The Lotus team made a success at the annual Digital Tomorrow event that we at Avanade hosted two weeks ago. But it was not only the Formula 1 car simulator that attracted attention. So did the presentation that Matthew Walmsley gave on how the Lotus team manage innovation to stay abreast of competition in the formula 1 circus. The down-to-earth presentation in combination with Matthew’s low-key British humor created an atmosphere that triggered many questions. One of the attendees even dared to express her frustration on the poor traction they have on innovation in her organization. She explained that they have all the ingredients for innovation in place but nothing happens. It was refreshing when Matthew asked her why they needed to innovate. You could really see the puzzled expression in all our faces on this basic and sincere question. All of us tend to regard innovation as the holy grail, a necessity to ensure the long term success of our companies, and we seldom or never challenge our ambition to innovate. But, innovations imply change and change may be disturbing. So, being an innovation peddler that even have argued that you shouldn’t listen to your customers when innovating, I feel obliged to dedicate this blog post to the question on why you should innovate and whether there are any industries where innovation is not motivated.
Matthew was clear on one of their key ingredients for innovation – goals. To them and probably everyone else in the formula 1 circus, it is really easy. The objective is to win and the winning formula is generic with four parameters; driver, engine, tyres and aero. As a mechanic, the only parameter that you can control is the aerodynamics since the engine is given and everyone is using the same tires from Pirelli. The chart below is a possible graph representing the advances in aerodynamics. The red dotted line represents the baseline. It is the improvements that their competitors achieve each year. The blue line represents the Lotus team’s improvements. Matthew estimated that they would lose 2-3 seconds to competitors if they didn’t innovate at all which could be the difference between winning and ending on the 10th place.
True, few of us can single out single key performance indicator as in the example above but, nevertheless; it raises the question on the innovation baseline in industries. Do we have industries where the baseline is flat? Boston Consulting Group, that developed the mother of all 2*2 matrices, may shed some light on the question. They have adopted their famous growth/share matrix to the new market conditions. They now recognize that relative market share and economies of scale is not the only competitive advantage to consider when assessing your business portfolio. The new model, The Advantage Matrix, distinguishes between two dimensions; the number of advantages and the importance of them as presented below:
Innovation is imperative to ensure that returns to scale is reaped in the production function for volume players. Similarly, innovation is a necessity to sustain a differentiation strategy on a market where there are many possible advantages, especially if they are small and easy to replicate. But there is quadrant that BCG refers to as “Stalemate”, where it may be hard to motivate innovations. In this quadrant, there are few and small advantages that everyone in the industry knows about.
And, let me be clear about it. The banking industry is not in the stalemate quadrant. I think it is fair to assume that an industry with few and small advantages should be characterized by players with roughly the same poor margin. That is not the case in the banking industry according to the following graph that illustrates the spread in Return on Equity (RoE) among the listed commercial banks in the Nordics.
To summarize, I still believe that everyone in the financial services sector need to trim their economic engine. The impact of not maintaining an innovation level that is at least on par with the innovation baseline in your industry will eventually hurt your competiveness. And there are clearly actors that leverage innovation to capitalize on the advantages in the industry to outperform their peers. The difference between the best and worst performers in the industry may exceed 10 percentage points.