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Artificial intelligence, robotics, blockchains, reusable rockets, self-driving cars, genetic engineering — there is an unprecedented explosion of innovation going on all around us, and nowhere is it creating more froth than in the corporate sphere. And yet, as Fredrik Erixon and Björn Weigel point out in their new book, The Innovation Illusion: How So Little Is Created by So Many Working So Hard (Yale University Press, 2016), GDP growth, productivity, and corporate investment in the capitalist economies of the West are all on the decline.
Erixon and Weigel, both of the European Centre for International Political Economy, an economic think tank, peg this counterintuitive reality to “gray capitalism, excessive corporate managerialism, second-generation globalization, and complex regulations.” They contend that these “Four Horsemen of capitalist decline” have rendered large companies moribund and risk-averse, and thus have produced an environment in which innovation flourishes, but never generates a full measure of economic output.
In the following excerpt, the authors remind us that while innovations may produce unicorns that enrich founders and VCs, they can’t drive broad-based economic progress on their own.
An excerpt from Chapter 8 of The Innovation Illusion: How So Little Is Created by So Many Working So Hard (Yale University Press, 2016) by Fredrik Erixon and Björn Weigel
While it is easy to be impressed by what modern science labs and tech innovators create, the chief lesson from economic history is that the economic benefit of new technology has less to do with that. The economic power of innovation comes mainly from its adoption, not from its creation. And adoption of technology requires investment resources, entrepreneurship, and dynamic markets. The Western economy has moved in the wrong direction on all three counts.
For technology to be adopted extensively, someone has to channel it from the inventor to the market. And that someone usually has to increase investment and capital expenditure for the invention to reach an audience. For Voice over Internet Protocol (VoIP) to become the preferred technology of telephony, significant investments are needed in high-speed telecommunication infrastructure, for instance. The same logic also applies to human capital. If a new surgical method for cancer treatment is invented, investment is needed in retraining surgeons and nurses before it can benefit patients. Or to take an example from the global warming debate: the problem with the struggle to reduce man-made greenhouse gases is not that scientists lack the knowledge and technology to radically cut emissions; rather it concerns the limits of capital: reductions of carbon emissions take longer because of costs and limits in quickly substituting new capital for old.
Do not expect ideas, technologies, or innovations to make it big just by showing up, therefore, no matter how brilliant they appear. Even when factors like sunk costs do not hold companies back, nothing materializes into marketable products or services without great effort — and a bit of luck. Innovation success is not a quick fix, or something that is parachuted into companies from the outside. The way companies and markets work, and the extent to which companies can muster their resources for an innovation, determine its success or failure. Entrepreneurs control their own performance, but they cannot control unpredictable markets; if they could, business failures would be a matter of choice. Innovation based only on its own technological or corporate merits does not have the power to break into markets. Markets are far too complex for that to happen.
Take Google Glass as an example. The air over the San Francisco Bay Area vibrated with anticipation when news circulated that this product was due to be released. The optical head-mounted display was like the Ericsson Cordless Web Screen that had been invented 15 years earlier — “the next big thing.” And if you have tried a pair, you will know they are pretty cool. Google went much further than Ericsson ever did when it started to sell the glasses in May 2014. Yet Google still failed and production was halted less than a year after release for the simple reason that sales were not good enough.
In the aftermath of this public mishap, Astro Teller — the head of what was then called the Google X research lab — explained that the company had failed by “not making clear to everyone else that what was out was really just a prototype of the smart glassware, and too much bad publicity was really what killed Google Glass.” Failure happens — every day — and premature scaling is a common recipe for disaster. But this was Google, a company with near limitless resources for planning and preparation. It is media savvy and its market reach is second to none, leaving many to question how the company could have allowed such a publicized failure. It was not the first time a Google project went sour for reasons that appeared predictable. Project Loon, for instance, was an idea to deliver internet services via balloons floating close to space. It failed because leakages meant the balloons could not stay afloat long enough. A peek into the history books reveals that leakages have been a familiar problem to the ballooning community for over 100 years, if not longer. One spectacular incident occurred in 1897 when Swedish adventurer S.A. Andrée and his crew failed to cross the North Pole in a hydrogen balloon because of this problem. Had it not, they would have been pioneers of balloon journeys across the Pole. Instead they may have been killed by polar bears as they were trying to make it back home by foot. Google X staff fortunately did not have to worry about hungry bears and they were still around to draw the right conclusions from the failure. To Astro Teller the leaking balloons were a good experiment and a lesson in the trial-and-error process of innovation and business development. “Sometimes the most interesting failures,” he concluded, “are the ones that you don’t expect. Particularly, when they are something that you think will be the easiest part of the project and it turns out to be the hardest part of the project instead.” Tech failures are just one of the problems faced by new innovations.
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New technologies have to fight for a place in the market. Take electronic payment and wallets as an example — a market and a technology that many oddly consider not to be very complex. With the introduction of digital payment technologies, the electronic wallet was initially considered a fundamental challenge to the payment market. Credit card companies and other established firms, using the old payment system, were thought to face a difficult future, or perhaps no future at all. The old guard had supposedly little resistance to offer when new and smarter ways to pay were suddenly introduced. The leather wallet was a thing of the past; the only thing consumers needed was a smartphone. Yet the incumbent payment companies are still here — and they are not about to become a footnote in economic history. On the contrary, it seems that their future is pretty bright.
The reason is market complexity. Credit card companies that came into existence in the 1940s and 1950s developed their businesses in a tough environment of conservative users and merchants, dealing with old habits, security, emotions, and different payment cultures. They were forced from the start to create business models that delivered value, and those models extended far beyond the use of the plastic cards. Plastic cards are an innovation introduced by American Express in 1959, which made payment more convenient. And that is how the sector has grown — by creating value in addition to immediate money transactions for people and store owners. A company stepping into this world, armed with only a technology, will not get far.
The first universal electronic wallet was announced in 2000. The use of electronic wallets is likely to increase, but to generate a lot of value, electronic wallet companies will have to become much more than their technology or else remain satisfied with being technology suppliers. Many e-payment newcomers are now working with the established market structure for that reason. Asked why, Will Wang Graylin, the CEO of LoopPay, a digital wallet company focusing on the interface between merchants and credit card firms, explained to MIT Technology Review: “Think about the infrastructure and how long it took to create that. It is very difficult to change merchant behavior.” No one knows how this market will evolve, but markets, competition, and consumer behavior — not only the technology itself — will determine its future success.
The same is true for another promising technology that can be applied to the payments market: blockchain, or mutual distributed ledger technology (like bitcoin). The market clearly sees a big potential in blockchain technology. It could reduce the costs and risks in transactions, and create a far better system for sharing information in financial markets. Some have billed it as a greater technological leap than the internet for capital markets. Perhaps it will be, but the hype around the technology is premature and the expectation of big market changes is an aspiration. A study from 2016 of how market actors work with this ledger technology concludes that “the understanding of the technology lags well behind the hype.” The technology, the authors argue, faces the problem of “excess inertia,” because the users of the technology are locked into existing market structures. And they point to a common feature in resistance to new technology: “private profit incentives are not strong enough for individual firms to adopt a more efficient standard or technology, even when adoption would reduce costs for the industry as a whole.”
What all these examples show is that there is no such thing as a superior technology that effortlessly sweeps through markets. What is required, however, is plenty of hard work, repeated processes of trial and error, and the temperament needed not to let errors get under the skin. For Google, leaking balloons and unhappy glass customers should feed back into the next generation of balloons and glasses — or other completely different projects. Google, like others, will certainly fail in the future — and hopefully they will, because failure is part of the innovation process. Without failures, nothing really new would be innovated. Aviation security, it is said, is “written in blood.” Likewise, the history of innovation is full of wrecked business attempts.
Markets are becoming increasingly complex because of vertical and horizontal specialization and a confluence of perpetual trial-and-error processes and generations of technologies, traditions, and customer values. Value chains are increasingly sliced up into smaller parts, and today, fortified turrets of firms stand in close ranks protecting their market territories and firm boundaries. New technologies that span several territories, boundaries and areas of specialization become sluggish affairs because the newcomer has to attack each turret to establish a foothold. Sunk costs bring additional layers of complexity that stand in the way of contestable innovation. Some find it appealing to look for simplifications — and the less someone knows about a market and business value, the easier it appears. This is where the analysis from the proponents of the New Machine Age often goes wrong. They simplify too much and ignore the actual realities of how markets are structured and where companies generate value. Their inclination is rather to focus only on what is seen on the surface of markets. They compare technologies as if they existed in a vacuum. But technologies that fail or succeed in the end do so because of economic factors.
That is not a new phenomenon. Societies have always had the tendency to overlook business and market complexity, and perhaps it has something to do with impatience, or the habit of favoring quick and easy answers over long and difficult ones. But there is another factor at play: the strange habit of taking the views of innovators and entrepreneurs as the final judgments about whether their new technology will make it or not. There are some things, author Hjalmar Söderberg once wrote, in which you have to be an expert in order not to understand, and there is a similar logic at play with innovators and their technology. Those who are too close to the technology are at risk of getting carried away. As anyone with experience of building businesses knows, entrepreneurship thrives on passion, but the same sentiment often also stands in the way of sober market analysis. Entrepreneurs in general exaggerate their technological achievements and tend to simplify business obstacles. When asked about their innovation, they promote it as much as they can and sometimes convince unsuspecting listeners that they have got further than they actually have. The flip side of passion is that it makes entrepreneurs biased and often blind to the shortcomings of their products and business models. Just as in other love affairs, everything looks different in corporateville when emotions run high. Most of all, passion makes entrepreneurs blind to market complexity and the gap between innovation and a market-adapted product.
Don’t get us wrong: the passion of entrepreneurs is exactly why societies should appreciate and encourage them. Entrepreneurs are usually unaware of their intemperance as they tend to be head over heels in love with the products they promote or the company they run. If they were not, few new companies would make it past their first birthday. Passion is why they sacrifice time with family and friends or neglect private interests and put their money and reputation on the line.
When technologies reach markets for the first time they are seldom that good because markets are never that simple. Consequently, business planning for how new products should develop gets complicated — at best. Stanford business professor George Foster, arguing against the simplistic view of market success, contends that the “hockey-stick world,” where growth takes off with a smooth turn upwards like the shape of a hockey stick, “is a fantasy.” In the real world, start-ups go through “a lot of jarring ups and downs, more like a high-speed game of snakes and ladders.” He should know because he has analyzed 158,000 early companies, and almost two-thirds of them experienced one or more consecutive years of decline in the third to fifth year of existence. Behind those numbers hides an army of entrepreneurs battling with market complexity every single day.
Take driverless cars. Listening to the current hype may make you think you will be able to own and be driven by one soon. But the technological development of driverless cars has been going on for decades and, from a market perspective, it has not come particularly far. Not more than 20 percent of the cars sold in 2015 had embedded connectivity solutions. Industry analysts believe it will take many years for the necessary infrastructure to be in place before they become commonplace. Business advisory firm AlixPartners, for instance, thinks that “nationwide autonomous driving infrastructures may not be available before 2035.” And that forecast assumes their thorny liability issues will have been addressed by then, allowing markets without substantial legal barriers to develop.
The world economy would be a far better place if intelligent vehicles or other radical innovations happened more quickly. Instant innovation is a good desire, but it makes a bad partner for understanding how markets — or capitalism writ large — work today. The gospel of the New Machine Age ignores that reality and almost takes for granted that there is an easy passage from the tech laboratory to the market. It appreciates entrepreneurs and their passion, but it does not capture the complexity of entrepreneurship and markets. Markets are difficult to read, let alone manoeuver, even for skilled entrepreneurs. Markets embrace and exclude at the same time. They are fluid yet stable. They are never one-dimensional but always changing. Thus, innovation can never succeed just by showing up.