Innovation in crisis?
Dr. Lysander Weiss
Adjunct Professor ? Management Advisor ? Senior Research Fellow ? Serial Book Author ? Speaker
#futureproof - the newsletter around future readiness for companies! Here, Dr. Lysander Weiss regularly writes on current topics relating to strategic renewal, innovation and transformation of established companies on their way into the future. As an adjunct professor, senior research fellow and management advisor, the bestselling author bridges the gap between theory and practice with fresh impulses to "rethink companies for the world of tomorrow, today“.
Welcome to the innovation crisis ??
Artificial superintelligence, eternal life, colonies on Mars, autonomous driving (and flying), infinite fusion energy and smart cities are just some of the innovations we are promised today. However, these promises hardly ever reach us, as a look at reality is much more depressing. Inflation and recessionary developments as a counter-reaction threaten prosperity and increase the fear of decline (1). In the EU and Germany, growth is stagnating due to structural problems and the associated weak productivity development. The existing economic model is being threatened by more volatile geopolitics, external security and the challenges in energy supply, as described by Mario Draghi in his highly acclaimed report (2). Decarbonisation, digitalisation and demographic change remain unresolved challenges, while at the same time global competition with China and the USA continues to increase (3). In short: while great innovations are promised, actual competitiveness continues to decline, at least in this country, while climate change continues unabated, populism is rampant, inequality is on the rise and the internet is also becoming increasingly unfriendly (don't worry, this #Futureproof edition will become more positive, keep on reading!).
It therefore seems that innovation cannot keep its promises and is itself in a crisis, as we are not managing to address the important problems with new solutions (but rather create even more problems in case of doubt) or, from the point of view of companies, to successfully bring new offerings to the market that really create new competitive advantages. And innovation is actually becoming increasingly difficult. A comprehensive scientific study shows that the efficiency of research and development in terms of commercial per capita output has decreased by an average of 5% since the 1930s (4)! This emphasises the impression that truly new solutions are hardly possible any more. Rather, we seem to be stuck in the past, where every idea has actually existed before, only to be resurrected with newer technologies, as the British philosopher Mark Fisher describes in an essay:
to live in the 21st century is to have 20th century culture delivered to you through 21st century technology. It is to have the ideas and the art of the 20th century shown in 4k or streamed with high speed internet. We are caught in a perpetual state of the present…
Especially in times of crisis, companies and often entire economies quickly come to the conclusion that it is better to forego innovation, avoid risky and expensive investments and instead "keep their money together", rely on tried and tested products, avoid risk and try to get by somehow.
Too little investment, too much bureaucracy, location costs too high - the German economy is stuck. It is losing out in Europe and internationally.
This is how Martin Wansleben, Managing Director of the German Chamber of Industry and Commerce (DIHK), summarised the results of the new DIHK economic survey at its presentation in Berlin (5). Such situations describe a dangerous downward spiral when crises or stagnation, as is currently the case in Germany, lead to less investment in innovation - and thus to a further downturn. Just as economies often reduce budgets for education, research or specific innovation funding in times of crisis instead of investing at precisely this time.? "Reduce investment, cut costs, cut jobs, restructure". That's the "formula F" when the spectre of recession or other crises is around, which then leads to a self-fulfilling prophecy. For example, a study by McKinsey (6) shows that innovation activities were significantly reduced in all sectors (except pharmaceuticals/medicine) during COVID-19 (see Figure 1).
In Europe in particular, this pattern F has already been applied for a long time, as described in the Draghi Report (7). The dynamics in the industrial complex are low and only a few companies are emerging as new growth drivers. Accordingly, no new company with a market capitalisation of over EUR 100 billion has been created in the EU in the last 50 years, while all 6 (tech) companies with a market capitalisation of over EUR 1 trillion (!) in the US were all newly created in this period. Instead, EU companies specialise in mature technologies with limited potential for new breakthrough innovations. Accordingly, they spend significantly less on research and development than their US counterparts - in 2021, for example, -270 billion euros! For 20 years, automotive companies have been investing the most in Germany, while in the US this has shifted from automotive and pharmaceuticals to tech companies.
Crisis? Innovation! ??
It is not only the comparison with the USA that suggests that the intuition to avoid "risky" innovation in general and especially in times of crisis is wrong. On the contrary, it is ultimately more expensive and riskier for companies and entire economies not to innovate!
It is risky to innovate but even more risky, not to innovate!
Not only because the multiple crises mentioned above can only be resolved through innovative new approaches. But also because the economic barometer will not improve on its own without investment in innovation. Cutting back on innovation not only drives affected companies further and further into the crisis, but in the worst-case scenario it also exacerbates the downward spiral for the economy as a whole. For example, cutting jobs often leads directly to lower performance, especially in large companies that are already highly optimised, as Professor Kamel Mellahi from the University of Sheffield describes:
Our research shows that many companies become lean and lame rather than lean and efficient as a result of downsizing.
The effects are particularly negative when linear savings are made in all areas. This is not only because the best employees often leave first when jobs are cut, but also because the remaining employees are less committed, as Cologne-based Professor Matthias Heinz and his research team discovered. He found a 12% drop in productivity and a decline in the quality of work among the remaining employees whose colleagues were unfairly dismissed.
The risk is particularly high for companies that are particularly reliant on innovation, as Viral Acharaya, Professor at the Stern School of Business in New York, describes. When these companies cut staff, they inevitably lose expertise, experience and relationships that cannot easily be brought back into the company. A McKinsey study shows that companies that scaled back their R&D activities during the 2009 financial crisis subsequently lost market share and competitiveness, and had less expertise, motivation and talent to catch up again - only 17% observed no negative effects (see Figure 2).
These long-term risks apply in particular to a large number of companies in Germany, which have often achieved their good competitive position through an innovative edge, while energy and labour costs are comparatively high here. This risk is also imminent for the economy as a whole. For example, the IMF (8) describes how, in view of rising debt and budget consolidation, cuts in government spending on research and development are an easy target in economically difficult times - countries that forego funding for research and development, however, give up their competitive advantages to other countries in the long term (as can be observed, for example, in the competition between Germany and China).
Whether for companies or national economies - these risks are particularly relevant in times of crisis, as this is when the wheat is separated from the chaff. According to a study by Bain, for example, only around one in five companies came through the financial crisis in good shape and were able to improve their position compared to the competition. In contrast, more than two thirds have lost competitiveness! However, the equation also applies the other way round: companies that innovate, particularly in times of crisis, can come through crises more successfully and also have higher long-term growth afterwards. This is demonstrated, for example, by the watch company Swatch: "We decided to keep the jobs even in the event of a fairly substantial drop in sales," wrote Nicolas G. Hayek, then President of Swatch, in the 2010 annual report on the financial crisis. By focussing on the development of new innovations in the face of lower order intake, Swatch was able to gain a clear competitive edge that is still paying off today.
This effect can also be observed in principle. Companies that outperform their competitors during a downturn also generate more value in the long term - measured in terms of increases in stock market value and dividend payouts (9). For example, only 14% of companies were able to generate sales and profit growth in times of crisis - but even after the crisis, these companies continued to achieve substantially higher growth in profitable sales (see Figure 3).
This is also easy to explain. Because in recessionary phases or other times of crisis, the market environment often changes massively. Previous priorities have to be reviewed and adapted to the new situation. It is therefore important to act proactively. Those who act more intelligently and faster than others can either gain market share during the crisis or utilise the subsequent market recovery in a more targeted manner. The "crisis winners" combine margin-stabilising cost reductions in the right areas with a sustained focus on their strategic growth areas, in which they continue to invest. This strengthens them in the long term and leads to an above-average increase in value.
This is because the positive effect of innovation on economic growth is undisputed - which can therefore have a doubly positive effect in times of crisis, when many companies reduce this growth lever. KfW describes in a study (10) that innovations have a significant impact on SMEs:
Turnover growth in companies with successfully completed innovation projects is 24.2% within a 2-year period after completion of the innovation projects, around a third higher than in comparable companies without innovations (!)
Equally, entire economies can - or even must - benefit from a strong innovation performance. This is because economic growth (as an indicator of the potential increase in prosperity) can either be fuelled by population growth or by higher productivity (11). In the many countries with declining populations, higher productivity and efficiency is therefore the key to success - and innovation plays a critical role in this. While historically most periods in human history have seen little economic growth, it surged after the first industrial revolution and has since multiplied. This was due in particular to advances in transport, physics, chemistry and other sciences and technologies. For example, a scientific study of millions of patents shows that the breakthrough innovations that can be found there were associated with positive changes in productivity levels in different time periods, industries and companies (12). Spikes in patent quality could predict both disruptive inventions and individual company profits, suggesting that innovation may indeed be the key to understanding the last two centuries of economic growth. And a study by the IMF shows a positive effect of a country's innovation performance on per capita economic output. For example, 1% more innovation results in 0.05 % more per capita income (13).
Overall, economies that promote innovation are more resilient, enjoy greater prosperity and get through recessionary times better (14). It is therefore no coincidence that the UN lists innovation as crucial for productivity, economic growth and the labour market in its Sustainable Development Goals 2030. Particularly in times of crisis, effective innovations can therefore give companies and entire economies new competitive advantages, turning them from a "nice-to-have" in times of upswing into a "must-have" in times of stagnation or downturn. So as long as a company can still tackle new activities, the focus should be on new innovations, especially in recessionary phases or other times of crisis. Or with the words of Google-CEO Sundar Pichai when asked about the current investments into AI/Cloud-Infrastructure:
When we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us
Even in scenarios where it turns out that Google has over-invested, Pichai said technology infrastructure has a long useful life and a wide range of applications (15).
But such promises might be easier said than done, because in tough times cash flow naturally becomes more important and the budget correspondingly more restrictive, so how can we actually pull it off to keep investing in innovation?
Innovation excellence for survival & growth ??
Innovation is therefore particularly challenging to implement in times of crisis, but at the same time all the more necessary. The key is therefore to focus on strategic innovation in order to develop new competitive advantages in a targeted manner, while peripheral, "nice-to-have" innovations can at best be reduced, which also saves the budget (see Figure 4).
In times of crisis, companies should therefore put their innovation and R&D activities to the test and optimise and focus them in terms of their impact. A portfolio strategy process can be carried out in three steps to optimise the effectiveness of innovation efforts.
Once the portfolio strategy process has been established, its regular repetition can also ensure continuous optimisation of the innovation portfolio, even if the environment changes volatilely in times of crisis.
With such an innovation portfolio, which is characterised by high effectiveness (what do I do?), the efficiency in the execution of the selected innovation projects (how do I do it?) can also be optimised. The most agile approach possible should be chosen here in order to avoid high upfront investments in the face of high uncertainty and tight budgets. Instead, assumption-based testing and iterative development ensure continuous learning and rapid adjustments. A stage-gate process can provide the right framework for this, for example by defining which maturity levels an innovation should pass through in terms of technology, market and business model, and repeatedly making investment decisions at important stages with a corresponding reassessment. Particularly in later stages, when it comes to the more expensive development and scaling of an innovation, open innovation with partnerships between companies, start-ups and possibly other organisations can also ensure a distribution of the risk and necessary investments and should therefore be promoted, especially in times of crisis.
With a high level of "innovation excellence" by increasing effectiveness and efficiency, there is an opportunity to significantly increase the strategic value contribution or "return on innovation". A significantly higher value contribution can be achieved with the same budget, and even if the budget has to be reduced, this can be done in a targeted manner in order to maximise the value contribution.
At the same time, politicians can and should promote strategic innovation by companies, especially in times of crisis, in order to get through the crisis better overall and gain long-term locational advantages. Unfortunately, even in normal times, this still happens far too little in this country, and in times of crisis, just as with companies, there is an even stronger focus on other topics for budget optimisation and short-term economic stimulation (or "rescue"), which do not provide any sustainable advantages (16).
The Draghi Report thus logically describes a large innovation gap in the EU. Compared to the USA and China, there is a lack of innovation in the EU, especially in future technologies. Because companies in the EU primarily produce technologically mature products, they invest less in research and innovation compared to US companies, which is reflected in lower investment overall. This in turn widens the innovation gap and reduces the chances of disruptive innovations.
In order to close the innovation gap, Draghi proposes, among other things, developing a common European R&D strategy, improving the financing environment for innovative companies and strategically orientating (further) education towards the future, with a particular focus on scarce skills. While governments usually limit themselves to promoting basic research and inventions, the commercialisation, adoption and diffusion of innovations in particular is crucial and must be followed up. Specifically, for example, through
Never waste a good crisis ??
From Churchill to Economist Paul Romer, many different people have been quoted as saying that a "good crisis should never be wasted". This may sound cynical at first, but ultimately it expresses precisely the (innovation) opportunities that arise as a result of crisis-related changes. The pressure to change can lead to a readjustment, which is then addressed with targeted innovation initiatives. If the prevailing problems exceed the innovative strength, this is therefore not a reason to innovate less, but rather a reason to organise innovation efforts better and more effectively!
The conditions for this are particularly good in times of crisis - because the prevailing pressure for change can be used to scrutinise all innovation activities and focus on strategically effective innovations. However, this focus must then be supported by a high level of "innovation excellence" at companies and the right framework conditions from the political sphere. If this succeeds, companies and entire economies can get through times of crisis better and also benefit in the long term after times of crisis. And then we may not get all the science fiction promises, but the adoption of innovations that help us directly and make cities more liveable, cars safer and more sustainable, life healthier, space travel more sustainable, energy more renewable and virtual communication more inclusive. And that already gives us reason to hope!
References
2 https://www.bmwk.de/Redaktion/DE/Schlaglichter-der-Wirtschaftspolitik/2024/10/04-draghi-bericht.html
9 Lanzer, Sauberschwarz, & Weiss: Erfolgreich durch die Krise. Springer, 2022.
11 https://blog-pfm.imf.org/en/pfmblog/2022/11/effects-of-innovation-on-fiscal-policies-and-economic-growth 12 https://insight.kellogg.northwestern.edu/article/measuring-innovation-patents-productivity