Two years ago, Elliott Ichimura, a colleague of mine, pulled together ideas from eight different sources to produce the Virtuous Cycle of Innovation shown above.  The eight sources he used are:

   Weird Ideas That Work – Robert Sutton
   Leading the Revolution – Gary Hamel

   The Sources of Innovation – Eric von Hippel
   The Art of Innovation – Tom Kelley
   Serious Play – Michael Schrage
   The Circle of Innovation – Tom Peters
   Business Dynamics – John Sterman
   MIT Strategy course  Rebecca Henderson

At the time, the elegant inner cycle of entrepreneurship -> innovative ideas -> value creation -> cash flows -> incentives, primed by high leves of R&D investment, was still fueling many sectors of the economy.

What stopped the cycle, and why? I believe four structural, systemic and cultural factors, which were temporarily overcome during the exuberant 1990s, turned the virtuous circle back into a vicious cycle and led to the abandonment of innovation as a driver of the economy:

  1. Short Term Focus: Businesses, especially public companies, are rewarded for short-term performance. The effect of this is to encourage actions that have positive bottom-line impact in the next fiscal quarter, even if their longer-term effect is negative. So in Elliott’s chart, the arrow from profitable cash flows to investment (in innovation) was cut, as investment was shifted to activities with a more immediate payback.
  2. Oligopoly: In many sectors of the economy, it is cheaper to buy (or buy off) innovation than to encourage it. When one or a few companies dominate the sector, they can corral all intellectual energies in the sector, locking up whole areas of intellectual property with massive numbers of broad patent applications, fiercely pursuing entrepreneurs who threaten this intellectual property, and buying off entrepreneurs they can’t scare off, then shelving the ideas. In the chart, the oligopoly’s cash flow converts the incentive for entrepreneurship into a dis-incentive for entrepreneurship.
  3. Risk Aversion: The new age business thinkers of the ’90s recognized that risk was a positive, an asset, rather than a negative. Some companies even exploiting this awareness, accepting and trading risk as a marketable commodity. Ironically, one of those was Enron. Cultural, this shift in thinking was unsustainable against our human aversion to risk. In the chart, the failure rate that was briefly considered a learning opportunity, began once again to be considered an unacceptable cost, and risks, even those that might have yielded huge opportunities, stopped being taken.
  4. Change Aversion: Very few people really embrace change. It is threatening, creates anxiety, makes it harder to plan and predict. Business, like people, changes when it must. What we saw briefly in the 1990s was a flurry of what is called discontinuous change, the Innovator’s Dilemma . There were so many innovations occurring that some of them, often accidentally or serendipitously, began to impact completely different sectors of the economy in unexpected ways. Miniaturization, laser and fibre optics technologies, and connectivity technologies had especially strong and broad impact on many businesses.

    But as the number and pace of innovation slowed, due to the first three factors above, many businesses breathed a sigh of relief, shelved their e-business strategies and went back to business as usual. The reaction of the commercial entertainment industry to peer-to-peer networks (i.e. sue them and close them down, rather than adapting to them), is a perfect example. The rate of change in the business environment has notably slowed in recent years, and the recession has less to do with the slowdon than does basic human nature.

Will we see another virtuous cycle of innovation in the future? Undoubtedly. Even the most conservative businesses realize that a lack of innovation stifles the economy and leads to stagnation. Our change aversion is balanced against our entrepreneurial spirit. We like new ideas and trying out new things — that is how we learn and grow. Eventually the pendulum will shift back, driven by a new set of basic human needs, and the virtuous cycle will shift back into gear.

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  1. Michael says:

    Dave, You have a bad URL on this post’s image. It’s pointing to your C: drive – file:///C:/Program%20Files/Radio%20UserLand/www/images/Innovation.gif

  2. mrG says:

    This virtuous cycle of innovation sounds very deja vu-ish — back in the early 80’s, I was involved with a group at the bank of montreal who were interested in “business cycles” and with outside-MIS computers becoming available, we looked at several models of business cycles for various kinds of domestic investments.For a theory to be useful, it has to be predictive. It’s always safe to say the rains will return, but this year? next year? in 2038?? The business cycle people started doing pretty much what agricultural-based astrologers had done some 6000 years before, they started charting the ups and downs and looking for waveforms. One of the most striking and incontrovertable being the Saros Cycle, the 11 year sunspot cycle that affects agriculture and radio communications and in turn pummel the economics of earth with cosmic rays.So that prompts me to ask: Have you charted the virtuous cycles? Data should exist well back into the 18th century, and I’d be curious to know if there is a rhythm that we can use.FWIW, one of the most successful of the trading cycle theories was based on “relativistic” cycles where the length of the cycles would contract as the volumes traded increased, with the cycle varying from 12 to 15 days … which was just too much co-incidence for me: We lined up 20 years of daily data against phases of the moon, and while both did remarkably better than chance, you’ll never guess which method was the more accurate :)

  3. Teledyne huh? Thought I recognized the accent. Eh?

  4. Dave Pollard says:

    Mike: Oops & Damn – embarrassing mistake. Thanks for pointing it out. Should show up properly now.

  5. Dave Pollard says:

    Gary: I agree that ideally a model needs to be predictive, but even if it isn’t demonstrably so, I find systems thinking maps like this (I’ve fixed the link so you should now be able to see it) help you think about cause-and-effect relationships, and allow you to understand how things tend to self-perpetuate and reinforce each other, and how disruptions to cycles occur. I do think we’ve seen a serious slide in innovation in a whole group of industries, including some facets of the entertainment ‘industry’, and this model does as good a job of explaining why that happened as any I’ve seen. And Elliott’s used it to good advantage in his area of our business, which is really the only business unit in our company that’s still doing a lot of innovative work.

  6. Elliott Ichimura says:

    A correction to the diagram: As Risk increases, so too does the Failure Rate. The sign between should be positive to show a direct correlation.

  7. Wyatt says:

    I think the Virtuous Cycle of Innovation is an overanalyzation of existing phenomena and is too unnecessarily complex to be a useful tool to anyone as a prescriptive element in how to foster innovation or as a way of understanding how innovations occur.

  8. The world is a complex place, and large businesses are complex ecosystems where metrics and measures heavily influence employee behavior. In the effort to foster innovation, it’s great if you can boil complexity down to a simple tagline that movitates employees to invent and share those inventions with their companies. But, converting invention into exploitable innovation requires a level of investment in organizational processes and incentives. “Gaming the system” isn’t as much of a problem in a small organization where intentions are transparent and incentives link fairly directly to individual effort and impact. The same is not true of large organizations. To manage innovation in large organizations, you need insight into the underlying complexities that determine whether or not inventions can and will be turned into innovations that produce revenue and profit. Managerial action without insight into cause and effect and active monitoring of leading indicators will gradually dampen employee interest in invention/innovation, or drive employees to strike out on their own rather than share risk and reward with a broader organization.

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