Microsoft and the Innovator's Paradox

"The Odds Are Increasing That Microsoft's Business Will Collapse"

That's a pretty good title if you (like Henry Blodget from Silicon Alley Insider, the writer of the article) are trying to grab eyeballs. It also provides a useful introduction to what I call the "Innovator's Paradox."

Blodget's article was provocative. He argued that Microsoft is in a no-win situation. It isn't sitting on any idea that is on the cusp of turning into a multi-billion dollar business. The personal computer is losing its dominance to mobile devices and tablets. The company's core profit drivers (Windows and Office) are under disruptive assault from Google's freely available applications and operating system. At best, Microsoft will respond with its own free products and erode its profit margin.

The most telling thing in Blodget's post was a chart that showed the sources of Microsoft's profits over the past few years. Microsoft's core business has continued — despite continued proclamations of the company's coming demise — to throw off cash and to grow. But new growth businesses that were specks in 2006 (entertainment and devices and online services) remain tiny, and Microsoft hasn't created any material new businesses over the past few years.

So the real problem isn't what Microsoft is doing today. It's what Microsoft did, or didn't do, five, or even 10 years ago. At the time, its base business was a bastion of strength. Today's threats were in their infancies. It would have been the perfect time to plant seeds that today would be blooming profit generators.

Why didn't it? It's The Innovator's Paradox: When you don't need the growth, you act in ways that lead to you not getting the growth you will need. And when you do need the growth, you can't act in ways that deliver it.

Got that?

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I use this chart to illustrate this point. It's helpful to stimulate discussion among a company's leadership team.

As the chart shows, when times are going great ("exploitation"), companies have ample resources to invest in growth. But because times are going great, innovation efforts tend to be undisciplined. New growth efforts get flooded with cash. Companies don't worry about iterating to find a successful business model. Overpriced acquisitions occur.
Then, inevitably, maturation sets in. The need for new growth intensifies. But resources are harder to come by. Acquisition targets would rather join forces with the new kid on the block whose rapidly appreciating stock acts as a powerful acquisition currency. The acute need for growth gives an almost gravitational pull to large, existing markets. After all, that's where the money is. But large, existing markets are an innovator's fool's gold; glimmery, shiny, but not of much value.

So what do you do about the Innovator's Paradox? Consider what my colleague Clark Gilbert found in his doctoral research. He looked at how newspaper companies responded to the Internet, intersecting the disruptive innovation research of Clayton Christensen and the famous behavioral research of Amos Tversky and Daniel Kahneman.

Some companies in Gilbert's study viewed the Internet as a threat. That led to them committing resources to innovation efforts. However, they responded in very rigid ways (typically creating replicas of the newspapers online). Other companies viewed the Internet as an opportunity. That framing allowed for more expansive response strategies, but made it difficult to support serious resource allocation. Gilbert summarized this challenge by saying, "Absent a sense of threat, response to disruptive opportunities is inadequate; but with threat, the fully funded response is too rigid."

The trick, Gilbert argued, was to decouple the allocation of resources from the use of the resources. Breaking the Innovator's Paradox requires similar logic. Companies have to recognize that their core business, no matter how great it seems today, has a limit. That recognition should drive consistent allocation of resources to new growth efforts, especially when times are good. But those resources can't be burdened with a "bunker" mentality, or else they will struggle. As one friend told me, "No great growth business was built from a defensive crouch." Further, companies have to make sure they avoid the "curse of abundance" that can lead overly resourced growth efforts to struggle.

So, all you have to do is invest when you don't need to, break psychological barriers that might unintentionally inhibit creativity, and somehow avoid the abundant resources that would seem to be your primary source of competitive advantage.

No one said this was going to be easy.

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