Why Innovation Investments are More Important than Ever During Economic Uncertainty

Why Innovation Investments are More Important than Ever During Economic Uncertainty
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Companies that invest in innovation during economic downturns, realized outsized long-term growth rates according to McKinsey research.

Many companies are tightening their belt in what has been predicted to be the year of austerity. While defensive measures may be warranted, the question is which budgets will be cut? Your company’s innovation program may be vulnerable to the outdated notion that innovation is a luxury only to be afforded in a bull market. Whereas the truth is the exact opposite — history shows that the innovative bets made during times of uncertainty and crisis often lead to breakthrough products and services that yield big returns and a stronger market position. “Prioritizing innovation today is the key to unlocking post crisis growth.” As the late Brazilian race car champion Ayrton Senna once said, “you cannot overtake fifteen cars in sunny     weather, but you can when it’s raining.” 

If you’re responsible for your company’s innovation program you already know that innovation is necessary in a business landscape rife with disruptors and rapid technological changes that can quickly drive your products and services into extinction. But leadership may need a reminder that this is the time to double down, not cut back, on your company’s innovation program. 

In this blog we’ll share our top ten takeaways from a recent McKinsey article on innovation that you may want to share with colleagues as a reminder that innovation is now more essential than ever. In fact, companies like Amazon, Chipotle, Pfizer, Toyota and many more have consistently funded innovation to fuel their growth. The article echoes our view at Brightidea that innovation has become an essential, even prudent, growth strategy in this time of rapid change and uncertainty.

1. Companies that invested in innovation saw 30%+ increase in their CAGR.

It’s important to balance short term investments with breakthrough bets. In McKinsey’s 2021 New Business Building Survey, respondents reported that, on average, they expect half of their revenues in the next five years to come from entirely new products, services, and businesses. “As customers’ demands change, over indexing on small product tweaks (that address needs which may be temporary) is unlikely to boost long-term performance. However, “renovations” to designs and processes can produce savings that help fund longer-term investments in innovations that may create routes to profitable growth.”

Sustained resilients' that lead on both growth and productivity build the largest performance gap

It’s important to note, as this chart from McKinsey indicates, that the investments companies made in innovation take time to accrue. Investments made in 2007 begin to separate those companies’ performance in 2011 which according to this study demonstrates a 4 year path to ROI. Innovation takes time, but the juice is worth the squeeze if your company has the discipline to stick with it. After year 4 the +30% enhanced CAGR quickly begins to compound into market dominance.

If your team is a bit less patient to see ROI, there are some innovation initiatives that support quicker returns. Scheduled innovation events are a great way to focus a team’s attention on generating short term innovative solutions or refinements. But breakthrough ideas tend to emerge when least expected and will require more time and resources to develop into new products and services that make it to market, and therefore require investment in an innovation software platform.

2. Some innovation activities outperform others, and may not be obvious at first glance.

Now that we can agree that investments in innovation are worth it… the next question that arises is, “What are those companies investing in?” Or, to put it more plainly, “What the frick are those guys doing?!!” Luckily, McKinsey breaks out the most common innovation activities across the outperforming cohort of companies investing in innovation.

Economic Outperformers

Some of the innovation investments above seem obvious when broken out; such as, increases in R&D Spending and acquisition of new IP. Afterall, this is how Pharma creates new revenue from drug and therapy research and how Oil and Gas companies find new ways to extract petrochemicals via new techniques like fracking. Acquisition of IP also rings true when we consider all the M&A that took place over the last decade in the tech sector.

The less obvious, but most impactful investment that these companies made was to create a dedicated innovation group. Unfortunately, investing in a dedicated innovation group is often the missing leg of the strategic innovation stool. If we take a step back and utilize first principles thinking, if innovation investments have the potential to yield a 30% CAGR over the rest of the market, and we see this to be true, then why wouldn’t innovation warrant its own business unit and strategic focus?

The answer is obvious, and the data above supports the case. The real issue is the counterintuitive logic to invest when times are tough. It goes against conventional wisdom of cuts and austerity measures, but the brave who do stay the course are rewarded with market dominance.

3. Balance your defensive and offensive strategies.

McKinsey’s research shows that companies tend to fall behind if they focus solely on avoiding the downside. “Since the start of the Great Recession in 2008, North American and European companies that controlled operating costs while also prioritizing revenue growth have delivered far more value to shareholders than their industry peers.”

Through-cycle outperformers achieved high excess TRS during downturn and recovery

The same research on corporate resilience shows that companies solely in defensive mode tend toward median performance, whereas companies solely in offensive mode experience a mix of big wins and losses. The data points to the merit of a middle ground approach.“The best leaders and companies are ambidextrous: prudent about managing the downside while aggressively pursuing the upside.” These “ambidextrous leaders create value despite volatility, setting up their organizations to thrive in a world that has likely changed in fundamental ways.”

According to Professor of Strategy & Innovation at Boston University, Siobhan O’Mahony, and Strategy & Innovation Research Assistant, Veronica Escobar-Mesa, “Many leaders consider innovation projects easy candidates for cost-cutting, as their impact on current operations is perceived to be minimal. This is called the “threat rigidity effect” where organizations become rigid rather than adaptive in threatening situations (Staw et al., 1981). When confronting a threat to existing operations, two challenges emerge.

First, leaders tend to restrict information processing — narrowing their field of attention and reducing the number and range of information channels used. But this can be counterproductive and hamper the ability to recognize and adapt to changing conditions.

Second, leaders often create new controls that concentrate power at higher levels of the hierarchy, inhibiting agility and adaptation to new circumstances. These responses may insulate the organization from immediate failure but may be maladaptive when fundamental changes are needed to align the business with the demands of the future.”

It is imperative not to fall victim to the conventional wisdom of cost cutting in a downturn. If innovation investments are curtailed, you are giving your competitors that stay the course a dramatic advantage that you will not be able to overcome in the future. The inertia built up from compounding benefits will put your business at a perpetual disadvantage even if you attempt to catch up when the economy improves.

4. Big innovation bets may now be safer than investing in incremental changes.

Incremental changes are essential but merely maintain the status quo. No company can afford to sit idle or rest on the laurels of past successes. When it comes to incremental changes, you may already be using a methodology like Lean or Agile, which are well suited to these smaller, more manageable, refinements. However, for quantum leaps that defy business as usual processes, such as a new product or service that requires significantly different sales, marketing, or operational tactics to be successful, a longform business narrative Memo Program is required to seek truth and allow the best ideas to win.

“Innovation has always been essential to long-term value creation and resilience because it creates countercyclical and non-cyclical revenue streams.” Counter-cyclical revenue streams are those that do well in economic downturns, since demand for these products and services continues regardless of the economy. In other words, these products and services are better able to weather the uncertainty of our time. The high performing companies from this report diversify their revenue streams in order to catalyze new growth and safeguard against disruption.

Disruption Increases 2023

5. Optimize for change rather than the current reality.

Change is the new constant, and if the pandemic has taught us anything it’s that big, structural, changes can happen much quicker than we thought. “Companies that are optimized to a specific set of global conditions are more vulnerable to the sea change underway and need to invest more, not less, in innovation to open new paths
“Challenges should align with identified needs of the business. Without that alignment, ideas—no matter how good they are—may never move to implementation.” of viability.” The steadily decreasing lifespan of companies on the S&P 500 is a cautionary tale about disruption and the high cost of deprioritizing innovation. According to research conducted by Next Gen Personal Finance, “at the current churn rate, about half of S&P 500 companies will be replaced over the next ten years.”

A climate of uncertainty is the perfect time to prepare for change and explore opportunities outside of your core business. Scheduled innovation events like brainstorms, hackathons, and pitch competitions can provide a quick injection of fresh thinking into your organization.

There’s also a regular need to capture ideas across the organization that arise organically. Idea management software empowers your entire workforce to collect, share, evaluate, and develop ideas, filling your company’s pipeline with valuable bets. Idea management software also helps ensure promising ideas get captured and developed into longform business narrative proposals so they stand a chance of turning into a commercially viable product or service.

A mass extinction of established organizations

6. Place a bet on sustainability.

A sustainability initiative is table stakes for what it means to be a responsible company in the 21st century. The goal in developing sustainable business practices is to create strategies that preserve the long-term viability of people, planet, and profit, otherwise known as the triple bottom line.

Companies like Panera Bread, Yeti, and Colgate-Palmolive are showing that sustainable innovation is a key priority, paving the way for other companies to commit. Not only do these practices improve our collective well-being, but they also enhance your brand, improving trust with customers, your workforce, and shareholders. In fact, according to Harvard Business Review, “corporate leaders will soon be held accountable by shareholders for environmental, social, and governance (ESG) performance—if they aren’t already.” Your company also becomes a more desirable place to work as many employees seek out companies with sustainable business practices.

“Today, the sustainability imperative is driving many such innovation bets…Sometimes, regulations can spur innovations in adjacent markets. For example, tax credits under 45Q, a section of the US federal tax code enacted in 2008, encourage investments in carbon capture and storage. The Inflation Reduction Act of 2022, meanwhile, creates opportunities in sustainable fuels and chemicals for firms that can leverage these incentives to build new businesses.”

7. Consider adopting a new business model.

Some innovations won’t fit into your current business model, but this shouldn’t disqualify them — new business models are needed as times change. Consider the evolution of Amazon. Amazon is not just a B2C marketplace, it’s also a streaming service, a B2B cloud service provider, as well as a B2B affiliate platform. Most of Amazon’s revenue now comes from Amazon Web Services (AWS), which provides hosting and cloud services to hundreds of thousands of companies worldwide. This is a huge shift from Amazon’s start as an online book retailer. 

New business models are common outcomes from major economic downturns. For example, the 2008 financial crisis gave birth to the sharing economy as companies such as AirBnB, Uber, and ZipCar, among many others, turned idle assets into profits. 

“Adopting new business models can enable companies to put more core competencies into play than investments further afield while also making the organization more adaptable and generating new growth.” Each business line will have its own unique vulnerabilities to external conditions, but in aggregate your company will diversify risk. 

Entering new markets and launching new business lines that call for new revenue models is a huge undertaking that benefits from a process that can handle that level of complexity. Consider adopting a Memo Program for navigating such fundamental and far reaching changes that can be disruptive to the company during times of transition and may create resistance from existing stakeholders. By leveraging the same longform written business narrative techniques pioneered at Amazon to help them navigate disruptive innovation bets, your team will think clearly about the opportunities presented and seek truth about how to invest the company’s resources.

8. Invest in partnerships or acquisitions.

Partnerships can be a highly effective growth channel. Smart companies leverage partnerships to acquire customers and enter new markets. “Over the past three years, top economic performers have doubled down on investments in new partnerships. Alliances and joint ventures can enable large companies to rapidly scale new business models or offerings that would take a long time to develop organically.”

Top economic performers were more effective at partnering with other organizations from 2020-22

Sometimes it makes more sense to acquire a company than form a partnership. Many start-ups will struggle in the current economic climate to procure capital. This puts your company in the position of being able to fill in this funding gap on favorable terms, while gaining access to new technological capabilities. The Brightidea Scout App can help expedite the process of identifying companies with the capabilities you need to enter new markets.

9. Companies that invest in innovation outperform those that do not.

McKinsey’s research reveals that, “organizations that prioritize growth and innovation during crises tend to leap ahead of competitors that retrench.”

Innovation leaders have increasingly outperformed competitors over the years overall

Boston Consulting Group has similar findings: “In the years following the financial crisis of 2008–2009, the publicly traded members of Boston Consulting Group’s 2007 ranking of the 50 Most Innovative Companies outperformed the broader market on shareholder return by 5.6% a year through the end of 2019.”

Tracking the ROI from your innovation investments is table stakes, not a nice to have, when making the case for sustained investments.

The data tells a clear and compelling story about the value and competitive advantage of innovation. But more than anything else, enrolling leadership in investing in your innovation program requires demonstrable results.

Our Idea management software provides a system of record to track the ROI of your innovation investments, helping demonstrate the value of the program and enabling you to refine your process. You’ll be able to see which teams contribute the most, as well as which initiatives have had the most impact in terms of revenue, market share, churn reduction, or whatever other metric you’d like to evaluate them by. You can even create and track the ROI of custom categories such as sustainability or DEI initiatives. 

With conviction in strategic innovation investments and software that can not only track your innovation results, but encourage and streamline the innovation process, your company can innovate with confidence throughout cycles of uncertainty and crisis to unlock post crisis growth.