Unveiling Innovation Bottlenecks: Navigating Challenges in Corporate Growth and Sustainability

Innovation has, over the years, been seen as a fundamental pillar for the growth and sustainability of any company, especially to remain relevant and competitive in markets that are constantly evolving. To clarify scopes, in the business context, innovation can be understood as the integrated set of activities that an organization undertakes with the goal of developing and introducing new products, services, or altering operational processes, or even introducing new and different business models. Innovating aims at the potential to transform the company's modus operandi, allowing it to defend itself, adapt, or anticipate trends and, consequently, maintain or increase its market share and/or its profit share.

Although the pursuit of innovation is ideally intrinsic to any company, there are clearly limits, and evidently not all companies innovate or derive benefits from innovation. My goal with this article is to bring visibility to the main "bottlenecks in innovation":

1. Financial Capacity: Innovation involves risks, and not all innovation processes carry similar risks. While process innovation may pose the risk of the impact on the return on investment being lower than expected, the level of investment required for launching a new product typically involves greater financial, reputational, and market risks, for example. The success rate varies primarily due to this degree of innovation ambition. For instance, a recent study from MTI suggests that the failure rate for new products reaches 95%. Companies with a strong dynamic of innovation in developing new products or markets typically use a portfolio approach, resorting to diversification. They acknowledge that most initiatives will fail, but the successes will more than compensate for the less successful efforts. This strategy implies incurring substantial fixed costs and functions as a natural barrier to market leadership in innovartion, as exemplified by companies like Google, Apple, and Microsoft. These companies have launched numerous products either to prevent other players from entering the market or to test the size of a potential market, enjoying the "first-mover" advantage. Private equity firms have, in a way, responded to this challenge, but they capture a large part of the value generated, typically outside the scope of established companies. As a consequence, companies usually engage only in incremental, not disruptive, innovation. This approach allows for asymmetrical growth rates among companies, helping larger companies grow even faster, contributing to the limitation of diseconomies of scale, and increasing the gap in revenues between them.
2. Organizational Culture: The skills needed to innovate are different from the skills required to exploit the company's current portfolio of products and services. The conclusion is that best practices suggest the segregation of resources, i.e., resources allocated to innovation should be exclusively allocated to these functions. The primary goal is to allow agility to pivot and even fail. The company Strategyzer , in this scope, I believe has been quite successful in redefining the "Explore – Exploit" portfolios framework that I recommend consulting. The main problem is that typically companies have a culture geared towards short-term results and contrary to the recognition of failure, besides seeing innovation as a cost and not as a growth driver, reinforcing a culture unfavorable to the dynamics of innovation.
3. Strategy: Often, innovation arises not from what the company believes in where and how it should position itself or operate, i.e., from a deliberate strategy, but rather from the emerging strategy imposed by external stakeholders, typically customers or competitors. An example is the “me too” strategies, which in reality will not help the company gain market share, but rather defend it, while mitigating the risk of innovation.

The consequences of not investing in innovation tend to be dramatic for the company in the medium term. It ceases to be able to position itself in a way to have a differentiated value proposition. In other words, it is doomed to face a almost perfectly elastic demand curve, where the only variable that the company can use to impact demand is price. However, getting out of this dynamic is complicated. First, because the company in this scenario operates with low margins, probably with falling revenue, and with a more expensive cost of capital than other players. Second, because the culture and mentality of innovation are not in the company's values, meaning it has a deficit in the capacity for innovation.

Two final notes, the first on the use of M&A operations to solve the innovation gap, i.e., acquiring companies to help reposition the parent company in the market. This operation is not naturally free of capital costs, but it may make more sense than developing organically given the company's internal (in)capacity to innovate, nor is it free of cultural shock costs. Based on my experience, M&A processes with companies with very different cultures tend to generate negative synergies.

The second note relates to the system of incentives for innovation present in different countries, with Portugal being no exception with the SIFIDE. These stimuli have encouraged a new form of innovation that I consider extremely perverse, the “innovation theater”. In this case, it is based on carrying out innovation to fit the criteria for maximizing the allocation of the subsidy. This type of innovation is perverse due to the inefficient allocation of resources, opting for projects with potential for subsidization instead of others with greater capacity to generate value for the economy and for the company.