The Economics of Innovation

Organisations seeking to innovate must look first at their business model

If innovation were easy, we’d have invented a better mousetrap by now – or how best to organise the NHS. It’s a difficult, complex process that may involve a light-bulb moment of sudden inspiration or gradual tweaks to an existing product or service. At Frontier, we believe that the key to successful innovation processes is often to be found through knowing the economic model at the heart of a business.

Building on that insight, we put five questions to any client that is clamouring to innovate. These cast light on the economics underlying a firm’s innovation needs and how they affect innovation decisions at every level of the business.

The five questions are:

  • What type of innovation do you want?
  • How does innovation fit with economics and culture?
  • What type of process do you need?
  • Should you innovate by yourself or with a partner?
  • How will you make it work in practice?

This article explores the second question: innovation as it fits with a firm’s economic model and its culture.

Organisations often start with the assumption that their ‘innovation culture’ needs to change. But we find that culture is rarely the root cause of innovation blockages. Rather it is the economic model that tends to determine what sort of innovation a business does well – and what it does poorly.

That’s not to say culture doesn’t matter. But culture is shaped by incentives –what a business values and what it shows it values – and in most successful businesses, incentives are aligned with economic models. 

Assessing your economic model calls for an understanding of how you make money today, but also how your competitive advantage will help you navigate what market changes might lie ahead. The model determines the processes, default settings and behaviours that teams follow, including in innovation. This means arming yourself with some important knowledge:

  • Know what type of innovation your economic model is good at. Large, successful companies find disruptive innovation difficult, fearing damage to their brand if a big bet falls flat. But thanks to their efficient processes they excel at high-frequency, incremental innovation, minimising the risk of unwanted customer outcomes.
  • Identify natural weaknesses – and capitalise on them. A risk-averse business may have drummed into its staff the need for perfection, which it fears will stifle innovation. But it can turn that supposed weakness into a strength, for example by setting goals for running ‘perfect’ innovation trials.

Someone who has thought deeply about innovation is Sir Dave Lewis, the chairman of Haleon, GSK’s former consumer health business. Dave, who spent 28 years at Unilever followed by more than six years as CEO at Tesco, agreed that innovation cannot be separated from a firm’s economic model.

Innovation is not just about products or technological breakthroughs, Dave told us. It’s also about operational practices and processes. That means every organisation has to be able to keep reinventing yourself, even if that involves radical change.

“The most important thing in all customer-facing businesses is starting with real customer insights. So you start with the end in mind, and then you’re saying, ‘Let me identify an opportunity to serve that person better to add value to that relationship’. Then you’re thinking: How can I make that work within the economic model of this business? Can we afford it? Does it fit?

“The economic model has a very important role to play at that stage, but you also have to be prepared to challenge it. Some of the best innovations I’ve ever seen completely reinvented the economic model of the business that created it,” Dave said.

An example he gave is Tesco, which made the leap from seeing itself as a traditional grocery retailer to a business intent on maximising the ‘lifetime value’ of its relationship with shoppers who also banked with Tesco and had a Tesco mobile phone. That innovative thinking led to Clubcard pricing.

“It's harder, but many industries have had to move from product delivery to service delivery. Over time that redefines the whole economic model of that business,” Dave said.

You can see his full interview here. You can read more of our reflections on successful innovation here.