Why You Should Never Defund the Innovation Department

The heading is intentionally provocative. I guess some of you may be thinking:

“But do we really need an innovation department? Shouldn't we be moving away from silos and instead make innovation everyone's job?"

The short answer is "it depends". It depends on how far along the development curve you have come. Most companies are still organized according to departments or some form of matrix structure. If that's your reality it's probably a good idea to leave that unchanged (at least for now).

Instead, it may be wise to choose your battles and find ways to work within the constraints of the existing organizational structure.

Let's not forget the overall aim, which is to incrementally strengthen your organization's innovation capacity (resources) and capabilities (competencies) by unlocking resources and introducing frameworks, tools, and methods to work more effectively with innovation.

And if you're serious about innovation you need someone who is in charge of all of this. Those people would normally be referred to as the "innovation department", or some variation thereof.

Also, if you don’t have anyone in charge, accountability becomes tough. And without accountability, there is no personal ownership with everyone “passing the buck”.

Furthermore, budgets and KPI’s need a “home”. Without an innovation department, there is nowhere to assign a budget and relevant KPIs.

If your company doesn’t have an innovation department and/or lacks accountability to get the innovation engine spinning, no one in your company will ever take “innovation” seriously. It will just be a distraction from the “real business”.

According to the legendary management guru Peter Drucker, a company only has two basic functions.

"Because the purpose of business is to create a customer, the business enterprise has two--and only two--basic functions: marketing and innovation. Marketing and innovation produce results; all the rest are costs.”

That’s why I tear my hair out whenever I hear of companies that want to defund innovation.

Saying that you are thinking of defunding innovation (i.e. developing new business models, products, and services that meet customer needs), signals that you don’t know what you are doing. It’s like saying that you want to defund schools or hospitals.

They are essential components of a healthy well-functioning society. We need them!

In comparison let us now take a look at some "darlings" of the corporate world that I think are less essential in comparison. To illustrate my point let me introduce you to our cash distribution cow!

Innovation H1, H2, H3 is a concept developed by McKinsey. We have given their definitions our own twist. It goes as follows:

H2 = Investing in areas that are new to your business.

If you simply want to survive as a company you must invest in H2, for example when Amazon adapted their business model to include Amazon Prime. Of course, there were also failures along the way such as the Amazon Fire Phone.

H3 = Investing in areas that are new to the world.

If you’re more ambitious and want to lead the world towards a new future you must also invest in H3, for example when Tesla and others invest in self-driving cars.

H1 = investing to extend the life of your core business

This is your proverbial “cash cow”, which you want to milk to the max.

The classic S-curve comes to mind. Make sure you have enough resources to be able to "jump the S-curve", i.e. to transition to new business models that will carry your company into the future. When there are only drops coming out of the cow's udder, it’s already too late!

Ask yourself, where are we on the classic growth curve? Have we been ramping up investments in innovation fast enough? Are we ready to “jump the S-curve”?

Dividends may seem necessary to some because it’s expected by investors. If you stop paying dividends, pension funds and others will probably sell your shares and your shares will most likely drop.

The flipside of the argument is that the market views companies that pay a large percentage of their profits as dividends as less innovative.

And as we know, less innovative companies carry lower P/E ratios (Price / Earnings), resulting in lower share prices, which in turn results in weaker muscles for the M&A department when they go shopping.

Also, by paying excessive dividends leadership shows that they don’t have any better use for the money than to return it to their shareholders. Another way for shareholders to get the same result is to sell their shares.

Ask yourself, is it more important for the long-term growth and prosperity of your company to continue to pay dividends at current levels instead of investing in the future?

Share buy-backs are essentially financial engineering. Management buys back outstanding shares thereby artificially inflating EPS (earnings per share).

That’s much easier and quicker to do than to organically increase EPS by investing in the future. Since management compensation is often tied to EPS this is a fast way for them to increase their bonus. 

Ask yourself, are share buy-backs a more responsible way to use funds compared to investing in H2, H3 innovation?

The war chest is the company amassing large sums of cash by propping up the asset side of the balance sheet. If your strategy is to be fast and powerful when acquiring other companies this can be seen as essential.

Ask yourself, how much cash is too much to carry on the books without producing a decent ROI? Are acquisitions the right way to grow our company long-term or is there more that we could do to expand on our innovation strategy? 

To summarize, you can choose amongst the following:

H1 = Milk the cow while slowly dying / incremental innovation

H2 = Survive long-term / disruptive innovation

H3 = Lead the world to a new future / transformative innovation

H3 is your opportunity to build a true legacy and “put a dent in the universe”.

The more you divert funds generated by your cash cow to pay dividends, buy-back shares, or put into the piggy bank, the less you will have left to invest in H1, H2, and H3.

H1 is often well understood by corporate CEOs and is clearly within their scope. That’s what they are talking about when they say that they want “innovation to be everyone’s responsibility”, or that “innovation should permeate the entire organization”.

However, H2 and H3 are often less understood by people who have been line managers most of their careers. People who have never built an entrepreneurial venture from scratch often see H2 and H3 as distractions from meeting the numbers for their next quarterly reports.

That’s why it’s so important that company leadership hires someone who can work alongside the CEO to oversee the investments into H2 and H3.

This person should report directly to the board of directors, or at the very least report directly to the CEO and together with the CEO report to the board of directors.

In conclusion, make sure that you strike a good balance and that you put someone in charge of H2 and H3.

Step one is to know what your current resource allocation balance looks like. Do you know?

Let me know in the comments below.

NB: Kudos to my colleague/friend Tristan Kromer for providing feedback on this article.