do something. A careful study of the process where the something is done may reveal problems that interfere with doing the task well or efficiently. Innovations that solve that problem are almost immediately accepted. In most cases, everybody in that situation knows about the problem but it is widely accepted and, in the sense of seeking solutions, ignored.

 

An interesting example comes from the early 1920s when a rapidly internationalizing US became interested in news from overseas. Local newspapers were poorly equipped to gather this news and no newspaper had the scale to gather subscribers and advertisers needed to support the newspaper. The innovation that responded to this need for international news was Time magazine. Weekly publication eased the distribution problem and a national audience accumulated sufficient readers. A more current example is phone-based GPS. People traveling to a new location need help in finding the way while driving alone and can’t be looking at a map. Spoken directions make driving safer and more efficient.

 

A process need innovation has five elements:

• A self-contained process
• One “weak” or missing link
• A clear definition of the objective
• That the specifications for the solution can be defined clearly;
• Widespread realization that “there ought to be a better way,” that is high receptivity.

The need must be understood well enough to specify the solution, so this is a higher bar than simple recognition that there is a problem. The potential solution must fit people’s approach to that work; it must fit into the process – not change it. Thus innovation of this type tends to be the result of systematic search and study.

 

Industry and Market Structures

Managers tend to think that market structure is stable and basically robust. This is incorrect. Leading firms can be rapidly displaced when their customers’ needs or interests change. Often it is the appearance of a “new” customer that triggers change. A change in industry structure offers exceptional opportunities, highly visible and quite predictable to outsiders. But the insiders perceive these same changes primarily as threats. Rising affluence in the 1950s created new potential customers for financial firms. One opportunity was the rise of pension funds which created a new class of investors. Another new class of investors rose with the spreading upper middle class who sought investment to protect their modest net worth. The first set of customers gave rise to the firm Donaldson, Lufkin and Jenrette who became the first firm to offer securities research and evolved into the first firm to underwrite junk bonds. The second group of customers gave rise to the Edward Jones brokerage that set up offices in suburbs and small town across the Midwest, and generally outperformed NY brokerages for a few decades. The established firms in the early 1950s knew about these customer groups, but they did not think they were serious future customers. The founders of these companies were not strictly outsiders, but they were not in the inner circles of the established industry.

 

Four near-certain, highly visible indicators of impending change in industry structure can be pinpointed. 1. The most reliable and the most easily spotted of these indicators is the rapid growth of an industry.

2. By the time an industry growing rapidly has doubled, the way that it perceives and services its market is likely to have become inappropriate.

3. Another development that will predictably lead to sudden changes in an industry structure is the convergence of technologies that hitherto were seen as completely separate.

4. An industry is ripe for basic structural change if the way in which it does business is rapidly changing.

Modern examples can be applied to all of these. Facebook was not the first big social media company, but it broke the original market structure and created the current environment. In part, this is because Facebook encouraged people to share a different type of information than MySpace or other early sharing sites did.  The “sudden” evolution of high-speed cellular networks triggered the long-expected convergence of phone and computer that enabled the iPhone to change the cellular phone business and usher in “smart phone” services. Finally, Amazon introduced a new way to buy books and that induced a change in the industry structure for all the firms that sold books in physical stores.

 

Innovations that exploit changes in industry structure are particularly effective if the industry and its markets are dominated by one very large manufacturer or supplier, or by a very few. Even if there is no true monopoly, these large, dominant producers and suppliers, having been successful and unchallenged for many years, tend to be arrogant. At first they dismiss the newcomer as insignificant and, indeed, amateurish. Modern examples of fallen champions seem to include Blackberry and Nokia, but earlier examples could include Sears, K-Mart, and Xerox. All were characterized by difficulty in shifting from an old group of customers to an emerging group of customers with different needs.

 

Again and again when market or industry structure changes, the producers and suppliers who are today’s leaders will be found neglecting the fastest-growing segments. They will cling to practices that are rapidly becoming dysfunctional and obsolete. The new growth opportunities rarely fit the way the industry has “always” approached the market, been organized for it, and defines it. The innovator in this area therefore has a good chance of being left alone.

 

Demographics

The size and distribution of the population has a huge effect on society. As demographics changes, it creates opportunities for innovation. Business people have always understood that demographics drives economic activity, but they tend to treat it as unimportant in the time frame of their business. Demographic change is just too slow. This may under estimate the range of things that are demographic in nature and just how fast these thing can change, Huge change took place in a 10-year period from 1950 to 1960 (the baby boom) with consequences that were realized by the late 1950s (need for schools, kids clothing, children’s books, etc.). A similar demographic change occurred in China with urbanization and the growth of a middle class over the last 20 years. During this same period, the number of people in the US with Mexican heritage jumped 3-5 fold. Some of the strains in the European economy may be due to the rapid transition of late middle aged people into retirement. Over a decade the makeup of a population can change markedly along with the needs of the people making the transition. Almost all of these changes are predictable. What makes demographics such a rewarding opportunity for the entrepreneur is precisely its neglect by decision makers, whether businessmen, public-service staffs, or government policymakers. Though these changes may be perfectly predictable, organizations struggle to act on the changes. Cities kept on building schools even as birth rates fell. Additional benefits were created for the elderly even as baby boomers kept on aging.

 

Interestingly, Drucker cites a number of examples of expert predictions of future demographic change being completely wrong. For example, demographers in the late 1930s predicted that the US population would peak at 140 million in 1943. They did not take the impact of WW II into consideration and the consequences of deferred fertility. So the direction of demographic change might not always be predictable, but demographic change can have a long time between advent and impact. A birth surge impacts day care in 6 months, schools in 5 years, universities in 18 years and the work force in 18-25 years. It impacts pensions in 60-70 years and mortuaries in 60-90 years.

 

This unwillingness, or inability, of the experts to accept demographic realities which do not conform to what they take for granted give the entrepreneur his opportunity. The lead times are known. The events have already happened. But no one accepts them as reality, let alone opportunity. Reacting to demographic change can be as simple as paying attention. Years before governments noticed the urbanization of Latin America, Sears Roebuck had. Sears chairman learned that a few Latin American cities were expected to grow larger than any American city, so he took a two week trip to Mexico and Brazil. He spent his time walking around and watching people shop. He looked at stores and traffic and determined what ventures might work in this changing society. Sears had decades of success because they paid attention to how people in the changing environment were different from their predecessors and what they needed to meet their needs.

 

Perception changes

Some innovations arise when people’s perceptions about a topic change. Drucker gives the example of the change in perception that took place in America during the 1950s where people who would previously classified themselves as working class begun to identify themselves as middle class. The core belief behind this was that their children would be better off than they were. This created opportunities for encyclopedias, community colleges and four-year universities. Drucker uses the metaphor of the half full/empty glass to describe the effect. When a large number of people switch from seeing the glass one way to seeing it the other, they may also see a need for new products and services. A more modern example might be massage. When more people perceive that they are stressed, they will be more receptive to massage as an antidote. There is no requirement for any actual change to occur; only the perception needs to change. Compared to some other sources of innovation, this is difficult to find and more difficult to quantify….by the time it can be quantified, it is too late to serve as an opportunity for innovation.

 

Thus changes in perception have a strong timing element to them. Too early and too late both risk failure. The book provides an example of a change in perception that arose from an incongruity. A food editor noticed three articles in a single copy of the newspaper which suggested three very different paths for American eating habits. One story described the rise of prepared foods and projected that 75% of all meals would be in the category shortly. The second described a gourmet cooking show that was getting top ratings while a third mentioned that a gourmet cook book had joined the best seller list. It did not seem possible that 75% of food would be mass produced and the remaining 25% gourmet, so he dug deeper and decided to launch a new type of cooking magazine. A few years earlier and the market would not be ready and few years later someone else would probably already have the same idea.

 

The other tricky thing about perception changes is that fads and real changes look very similar in the beginning. This is a significant challenge for innovators hoping to ride a wave of perception change. Changes may not be slow and steady either.

 

Knowledge-based innovation

Knowledge-based innovation differs from all the other innovations in its basic characteristics: time span, casualty rate, predictability, and in the challenges it poses to the entrepreneur. And like most “super-stars’” knowledge-based innovation is temperamental, capricious, and hard to manage. Drucker discusses a long list of innovations with 20-30 year periods between discovery or the basic concept and commercialization. This may be partly because few knowledge-based innovations actually stand alone. There are often convergences between different fields that are required to make a discovery useful. Until all the needed knowledge can be provided, knowledge-based innovation is premature and will fail. In most cases, the innovation occurs only when these various factors are known, already available, already in use someplace.

 

Drucker suggests the following requirements for a knowledge-based innovation.

• In the beginning, many knowledge-based innovations are incomplete. Success requires the missing knowledge or capabilities be identified and put into place. Failure to make such an analysis is an almost sure-fire prescription for disaster….Or the inventor loses the fruits of his innovation and only succeeds in creating an opportunity for somebody else.
• The introduction of a knowledge-based innovation requires an emphasis on strategic and competitive positioning. The innovation will attract attention and others will try to exploit the innovation. Resisting these other entries may involve making the innovation part of a complete system (as Polaroid did for its camera) or creating a new market for the innovation (as Dupont did for nylon and Antron).
• A third requirement is to control a key position in the market by supplying a critical function in the “ecology” of the innovation (like Intel has done with microprocessors).
• Knowledge-based innovations must be managed entrepreneurially. In fact, entrepreneurial management is more crucial to knowledge-based innovation than to any other kind. Its risks are high, thus putting a much higher premium of foresight, both financial and managerial, and on being market-focused and market-driven.

 

Innovation spreads fast when it solves an important problem. Roger Bacon invented eye glasses in about 1250 In England. Within 30 years, they were in use in southern France and in Cairo within another 10 years. The explosive growth of knowledge-based innovations creates some unique risks. One risk is that the early entries historically have been the winners. Though lots of companies may subsequently crowd into the innovative arena, most fail to take leadership from the first entries. The window of innovation-specific growth may be relatively short. The new knowledge becomes part of the routine and those who had a problem now have a solution. In this sense, knowledge-based innovation must command a significant premium early because the uniqueness will be short lived.

 

The inverse of the knowledge-ecosystem problem is a receptivity problem. Some knowledge-based innovations are created before there are a significant number of people who recognize that they have a problem. All other innovations exploit a change that has already occurred. They satisfy a need that already exists. But in knowledge-based innovation, the innovation brings about the change. It aims at creating a want. And no one can tell in advance whether the user is going to be receptive, indifferent, or actively resistant. Drucker spends the next few pages of the book emphasizing that “expert” predictions of demand for this sort of innovation are terrible. People can be highly anchored to the existing solutions. Asked about the need for telephones, people expressed satisfaction with the telegraph. There is no way to eliminate the element of risk, no way even to reduce it. Market research does not work – one cannot do market research on something that does not exist. Opinion research is probably not just useless but likely to do damage. The risk of knowledge-based innovations might be lower if it is combined with innovation based of success, failures or incongruities. When the knowledge is the “final” piece in creating the complete innovation, the probability of success is probably highest.

 

The Bright Idea

Most inventions are bright ideas and most fail commercially. A bright idea is a bit like a slot machine in that some succeed but the vast majority fail. For companies, depending on bright ideas lacks systematic potential. Drucker does not use the term, but his description makes clear that these are practically random ideas. The individual innovation of this kind is not predictable, cannot be organized, cannot be systematized, and fails in the overwhelming majority of cases. Companies can’t count on this source of innovation. However, Drucker thinks that organizations (and society) should do nothing to discourage this sort of innovation either. Some bright ideas succeed and preventing them is counterproductive.

 

Drucker proposes five principles of innovation and three “anti-principles”.

• Purposeful, systematic innovation begins with the analysis of the opportunities. What is the problem that need solving or what is the situation that is changing?
• Innovation is both conceptual and perceptual. The second imperative of innovation is therefore to go out to look, to ask, to listen. This cannot be stressed too often. Successful innovators….look at figures, and they look at people.
• An innovation, to be effective, has to be simple and it has to be focused. It should only do one thing….If it is not simple, it won’t work. Everything new runs into trouble; if complicated, it cannot be repaired or fixed. All effective innovations are breathtakingly simple.
• Effective innovations start small. They are not grandiose. They try to do one specific thing.
• But…a successful innovation aims at leadership. It does not aim necessarily at becoming eventually a “big” business….But if an innovation does not aim at leadership from the beginning, it is unlikely to be innovative enough….

Anti-principles can be expressed as things not to do.

• Don’t be too clever. Innovations have to be handled by ordinary human beings….
• Don’t diversify, don’t splinter, don’t try to do too many things at once.
• Don’t try to innovate for the future. The future is unknown and unknowable. Innovation is hard enough without depending on an unknowable future.

With all of this in mind, it pays to remember that innovation is hard work. Talent helps and clearly talent varies between organizations, but effort is more important. Good innovators build on their strengths and pick those concepts that fit their own capabilities best. The inverse of this is that organizations will struggle to innovate when they depend on skills and bodies of knowledge that they do not respect. A technical organization will struggle to innovate when they need marketing and don’t think marketing is a serious discipline. It is also useful to remember that an innovation probably changes peoples’ lives. They will do things differently in the world of the innovation, and getting from the present to that future may be trying for them. This is why it is important to be close to the people who will benefit from the innovation. Part of the innovation may be in helping them make the transition.

 

While innovation involves risk, it is incorrect to think that innovators are business daredevils. Most successful innovators are quite cautious. They study the opportunity closely, consider optional solutions, identify and mitigate as many risks as possible. Even at the end of this effort, risk remains. Some organizations shy away from the risk of new things…defending yesterday – that is, not innovating – is far more risky than making tomorrow.  

 

ENTREPRENEURSHIP - Management

The entrepreneurial requires different management from the existing. But like the existing it requires systematic, organized, purposeful management. And while the ground rules are the same for every entrepreneurial organization, the existing business…and the new venture present different challenges, have different problems, and have to guard against different degenerative tendencies.

 

Drucker begins the second section of the book by asserting that the structure of the American economy over the next 25 years (from 1984-2009) will see a 66% decrease in manufacturing employment while output would rise 3-4 fold. The forces driving this change will act everywhere in the economy and almost every business that survives will change in significant ways. This will require a kind of internal entrepreneurship. There will also be new ventures formed during this period, but the most profound change will be in businesses already in operation. The idea that large businesses don’t, and can’t be entrepreneurial is a misunderstanding. Lots of big, old businesses routinely show innovative entrepreneurship. Many big businesses are innovative in one part of their business, while failing at innovation in another part of the business. It is also a misunderstanding that small businesses are more innovative than large businesses – in fact the opposite is easily demonstrated. For a medium or large business, It is not size that is an impediment to entrepreneurship and innovation; it is the existing operation itself, and especially the existing successful operation….The new always looks so small, so puny, so unpromising next to the size and performance of maturity. Anything truly new that looks big is indeed to be mistrusted.

 

One misunderstanding is that innovation and entrepreneurship are naturally present in organizations; if an organization is not innovating – the explanation must be that innovation is being suppressed. Bureaucracy or risk aversion get the blame. Drucker suggests that the idea that innovation is “natural” is wrong; innovation is actually unnatural, which is why it is hard work. An organization that wants to be innovative needs to have the policies and practices in place to enable it – even require it.

• Rather than thinking about practices that resist innovation, it is beneficial to think about practices that invite innovation. It is easier for an organization to innovate when people understand that the innovation is “normal”, instead of special. The most important single thing might be to make it easier to abandon obsolete business. When managers gain bigger incentives from defending the status quo that creating a change, they will defend the status quo.
• To help this, it is important to acknowledge that products, services and technologies become obsolete. Life cycle analysis and competitive analysis help identify those areas that are at the end of their lives and the opportunities that might replace them. This analysis is not a strategy, but a diagnosis. Business judgment is required to understand the information, and this often means experience. The idea that bright young people with sharp analytical tools could crunch out of their computer life-and-death decisions about businesses, products, and markets is pure quackery….This analysis…is intended to find the right questions rather…the right answers.
• Once the analysis is complete, a range of activities to replace that business should be begun. The portfolio of projects should be three-times the size of the future gap. Most executives consider this excessively high. Yet experience has proved that it errs on the low side, if it errs at all. Innovation in uncertain. There are always delays for one reason or another, projects need to change in unexpected ways, and many will never succeed. Having 3x effort is conservative.
• An organization needs to have a practice of systematic abandonment. The analysis that shows when offerings begin to fail should be used to divert investment and talent away from dying businesses to new ones.

 

Most managers pay attention to problems because this is what they are presented with, and expect to spend their time on. They don’t spend as much time on opportunity. Meetings among managers focus on identifying and solving problems. If opportunity is on the agenda, it is the last item and is prone to being skipped. Drucker observes that successful entrepreneurial companies often have two management meetings, with one totally devoted to opportunities. A second practice is to focus time on businesses that are doing exceptionally well to understand what they are doing “right” that other businesses could adopt. This attention to success is also atypical of most management groups; there is more focus on failures. A third practice is some form of irregular, informal interaction between senior managers and people working lower in the business. These meetings both encourage innovation across the hierarchy, but also gives the senior managers insight into opportunities as viewed by people close to the products, services and processes of the company. This last practice is less about actually getting innovative ideas than insuring that the importance of innovation and entrepreneurial thinking spreads throughout the organization.

 

Drucker believed that most entrepreneurship occurred in medium to large businesses, but that those efforts needed to be separated from the regular management of the company. In the simplest of terms, the executives in charge of existing businesses or products, will have neither time nor understanding for the…project. They cannot afford to be bothered. A second reason to segregate new business from old is to spare it the wrong scrutiny and expectations until it is mature enough. Both the investment in a new product line and its return should…not be included in the traditional return-on-investment analysis until the product line has been on the market for a number of years. Many policies make little sense when applied to a new business. For example, a bonus dependent on ROI will be demotivating to employees of a venture in its growth phase that must reinvest cash flow to support the business’ needs.

 

Numerous authors attribute entrepreneurship to people and their personalities – an attempt that Drucker rejects. While it is easy to show that some styles will inhibit innovation, it is hard to show that any style will promote it. This is why Drucker thinks that policies, practices and structures are important to an organization that desires innovation and entrepreneurship. In a similar way, it does not seem that any particular kind of formal training favors entrepreneurial thinking. Within large organizations, many sorts of people develop and build new business ventures.

 

Many companies have tried other approaches to innovation, but failure is more common than success. For example, large companies often try to buy innovation by acquiring an innovative company. They then apply their standard policies and inadvertently suppress the innovative effort. Similarly, joint ventures between established and entrepreneurial companies struggle to find a mutually acceptable way of working together. An organization that wants innovation will have the greatest success if it creates the appropriate policies within its own business and separates it from the routine structures of the company.

 

A section of the book is dedicated to entrepreneurship in the form of a new venture – the start-up. Drucker suggests that there are four requirements for success.

• A new venture must be focused on the market. The key is to pay attention to the users and their needs. Many products and services have been introduced intending to serve a particular customer, but only found success when the venture found a different customer who valued the offering more. Entrepreneur/inventors often resist shifting to a new customer group. The inventor of Novocain never imagined it being used by dentists and campaign actively against its use by them. Because they “know” what their product is for, they do not want to sell it to the wrong people. The textbook prescription for this problem is “market research.” But it is the wrong prescription. One cannot do market research for something truly new. Market research is limited by assumptions that are linked to the present state and do not anticipate how the new offering will be adapted by “non-customers”. For example, Univac in 1950 predicted a global market for computers of about 1000/year in 2000, but many kinds of people and businesses found uses for computers: there were over 1 million computers in use in 1984. The new venture therefor needs to start out with the assumption that its product or service may find customers in markets no one thought of, for uses no one envisaged when the product or service was designed, and that it will be bought by customers outsides its field of vision and even unknown to the new venture.
• A new venture needs strong financial foresight. The key problem is that success will create demands for further financing that the nascent business can’t support. A new venture must worry less about profit than cash flow. As much as possible, financing should be in place before it is needed, because when the need comes the managers will need to focus on serving increasing demand – not finding money.
• A new venture must put a strong management team in place before the organization needs management. It takes time for a group of people to form a team, so it can’t be done at the last minute. Founders must be willing to surrender some control to others and failure in this activity dooms many promising companies - or leads to the ejection of a founder. Each venture is different, so the skills required by the leaders also differ.
• A new venture needs outside advice. This need not be a board of directors, but insiders need outsiders to help provide perspective and to challenge insular thinking. This may seem like a trivial thing, but inability or refusal to listen to others is usually a fatal mistake.

 

ENTREPRENEURSHIP - Strategies

Drucker identifies four basic entrepreneurial strategies, which may be used singly or in combination. In every case, the desired outcome of the strategy is to establish and maintain leadership in the arena of the innovation.

• Be the first with the most. The basic idea to be first and create an overwhelming advantage to deter competitors. Thought by many to be the best entrepreneurial strategy it may actually be the most difficult and highest risk approach. Though risky, success is highly rewarding. A successful position can be defended for decades. However, it requires a degree of precision. Small mistakes can leave opportunities for others to find the “real” opportunity and be there first.
• Creative imitation combines an element of copying parts of an innovation with an element of creative change. For example, IBM copied the idea of a personal computer from Apple, but creatively realized that users wanted software to use the computer as much as they wanted the machine. By offering a package, IBM catapulted off of Apple’s success. One of the requirements of this strategy is that the first innovator (Apple) be successful. Their success is the foundation for the contrast (creative part) that is offered to customers. Often creative imitators take an innovation to a new audience or application that the original innovator ignored.
• Entrepreneurial judo is the idea that most organizations are stuck in their ways. For example, AT&T invented the transistor, but was not an electronic component manufacturer. It sold the patent for $25,000 to Sony. Sony used the transistor to introduce a portable radio; something that was not possible for companies building radios with vacuum tubes. Those companies (RCA, for example) were very proud of their technology and quality, and would not degrade their brand with a low quality transistor radio. This arrogance was their undoing. Drucker observes that arrogance and pride are highly predictable aspects of successful companies and set them up for entrepreneurial judo. This is by far the lowest risk strategy. Companies that are set up to be thrown practice such things as aversion to ideas “not invented here”, a tendency to collect the cream off the market by focusing on the top end of the market, a focus on “quality” which is unrelated to the customer’s definition of value, and dedication to the idea of a premium price. A final problem is a tendency to try to serve every possible customer with the SAME product or service. Inevitably, this dissatisfies everyone and creates opportunities for entrepreneurs to offer a simpler and more effective product. Entrepreneurial judo is always market focused and market-driven.
• Niche strategies succeed by narrowly focusing on a particular market dynamic. One niche strategy is a sort of toll gate strategy where the entrepreneur supplies some form of vital service for others. There is a strong network effect that protects the occupant and there seems like little reason to seek competition with the niche occupant – as long as pricing seems fair. For example, there is a sealant used to prevent leaks from steel cans. One company supplied this product to canners. It is necessary for a good can, but contributes a nearly meaningless additional cost per can. A company that uses this strategy is bound to its customers and grows and fails in proportion to their business. A second niche-based strategy is to employ a specialty skill. The book does not use this example, but there is a business that offers the specialty skill of putting out an oil well fire. Imploding buildings is a similar specialty skill. Demand is limited, but few companies want to develop the required skills for occasional needs. This niche may develop early in the life of a technology (used in the widest meaning of the word) when nobody really understands what is going on. In many ways, competition ceases once the skill is developed. However, this strategy is at risk when the technology continues to develop. The skill-niche occupant must be upgrading their skills as fast or faster than the customers they serve. Specialty skill companies often serve other businesses rather than end users, so are also subject to the fortunes of their customers’ ability to serve end-users. In a recent example, the problems at General Motors has disastrous effects on their specialty parts suppliers, some of whom went bankrupt. The final niche strategy is based on specialized market knowledge. For example, in the 1950-1970 period American Express developed an in-depth understanding of travelers that allowed them to introduce traveler checks. They were able to use their existing worldwide travel office network to offer a financial service to travelers. The specialty market niche has the same requirements as the specialty skill niche: systematic analysis of a new trend, industry of market; a specific innovative contribution, if only a “twist”…and continuous work to improve the product and especially the service; so that leadership, once obtained, will be retained.
• The previous strategies involved offering a new product or service. A different approach might be to use a different strategy to deliver an existing product or service. New strategies might involve greater convenience (big box retail, Amazon.com), better pricing (Walmart, Aldi), adjustments to the nature of a customer’s use (aircraft leasing to spread payments over time) and a focus on customer value. In fact, all of these strategies involve a better understanding of what customers value. The idea that customers with buy something in order to complete a certain job that is valuable to them is embodied in these strategies. For example, Xerox realized that companies did not want copy machines – but they did want copies; Xerox asked customers to pay them per copy made.  When a strategy develops based on deep customer understanding, rewards tend to be high. However, many companies think that their idea of customer value dictates value and are disappointed in the end. Manufacturers are wont to talk about the “irrational customer”….But there are no “irrational customers”….”There are only lazy manufacturers.” The customer has to be assumed to be rational. His or her reality…is usually quite different from that of the manufacturer….The innovative strategy consists in accepting that these realities are not extraneous to the product, but are…the product as far as the customer is concerned. Whatever customers buy has to fit their realities, or it is of no use to them. Drucker clearly thinks that most companies miss the huge opportunities that arise from customer and market understanding. These strategies work, not because they are clever, but because most suppliers – of goods as well as of service…do not think. They work precisely because they are so obvious. Drucker goes on to say that many people object that this is basic marketing and nothing special. He’d agree that this was true if only companies acted like it was true.

 

An innovation is a change in market or society. It produces a greater yield for the user, greater wealth-producing capacity for society, higher value or greater satisfaction. The test of an innovation is always what it does for the user. Hence, entrepreneurship always needs to be market-focused, indeed, market-driven. The book concludes by observing that an entrepreneurial society places different demands on people than a non-entrepreneurial one. In traditional society, you learn what you need to function by age 21 and society is essentially stable. In an entrepreneurial society, learning is continuous. Society is changing constantly and expert knowledge becomes obsolete. We need to encourage habits of flexibility, of continuous learning, and of acceptance of change as normal and as opportunity – for institutions as well as for individuals.

 

Comment & Interpretation

• I first read this book in the early 1990s and thought it was pretty interesting then. I have read a lot of books since. On re-reading this book, I am realizing how many of these books are essentially sequels to this book. Entire consulting practices and “tools” are based on concepts from this book. And yet, they have also taken some of the sting out of the book as well. Drucker makes it perfectly clear that what is required is observation and thinking, and not all managers seem interested in this effort. I began to notice how many times he said that managers need to “take it seriously” which contains an implication that this is not the common response.
• One example of a topic that was made popular later was job-to-be-done, a concept that is explicitly mention in this book (the section on process need). Drucker also talks about this in the section describing the problem of the mismatch between the perceptions of what value a customer and supplier see in a transaction.
• Drucker is fairly blunt about the status quo bias of the managers at leading companies. On one level, this complaint is fair in that the incumbents are over-confidant in their established positions and fully aware of how difficult it is for a true head-to-head competitor to gain ground in the market. Drucker’s point is that problems don’t come from head-to-head competitors, but from end-around competitor who find a “new” customer right under the nose of the incumbents. The “new” customer may be an “old” customer – but with an unserved need. But I also think that managers are under great pressure to serve old customers more efficiently rather than find and serve new customers. Public companies are pressured to predict and then meet those predictions. New customers are not that predictable and thus risk “not meeting expectations”. Something similar probably exists in private companies whose owners compare their holdings to public companies. Nobody escapes this expectation trap and not meeting expectations is punished quite harshly; nobody gets credit for trying and almost succeeding. Managers learn this lesson quickly. Even competitive analysis is distorted by this perspective. New entrants are dismissed as sub-scale, lacking the full range of products and services, or failing to meet some basic need of the customer. As I write this, I think about the various explanations offered for why Amazon would not succeed (people want to touch what they buy) and which missed the value of the offer (Amazon actually has my book and the local Borders does not).
• The interesting thing about changing market structure is that it probably actually changes before the change is visible. I am thinking about the invasion of Japanese cars in the 1970s. US car companies vehicle quality had declined (and every consumer knew it), cars were big and consumed lots of gas (under 20 mpg), and were increasingly expensive. Though Japanese cars had a poor quality reputation (based on stereotype), young buyers could afford them and learned that the quality was actually superior to US cars just as the price of gasoline jumped 40%. US car companies assumed that their “quality” and brands would protect them, but these new buyers had found an alternative.   The full effects of the Japanese invasion would not be clear for nearly 10 years – and US car companies have never really recovered their dominance. A similar story can probably be told about Blackberry. Some food brands may now be in this situation.
• Drucker comments on the difficulty of judging a new venture in an environment of mature big businesses. For managers, it seems so much safer to invest in the current predictable business than in the uncertain future business. I also wonder if this problem is an expression of a combination of status quo bias and loss aversion. Managers think that the current business will continue as it is forever (and even grow because it has in the past), when it may have passed its peak. They invest to defend the business more than they invest to replace the business because they are more comfortable with the status quo and want to protect the old investment. The temptation… is always to feed yesterday and to starve tomorrow.
• We realized that everything that we’d assumed. Everything that we were so absolutely certain of was wrong. The quote from an IBM employee about their reaction to the early success of personal computers says a lot about how business then and now perceive customers and opportunity. It is dependent on supplier logic instead of user logic combined with a bias that assumes that the present situation is stable and perhaps “optimal”. There seems to be resistance to going out and spending time with users to learn their logic. Even focus groups, which would seem to serve this purpose, fail because they take the user out of their environment where they actually operate. I harp on this because there is a risk that market research data will mislead innovators. It describes the status quo (or often the past instead of the present but does not describe the sources of change and disruption for users. Thus IBM was surprised because they thought they understood that a rational consumer would not buy a low performance personal computer and failed to understand that any computer outperformed a typewriter.
• Drucker does not spend much time on the problem of market research, but the problems inherent in collecting and interpreting market research data are considerable. Any valid market data describes the past, not the present. If the only source of insight into the needs of customers is market data, it will be hard to innovate. Market data rarely addresses “why” customers act. Market research firms that offer explanations often expose their unfamiliarity with the details of those markets, and thus decrease the credibility of their insights. This may be why it is so important to directly observe users to understand the link between what they do and why they do it. These motivations are usually the real job-to-be-done that create value upon completion.

 *text in italics is directly quoted from the book