Friday, December 31, 2010

Historical Research: The Canal Builder

How DeWitt Clinton's Erie Canal changed the financial landscape.

Research Magazine
December 1, 2009 | By Kenneth Silber
DeWitt Clinton (1769-1828) was an early American politician who transformed the country in far-reaching ways -- physically, economically and financially. He was the driving force in building the Erie Canal, a massive engineering achievement that helped make Wall Street into a major financial center and the United States into an economically dynamic nation where investors would want to put their money.
Clinton served at various times as governor of New York state, mayor of New York City, U.S. senator and member of the Erie Canal commission. … He was an intellectual with interests ranging from rattlesnake biology to the history of Native Americans. He also was imperious and abrasive. …
Among Clinton's accomplishments were improvements in public education, sanitation and city planning, reforms of criminal laws and helping found and promote cultural institutions such as the New York Historical Society. But his lasting place in history comes primarily from his role in spearheading development of the Erie Canal, notwithstanding the skeptics who called it "Clinton's folly" or "Clinton's ditch."
Large-Scale Project
In 1810, Clinton, who had served intermittently as mayor, was picked by the State Legislature to be one of the first members of the Commission to Explore a Route for a Canal to Lake Erie and Report, which would go through various unwieldy names and become known as the Erie Canal commission.
Erie Canal Map, 1853.Image via WikipediaThe idea of opening America's interior through a canal linking upstate New York to the Great Lakes region had been floating around for decades. … A more ambitious plan would be to connect Lake Erie to the Hudson River.
That, however, would mean crossing hundreds of miles of often difficult terrain, passing through swamplands and cutting through rock ridges. …
Clinton spent the next few years campaigning for an Erie Canal, arguing that New York state should build the thing without federal help if necessary. In 1817, a veto by President Madison showed that this was indeed necessary. But that same year, the State Legislature passed a Canal Act, and Clinton, his career increasingly connected to the issue, became governor. Overturning some soil with a shovel, he promised that the huge undertaking would be done in 10 years. It ended up taking just eight.
Buy Canal Bonds
The canal's projected cost was $7 million, a stupendous sum. New York state issued bonds on an unprecedented scale, while also taxing land, salt and other items in the canal area so as to have ready cash to service the debt. Relatively small investors provided a substantial portion of the initial capital. An 1818 bond issue attracted 69 subscribers, with 51 investing less than $2,000 and 27 investing less than $1,000. The Bank for Savings, an institution set up with Clinton's encouragement to serve small depositors, became a major buyer of canal bonds as well.
With construction moving fast and the canal demonstrating itself to be a reliable generator of interest payments, wealthier individuals and institutions increasingly got in on the action. By the end of 1822, John Jacob Astor owned $213,000 of canal bonds. Foreign interest grew as well, as Barings and other British firms became big buyers of canal paper. The London Times opined that the canal would turn New York City into the "London of the New World."
That would prove accurate. Once the 363-mile-long canal was completed in 1825, New York was essentially guaranteed preeminence as the nation's top commercial and financial city. … Moreover, the city's banks and investors had gained sophistication in dealing with financial instruments such as canal bonds. This would serve them well in future decades, as railroad bonds and other securities came to the fore.
At the same time, the whole country stood to benefit. Shipping times and costs were slashed. People could move west with relative ease, and substantial cities such as Chicago, Cleveland and Milwaukee would grow along the Great Lakes. And the United States, barely a decade after the 1814 burning of public buildings in Washington, D.C. by occupying British troops, was now a magnet for British and other foreign investment. In the parlance of a later age, the U.S. had become a very promising "emerging market."
Political Twists
Clinton's political fortunes took a hit while the canal was still under construction. He was dumped from the governorship in 1822, after a state constitutional convention changed the term of office from three years to two and canceled his final months. … Clinton was losing a political contest with a faction headed by Martin Van Buren, who would be president years later.
Then his opponents overreached, orchestrating a vote in the State Legislature to remove Clinton from his post as head of the Erie Canal commission. "There is such a thing in politics as killing a man too dead," Van Buren fretted, and he was right. A wave of popular indignation at Clinton's dismissal got him reelected as governor in 1825.
Thus, Clinton was in office in time for the canal's official opening ceremonies. On Oct. 26, 1825 he set off from Buffalo in the boat Seneca Chief, heading a flotilla of vessels that would go through the new canal and then down the Hudson. On Nov. 4, the celebrants passed lower Manhattan and moved onto Sandy Hook, N.J. There, Clinton poured a cask of Lake Erie water into the Atlantic.
Note: The author's interest in this subject is personal as well as professional. His wife C. Brooke Silber, n?e Carter, is DeWitt Clinton's great-great-great-great granddaughter.

DeWitt Clinton Facts

  • George Clinton, from http://library.thinkquest...Image via WikipediaDeWitt Clinton was born in Little Britain, N.Y. to a family that was increasingly politically prominent. His father James Clinton was a Revolutionary War general, and his uncle George Clinton would become governor of New York and later vice president.
  • DeWitt Clinton, one of the first students enro...Image via WikipediaDeWitt graduated on April 11, 1786 from what is now Columbia University, giving a commencement speech in Latin with the U.S. Congress in attendance.
  • Clinton was married twice, first to Martha Franklin in 1796 and then to Catharine Jones in 1819. DeWitt and Martha had 10 children, seven of which were alive at the time of her death in 1818.
  • Worried about a buildup of federal power, Clinton opposed ratification of the Constitution and later argued for narrow interpretation of its provisions. …
  • He served in the State Legislature during 1798-1802 and 1806-1811. … He was mayor of New York during the three separate periods, and was governor of New York twice.
  • In July 1802, Clinton fought a duel with John Swartwout, a friend of Aaron Burr, over allegations that Clinton was trying to ruin Burr's political career through smears. Five shots were exchanged, one grazing Clinton's jacket. After shooting his opponent's leg, Clinton walked off in disgust, saying he did not wish to hurt Swartwout and that he wished "the principal" (Burr) were present as his opponent.
  • Clinton was initially a member of the Democratic-Republican Party that was led in the early 1800s by Thomas Jefferson. However, he ran for president in 1812 as a candidate of the rival Federalists, having broken with his party over the issue of war with Britain. … Clinton won 47.6 percent of the popular vote, to Madison's 50.4 percent.
  • DeWitt Clinton memorial by Henry Kirke Brown (...Image via WikipediaClinton was contemplating another run for the presidency in the 1828 election.
    He died in Albany, N.Y. on February 11, 1828 at age 58, while serving as governor. …
  • A DeWitt Clinton steam locomotive began operating in 1831. DeWitt Clinton High School in the Bronx is one of a number of educational institutions given his name. Various towns and counties in states across America are named Clinton or DeWitt in his honor. A portrait of DeWitt Clinton appeared on a $1,000 bill issued in 1880.
Oil on canvas painting of DeWitt Clinton; size...Image via WikipediaAbout the Author
Kenneth Silber
Senior Editor, Research Magazine
Kenneth Silber is a senior editor at Research magazine. His work on science, economics and history has appeared in a variety of publications, including The Wall Street Journal and The New York Post. He appears on a monthly radio show on the Business Talk Radio Network.
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Wednesday, December 29, 2010

A new way to measure word-of-mouth marketing

Assessing its impact as well as its volume will help companies take better advantage of buzz.

McKinsey Quarterly
APRIL 2010 • Jacques Bughin, Jonathan Doogan, and Ole Jørgen Vetvik

A new way to measure word-of-mouth marketing article, how to measure measuring buzz, Marketing
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Consumers have always valued opinions expressed directly to them. … As consumers overwhelmed by product choices tune out the ever-growing barrage of traditional marketing, word of mouth cuts through the noise quickly and effectively.
Indeed, word of mouth1 is the primary factor behind 20 to 50 percent of all purchasing decisions. … And its influence will probably grow: the digital revolution has amplified and accelerated its reach to the point where word of mouth is no longer an act of intimate, one-on-one communication. …
As online communities increase in size, number, and character, marketers have come to recognize word of mouth’s growing importance. But measuring and managing it is far from easy. … Understanding how and why messages work allows marketers to craft a coordinated, consistent response that reaches the right people with the right content in the right setting. …
A consumer-driven world
… As consumers have become overloaded, they have become increasingly skeptical about traditional company-driven advertising and marketing and increasingly prefer to make purchasing decisions largely independent of what companies tell them about products.
This tectonic power shift toward consumers reflects the way people now make purchasing decisions.2 Once consumers make a decision to buy a product, they start with an initial consideration set of brands formed through product experience, recommendations, or awareness-building marketing. … [Consumers] gather product information from a variety of sources and decide which brand to purchase. Their post-sales experience then informs their next purchasing decision. While word of mouth has different degrees of influence on consumers at each stage of this journey (Exhibit 1), it’s the only factor that ranks among the three biggest consumer influencers at every step.

Exhibit 1: Word of mouth is influential throughout the consumer decision journey.
It’s also the most disruptive factor. Word of mouth can prompt a consumer to consider a brand or product in a way that incremental advertising spending simply cannot. … In the mobile-phone market, for example, we have observed that the pass-on rates for key positive and negative messages can increase a company’s market share by as much as 10 percent or reduce it by 20 percent over a two-year period, all other things being equal. This effect alone makes a case for more systematically investigating and managing word of mouth.
Understanding word of mouth
While word of mouth is undeniably complex and has a multitude of potential origins and motivations, we have identified three forms of word of mouth that marketers should understand: experiential, consequential, and intentional.
Experiential word of mouth is the most common and powerful form, typically accounting for 50 to 80 percent of word-of-mouth activity in any given product category. It results from a consumer’s direct experience with a product or service, largely when that experience deviates from what’s expected. …
… The most common is what we call consequential word of mouth, which occurs when consumers directly exposed to traditional marketing campaigns pass on messages about them or brands they publicize. …Marketers need to consider both the direct and the pass-on effects of word of mouth when determining the message and media mix that maximizes the return on their investments.
A less common form of word of mouth is intentional—for example, when marketers use celebrity endorsements to trigger positive buzz for product launches. …
What marketers need for all three forms of word of mouth is a way to understand and measure its impact and financial ramifications, both good and bad.
Word-of-mouth equity
A starting point has been to count the number of recommendations and dissuasions for a given product. There’s an appealing power and simplicity to this approach, but also a challenge: it’s difficult for marketers to account for variability in the power of different kinds of word-of-mouth messages. … In fact, our research shows that a high-impact recommendation—from a trusted friend conveying a relevant message, for example—is up to 50 times more likely to trigger a purchase than is a low-impact recommendation.
To assess the impact of these different kinds of recommendations, we developed a way to calculate what we call word-of-mouth equity. … By looking at the impact—as well as the volume—of these messages, this metric lets a marketer accurately test their effect on sales and market share for brands, individual campaigns, and companies as a whole (Exhibit 2). That impact—in other words, the ability of any one word-of-mouth recommendation or dissuasion to change behavior—reflects what is said, who says it, and where it is said. It also varies by product category.

Exhibit 2: By looking at impact as well as volume, marketers can measure the effects of word-of-mouth messages more accurately.
Score chart showing the star rating bands for ...Image via WikipediaWhat’s said is the primary driver of word-of-mouth impact. Across most product categories, we found that the content of a message must address important product or service features if it is to influence consumer decisions. In the mobile-phone category, for example, design is more important than battery life. … Marketers tend to build campaigns around emotional positioning, yet we found that consumers actually tend to talk—and generate buzz—about functional messages.
The second critical driver is the identity of the person who sends a message: the word-of-mouth receiver must trust the sender and believe that he or she really knows the product or service in question. … About 8 to 10 percent of consumers are what we call influentials, whose common factor is trust and competence. Influentials typically generate three times more word-of-mouth messages than noninfluentials do, and each message has four times more impact on a recipient’s purchasing decision. About 1 percent of these people are digital influentials—most notably, bloggers—with disproportionate power.
Finally, the environment where word of mouth circulates is crucial to the power of messages. Typically, messages passed within tight, trusted networks have less reach but greater impact than those circulated through dispersed communities—in part, because there’s usually a high correlation between people whose opinions we trust and the members of networks we most value. …
Word-of-mouth equity empowers companies by allowing them to understand word of mouth’s relative impact on brand and product performance. … When Apple’s iPhone was launched in Germany, … its share of word-of-mouth volume in the mobile-phone category—or how many consumers were talking about it—was about 10 percent, or a third less than that of the market leader. Yet the iPhone had launched in other countries, and the buzz accompanying those messages in Germany was about five times more powerful than average. This meant the iPhone’s word-of-mouth equity score was 30 percent higher than that of the market leader, with three times more influentials recommending the iPhone over leading handsets. As a result, sales directly attributable to the positive word of mouth surrounding the iPhone outstripped those attributable to Apple’s paid marketing sixfold. …
Harnessing word of mouth
The rewards of pursuing excellence in word-of-mouth marketing are huge, and it can deliver a sustainable and significant competitive edge few other marketing approaches can match. … [The] incremental gain from outperforming competitors with superior television ads, … is relatively small. That’s because all companies actively manage their traditional marketing activities and all have similar knowledge. With so few companies actively managing word of mouth—the most powerful form of marketing—the potential upside is exponentially greater.
The starting point for managing word of mouth is understanding which dimensions of word-of-mouth equity are most important to a product category: the who, the what, or the where. In skincare, for example, it’s the what; in retail banks, the who. Word-of-mouth-equity analysis can detail the precise nature of a category’s influentials and pinpoint the highest-impact messages, contexts, and networks. …
… Harnessing experiential word of mouth is fundamentally about providing customers with the opportunity to share positive experiences and making the story relatable and relevant to the audience. … [Consumers] are more likely to talk about a product early in its life cycle, which is why product launches or enhancements are so crucial to generating positive word of mouth. Buzz also can be sustained after launch: …
… To create positive word of mouth that actually has impact, the customer experience must not only deviate significantly from expectations but also deviate on the dimensions that matter to the customer and that he or she is likely to talk about. For instance, while battery life is a crucial driver of satisfaction for mobile-handset consumers, they talk about it less than other product features, such as design and usability. …
Managing consequential word of mouth involves using the insights provided by word-of-mouth equity to maximize the return on marketing activities. …. In fact, McKinsey research shows that marketing-induced consumer-to-consumer word of mouth generates more than twice the sales of paid advertising in categories as diverse as skincare and mobile phones.
Two things supercharge the creation of positive consequential word of mouth: interactivity and creativity. … One example of a company successfully harnessing this power is the UK confectioner Cadbury, whose “Glass and a Half Full” advertising campaign used creative, thoughtful, and integrated online and traditional marketing to spur consumer interaction and sales.
The campaign began with a television commercial featuring a gorilla playing drums to an iconic Phil Collins song. … The concept so engaged consumers that they were willing to go online, view the commercial, and create amateur versions of their own, triggering a torrent of YouTube imitations. Within three months of the advertisement’s appearance, the video had been viewed more than six million times online, year-on-year sales of Cadbury’s Dairy Milk chocolate had increased by more than 9 percent, and the brand’s positive perception among consumers had improved by about 20 percent.
Intentional word-of-mouth campaigns revolve around identifying influentials who become brand and product advocates. … [Ambitious] marketers can use word-of-mouth equity insights to shift from consequential to intentional campaigning.
Mobile phone manufacturers market share in Q3-...Image via WikipediaThe type of campaign that companies choose to adopt depends on the degree to which marketers can find and target influentials. … Mobile carriers have granular customer data that can precisely locate influentials who know the category, talk to many people, and provide them with trusted opinions. That means messages can be directed at specific individuals who are most likely to spread positive word of mouth through their social networks. As a message spreads, this approach generates an exponential word-of-mouth impact, similar to the ripple effect when a pebble is dropped in a pond.
Companies unable to target influentials precisely must take a different approach. While Red Bull, for example, can’t send text messages to specific consumers, it has successfully deployed science to orchestrate effective intentional word-of-mouth campaigns. After identifying influentials among its different target segments, the energy-drink company ensures that celebrities and other opinion makers seed the right messages among consumers, often through events. While it can’t be sure who will attend, Red Bull knows that those who do will be the kinds of consumers it seeks—and that the positive messages they will relay across their own social networks can generate a superior return for its marketing investment.
Marketers have always been aware of the effect of word of mouth, and there is clearly an art to effective word-of-mouth campaigning. Yet the science behind word-of-mouth equity helps reveal how to hone and deploy that art: it shows which messages consumers are likely to pass on and the impact of those messages, allowing marketers to estimate the tangible effect word of mouth has on brand equity and sales. These insights are essential for companies that want to harness the potential of word of mouth and to realize higher returns on their marketing investments.

About the Authors
Jacques Bughin is a director in McKinsey’s Brussels office, Jonathan Doogan is an associate principal in the London office, and Ole Jørgen Vetvik is a principal in the Oslo office.
1 The term word of mouth, as used in this article, means consumer-to-consumer communication with no economic incentives. The sender may, however, reap social gratification or rewards.
2 See David Court, Dave Elzinga, Susan Mulder, and Ole Jørgen Vetvik, “The consumer decision journey,”, June 2009.
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Monday, December 20, 2010

The commodity crunch in consumer packaged goods

Packaged-goods companies have been socked by rising commodity prices. Executives in other industries can learn from their experience.
McKinsey Quarterly
DECEMBER 2010 • Richard Benson-Armer, Peter Czerepak, and Tim Koller

rising commodity prices in consumer packaged goods article, passing on commodity prices to consumers, Retail & Consumer Goods

For almost 40 years, the US consumer goods sector was among the safest of havens for investors. It rewarded them with annual returns well above the market average—second only to those of the energy sector—and in a bumper period from 1985 to 2002 outperformed the S&P 500 index by almost 20 percent annually. Since then, the sector has barely outpaced the index, despite persistent attempts by companies to find winning strategies. While inadequate cost controls and a failure to deliver significant value from a wave of mergers and acquisitions haven’t helped, one factor is the dominant culprit for the current malaise: the industry’s response to changing commodity prices.

Losing control

From 1985 to 2002, consumer-packaged-goods companies regularly passed on to consumers increases in the price of inputs (including aluminum, cereals, oil, and paper) while holding the line on prices when raw-material costs declined. In this way, these companies maintained profit margins when input costs rose and enjoyed expanding margins when they fell. …
The tables turned in 2002. From that year until 2007, industry players passed on price increases of just 15 percent as cumulative commodity costs grew by 40 percent (exhibit). As a result, we estimate that the failure to pass on commodity price increases was responsible, during that period, for 75 percent of the sector’s margin contraction, which cost about $70 billion.1

  • Exhibit: Since 2002, industry players in packaged goods have been less able to pass on input price increases to consumers.

    • A return to the days of passing commodity price increases on to consumers won’t come easily. The structural shifts that dampened the industry’s pricing power remain: consumers are increasingly value conscious, and large discounters still dominate the retail landscape. These retailers, … today have a sophisticated understanding of the prices they want and of their ability to demand those prices.
      The net result is that the industry continues to face downward pressure on prices. Some of the solutions aren’t complicated, but they are extremely difficult to implement and probably hold lessons for companies—in sectors ranging from consumer electronics to industrial chemicals to medical devices—currently facing an unfavorable and volatile environment for raw-material costs and pricing.

      Regaining the initiative

      Many economists and financial-market forecasters believe that continued price volatility amid a general rise in commodity prices is likely as the world economy recovers, so companies across many sectors may easily destroy value in the years ahead. Suppose that in consumer packaged goods, commodity prices increase by about 20 percent during the next five years, and companies hold prices constant in a quest to maintain market share. In that case, …margin could be lost— about 33 percent of current … EBITDA. … If commodity prices fall by 5 percent in the next five years but companies hold product prices steady, for example, we estimate that … EBITDA will jump by 8 percent … .
      Conceiving, developing, and marketing category-changing products that consumers crave has long been … a priority for companies in a great many industries. An important question … is how to capitalize on the opportunity that such innovations present …, as P&G managed to do when the company introduced its Swiffer cleaning product.2 Capitalizing on innovations isn’t easy. But in an industry like packaged goods, it’s probably critical for companies that aim for a financially sustainable innovation pipeline, for consumers who seek a steady stream of new products that satisfy new needs, and for retailers that hope to benefit from greater demand for new and existing products.

      About the Authors

      Richard Benson-Armer is a director in McKinsey’s New Jersey office, Peter Czerepak is an associate principal in the Boston office, and Tim Koller is a principal in the New York office.
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      1 Our analysis excludes 2008 and 2009, when the global recession and dramatic market fluctuations skewed the data.
      2 See Walter L. Baker, Michael V. Marn, and Craig C. Zawada, “Do you have a long-term pricing strategy?”, October 2010.
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      Monday, December 6, 2010

      The Global Innovation 1000: How the Top Innovators Keep Winning

      Booz & Company’s annual study of the world’s biggest R&D spenders shows why highly innovative companies are able to consistently outperform. Their secret? They’re good at the right things, not at everything.

      s+b magazine
      by Barry Jaruzelski and Kevin Dehoff

      Illustration by Otto Steininger
      InnovationImage via WikipediaWhy are some companies able to consistently conceive of, create, and bring to market innovative and profitable new products and services while so many others struggle? It isn’t the amount of money they spend on research and development. After all, our annual Global Innovation 1000 study has shown time and again that there is no statistically significant relationship between financial performance and innovation spending, in terms of either total R&D dollars or R&D as a percentage of revenues.
      What matters instead is the particular combination of talent, knowledge, team structures, tools, and processes — the capabilities — that successful companies put together to enable their innovation efforts, and thus create products and services they can successfully take to market. … Innovators that have achieved this state of coherence, we have found, consistently and significantly outperform their rivals on several financial measures.
      We believe that this assessment of key innovation capabilities comes at a particularly opportune time. … (See “Profiling the 2009 Global Innovation 1000,” below.) Clearly, the global recession, which had not yet taken its toll on the world of innovation in 2008, finally came home to roost last year. Yet that decline makes it even more imperative that companies spend their available R&D dollars wisely. Our goal this year is to examine the capabilities needed to maximize the impact of a company’s innovation efforts in good times and bad, and to highlight the benefits both of focusing on the short list of capabilities that generate differential advantage, and of clearly linking the specific decisions within innovation to the company’s overall capabilities system and strategy.
      Strategies and Capabilities
      Three years ago, in 2007, we focused our annual innovation study on how companies use distinct innovation strategies to create their products and take them to market. Nearly every company, we found, followed one of three fundamental innovation strategies:
      Need Seekers actively and directly engage current and potential customers to shape new products and services based on superior end-user understanding, and strive to be the first to market with those new offerings.
      Market Readers watch their customers and competitors carefully, focusing largely on creating value through incremental change and by capitalizing on proven market trends.
      Technology Drivers follow the direction suggested by their technological capabilities, leveraging their investment in research and development to drive both breakthrough innovation and incremental change, often seeking to solve the unarticulated needs of their customers via new technology.
      It is important to note that we found that none of these three strategies were any better than the others at producing sustained superior financial results, although of course individual companies outperform others within each strategic group. The success of each of the strategies depends on how closely companies, in pursuing innovation, align their innovation strategy with their business strategy and how much effort they devote to directly understanding the needs of end-users.
      This year we set out to answer two new questions: Which sets of capabilities are the most critical for the success of each of the three strategies? And do companies that focus on those critical capabilities see improved overall financial results? …
      Innovation capabilities enable companies to perform specific functions at all the stages of the R&D value chain — ideation, project selection, product development, and commercialization. We asked respondents to this year’s Global Innovation 1000 survey to identify which capabilities were most important in achieving success at innovation. (See Exhibit 1.) Then, in hopes of getting further insight into which capabilities companies ought to work toward, we looked at the capabilities focused on by the top 25 percent of performers within the group using each of the three innovation strategies. (See Exhibit 2.)

      No matter which of the three innovation strategies they pursued, all the successful companies depended on a common set of critical innovation capabilities. These include the ability to gain insights into customer needs and to understand the potential relevance of emerging technologies at the ideation stage, to engage actively with customers to prove the validity of concepts during product development, and to work with pilot users to roll out products carefully during commercialization.
      In addition to these common capabilities, companies among the top 25 percent in performance within each strategic group depend on a set of distinct capabilities they feel are critical to achieve success, some of which overlap with those of other strategies. The most successful companies, we found, are those that focus on a particular, narrow set of common and distinct capabilities that enable them to better execute their chosen strategy.

      Profiling the 2009 Global Innovation 1000

      The global recession finally caught up with the world’s top innovators in 2009. Following a relatively strong 2008, during which total R&D spending continued to grow despite the recessionary headwinds, the 1,000 companies that spent the most on research and development decreased their total R&D spending in 2009 by 3.5 percent, to US$503 billion.
      … Revenue for the Global Innovation 1000 plunged at an 11 percent rate, from $15.1 trillion in 2008 to $13.4 trillion in 2009 — nearly three times the rate of decline in R&D spending. The result was that R&D intensity (innovation spending as a percentage of revenue) actually increased, from 3.5 percent to 3.8 percent, indicating that companies attempted to stay the course with their overall innovation programs, and that they continue to see innovation as essential for future growth. (See Exhibit 3.) Compared to the 3.5 percent reduction in R&D spending, the 1,000 top R&D spenders cut much more deeply into both sales, general, and administrative expenses (a 5.4 percent reduction) and capital expenditures (a 17.5 percent drop). (See Exhibit 4.)

      The reductions in R&D spending, however, were neither as widespread nor as evenly distributed among industries as the overall numbers might suggest. Just over half of all the companies we tracked this year cut their R&D spending in 2009. Nearly all the cuts, however, came in just three industries: auto, computing and electronics, and industrials. The other industries increased spending to a greater or lesser degree. (See Exhibit 5.)

      The auto industry alone accounted for fully two-thirds of the $18 billion contraction in R&D spending — … A large number of auto parts suppliers fell into bankruptcy protection last year, and virtually every company in the industry cut spending in all areas of operations. Still, the industry’s 14 percent decrease in R&D spending was roughly in line with its 12.7 percent decrease in revenue; as a result, the auto industry’s R&D intensity was essentially unchanged, at 3.9 percent.
      The computing and electronics industry reported similar but less drastic R&D spending reductions. The industry’s revenues were down by 7 percent from 2008 as a result of the recession and the accompanying drop in sales. Yet as with autos, the decline in R&D spending for computing and electronics — 7 percent — tracked the decline in revenue, so there was virtually no change in the industry’s R&D intensity.
      Despite the $9.7 billion decline in its R&D spending, computing and electronics kept its top spot as the biggest spender on innovation, while autos remained at number three. (See Exhibit 6.) The industry in the number two spot, healthcare, increased its R&D spending by 1.5 percent — much slower than the industry’s recession-defying revenue growth rate of 6 percent.

      Given the recession’s overall effect on innovation spending, it’s not surprising that companies headquartered in the regions that were hit hardest cut their R&D spending the most, on average. … (See Exhibit 7.)
      The innovation programs of companies based in China and India, on the other hand, seemed unaffected by the recession: They boosted R&D spending by 41.8 percent (albeit from a small base; they account for only 1 percent of total Global Innovation 1000 corporate R&D spending). (See Exhibit 8.)

      Changes in the list of the top 20 spenders provided further signs of the times. … (See Exhibit 9.) Toyota cut spending almost 20 percent, while its R&D intensity fell to 3.8 percent from 4.4 percent in 2008 — no doubt a direct result of its first-ever loss (more than $4.3 billion that year). Other automakers also fell on the Top 20 list, while most companies in computing and electronics rose a notch or two.

      Taking over the number one position was pharmaceutical giant Roche Holding Ltd., which boosted its R&D spending 11.6 percent, to $9.1 billion. Indeed, healthcare companies took six of the top 10 spots on the list, and seven of the top 20. Coming in at number 1,000 was the medical manufacturer Seikagaku Corporation, which spent $59.5 million in 2009, down 7.5 percent from the previous year.
      In hindsight, given the severity of the recession and the economic uncertainty that gripped the world, it seems inevitable that companies would cut their innovation budgets in 2009. Still, their overall unwillingness to reduce spending in line with their decline in revenues is a tribute to the importance companies in every industry now place on innovation as a key source of growth. Thus, with the recession drawing to a close and companies continuing to post strong earnings, 2010 will be an important test of their innovation mettle: The most forward-looking companies will move quickly to restore or even increase the R&D spending they cut in 2009 and to deploy it still more effectively.
      — B.J. and K.D.
      Need Seekers
      The distinct strategy of Need Seekers is to ascertain the needs and desires of consumers and then to develop products that address those needs and get them to market before the competition does. The capabilities required for success begin at the ideation stage, where Need Seekers pursue open innovation and directly generated, deep consumer and customer insights and analytics, as well as a detailed understanding of emerging technologies and trends, in order to identify both their customers’ needs and the technology trends that can help them meet those needs.
      An example is Stanley Black & Decker Inc.’s DeWalt division, a maker of power tools for professional contractors. In its efforts to connect directly with customers even before it starts selecting which projects to develop, DeWalt regularly sends people out to construction sites to research builders’ needs and observe construction crews in action. One notable result of such efforts was the development of a 12-inch miter saw, which became one of the company’s bestsellers, after researchers watched carpenters struggle to cut large pieces of molding on the industry-standard 10-inch saw.
      Need Seekers generally continue to remain connected to customers both during the project selection process, in which ongoing assessment of market potential is a key capability, and during product development, when it is critical for Need Seekers to engage with customers to prove the real-world feasibility of their products. At DeWalt, for instance, once prototypes of new products have been completed, engineers and marketers take them back to the same job sites where the research was originally done. They leave the new tools with the customers, and come back a week or so later to collect information on how the tools performed. That information feeds directly into the company’s iterative development process.
      Given that Need Seekers frequently depend for their success on developing technically innovative products, a further key capability at the project selection stage involves technology risk assessment and management. At the Xerox Corporation, for example, Steve Hoover, vice president of R&D in charge of software development for the company’s products, notes the importance of risk management in assessing the potential business value of any project under development. “How big an opportunity are you going after here?” he asks. “What will drive its value? Where are the biggest technical risks? What might cause the project to fail? You’re looking for correlations. Where there’s risk, you have to put in the extra work to ensure you capture the potential value.”
      At the commercialization stage, Need Seekers value pilot-user programs and global product launches as crucial for keeping in touch with customers even as they scale up their sales efforts to capture the maximum value of being first to market. Both DeWalt and dental equipment maker Dentsply rigorously assess the percentage of sales coming from new products. For Xerox, which sells its products around the world, managing the launch phase is a critical and highly complex endeavor, designed to accommodate the long lead times, logistics, and training needs involved in selling large and sophisticated machines in very diverse markets.
      Market Readers
      Market Readers, on the other hand, pursue their customers more cautiously, preferring to innovate incrementally and keeping a close eye on the innovations of competitors. …
      Tim Yerdon is director of innovation and design at Visteon, a global auto parts manufacturer. But his real focus, he says, is “to look at market trends and translate those trends and needs into new products and services.” That’s why taking accurate readings of the marketplace at both the ideation and the project selection stages is a key capability for Visteon. A case in point is the company’s development of reconfigurable digital displays for cars. …[Consumers] were clearly happy with the flat-screen TVs they were buying for their homes. Says Yerdon: “We did the market research, we put all these data points together, and we could see where the trends were going.” In late 2009, Visteon successfully launched its first reconfigurable displays.
      The success of the Market Readers strategy depends on managers making sure the right products hit the market at the right time. … At the Parker Hannifin Corporation, a diversified manufacturer of industrial equipment, this understanding led to the implementation of a highly disciplined stage-gate process for green-lighting projects, embedded in every division in the company. Parker Hannifin treats its general managers and their staff as venture capitalists who are being asked to invest the company’s money in certain projects. The rigorous value screens that the company has developed as part of this process have enabled management to filter out the good projects from the bad much more successfully than before.
      For companies like Visteon, an equally critical capability is engagement with customers to prove real-world feasibility throughout the product development stage. By working actively with automakers, says Visteon’s Yerdon, “we’re taking a substantial amount of risk out of the system. Rather than coming up with an idea, building it, and then bringing it to a customer, only to find out they don’t want it, we’re much better off working together and more openly.”…
      Technology Drivers
      Technology Drivers begin with a different approach to ideation, using their technological prowess to develop products their customers may not know they need. … In addition, Technology Drivers must ensure that their technical personnel have time to ideate: This is the rationale for Google’s well-known “70-20-10” rule, which directs engineers to spend 70 percent of their time on core business tasks and 20 percent on related projects, but allows them to spend 10 percent of their time pursuing their own ideas.
      …The German technology giant Siemens AG, for example, spends 5 percent of its overall R&D budget on planning for the long term, which involves developing detailed technology road maps within individual business units, as well as longer-range scenarios of future technology trends at the corporate level. This dual process has generated perspectives that have enabled the company to expand its large health technologies business into new areas such as personalized healthcare. And Siemens works hard to track the payback from its centralized innovation office in the form of actual new products launched.
      The Masco Corporation, an $8 billion building products company, … seeks to be ready to leverage new technologies no matter where they can be found. A few years back, company representatives noticed some interesting technology at a trade show — a wireless, battery-less switch, which they were sure would have applications in the home. “We vetted the technology, brainstormed specific applications for the home, and developed a pilot,” recalls Thom Nealssohn, manager of innovation implementation services at Masco. “Every time we showed it to someone, we learned a little bit more, and that gave us the fuel that we needed to go back and make it better.” Masco launched a new line of innovative programmable lighting products based on the technology — Verve Living Systems — in 2009.
      … “In many cases, it’s just a matter of sitting down and saying, ‘Here’s the problem we want to solve,’” Nealssohn says. “What really differentiates us is our willingness to partner with customers, to try not only to understand what issues they’re struggling with today, but to anticipate issues that may arise as a result of what we see going on in the world around us.” That strategy, in turn, demands that Technology Drivers like Masco also focus on rigorous decision making in R&D portfolio trade-offs at the project selection stage, if they are to funnel their wide-ranging ideas into products that can succeed in the market.
      Finally, because of the nature of their products, Technology Drivers must pay strict attention to two key capabilities in the commercialization stage: pilot-user selection/controlled rollouts, and product life-cycle management. … Says Nealssohn: “We believe that everyone in the distribution chain has to win. A shift of margin from one partner in the chain to another does not necessarily equate to a winning product. So it doesn’t matter how much the customer wants the product — if the distributor or the home builder doesn’t see the opportunity to make money, chances are that product is going to struggle or even fail.”
      Focus Matters
      The capabilities required to pursue each strategy form a systematic set of skills, processes, and tools that companies must focus on to succeed at each stage of the innovation process. In contrast to top-performing innovators such as Apple, Google, Xerox, Visteon, and Siemens, the poorest-performing companies within each strategic group — those among the bottom 25 percent — take a less-focused approach to the most critical innovation capabilities.
      These lower-performing companies, regardless of which of the three strategies they are pursuing, cite only three common capabilities as important: early customer insight, assessment of market potential during project selection, and engaging with customers at the development stage. …. Notably, there is significantly less overlap among the capabilities that low-performing companies depend on. This suggests that these companies take more of a scattershot approach to building the innovation capabilities systems they need. This lack of focus, we believe, is a primary cause of their inferior performance.
      Focusing on a systematic set of capabilities means that companies must first choose the capabilities that matter most to their particular innovation strategy, and then execute them well. Our analysis suggests, however, that although most companies are relatively strong at executing critical capabilities within the areas of ideation, project selection, and product development, they underperform at the commercialization stage. (See Exhibit 10.) Executives agree consistently that there are three customer- and market-oriented capabilities that matter most: Gathering customer insights during the ideation stage, assessing market potential during the selection stage, and engaging with customers during the development stage. Yet when it comes to the capabilities needed to introduce their products into the market, there is no single one consistently named as a strength. …
      In commercialization, the top performers stand out by executing well in two critical areas: global product launches and pilot-user selection and rollout. … Xerox’s Hoover acknowledges just how important the company-wide process of launching products in the marketplace is in the ability to capture the business value of innovation. “What do we have to get done, and when, so that we can feed the new product into the global operating companies’ pipeline, and what do they have to have ready so they can push it out? It’s really basic project management, but it has to be executed really well.”
      Aligning with Corporate Strategy
      Companies that focus on a consistent set of innovation capabilities clearly outperform their rivals. … Innovation — and the particular strategies companies employ to pursue innovation — is just one aspect of every company’s efforts to succeed in the marketplace. (See “The 10 Most Innovative Companies.”) They must also excel in areas outside R&D, including manufacturing, logistics, sales, marketing, and human resources. And their innovation efforts must be in sync with their overall corporate strategy: They must integrate the right innovation capabilities with the right set of firm-wide capabilities, as determined by their overall strategy.

      The 10 Most Innovative Companies

      Every year, readers of the annual Global Innovation 1000 study — which tracks the companies that spend the most on innovation — ask us which companies are in fact the most innovative. … As part of our survey exploring the relationship between innovation capabilities, corporate strategy, and financial performance, we asked more than 450 innovation leaders in more than 400 companies and 10 industries to name the three companies they considered to be the most innovative in the world.
      Our survey participants’ collective opinion suggests that their views are very much in line with popular perception. Apple far and away leads the Top 10, capturing 79 percent of the vote; it is followed by Google, with 49 percent; 3M is in third place, with 20 percent. Apple is an exceptional example of our observation that success in innovation is determined not by how much money you spend, but rather by how you spend it. The company has a long history of bringing innovative and stylish products to market, from the first Apple personal computer in 1976 to the iPod, the iPhone, and the iPad today. Yet it invests just 3.1 percent of its revenues in R&D, less than half the average percentage of the computing and electronics industry. Apple’s financial performance has been stellar: a five-year total shareholder return (TSR) of 63 percent. Second-place Google’s five-year TSR is even more impressive, at 102 percent; its R&D intensity (innovation spending as a percentage of revenue), at 12 percent, is just 1.3 percentage points lower than the average of the software and Internet industry as a whole. Third-place 3M has been seen as a highly innovative company for many years, and its five-year TSR of almost 50 percent shows that it continues to spend its R&D money in the right places. (See Exhibit 11.)

      Only three of the companies on the “10 most innovative” list — Toyota, Microsoft, and Samsung — also appear among this year’s top 10 spenders, reiterating the lack of correlation between R&D spending and innovation results. … The results are clear: The most innovative companies outperformed their industry peers on three different indicators of financial success. (See Exhibit 12.)

      Companies that are perceived to be highly innovative are clearly successful in creating new products and bringing them to market. Some spend more than others to accomplish this goal, but the real winners, financially speaking, are those companies, like Apple, Google, and 3M, that can innovate successfully without breaking the bank.
      — B.J. and K.D.
      Why is strategic alignment so critical? As part of corporate strategy, every company needs to ask itself what business it is really in, and how it intends to win — and then ask the individual business units the same question. … On the one hand, the business units, which are so much closer to the customer, must first see an opportunity, and begin to innovate. On the other hand, corporate strategists must manage the companywide R&D and sales agenda necessary to compete successfully, even as they work to minimize spending and make the process as efficient as possible. As we demonstrated in 2007, companies that achieve a tight alignment of their firm-wide and innovation strategies on average generate 40 percent higher operating income growth and 100 percent greater total shareholder return.
      The Coherent Innovator
      Companies that develop the relatively cohesive set of innovation capabilities we have outlined, and then combine them with similarly distinctive firm-wide capabilities — thus aligning their innovation strategy with the overall corporate strategy — can be said to be coherent. …By comparing the financial results of highly coherent companies in the Global Innovation 1000 to their less-coherent rivals, we found that, when normalized, the profit margins of companies ranked in the top third in terms of coherence were 22 percent higher, on average, than those of companies in the bottom two-thirds, and that the coherent companies achieved 18 percent greater market capitalization growth as well. (See Exhibit 13.) In general, the more coherent a company is, the more competitive success it will have — and the more it will be able to generate the higher margins that result from being truly differentiated.

      Why are strong margins associated with higher coherence? Optimizing the proper set of capabilities allows companies to focus on what matters most, and not spread effort and resources across a wide range of capabilities that are less critical. … Regarding market cap growth, as companies gain the differentiating capabilities that give them coherence, their built-in advantage enables them to improve earnings growth, a key metric that the stock market takes into account when pricing a company’s shares.
      Apple is the classic example: In the early 1990s, the company squandered enormous resources and billions of dollars on a series of failed products like printers, scanners, and the Newton PDA. … But once Steve Jobs returned as chairman and CEO in 1997, Apple began to focus its portfolio and its capabilities. The company has since concentrated very selectively on what it does well, and what really differentiates it from its peers: deep understanding of end-users, a high-touch consumer experience, intuitive user interfaces, sleek product design, and iconic branding. For example, Apple narrowed its product line and began leveraging the Apple brand through its Apple Store retail strategy.
      The results speak for themselves. Apple’s profitability and market cap are well above the industry average, and this year our survey respondents voted it far and away the most innovative company — all of which it achieved while consistently spending far less on R&D as a percentage of sales than the median company in the computing and electronics sector.
      Innovators and Strategists
      The virtue of thinking about innovation in terms of capabilities and the capabilities systems that enable companies to be coherent is that it provides a specific way of talking about what companies need to focus on to translate their innovation efforts into sustained success. …As Xerox’s Steve Hoover puts it, “If a certain competency has nothing to do with how you’re positioning yourself in your market and creating value for your customers, then don’t oversupply it. Put your energy elsewhere, where you are going to differentiate.”
      Companies, by focusing on the capabilities they believe are critical differentiating factors in their efforts to conceive of, develop, and sell their product in their particular markets — on what they need to do better than competitors — can gain the coherence necessary to outperform. And that, of course, is what innovation — and corporate strategy — is really all about.

      Booz & Company Global Innovation 1000: Methodology

      Booz & Company identified the 1,000 public companies around the world that spent the most on research and development in 2009. … This is the same core approach we have used in the previous five years of the study.
      For each of the top 1,000 companies, we obtained key financial metrics for 2002 through 2009, including sales, gross profit, operating profit, net profit, R&D expenditures, and market capitalization. … In addition, total shareholder return was gathered and adjusted for each company’s corresponding local market.
      Each company was coded into one of nine industry sectors (or “other”) according to Bloomberg’s standard industry designations, and into one of five regional designations as determined by each company’s reported headquarters location. To enable meaningful comparisons across industries, we indexed the R&D spending levels and financial performance metrics of each company against its industry group’s median values.
      This year, to better understand the relationship between innovation strategy and capabilities, we also conducted a Web-based survey of more than 450 senior managers and R&D professionals from more than 400 different companies around the globe. …Respondents came from all industry sectors; 52 percent came from North America, 33 percent from Europe, and 15 percent from the rest of the world.
      We asked respondents to evaluate the innovation capabilities they believed were most important across the value chain, as well as their performance in each of these capabilities. Responses were analyzed with a variety of statistical methods to allow us to distinguish the capabilities most important in pursuing each of the three innovation strategies we defined in our 2007 study. Although company names and responses were kept confidential (unless permission to use them was explicitly given), a large number of the respondents identified themselves, enabling us to associate their survey answers with their company’s performance. Financial performance was normalized by industry to compare the impact of capability coherence on corporate financial performance both within strategies and across all companies.
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      Reduce, Reuse, Recycle…or Rethink

      For consumer durables, environmental sustainability starts with discarding conventional wisdom.

      strategy+business magazine
      by Tim Laseter, Anton Ovchinnikov, and Gal Raz

      Illustration by Lars Leetaru
      Image via WikipediaSince Earth Day in 1970, schoolchildren have heard the mantra “reduce, reuse, recycle” as the solution for the growing problem of consumer waste. … Over the last decade, the reduce and reuse parts of the slogan have shown signs of catching on, as per capita waste generation has declined to 4.5 pounds per day, and the volume going into U.S. landfills is now less on a per capita basis than it was 50 years ago. Europe has, if anything, made even more progress.
      Some forms of recycling have become the dominant mode for consumers. For example, 88 percent of newspapers and 77 percent of corrugated boxes are now recycled. Even though 38 percent of paper bags are recycled, consumers are now attacking the source by shifting to reusable shopping bags.
      But consumer durable products — including televisions, refrigerators and other appliances, cell phones, and automobiles — offer a more intractable problem that requires deeper thought for consumers and — especially — for the businesses producing them. Overall, a third of municipal waste is now recycled, but the percentage for durable goods stands at only 17 percent. Worse yet, durables often contain hazardous materials not found in consumables and packaging. Unlike consumables, durable products face an “end of life” problem that requires more options than simply reducing, reusing, and recycling. For this set of products, the new mantra for producers increasingly includes a fourth “R”: rethink. Rethinking the environmental challenges posed by durable-goods waste also provides interesting opportunities for businesses. The challenges presented by discarded and unused cell phones, which we have studied closely, are a particularly good example.
      Flaws of the “Three Rs”
      1. Reduce. Decreasing the generation of waste makes sense, and has proven highly effective for consumer goods. …
      Some consumer durables offer a similar opportunity to reduce size. … Reducing the size and weight does not work for many categories of durable goods, however. …
      Moreover, reducing product dimensions may have unintended negative consequences. Consider the fate of the largest carpet recycling facility ever built. The state-of-the-art Polyamid 2000 recycling facility in Premnitz, Germany, which cost US$200 million to build in 1999, closed after only three years. It turned out that a “reduce” strategy by European carpet manufacturers had shortened carpet pile and reduced the nylon content to a level that made recycling uneconomical.
      2. Reuse. Shifting a culture from the disposable to the reusable has also worked well in general. The cycle experienced by the bottled water industry offers a great case in point. At the beginning of the new millennium, consumption of bottled water grew at double-digit rates to the point where water became the second-largest beverage category, behind only carbonated soft drinks. After peaking around 2007, however, the industry contracted by 1 percent in 2008 and 2.5 percent in 2009. Environmentally conscious (as well as cash-strapped) consumers had turned to tap water and refillable bottles. …
      In the case of durable goods, the issue of reuse proves a bit more complex. In fact, academics in the field use the terms refurbishment and remanufacturing to clarify the extent of work needed to make a used product serviceable again. Consumer electronics are often refurbished simply by having their software tested and upgraded. But the reuse of products such as automotive parts and toner cartridges requires extensive remanufacturing labor, including such tasks as disassembly, cleaning, and parts replacement.
      Reusing durable products can offer substantial economic and environmental improvements. Currently, remanufactured cartridges make up 6 percent of toner sales, and can be produced at 20 percent of the cost of a new cartridge. …
      But reuse can also have drawbacks. From a broad environmental perspective it is better, for example, to recycle than to reuse energy-inefficient cars. … Other energy-intensive products — such as home appliances and even high-power computer chips — often offer similar benefits if they receive “early retirement” ahead of their functional life expectancy.
      International Recycle SymbolImage via Wikipedia3. Recycle. Recycling comes last in the hierarchy of waste management techniques for decreasing landfill disposals, but has generally had the greatest environmental impact to date. Lead acid batteries provide the best case study of recycling of consumer durable products, with a 99 percent recycling rate. At the other extreme, consumer electronics offer one of the biggest areas of opportunity. … Because product life cycles for electronic gadgets are growing ever shorter, electronics represent a growing component of the waste stream, but currently attain only a 15 percent recycling rate. …
      Rethinking Durables
      Sustainability for consumer durables demands deeper thinking than the simple “reduce, reuse, recycle” framework. And unlike consumables, where the responsibility for rethinking falls on consumers, for durables, the primary rethinking job belongs to business executives and environmental regulators.
      A rethinking of the problem should start with an examination of the ecological impact and economics across the full product life cycle — from manufacture through use, reuse, recycling, and disposal. The economic incentives for the various industry players must also be considered, including original equipment manufacturers (OEMs), retailers, service providers, remanufacturers, recyclers, and waste management companies. Every industry has a unique set of players; for each of them, the costs and benefits vary considerably, and are sometimes at odds. This insight provides a starting point for thinking strategically about reshaping the industry value chain in ways that increase profits while reducing environmental impact. Such rethinking can be employed by business executives to seek out new profit pools — or, alternatively, by regulators to alter the profit pools and enhance overall societal benefits.
      Mobile phone subscribers per 100 inhabitants 1...Image via WikipediaConsider the case of cell phones. …Some 285 million people in the U.S. have cell phones; that is, the penetration rate stands at 91 percent.

      A printed circuit board inside a mobile phoneImage via WikipediaCell phones, however, quickly become obsolete, creating a glut of older, unused phones with waste and environmental implications. … As a result, the initial lifespan of a phone has fallen to between 18 and 24 months. In other words, roughly half of the phones in use one year are retired the next year. An estimated 10 to 15 percent of these are simply discarded and merged invisibly into the municipal waste stream. A much larger percentage of those retired are “stockpiled.” Because of their small size but high perceived value, roughly 65 to 70 percent of the old phones end up in a drawer as a rarely used backup.
      That leaves less than 20 percent of retired phones in the U.S. to be collected for reuse or recycling. Of those, about 65 percent are reused, mostly in emerging markets in Africa and Latin America. …
      Ultimately, only 6 or 7 percent of cell phones are recycled for scrap metal. The typical recycled phone generates less than a dollar of revenue from the recovery of about an ounce of copper and trace levels of the more expensive precious metals such as gold, palladium, and silver. …
      Electronic waste, which includes cell phones, makes up less than 2 percent of the mass disposed of in landfills, but it accounts for 70 percent of the hazardous waste. Since most old handsets remain stockpiled in a drawer, cell phones have had little impact on landfills to date. But with the retirement of 130 million handsets per year, there may well be more than a billion stashed handsets that could eventually end up as toxic waste.
      Rethinking the Cell Phone Cycle
      Our research into the cell phone value chain, in collaboration with Vered Doctori Blass of Tel Aviv University, offers two examples of how industry players at different points along the value chain could potentially increase profits while reducing the environmental impact.
      The first opportunity is in phone design. … By focusing explicitly on the end-of-life stage in addition to the initial production stage, cell phone companies can design the product to automate the disassembly process and lower the cost of refurbishment and component reclamation. A clear technology road map for such modular designs would increase the odds that components can be reused rather than merely recycled. And components that are not likely to be reused can be designed for easier recovery of valuable raw materials.
      Additionally, innovative design can reduce the energy consumption of the phone, therefore reducing the cost to the consumer and increasing demand. …Changes in design that reduce the quantity of precious metals in cell phones can also be critical. …The downside is that if cell phone manufacturers keep decreasing the amount of gold, recycling will become unprofitable (unless gold prices continue to increase or government regulation provides incentives or makes recycling mandatory).
      These trade-offs illustrate that cell phone companies need to rethink their design efforts. … Because innovation can be applied to different aspects of design, manufacturers need to rethink where changes in design can be most effective economically and environmentally.
      The second opportunity is in refurbishing older phones. Our research into smartphone pricing in a monopoly environment — such as the U.S. partnership between Apple and AT&T for the iPhone or Sprint and HTC for the Android-based Evo 4G — indicates that a service provider could significantly increase profits by offering refurbished models along with new ones. … In short, a service provider such as AT&T or Sprint could use refurbishing to expand its market by actively creating a secondary market to serve a more cost-conscious set of consumers.
      The environmental and societal impacts of such a refurbishing strategy, however, would require further assessment. On the one hand, refurbishing a used smartphone consumes less energy than manufacturing a new one. …On the other hand, in this example, refurbishment does not displace production but instead is used to expand the market.
      Some of this negative impact could be offset by expanding processes to collect the phones after the second use. … Ultimately, a service provider like AT&T might find it necessary and lucrative to expand geographically to developing regions to control both the demand for the refurbished products and their eventual collection and disposal.
      Independent of whether better collection and recycling offsets the environmental impact of more smartphones, industry leaders must make sure that government regulators understand the societal benefits of such a strategy. Expanding the reach of smartphones to more of the world’s population offers a low-cost way to reduce the digital divide between people in developed versus developing nations, with perhaps even less environmental impact than the much-lauded $100 laptop. Regulations must avoid discouraging such innovation.
      As these examples suggest, creating a more sustainable solution to managing consumer durables’ end of life requires significant rethinking. By taking a strategic perspective that embraces a wide range of levers, from design to pricing to vertical integration, companies could avoid the win–lose mind-set so often imposed on them through government regulation. Given the current unsustainable approach to consumer durables life-cycle management, the creative capitalist can easily find opportunities to increase profits while reducing environmental impact.
      Reprint No. 10406

      Author Profiles:

      • Tim Laseter holds teaching appointments at the London Business School, the Darden School at the University of Virginia, and the Tuck School at Dartmouth College. He is the coauthor of Strategic Product Creation (McGraw-Hill, 2007) and the newest edition of The Portable MBA (Wiley, 2010). Formerly a partner with Booz & Company, he has more than 20 years of experience in operations.
      • Anton Ovchinnikov is an assistant professor of business administration at the Darden School of Business at the University of Virginia. His research addresses theoretical and application issues, including behavioral operations and environmental sustainability in the business, government, and nonprofit sectors.
      • Gal Raz is an associate professor of business administration at the Darden School of Business at the University of Virginia. His research focuses on supply chain pricing and contracts and the public policy implications of supply chain management. Previously, he was on the faculty of the Australian Graduate School of Management in Sydney.
      • Also contributing to this article was Vered Doctori Blass, who holds a teaching and research appointment at the Leon Recanati Graduate School of Business Administration, Tel Aviv University.
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      How Aha! Really Happens

      The theory of intelligent memory suggests that companies relying on conventional creativity tools are getting shortchanged.

      strategy+business magazine
      by William Duggan

      Illustration by Lars Leetaru
      Image representing Google as depicted in Crunc...Image via CrunchBaseHow do companies innovate? Look at Google Inc., widely admired as a great innovator. The company offers toys in the lobby, beanbag chairs, game rooms, and time for employees to work on ideas of their own. Isn’t that what other companies should do too?
      The answer is no. These Google methods are derived from an inaccurate theory of creativity: that people need to turn off their analytical left brain and turn on their creative right brain to produce new ideas. In fact, the Google founders did not come up with the original idea for Google itself by using these methods. Instead, they applied a very different method, one that follows a more plausible theory of how the brain produces creative ideas. Unfortunately, Google is just one of countless companies whose methods for innovation are woefully out of date.
      Over the past decade, neuroscientists have come a long way in figuring out how ideas form in the human mind. As it turns out, their findings contradict how most companies understand and organize innovation. …
      To understand the new model of the brain, and why it matters so much for business innovation, we must go back to 1981, when Roger Sperry won the Nobel Prize for his work on the two sides of the brain. According to Sperry, the right side was creative, artistic, and intuitive, whereas the left side of the brain was analytical, logical, and rational. This split-brain model spread quickly throughout the business world, because it seemed to explain why some people came up with new ideas easily and others struggled. …
      Today, brainstorming is nearly universal in business practice around the world. … It is found under different names and with slight variations, but all the versions follow the same basic model: They tell you how to analyze your strategic situation, but they do not tell you how to come up with a strategic idea for what to do. …
      In other words, our most-accepted approach to problem solving is grounded in an incorrect premise about the source of creativity in the brain.
      How Creativity Works
      Kandel in 1978Image via WikipediaNow let’s turn to the more accurate view of creativity, with its roots in modern science. The watershed year is 1998, when Brenda Milner, Larry Squire, and Eric Kandel published a breakthrough article in the journal Neuron, “Cognitive Neuroscience and the Study of Memory.” Kandel won the Nobel Prize two years later for his contribution to this work. Since then, neuroscientists have ceased to accept Sperry’s two-sided brain. The new model of the brain is “intelligent memory,” in which analysis and intuition work together in the mind in all modes of thought. There is no left brain; there is no right. There is only learning and recall, in various combinations, throughout the entire brain.
      Cover of Cover via AmazonNeuroscientist Barry Gordon gives an overview of this newer model of the brain in his book Intelligent Memory: Improve the Memory That Makes You Smarter (Viking, 2003), with coauthor Lisa Berger. He portrays the everyday intelligent memory of human beings as the greatest inventory system on earth. From the moment you’re born, your brain takes things in, breaks them down, and puts them on shelves. As new information comes in, your brain does a search to see how it might fit with other information already stored in your memory. When it finds a match, the previous memories come off the shelf and combine with the new, and the result is a thought. The breaking down and storing process is analysis. The searching and combining is intuition. Both are necessary for all kinds of thought. Even a mathematical calculation requires the intuition part, to recall the symbols and formula previously learned in order to apply them to the problem. …
      Just as the intelligent memory concept has replaced the old two-sided brain theory in neuroscience, companies need to replace brainstorming with methods that reflect more accurately how creative ideas actually form in the mind. And they don’t need to start from scratch. Once we understand how intelligent memory works, we find several existing techniques that fit. After all, human beings have innovated for eons. If we study how innovation actually happens, we can learn how to do it more reliably.
      Clausewitz and Motwani
      …Business strategy emerged from the military a century ago, … The word strategy entered the English language from French in 1810 for direct military reasons: … And so was born the formal discipline of strategy that business has inherited today.
      Carl von Clausewitz, painting by Karl Wilhelm ...Image via WikipediaThe greatest military scholar of that period was Carl von Clausewitz, a Prussian, whose lifetime of work led to the book On War in 1832. … A great general gets a strategic idea as a coup d’oeil, which means “strike of the eye.” It’s a glance that shows you what to do — a flash of insight. Two steps precede the flash: “examples from history,” when you explicitly study what others have done before you, and “presence of mind,” when you clear your brain of all expectations of solutions. In a clear mind, selected examples from history combine as insight. The last step is resolution, when the flash gives you the will to act on the idea despite the obstacles you face.
      Examples from history are a form of intelligent memory. The …brain [is] stocked with what you’ve seen or heard or read about what others have done before. This process takes place naturally in every human brain, but active study can accelerate and improve it. …
      The presence of mind Clausewitz describes is akin to the calm state that precedes a flash of insight, which neuroscientists can now measure. … That explains why you get your best ideas not in formal brainstorming meetings but in the shower, or driving, or falling asleep at night — when your brain is relaxed and wandering, instead of focused on a particular problem. Incidentally, brian scans of these masters also show this presence of mind and reveal it as a mental discipline you can learn….
      Harnessing Intelligent Memory
      … In the late 1990s, CEO Jack Welch and Chief Learning Officer Steve Kerr adopted the concept of making new combinations from existing elements as the basic problem-solving method for the whole company. They used a simple matrix that took the process of intelligent memory — what the brain does in flashes of insight — and turned it into a step-by-step team method. …
      Here’s how it works. At the top of the matrix, write down your current understanding of the situation (always as a provisional draft, because your understanding might change). Then comes analysis: List in rows what actions you think you might need to take to succeed in the situation (these too are in draft form, because they also might change). Then ask the most important question you can ever ask to solve any problem of any kind: Has anyone else in the world ever made progress on any piece of this puzzle? List sources to search for an answer to this question, across the top, as columns (in draft again). The team then starts a treasure hunt. They search the sources for elements that might apply to the list of actions, trying to find a good combination.
      This matches how your brain works when you have a flash of insight. Your mind wanders from piece to piece of the puzzle, searching its shelves for pieces that go together, and only when it finds them does it know what the full picture looks like. …
      Eventually, we can expect more techniques based on the new science of intelligent memory to replace methods from the previous paradigm. Companies that get there first will have a distinct advantage. What innovation methods does your company use, and in which paradigm do they fit, the old view of the mind or the new? The race is on, and to the winner go the spoils.
      Reprint No. 10405

      Author Profile:

      • William Duggan is a professor at Columbia Business School, where he teaches innovation in the MBA, executive MBA, and executive education programs. He is the author of Strategic Intuition: The Creative Spark in Human Achievement (Columbia Business School Publishing, 2007).
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