Everyone is familiar with financial leverage. It is a powerful way to improve performance when times are good. The danger, of course, is that financial leverage magnifies the impact of downturns in demand as well. It can literally kill a company, as we are witnessing in the financial-services industry.
But there are other forms of leverage. And executives should be searching for them in order to navigate the current crisis and allow firms to continue to create economic value, rather than becoming a victim of the destruction in value unfolding around us.
Capability leverage, for instance, seeks to connect with the resources and capabilities of a large number of other companies to deliver even more value to the marketplace, without requiring significant up-front investments for organic growth or acquisitions. Companies like Li & Fung in China have built a global network of more than 10,000 business partners that access a broad range of specialized capability in the apparel industry. The company has enjoyed double-digit growth over the past couple of decades, as well as return on equity in excess of 20%—an impressive achievement in a low-growth industry known for razor-thin margins.
Learning leverage goes one step further. This form of leverage builds scalable relationships across large numbers of companies that help to accelerate the development of all participants. When done right, it creates powerful opportunities, rapidly increasing the value delivered to the marketplace and allowing all participants to reap increasing rewards.
Open innovation is an important step in this direction, but prominent examples of open innovation, such as InnoCentive and GoldCorp (GG), tend to focus on short-term transactions to access outside capabilities. Learning leverage requires the development of scalable, long-term, trust-based relationships across a large number of participants. It is more challenging but it is also far more rewarding. SAP's (SAP) developer ecosystem illustrates this potential (BusinessWeek.com, 7/23/08) —it mobilizes more than 9,000 companies and engages more than 1 million individuals in sustained interactions on its online discussion forums.
Effectively harnessing capability and learning leverage requires another form of innovation—institutional innovation. Companies will have to redefine governance structures as well as the roles and relationships required to effectively mobilize and coordinate activities of large numbers of firms. There's significant complexity in trying to scale the number of participants in networks and conventional rules might not apply.
This institutional innovation should be pursued in rapid increments. Rather than reimagining from the ground up a fundamentally different way of organizing activities across thousands of participants, companies need to find pragmatic ways to move from where they are today in ways that generate near-term financial returns. The well-known case of Procter & Gamble's (PG) "Connect and Develop" program illustrates some of the opportunities that can be reaped by building broader networks to source promising product ideas. Nearly 50% of P&G's products today have benefited from some form of external collaboration. Other companies might follow this example to position themselves to pursue even more powerful forms of capability and learning leverage, especially once the economy recovers.
The bottom line is that innovation should not be an afterthought in times of financial and economic pressure. Innovation can be reconceived to provide powerful economic (rather than financial) leverage at a time when there is an imperative to do more with less. Simply cutting headcount or programs while demanding that the remaining employees do more may work for a while, but it is a diminishing-returns game. The challenge, and opportunity, is to find ways to generate increasing returns. The insights generated from these efforts will serve companies well not only during the downturn, but in more prosperous times as well. In fact, the companies that harness this potential will develop a new edge, positioning themselves as long-term winners.