Most of the leading developed countries have announced national initiatives to promote innovation in their markets, which have been strongly reflected in efforts by leading manufacturing companies. Recent research by PA Consulting Group (PA) showed that nearly three-quarters of the top-performing companies in the automotive, process industry, food and beverage, fast-moving consumer goods, and general engineering/ conglomerates sectors have adopted an innovation programme as a key strategic initiative.
Additional research by PA confirms the link between innovation and the ability to create shareholder value. The companies that created the highest value were those that developed an innovation strategy focusing on areas that added value as well as variety. They generated 9.9% higher Total Shareholder Return (TSR) than their peers.
Surveys by Fortune magazine and Harvard Business Review support these findings. They found that innovative companies not only have healthier growth rates, but also deliver twice as much TSR as the industry average.
The dilemma for manufacturers
As they seek the rewards of innovation, managers in manufacturing face an increasing threat from low-cost countries. They offer not only lower labour and infrastructure costs than western countries, but also growing labour skills and improving technology. On top of this general challenge, the automotive industry faces a particular problem. Its customers are demanding more and more electronic or safety features.
Air conditioning, ABS, and ESP have become standard items. But the average price of a passenger car rose by only 1.2% a year during the 1990s, and it is expected to grow no faster until 2010. If these market conditions continue, car makers will be forced to offer better and better cars to their customers and keep little of the extra value for themselves.
Although business executives acknowledge the long-term benefits of innovation, they are caught by the need to cut cost in the short term. Most of the manufacturing companies have initiated major cost-reduction programmes: VW has implemented ‘Four Motion’ to save €3.1bn; BMW has announced cost-reduction initiatives of several hundred million euros to offset the impact of raw material cost increases and currency movements; GM has asked Opel in Germany to lay off 12,000 people to stay competitive; and Cadbury Schweppes has launched a €600m cost-saving programme.
Although there are many corporate-led innovation initiatives, companies (and, in particular, individual business units) do not have the funds available to carry them out. Moreover, short-term cost cutting and performance improvement projects divert companies from building successful innovation pipelines.
So how can business leaders overcome this dilemma? How should they meet their urgent need for short-term cost saving and still make essential long-term investment in innovation programmes?
Success means combining creative performance improvements and innovation. Our analysis of high-performing companies shows that cost reduction need not conflict with innovation. On the contrary, the two should run in parallel. Instead of traditional cost reduction from laying off thousands of people or closing plants, successful companies conduct a balanced programme combining creative performance improvement and short- and long-term innovation projects. PA analysed the ROE and TSR of the top ten companies in each manufacturing sub sector – automotive, process industry, FMCG, food and beverage, general engineering. The top companies outperformed their rivals both in adopting innovation and applying creative performance improvement programmes.
Five key lessons can be taken from these successful companies (see lessons 1-5)
There is no contradiction between cost cutting, performance improvement and innovating products, services, or even entire businesses. Successful companies have proved that the route to success is the exploitation of both sources of value-creation potential. The answer to the apparent contradiction is a strategy-led programme, which combines creative and smart performance improvement measurements with focused innovation initiatives. It is entirely possible to save money on today’s operations and invest prudently in tomorrow.
Lesson 1:
Question the value of traditional cost-reduction programmes
Although cost-reduction programmes provide a short-term relief both in operational performance and short-term success in capital markets, they often undermine the long-term competitiveness of a company. Typically, the stock market’s euphoria at the company’s short-term financial improvement fades, while the cost-cutting programmes continue to starve innovation – the oxygen of long-term competitiveness. By the time they reach the middle of their term, traditional cost-cutting measures will usually destroy rather than create value for a company, by:
- preventing people from risk taking and creative thinking – both essential success factors for innovation
- creating an efficiency loss of up to 15%, because they make staff focus on internal issues rather than market-facing activities
- making the best people leave the firm (labour law, particularly in continental Europe, tends to protect low-performing employees rather than the high performers)
- lowering the company’s image and appeal in both consumer and labour markets
- demonstrating the company’s failure to put cost pressures on suppliers.
Originally praised as a new Messiah in the automotive industry, Jose Ignacio Lopez’s cost-reduction programmes failed both with GM and VW. Although he gained significant short-term cost reductions, the long-term effect of these programmes has been negative. In addition, Opel in Germany is still suffering from quality problems and a damaged image that was created in
the 1990s.
Lesson 2:
Make innovation reflect the strategic position of the business
Business innovation covers three distinctive areas, which are the main sources of competitive innovation and value creation:
- products and services
- customer and markets
- technology, organisation, and the business model.
Successful companies tackle all three areas at the same time. They understand that they could gain the greatest competitive advantage from a combination of two areas – such as a new product on a new production technology – or even all three.
Secondly, companies have to align their innovation programmes with their strategic positioning in the market place. Basically, there are three distinctive positions: Cost leadership; Customer leadership; Technology and quality leadership.
Within each strategic position, exploiting innovation as the main source of value creation clearly requires different mindsets and capabilities. However, many companies do not focus and develop their resources sufficiently to achieve strategic innovation and the extra value that goes with it.
Lesson 3:
Introduce creative performance improvement programmes which contribute to short-term requirements
Although one might doubt the merits of traditional cost-reduction exercises, all companies still face consistent pressure to improve their cost base to stay ahead of the game. This is just as true for innovative companies as for conservative ones. The difference is that innovative companies all apply distinctive performance improvement measures and initiatives.
These often focus on incremental changes, but also incorporate structural approaches reflecting an entirely new view of the business. The difference between these ‘smart’ initiatives and traditional cost initiatives is that the smart ones draw very much on the involvement of people and on creative approaches for differentiation. Examples of such innovation come from companies such as General Electric, Caterpillar, Bosch and Nissan.
Such initiatives not only improve companies’ performance, but also build the foundation for innovation itself, as they: Foster creativity, risk-taking, and forward vision; Encourage people to try new ways of thinking; Build the performance level or organisational structure to encourage innovation.
Lesson 4:
Implement short-term innovation initiatives balanced by longer-term programmes
Innovation programmes often face the dilemma that, although they are regarded as crucial to long-term success, they may not pay off in the short term. A feasible answer to this challenge is to view innovation not only as a long-term initiative, building the ground for sustainable success, but also as a set of measurements of benefits in the short term. Innovation programmes for the short term usually focus on process issues, either to stimulate innovation or to build competencies for new products and services to grow the top line.
Typical short-term initiatives include: streamlining new product development and commercialisation processes; getting customer-facing people and R&D people closer together to share common language and tools. This will enable the company to translate customer trends into specifications, which the technical people understand and could translate into new product features and processes and vice versa; reorganising the R&D assets for better usage as well as realising the benefits from global R&D presence; pro-actively using customers and suppliers to stimulate short-term innovation; upgrading existing products and services to grow the top line; and providing existing products and services to new market segments and/or channels.
Although short-term innovation initiatives create short-term benefits, which justify further investments, companies must simultaneously embark on more long-term programmes in order to stay ahead in the innovation race. Typically these programmes comprise
- Creating insights into future customer trends and technologies to recognise and exploit opportunities from both sources
- Investing in the development of new technologies to create a superior position – Bosch Automotive is a prominent example of a long-term innovation approach: it invests almost 10% of its sales in R&D; 2% and more above its peers. Bosch is regarded as one of the leading technology suppliers in the automotive industry with the ability to command the highest margins
- Identifying and bundling capabilities of the company in a way that creates a new business system as well as superior value to customers. For example, Lou Gerstner refocused IBM from a mainly manufacturing-focused company towards a solution and service provider. Now IBM´s offers range from manufacturing servers to software design, IT outsourcing, and consulting. This included massive reorganisation effort as well as educating staff and acquiring new capabilities.
- Building networks with universities and organisations outside the industry for further breakthrough innovation. For example, BMW recently announced a programme based on a network of universities, venture capitalists, and innovative suppliers and outside industry organisations to develop fresh and innovative thinking.
- Creating an innovative company culture. It is vital to ensure that innovation is not perceived as something special, but part of day-to-day work by both management and staff. This has to be reflected in performance systems and a risk-taking culture, as well as in internal processes and collaboration.
Lesson 5:
Allocate resources to innovation projects with the greatest value-creation potential
A key finding of PA’s growth survey was that successful companies invest more in healthy performers than in loss-making businesses. Unless they can achieve a turnaround, they will not invest in trying to grow loss-making businesses, since this is the fastest way to destroy value. They apply the same principles in allocating resources – manpower and financial – to innovation projects: they invest only in projects with value potential.
At a corporate level, managers have to consider the performance and core activities of the business. This means: investing in performing businesses with the biggest value potential; fixing a loss-making business first, before agreeing further investments; avoiding investment in businesses where products or services have become commoditised for customers, unless they can prove that these investments will lead to a step change in competitiveness; using cost savings to reinvest in innovation programmes. In Cadbury-Schweppes’s cost saving and performance improvement programme, already mentioned, one-third of the intended €600m savings will be used for accelerating innovation and marketing.
On a business unit/product level, similar considerations apply: investment should be focused on products with the biggest value potential, either through achieving premium margins or winning market share or both; commodity products should be shifted from high-cost to low-cost countries; investment in commodity products should be made only if they have a significant differentiation potential which might allow them to earn premium margins.
