Incremental versus Transformational Innovation

Incremental innovation, once viewed as the key to sustained success, is now the norm. It’s expected. And it’s just not enough. On the other hand, transformational innovation doesn’t necessarily improve on the existing model. It creates breakthroughs. You launch new product categories. You disrupt existing business models. You cannibalize existing businesses. Transformational innovation is hard. It’s scary. It’s hairy. And most people don’t get there, because the culture’s not there.

So how do you do it? First you have to understand your organizational DNA. You also have to understand the difference between incremental innovation and transformational innovation. And, more important, you’ve got to focus in on the business model shifts. This is not about technology. Simply adding a digital moniker in front of a tired concept is not enough. This movement is about breakthrough innovations in business models, and it is a completely different way of looking at things.

Organizational DNA

So let’s start by talking about understanding your organizational DNA. The first question to ask is, How ready are you for transformation? If you feel your company is truly ready for change, a systematic approach is to build this culture from three organizational building blocks. First, you have to understand your organizational DNA. Second, you have to set up the right reporting structure. And third, you have to design a budget that supports digital transformation.

Many digital leaders already know this. Our research and our digital CXO panels tell us there’s a high correlation between organizational alignment and successful digital transformation. Whether you’re a general manager or a top executive, the point is to move successfully from basic infrastructure tasks toward innovation.

Business Model Shifts

You’re either going to disrupt or be disrupted in part of this transformation. As we all know, the pace of change has been intense. The incremental innovation that is out there is normal, but companies that follow that approach won’t be able to keep up.

Consider the Sony Walkman. It was invented nearly thirty-five years ago. One could argue that this was Sony’s big transformational innovation, the one thing that really put Sony on the map as an innovator. You could make the case that other products—perhaps TVs—did that as well. You could argue that PlayStation was an innovative part of Sony’s identity. But other companies also had video game systems. You could say that Sony led in CD and DVD players. But they partnered with Philips, so Sony wasn’t alone. You could talk about Sony’s Trinitron technology, but that was before the Walkman.

Sony actually hasn’t really innovated in the past thirty-five years. In fact, the company has been destroyed by others like Samsung because it hasn’t had much transformative innovation. Sony’s next innovation after the Walkman was the double cassette Walkman. It was cool. You could put two cassettes in the cassette case. You could play 180 minutes of music. I personally waited four or five years to get it. I couldn’t even buy it in the United States—I had to go to Japan to pick one up.

But that shift from the Walkman to the double cassette Walkman was an incremental innovation. The transformational piece would have been an MP3 player.

Sony actually had three MP3 players. There were different divisions warring with each other within the company. The units were coming out at a time when Napster, LimeWire, and others allowed anyone to share music for free. You never had to pay for music again. These services, and their users, were flipping the bird to the music industry for, as they saw it, gouging customers for years by charging $20 for an album that really had only one to two good songs, and maybe a love ballad you could barely tolerate.

Let’s be clear. Since Sony was also in the business of producing and selling music, there was no way it was going to cannibalize itself by introducing one of those three MP3 players into the market so that people could more effectively steal the company’s music. So it sat on the technology.

At the same time, Apple decided to get into the music industry. And the company came through with a breakthrough innovation: the iPod. When Apple announced and launched the device, it was not the best-sounding music player. It didn’t have the best battery life. It was actually predicted to fail because of these problems. It had a great interface, but its real success was the fact that it was a business model innovation. Apple got users to spend 99 times more for music that they could get for free. People were willing to go from free to 99 cents because they liked the iTunes store, they liked the ecosystem, and they liked the interface. Apple changed the music business.

Sony wanted to be Apple. Sony had all the digital IP and design—the same components Apple had. But Sony didn’t want to cannibalize its existing music business with a new business model, so Apple eventually took that digital mantle away from Sony. Then Apple released another breakthrough innovation—the iPhone. The iPhone single-handedly destroyed twenty-seven business models.

We’re talking about businesses that are never going to come back, businesses that were part of the 52 percent of organizations that have been eliminated, merged, acquired or fallen off the list of the Fortune 500. That’s huge. It’s everything. Where do you go to get your film developed? Not a one-hour photo shop. You don’t do that anymore. Film’s gone. Kodak’s dead. What do you do when you want GPS? Do you get a Garmin or other navigation device? You don’t need that. It’s on your phone. What do you do to take a memo? Do you buy a little Casio recorder? No. What do you shoot movies with? A camcorder? You don’t need that video camera anymore. You don’t need a compass. You don’t need a flashlight. You don’t need an alarm clock. It’s all on the iPhone.

Just look at the mobile business. If we go back to the year 2000, the companies that were going to be hot, the companies that were in charge of mobile, that were going to change the world, were BlackBerry, Microsoft, Nokia, Symbian. BlackBerry scoffed: Who wants a smartphone? Those things are ridiculous. But the fact was, this was the breakthrough innovation, the business model innovation that led the way.

The pace of change is fierce as these business models converge. Apple, seen as innovative, puts out one device a year. But that’s not fast enough on the phone side. It’s not fast enough on the tablet side. Samsung, which produces many of the components for Apple, puts out a new device every thirty to forty days. It might be a Galaxy S, it might be something else, but they put out a new phone every thirty-six days. They are putting out innovation at a faster rate, and some say maybe they’re copying innovation at a faster rate. But the point is, Samsung wants to be Apple. And it could be.

This pace of change is massive in other industries as well. One of our clients, a clothing manufacturer in Sri Lanka, can deliver anything you see on a fashion runway in Milan or Paris into their customer’s stores or into their contractor stores in seven to ten days.

Just being faster, just being better, just being cheaper is not enough. We’re actually battling for something bigger in this transformation, which is why we’re fighting for experiences and outcomes. We have to transform business models.

The important thing is to think about the metrics that really measure your business. Consider the airline industry. In the airline industry, the top metric is not safety. It’s not on-time arrival. It’s not customer satisfaction. For the airline industry, there’s only one metric that counts: revenue per passenger mile. More money, more butts in seats. That’s what matters.

In the airline industry, the hub-and-spoke model has been the predominant approach. You take lots of passengers. You create super-hubs. You get massive economies of scale. Then you fly everyone into a hub—whether it’s Dallas or Chicago, whether it’s LA or New York or DC or Houston or Denver—for a stopover or connecting flight. You create these mega hubs, and you create a route system around that.

Incrementally innovating to get to those super-hubs is what happens if you decide that you need more butts in seats. Enter the Airbus A380. The Airbus A380 is a double-decker plane, similar to the double-decker McDonnell Douglas MD12 plane that was put out in the 1990s. The point is, you’re putting more butts in seats. The Airbus A380 is an ultra-high-capacity airliner that can hold more than eight hundred passengers. That’s a lot of passengers. This airliner is really designed for the traditional hub-and-spoke model. And that fact ultimately drives the revenue per passenger mile at the airline’s convenience. That is the most important thing. It’s also a bit more fuel efficient. That’s the design point. So the A380 is set up to address the problems of revenue per passenger and fuel efficiency, but it uses the existing business model. That’s incremental innovation.

But you can also address this problem in a transformational way. Enter the Boeing 787 Dreamliner. The Dreamliner is ultra light, ultra fuel efficient—and designed to do point to point. Wait, what’s point to point? That means nonstop. Yes. It’s basically an affront to the hub-and-spoke model. The way it is designed, because it is so efficient, allows you to create brand-new routes. So when the Boeing Dreamliner is up and flying, you’re able to do crazy things like Osaka to San Jose. You could actually create a route from Indianapolis to Dubai, or Indianapolis to Belfast, if there’s enough demand. And so it changes the hub-and-spoke model. It gets to what passengers really want to do, which is not have to make flight connections, not have to lose their luggage somewhere along the way. It also addresses revenue per passenger mile, but the Dreamliner reinvents the model at the customer’s convenience.

The Dreamliner is transformational—so transformational that Airbus had to issue its own version, the A350 widebody.

This is what we want to do in our own industries: transform business models. And as we transform our business models, we create a transformational culture.

Let’s look at companies, like Siemens, Philips, or GE, or health-care companies that sell big medical-imaging systems. They sell these devices at a million bucks each. You could buy one of these devices at a million bucks. You could then get a financing plan to pay for it over time. You could then get a maintenance plan to make sure the machine stays up and running. But when you’re in the health-care industry, at least in America, or in a fee-for-service environment, the thing that matters the most is revenue per scan per hour. That’s the metric that counts.

Remember, when you’re thinking about transformation, you have to focus on the metrics that matter. So what do you want to see? How fast you can run these machines. You want to see how much bang for your buck you can get for them.

More important, these machines have to be up and running. So what does that mean? Well, when people look at that reality from a business model transformation perspective, they start to think, “Hey, if we could put sensors on these machines, and we could actually identify which parts fail first or fail more often than others, if we connect these machines into different networks and have those networks talk to one another, we could get to some very interesting business models.”

And in fact, Siemens, GE, Varian Medical Systems, and a lot of other providers no longer care about just selling the machine. What their customers actually want—the outcome that matters—is up time. So instead of charging a million dollars for a machine and a service contract, these companies might say, “Look, let us guarantee you 85 percent up time over the next three years. We’ll charge you $3 million, and that will guarantee you 80 percent. If you give us $4 million, we’ll give you 95 percent up time. That means if the machine ever goes down, we will drop off a brand-new machine if we have to, get it up and running, get you all set in two days max, so you have very, very little down time.”

That’s transformational. “And on top of that,” the companies are saying, “we’ll even manage the machines for you remotely, do proactive diagnosis. We’re going to take care of all the parts. We’re going to take care of failures. We can even provide benchmarking data.” Why is it that a Johns Hopkins Hospital, a Mayo Clinic, a Cleveland Clinic, is more expensive than a community hospital out in Palo Alto? What’s going on with these academic medical centers? How come they’re making more per scan than the community hospital? Well, they can actually provide that benchmarking data. They actually know what parts are going to break down first. They know exactly how to build around it.

This is another example of digital transformation. Transformational culture involves thinking about how to change what customers want, and deliver to it. The transformational culture is, We’re now going to shift to delivering on experiences and outcomes. The transformational culture is, We’re going to use data to change the way we serve our customers. What you must build is an organization to do that.

Let’s take Disney as another great example. For Siemens or GE or any other health-care provider, the goal was not to sell imaging systems. For Disney, the goal isn’t to sell theme park tickets or another movie. Think about Disney’s films. You started out watching a movie. You physically went to the theater. Then you might have picked up the VHS, and later you might get the DVD. When the latest technology released the same movie yet again, you might have gotten it on Blu-ray. You might even get it again by subscribing to Netflix. Think about this. You’ve bought, you’ve watched, you’ve acquired the same movie three to five times. What a great model for IP innovation. But there is more to the Disney model than just IP innovation. You might pick up an action figure or a book or another licensed product that features the movie’s characters. You might actually go to a theme park. You might take a Disney vacation or go on a Disney cruise. There are even retirement communities in Bangalore, India, and in Celebration, Florida, that are Disney designed. And you’re going to pay for the brand. You know you’re going to pay more. You know the experience will be tightly scripted and controlled. You also know it’s Disney, you know it’s going to be family friendly, and you’re OK with paying more. And this comes back to my point that Disney doesn’t sell theme park tickets. Disney sells a promise. When you keep your brand promise, you keep your value. You can keep your margins. This is part of that culture of transformation, which is not only understanding the metrics that matter, but also understanding what brand promises you have to keep and designing and building everything from that brand promise.

This business model shift is already here. Customers know that we’re no longer selling products or services—we’re keeping brand promises. Product companies are giving away products for services revenues. They’re giving them away against their margin. Products are being given away, and companies are making money on maintenance fees.

Service-based companies are trying to sell experiences at various price points, and on insurance plans, delivery, and installation. Experience-based businesses like Siemens, GE, and Disney are selling peace of mind by keeping brand promises. There is a natural hierarchy in this business model shift, and it’s a big part of what we’re talking about in business model transformation. First, you have to know yourself and understand your organizational DNA. Second, you have to figure out the difference between incremental innovation and transformational innovation. Are you ready? And then you have to think in terms of business model shifts that deliver on the brand promise. It’s that brand promise that helps us get there, that helps us maintain our margins, that helps keep us disciplined in terms of how we innovate. And in terms of digital business model disruption, transformation is that first element that has to be achieved.