As I sit and eat my bowl of cereal, hearing and feeling that delightful crunch before the milk saturates the toasted flakes of grain, I am reminded of one of my favorite quotes attributed to the original management guru, Peter Drucker: “Culture eats strategy for breakfast.” 
As my molars transform the once hardened, well-defined pieces of cereal into a digestible paste, I reflect on just how true that quote can be.
Virtually every organization in the known universe trumpets their commitment to innovation as a key component of their strategy for sustainable growth and profitability. So naturally, all of those organizations are innovative, producing valuable new solutions to internal and external problems regularly, right?
The problem is not that innovation does not belong in a strategic plan. To quote Drucker again, “the business enterprise has two – and only two – basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs.” So what’s preventing innovations from pouring forth from organizations like water from a hydrant?
Culture that does not align with an innovation strategy, eating it for breakfast.
Imagine Thomas Edison walking into his manager’s office for an annual performance appraisal, if he had to do so in a typical 21st century company…
Manager: Tom, you know, I’m not seeing a great deal of progress on this “Project Light Bulb.” You’ve failed to make anything we could possibly sell, and the fiscal year ends next week.
Edison: I haven’t failed. I’ve just found 10,000 ways that don’t work.
Manager: We’re paying you to find ways that do work, not ways that don’t. I think it’s about time we gave up on this.
Edison: Our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time.
Manager: Sorry, Tom, but our stockholders think our greatest weakness lies in not launching this product in time for the Walmart shelf reset. And all I see in your lab is a pile of junk.
Edison: To invent, you need a good imagination and a pile of junk.
Manager: Well, to make our quarterly numbers, we need to get some revenues out of all this money we’re spending on you. Your research is like a black hole! Money goes in, but never comes out. You’ve spent a fortune, with no sign of any fortune ever coming back in return!
Edison: Good fortune is what happens when opportunity meets with planning.
Manager: Well, Tom, I think you ought to start planning to look for opportunities somewhere else.
A culture focused exclusively on short-term returns, a culture averse to risk, a culture adhering to metrics that devalue new product development, will devour any strategic plan for innovation. Companies that really want to innovate, and not just pay lip service to innovation, need to do a few things:
1) Encourage good failure
Wait, isn’t “good failure” an oxymoron? No, it is not. Good failure comes from trying to achieve a stretch objective, not quite getting there, but learning something that will lead to future success in the process. It is different from bad failure, which comes from carelessness or stupidity. When organizations systematically punish both forms of failure equally, risk acceptance and employee effort are stymied. Find ways to reward “good failures,” and provide public recognition for such things, so people know that trying, failing, and getting up to try again is not only acceptable, but encouraged.
The Apollo 13 mantra, “Failure is not an option,” is a great motivator, and is completely appropriate in life-or-death scenarios, but even then, I am certain that the engineers who famously modified the CO2 filter with plastic bags, cardboard, and duct tape had several failures on the way to their eventual solution.
Not tolerating failure leads to Homer Simpson management: “You tried your best and failed miserably. The lesson is – never try.”
Don’t believe me? Check out this interview with Eric Reis, author of The Lean Startup from the McKinsey Quarterly.
2) Change internal accounting practices
I know that there are Generally Accepted Accounting Principles established for external reporting, but at least one of those principles is wrong from the standpoint of managing innovation. Forcing all R&D expenditures to be treated as expenses distorts the value of R&D spending.
R&D is an investment – you spend money now in the hopes of excess future returns. Some of the more advanced project and portfolio financial evaluation models are based on options valuation theory, but for the most part, organizations look at expenditures on new product development as expenses, like pencils and janitorial service. Many, if not most, R&D expenditures should be treated as capital investments, at least when it comes to managerial decision-making. Economic Value Added accounting does this, with the result that investment in innovation is recognized for its true worth, and is encouraged accordingly. Studies in countries outside the US have shown the value of this treatment (e.g. The Canadian Academic Accounting Association study).
3) Implement innovative metrics compensation systems
Metrics for innovation are always tricky, but firms must tackle this issue if they are to genuinely encourage innovation. The rewards for incremental innovation and breakthrough innovation should not be the same. Measuring things such as percent of revenue from new products or number of new product launches can be gamed (e.g., manipulating what constitutes a “new” product), so tying compensation to such metrics can lead to disconnecting the efforts of management and staff from the mission and objectives of the organization.
Just as venture capitalists are rewarded for finding diamonds in the rough, innovative managers and staff should be compensated for taking on risk and succeeding.
Rewards should not be exclusively monetary, nor exclusively individualized. Psychological research demonstrates the power of recognition and the opportunity to perform meaningful work as a motivator. Create systems that provide real opportunities and real recognition. If you fake it, such programs will fail (see note above regarding the difference between good failure and bad failure, and make the creation of such programs a cultural innovation effort that, even if it fails, produces learning for future development).
Recent research in behavioral economics has demonstrated how large bonuses tied to intellectual work actually reduces effective output, even though motivation may be high. A large bonus system specifically tied to the outcome of a project will likely increase the rate of failure. For best results, financial incentives for innovation work should be broadly based, such as profit sharing among the whole business, and not tied to specific individuals and projects.
4) Manage for long-term profitability and short-term cash flow
Often, the pressure to meet short-term profitability targets cause companies to look for spending to hack away. All too often, this spending comes from what is really an investment in the future. Evaluate both your present and future cash flows, and keep the company healthy and resilient, even if it means missing profitability targets now. Maintain sound investment in innovation, and the value of the future rewards will compensate for current profit shortfalls.
Warren Buffet avoided the dot-com bubble burst by sticking to a long-term investment strategy that skillfully avoided the rush to find someone, anyone, in the dot-com world to invest in. Berkshire Hathaway succeeded through the early 2000s against heavy pressure and criticism from the world that believed in “the new economy.” Looking back a decade later, his cool head and commitment to investing in long-term strength looks like pure genius.
Short-term pressures can lead to sub-optimal business decisions. Unless your organizational back is to the wall, and immediate survival is at stake, remember to think long-term.
All of this, of course, is not to say that deadlines are unimportant, spending should be unrestricted, or managers should not be held accountable for achievement. Going back to the Apollo 13 engineers, they had absolute deadlines and minimal resources with extremely serious consequences that could not be ignored. Their success came from combining that urgency with a willingness to do whatever it took to get the job done. Corporate business practices should also encourage such willingness — to try and fail, to exchange “crazy” ideas, to test multiple solutions, to break some rules. They will find greater innovation and financial success by doing so.