The secret ingredient in successful innovation

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Corporate history is littered with examples of companies that fell by the wayside due to their failure to innovate. Nokia, which was arguably one of the most successful mobile phone companies in the world, wound a path to near extinction by not innovating enough. Kodak, the pioneer in the photo film industry, was disrupted by digital photography (ironically enough Kodak was the first company to come up with the technology for digital photography but decided not to commercialize it so as not to cannibalize its existing photo film business).

And not just companies, entire industries can get disrupted too. The internet disrupted news media and publishing. Skype interrupted telecommunications. And as we speak, the hospitality industry is getting disrupted by companies like AirBnB.

Even as the fear of their industries getting disrupted keeps CEOs awake at night, a breed of smart and agile entrepreneurs is looking for opportunities here. That brings us to the key underlying question: how do you know if an industry is likely to be disrupted?

In my opinion, there seem to be two crucial factors:
1. Any industry with some kind of ‘friction’ is likely to be disrupted:
Do you remember the time when you actually walked into a store to buy cassettes so that you could listen to your favorite ABBA numbers? As time went by, the cassettes got phased out by the slimmer sleeker compact discs (and you were probably in the Pearl Jam era), but the store remained. Fast forward a few years to the 1990s and you discovered Napster which allowed people to share music online and for free. With the advent of Napster and later Apple’s iTunes, you stopped making your weekly trips to the music store. Music stores are redundant today. By that same logic, streaming websites like Netflix and Hulu have led to the demise of brick and mortar video rental stores such as Blockbuster.

The lesson is clear: any industry that has some kind of a ‘friction’ or a ‘middleman’ (in this case, the video rental store or the music CD store) prevents the consumer from engaging in an easy and convenient transaction. If there are companies or services—in this case Netflix or Napster—that remove that ‘friction’ and make the transaction smooth, the consumer will quickly shift allegiance.

Industries which have such a middleman in between are highly likely to be disrupted. During the World Economic Forum’s Summer Davos conference held in Tianjin recently, there was an interesting session led by IDEO CEO Tim Brown. During that session, there were lively discussions about the industries that might face disruption in the next 5-10 years. They include healthcare and transportation. Just think about your last visit to a hospital and the numerous times you had trouble getting a taxi and finding a place to park! Interestingly, some offbeat ‘industries’ were also identified, such as matchmaking, fast food, and democracy.

2. Any industry with information asymmetry is likely to be disrupted:
If technology can make information more transparent in an industry, that is an opportunity to create a business. Take review sites for example. TripAdvisor revolutionized the travel industry by providing users a forum to post and view hotel reviews. Through something called the ‘TripAdvisor Effect’, bad reviews are actually forcing some hotels to improve their service standards. Similarly before Dianping.com launched in China, there was no way to know how good or bad a restaurant was until you ate there. By crowdsourcing reviews, the restaurant review site that some call ‘China’s Yelp’ has become the go-to source of information on dining. Launched in 2003, Dianping now has more than 150 million active users from 2,300 cities who have contributed more than 36 million reviews. Recently Tencent took a 20% stake in Dianping and the company is also said to be planning an IPO.

So we now know about how to identify business opportunities that can be disruptive.

Next let’s get down to the how-to. If you are an entrepreneur or a would-be entrepreneur who wants to launch a new company, what is a good place to start? There are no easy answers to this questions but I can give you some broad pointers.

1. Find an area with an unmet consumer need.
This is not rocket science. In fact, it is Entrepreneurship 1.1. But all the successful entrepreneurs that I have seen are really finding ways to solve a problem. It’s as basic as that.

Take Gilt Groupe, an e-commerce site in the US that allows you to buy designer brands at heavily discounted prices (as low as 60% off). Gilt, which now has over 8 million active users, sits in a very interesting niche within the luxury brands industry. All big luxury brands have products that they sometimes can’t sell at their regular price or even discounted price. Those familiar with the luxury business know that you can’t price products so low that it starts hurting the brand. This is where Gilt comes in. It organizes ‘flash sales’, “deep discounts on a deadline” as a Bloomberg article put it. Every day at a fixed time Gilt begins its flash sale. Because it is for a limited time only and there are limited numbers of different styles or sizes available, people are forced to make a purchase decision quickly. Most sales happen within the first hour itself. The interesting thing is that this process cuts out the rich and well-heeled who probably don’t have time to log on to the site within that limited time band, do their research and make a buying decision, thus indirectly protecting the brand image. In short, Gilt found an unmet need—of consumers who vie for luxury brands but can’t afford them—and launched a business around it. Gilt is very successful today—reports suggest that its 2013 sales were worth $600 million.

2. Solve a need and also have a large impact:
Most people have a very micro view of innovation. They think of innovation at a business level or at an individual entrepreneur’s level. But to have a large impact one should think in terms of social innovation that can help solve prickly social problems that don’t have easy solutions. Take SEED, a program run by Stanford University, that helps build local businesses in rural and underdeveloped areas in Africa. Stanford professors set up training camps in rural areas and train these entrepreneurs on how to do business and how to become more profitable. The idea is to create a ripple effect: if these businesses are able to scale up, they’ll benefit the local consumers, and they can also further train other entrepreneurs in the region. Even though we are talking about business here, the beauty of social innovation is that it ultimately solves deep-rooted social problems.

There are other examples of successful social innovation too: such as Grameen Phone in rural Bangladesh or ITC’s eChoupal in India. Over time they have solved created successful micro-entrepreneurs and raised rural incomes and living standards.

There are a couple of reasons why social innovation is a better way of kick-starting development in rural areas. Traditional methods such as financial aid are top-down, out of sync with local realities and in the end, have lesser impact. Also, since the entrepreneurs who have set up businesses here are local people, they are more familiar with local realities and what will work and what won’t. These businesses will have a greater chance of success than those started by outsiders.

Even as social innovation focuses on unmet needs, it has an added advantage of generating the largest impact with the smallest investment.

If you are a fan of Kung-Fu Panda, you may recall Po’s father, the goose, confiding in his son about the secret ingredient in his noodle soup. “There is no secret ingredient,” he whispers. It’s the same with innovation. The best innovations are the ones that are simple and fuss-free. You just need to find unmet needs, be clear of your product vision, and then creatively deliver a product/service that is easy to use. That is the only way you can win the heart of the consumer.

[This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.]