Innovation and Entrepreneurship

Volume 20, No. 8 (2 sections). Section 1, August 2011. © 2011 AudioTech Business Book Summaries 20-15. All rights reserved. No part of this publication maybe used or reproduced in any manner whatsoever without written permission. To order additional copies of this summary, reference Catalog #8111.

BusinessBook Summaries

In this summary:

� Sharpen...your understanding of innovation by absorbing theideas in management guru Peter F. Drucker's highlyinfluential and timeless classic.

� Discover...profitable opportunities by using the discipline of sys-tematic innovation to search for change, respond to it,and exploit it with new products.

� Focus...on four sources of innovation within your business orindustry: (1) the unexpected; (2) incongruities; (3)process need; and (4) changes in structure.

� Build...competitive advantage by exploiting three sources ofexternal change: (1) demographics; (2) changes inperception; and (3) new knowledge.

� Excel...at innovation by learning the five "do's" and the three "don'ts" that can mean the difference between asuccessful innovation and a failure.

INNOVATION AND ENTREPRENEURSHIP

by Peter F. Drucker

A summary of the original text.

Whereas much of today's discussion treats entrepreneurship as something mysteri-ous, whether a gift, talent, inspiration, or "flash of genius," innovation and entre-

preneurship are a practice and a discipline. They are purposeful tasks that can andshould be organized.

Entrepreneurs see change as the norm and as healthy. Usually, they do not bring aboutthe change themselves. But, the entrepreneur always searches for change, responds toit, and exploits it as an opportunity.

Although it is commonly believed that entrepreneurship is "risky," this is true mainlybecause so few of the so-called entrepreneurs know what they are doing. They violateelementary and well-known rules.

But entrepreneurship does not have to be high-risk. It does need, however, to be systematic.

Systematic innovation is the purposeful and organized search for changes, and thesystematic analysis of the opportunities such changes might offer for economic or socialinnovation.

As a rule, these are changes that have already occurred or are under way. The over-whelming majority of successful innovations exploit change. To be sure, there areinnovations that in themselves constitute a major change; some of the major technicalinnovations, such as the Wright Brothers' airplane, are examples.

But these are exceptions, and fairly uncommon ones. Most successful innovations exploitchange. Thus, the discipline of innovation is a diagnostic discipline: a systematicexamination of the areas of change that typically offer entrepreneurial opportunities.

Specifically, systematic innovation means monitoring seven sources for innovativeopportunity.

The first four sources lie within the enterprise or within an industry or service sector,and are visible primarily to people within that industry or service sector. They are basi-cally symptoms. But they are highly reliable indicators of changes that have alreadyhappened or can be made to happen with little effort. These four areas are:

1. The unexpected — the unexpected success and the unexpected failure.

2. The incongruity — between reality as it actually is and reality as it is assumed tobe, or as it "ought to be."

3. Innovation based on process need.

4. Changes in industry structure or market structure that catch everyoneunaware.

The second set of sources for innovative opportunity involves changes outside theenterprise or industry. These sources are:

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5. Demographics.

6. Changes in perception, mood, and meaning.

7. New knowledge, both scientific and nonscientific.

The lines between these seven sources of innovative opportunities are blurred, andthere is considerable overlap between them. They can be likened to seven windows,each on a different side of the same building. Each window shows some features thatcan also be seen from the window on either side of it. But the view from the center ofeach is different.

The seven sources require separate analysis, since each has its own distinct characteris-tics. No area is more important or more productive than another. Major innovations arejust as likely to come out of an analysis of symptoms of change (such as the unexpectedsuccess of what was considered an insignificant change in product or pricing) as they areto come out of the massive application of new knowledge resulting from a great scientif-ic breakthrough.

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Source #1: The unexpecTed

No other area offers richer opportunities for successful innovation than the unexpectedsuccess — and yet, managements tend to actively reject it.

For example, in the 1950s, the chairman of Macy's told Drucker, "We don't know how tostop the growth of appliance sales." Drucker was mystified. "Why do you want to stopthem?" he asked. "Are you losing money on them?"

The chairman said, "On the contrary. Profit margins are better than on fashion goods;there are no returns, and practically no pilferage."

The "problem," as Macy's chairman saw it, was that sales of apparel typically account-ed for 70 percent of the store's sales. But customers were now buying so many ovensand refrigerators that appliances made up three-fifth of sales, and Macy's wanted tobe seen as a fashion retailer, not as an appliance store. Despite the high profit mar-gins, Macy's wanted to find a way to put an end to its unexpected success in the lessprestigious product category.

Far too many managements act the way that Macy's did. It is never easy for a manage-ment to accept the unexpected success. It takes determination, a willingness to look atreality, and the humility to say, "We were wrong."

One reason why it is difficult to accept unexpected success is that all of us tend to believethat anything that has lasted a fair amount of time must be "normal" and will go on for-ever. Anything that contradicts what we have come to consider a law of nature is thenrejected as unsound, unhealthy, and abnormal.

Top management people in most organizations have typically grown up in one function

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of the organization. To them, this is the area in which they feel comfortable. At Macy's,when Drucker talked to the chairman, only one member of top management, the vicepresident of personnel, had not started as a fashion buyer and made his career in thefashion end of the business. To these men, appliances were something that other peoplesold.

To exploit the opportunity for innovation offered by unexpected success requiresanalysis. Unexpected success is a symptom. But a symptom of what?

The unexpected success of appliances at Macy's was a symptom of a fundamental changein the behavior, expectations, and values of substantial numbers of consumers. Up untilWorld War II, department store consumers bought primarily by socioeconomic status —that is, by income group. After the war, the market increasingly segmented itself bywhat we now call "lifestyles."

Thus, the unexpected success is not just an opportunity for innovation; it demands inno-vation. It forces us to ask, "What basic changes are now appropriate for this organizationin the way it defines its business? Its technology? Its markets?"

If these questions are confronted, then the unexpected success is likely to open up themost rewarding and least risky of all innovative opportunities.

Managements must look at every unexpected success with the following four questions:

1. What would it mean to us if we exploited it?

2. Where would it lead us?

3. What would we have to do to convert it into an opportunity?

4. How do we go about it?

This means, first, that managements need to set aside specific time in which to discussunexpected successes; and second, that someone should always be designated to analyzean unexpected success and to think through how it could be exploited.

Unlike successes, failures cannot be rejected and they rarely go unnoticed. But they areseldom seen as symptoms of opportunity. Yet if something fails despite being carefullyplanned, carefully designed, and conscientiously executed, that failure often suggestsunderlying change — and with it, opportunity.

The assumptions on which a product or service, its design, or its marketing strategywere based may no longer fit reality. Perhaps customers have changed their values andperceptions; while they still buy the same product, they are actually purchasing a verydifferent "value." Or perhaps, what has always been one market or one end use is nowsplitting itself into two or more, with each demanding something quite different. Anychange like this is an opportunity for innovation.

Faced with unexpected failure, executives tend to call for more study and more analysis.But this is the wrong response. The unexpected failure demands that you go out, look

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around, and listen. Failure should always be considered a symptom of an innovativeopportunity.

It is precisely because the unexpected jolts us out of our preconceived notions and cer-tainties that it is such a fertile source of innovation. In fact, it is not even necessary tounderstand why reality has changed. We can innovate successfully by finding out whatis happening without much clue as to why. Here is one example.

The failure of the Ford Motor Company's Edsel has become American folklore. But thegeneral belief that the Edsel was a reckless gamble is totally mistaken.

Very few products were ever more carefully designed, more carefully introduced, or moreskillfully marketed. By 1957, Ford had already successfully reestablished itself as astrong competitor in the three of the four main American automobile markets: the"standard" market with the Ford nameplate; the "lower-middle" one with Mercury; andthe "upper" one with the Continental.

The Edsel was designed for the only remaining segment, the "upper-middle" one for whichFord's big rival, General Motors, produced the Buick and Oldsmobile. This segment wasthe fastest-growing part of the automobile market in the post-War period.

Ford went to extreme lengths to plan and design the Edsel, embodying in its design thebest information from market research, the best data about customer preferences inappearance and styling, and the highest standards of quality control.

Yet the Edsel became a total failure right away.

Ford's executives realized that something was happening that did not align with theassumptions about reality everyone in the industry had been making about consumerbehavior. The result of the company's decision to go out and investigate was the firstgenuine innovation in the American automobile industry since the 1920s, when AlfredSloan had segmented the market into four segments, from "low" to "upper."

When the Ford people went out, they discovered that this segmentation was rapidlybeing replaced by another, quite different one, the one we would now call "lifestyle seg-mentation." The result, within a short period after Edsel's failure, was the introductionof Ford's Thunderbird, the greatest success of any American car since the Model T in1908.

Yet to this day, we do not know what caused the change. It occurred well before any of theevents by which it is usually explained, such as the shift of the center of demographic grav-ity to teenagers as a result of the Baby Boom, the explosive expansion of higher education,or the change in sexual mores. All we know is that something happened.

But that is often enough to convert the unexpected, whether success or failure, into anopportunity for effective and purposeful innovation.

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Source #2: IncongruITy

An incongruity is a discrepancy between what is and what "ought" to be, or betweenwhat is and what everyone assumes it to be. We may not understand the reason for it,but an incongruity is a symptom of an opportunity to innovate.

Like the unexpected event, incongruity is a symptom of change — either change that hasalready occurred, or change that is about to happen. There are four kinds of incongruity:

1. An incongruity between the economic realities of an industry.

2. An incongruity between the reality of an industry and the assumptions about it.

3. An incongruity between the efforts of an industry and the values and expectationsof its customers.

4. An internal incongruity within the rhythm or logic of a process.

Let's consider each of these four types.

If the demand for a product or service is growing steadily, its economic performance shouldsteadily improve, too. It should be easy to be profitable in an industry with already risingdemand. A lack of profitability in such an industry points to an incongruity betweeneconomic realities.

Typically, these incongruities are macro-phenomena, which occur within a whole indus-try or a whole service sector. However, the major opportunities for innovation exist forthe small and highly focused new enterprise, new process, or new service. Usually, theinnovator who exploits this incongruity can count on being left alone for a long timebefore the existing businesses or suppliers wake up to the fact that they have new anddangerous competition. While they are busy trying to bridge the gap between risingdemand and lagging results, they barely even notice that somebody is doing somethingdifferent that exploits the rising demand.

Sometimes, faced with such an incongruity, we understand what is going on. But othertimes, it is impossible to figure out why rising demand does not result in better perfor-mance. Therefore, the innovator doesn't always need to understand why things do notwork as they should. Instead, the important questions are:

1. What would exploit this incongruity?2. What would convert it into an opportunity? 3. What can be done?

The second type is an incongruity between the reality of an industry and theassumptions about it. Whenever people hold the wrong assumptions about an indus-try, they will concentrate on the area where the results do not exist. Yet, in all likelihood,focusing on where the results are will yield substantial returns easily and fast.

For example, in the early 1950s, the ocean-going freighter was believed to be dying. Thegeneral forecast was that it would be replaced by air freight, except for bulk commodities.

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Costs of ocean freight were rising quickly, and it took longer and longer to get merchandisedelivered by freighter, as one port after another became badly congested.

The basic reason was that the shipping industry had misdirected its efforts toward non-results for many years. It had tried to design and build faster ships, and ships thatrequired less fuel and a smaller crew. It concentrated on the economics of the ship whileat sea and in transit from one port to another.

But a ship is capital equipment, and for all capital equipment the biggest cost is the costof not working, during which interest has to be paid while the equipment does not earn.Everybody in the industry knew that the main expense of a ship is interest on the invest-ment. But the industry kept concentrating its efforts on costs that were already quitelow — the costs of the ship while at sea and doing work.

The solution was simple: Uncouple loading from stowing. Do the loading on land, wherethere is ample space and where it can be performed before the ship is in port, so that allthat has to be done is to put on and take off preloaded freight. The answer was the roll-on, roll-off ship and the container ship.

The results of these simple innovations were startling. Over the next 30 years, freightertraffic increased 500 percent, while costs fell by 60 percent. All it took was to focus onthe costs of not working rather than on the costs of working.

The third type of incongruity is an incongruity between the efforts of an industryand the values and expectations of its customers. In the early 1950s, Japanesemanufacturers knew that television would not grow fast in Japan. The chairman ofToshiba declared, "Japan is much too poor to afford such a luxury."

But the executives at Matsushita, which was a fairly small company at the time, wereintelligent enough to accept that Japanese farmers apparently did not know that theywere too poor for television.

What the farmers knew was the TV offered them, for the first time, access to a big world.They could not afford television sets, but they were determined to buy them anyway.Toshiba and Hitachi made better television sets at the time, but they showed the prod-ucts in big-city department stores, making it clear that farmers were not particularlywelcome in such elegant surroundings. Matsushita went to the farmers and sold its tele-visions door to door, something no one in Japan had ever done before for anything moreexpensive than cotton pants or aprons.

Long before Matsushita's success, the poor in the United States and in Europe hadalready shown that TV satisfied expectations that had little to do with traditional eco-nomics. But the highly intelligent head of Toshiba simply could not conceive that forpoor customers, the TV is not just a "thing." It represented access to a new world and awhole new life.

The final type of incongruity is an internal incongruity within the rhythm or logicof a process. For example, The Scotts Miracle-Gro Company is the leader among pro-ducers of lawn-care products such as grass seed, fertilizer, and pesticides. It attained itsmarket leadership while still a small company in fierce competition with firms many


times its size. It built its leadership on the Spreader, a small, lightweight wheelbarrowwith holes that can be set to allow the proper quantities of Scotts' products to passthrough in an even flow.

All products for the lawn prescribe in meticulous detail how much seed, fertilizer, or pes-ticide should be distributed per square inch; but, until the Spreader, no supplier of lawn-care products gave the customer a tool to control the process of applying the products toconsumers' lawns. Without such a tool, there was an internal incongruity in the logic ofthe process that upset and frustrated customers.

The firm grew from a tiny local seed retailer into a large national company because itasked dealers and customers what they missed in available products. Then it designedits product line around the Spreader.

The incongruity within a process, its rhythm or its logic, is not a very subtle matter.Users are always aware of it. Every hardware-store clerk knew the frustration of hislawn customers, and talked about it. What was missing was someone willing to listen,somebody who took seriously what everybody proclaims: That the purpose of a productor service is to satisfy the customer. If this axiom is accepted and acted upon, usingincongruity as an opportunity for innovation becomes fairly easy — and highly effective.

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Source #3: proceSS need

As the old proverb says, "Necessity is the mother of invention." This section looks atneed as a source of innovation, and as a major innovative opportunity.

The need we will discuss is a very specific one that Drucker called "process need."Process need does not start with an event in the environment. It starts with a job to bedone. It perfects a process that already exists, replaces a link that is weak, or redesignsan existing old process around new available knowledge.

In innovations that are based on process need, everybody in the organization alreadyknows that the need exists. Yet usually no one does anything about it. However, whenthe innovation appears, it is immediately accepted as "obvious" and soon becomes"standard."

For example, one of the most common surgical operations is the removal of cataracts inthe eye. Long before laser surgery replaced scalpels, the procedure had become refinedto the point that the operation became routine. But there was one point in this opera-tion in which the eye surgeon had to cut a ligament to tie blood vessels. The risk ofbleeding during this step endangered the eye, and it greatly bothered the surgeons. Nomatter how often they had done the operation, eye surgeons dreaded this one, quick stepin the process.

A pharmaceutical company salesman named William Conner found out about thisprocess need by asking surgeons what parts of their work made them uncomfortable oranxious. Next, he found out, without much research, that an enzyme had been isolatedin the 1890s that almost instantaneously dissolved this particular ligament. Further, he

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learned that nobody at the time, 60 years earlier, had been able to store this enzyme,even under refrigeration, for more than a few hours.

However, preservation techniques had made quite a bit of progress since the 1890s. SoConner, within a few months, was able by trial and error to find a preservative that givesthe enzyme substantial shelf life without destroying its potency.

Within a few years, every eye surgeon in the world was using Conner's patented com-pound. Twenty years later, he sold his company, Alcon Laboratories, to one of themultinationals for a very large amount.

The process of cataract surgery was a very old one. The enzyme to perfect the processhad been known for decades. The innovation was the preservative to keep the enzymefresh under refrigeration. Once that process need had been satisfied, no eye surgeoncould possibly imagine doing without Conner's compound.

Very few innovations based on process need are so sharply focused as this one, in whichformulating the need right away produced the required solution. But in their essentials,successful innovations based on process need share the same five criteria:

1. A self-contained process.

2. One "weak" or "missing" link.

3. A clear definition of the objective.

4. Specifications for the solution that can be defined clearly.

5. Widespread realization that "there ought to be a better way" — that is, highreceptivity.

There are, however, three important constraints:

• First, the need must be understood. It is not enough for it to be "felt." Otherwise,one cannot define the specifications for the solution.

• Second, the knowledge to do the job must be found. If the problem is understood,but no one can figure out how to solve it, all we can do is try something else.

• Third, the solution must fit the way people do the work and want to do it. Eye sur-geons were interested only in an elegant, logical, bloodless process. An enzyme thatgave this to them therefore satisfied their expectations and values.

Opportunities for innovation based on process need can be found systematically. This iswhat William Conner did. But once a process need has been found, it must be testedagainst the five basic criteria listed here. Then, finally, the process need opportunity hasto be tested against the three constraints:

1. Do we understand what is needed?


2. Is the knowledge available or can it be procured?

3. Does the solution fit, or does it violate the mores and values of the intended users?

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Source #4: changeS In InduSTry STrucTure or MarkeT STrucTure

Industry and market structures might seem stable, but they are quite brittle. One smallchange and they disintegrate — often quickly. When this happens, every member of theindustry has to act.

To continue to do business as before is almost a guarantee of disaster and might wellcondemn a company to extinction. At the very least, the company will lose its leader-ship position; and once lost, such leadership is almost never regained. But a change inindustry or market structure is also a major opportunity for innovation.

In industry structure, a change requires entrepreneurship from every member of theindustry. It requires that each one ask, "What is our business?" Each of the memberswill have to give a new answer to that question.

A change in industry structure offers exceptional opportunities that are highly visible tooutsiders. But the insiders perceive these same changes primarily as threats. The out-siders who innovate can thus become a major factor in an important industry or areaquite fast, and at relatively low risk.

For example, during the 1960s, the structure of the healthcare industry began to changevery rapidly. Three young managers in a large Midwestern hospital decided that thisoffered them an opportunity to start their own innovative business. They concluded thathospitals would increasingly need expertise in running such housekeeping services askitchen, laundry, maintenance, and so on.

They systematized the work to be done. Then they offered contracts to hospitals underwhich their new firm would put in its own trained people to run those services, with thefee paid from a portion of the savings that resulted. Within 20 years, this company wasbilling almost $1 billion of services.

Again, the search for such opportunities can be done systematically. There are fourhighly visible indicators of impending change in industry structure that can lead toinnovation opportunities.

The first of these four signals is rapid growth of the industry. If an industry growssignificantly faster than the economy or the population, it can be predicted with highprobability that its structure will change drastically. Existing practices are still highlysuccessful, so nobody is inclined to tamper with them. Yet they are becoming obsolete.But the established industry leaders are rarely willing to accept the new reality, whichexplains why newcomers and outsiders can beat them in their own markets.

The second signal is that by the time a rapidly growing industry has doubled in vol-ume, the way in which the traditional leaders define and segment the market

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no longer reflect reality — they reflect history. This is illustrated by a hospitalmanagement example. In the years after World War II, there was rapid growth in thehospital professions like X-ray, pathology, the medical lab, therapists of all kinds, andso on. Before the 1940s, these barely existed. Additionally, hospital administrationitself became a profession. The traditional "housekeeping" services, which had domi-nated hospital operations in earlier times, steadily became a problem for the adminis-trator, proving increasingly difficult and costly as hospital employees, especially thelow-paid ones, began to unionize.

The third signal that will predictably lead to sudden changes in industry structure is theconvergence of technologies that were previously seen as separate. For example, whencomputers converged with telephones, computer hardware manufacturers suddenlyfound themselves competing with the makers of mobile phones.

The fourth signal that an industry is ripe for basic structural change is evidence that theway in which it does business is changing rapidly. In the 1950s, the overwhelm-ing majority of American physicians practiced on their own. By 1980, only 60 percentwere doing so. The other 40 percent were practicing in a group, either in a partnershipor as employees of an HMO or a hospital. A few people who saw what was happeningearly on, around 1970, realized that this change offered an opportunity for innovation.A service company could design the group's office, tell the physicians what equipmentthey needed, and either manage their group practice for them or train their managers.

Innovations that exploit changes in industry structure are particularly effective if theindustry and its markets are dominated by one very large manufacturer or supplier, orby a very few. Even if there is no true monopoly, these large, dominant producers andsuppliers, having been successful and unchallenged for many years, tend to be arrogant.At first, they dismiss the newcomer as insignificant. But even when the upstart takes alarger and larger share of their business, they find it hard to mobilize themselves to fightback.

For example, the American producers of aspirin were slow to respond when the non-aspirin painkillers like Tylenol and Datril first appeared. Again, the innovators diag-nosed an opportunity because of an impending change in industry structure, based verylargely on rapid growth, in this case. There was no reason why the existing aspirin man-ufacturers, a very small number of very large companies, could not have brought outnon-aspirin painkillers of their own. Yet, for the first several years, the newcomers hadthe market to themselves.

Similarly, the United States Postal Service did not react for many years to innovatorswho took away larger and larger chunks of the most profitable services. First, UnitedParcel Service took away ordinary parcel post; then Emery Air Freight and FederalExpress took away the even more profitable delivery of urgent or high-value merchan-dise and letters. What made the Postal Service so vulnerable was its rapid growth.Volume grew so fast that it neglected what seemed to be minor categories, and thuspractically delivered an invitation to the innovators.

Again and again, when market or industry structure changes, the producers or suppli-ers who are today's industry leaders will neglect the fastest-growing market segments.They will cling to practices that are rapidly becoming dysfunctional or obsolete. The new


growth opportunities rarely fit the way the industry has "always" approached the mar-ket, been organized for it, and defines it. The innovator in this area, therefore, has agood chance of being left alone. For some time, the old businesses will still be doing wellserving the old market the old way. They are likely to pay little attention to the newchallenge, until it is too late.

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Source #5: deMographIcS

The first four sources of innovative opportunity that we've considered manifest them-selves within a business, industry, or market. They may actually be symptoms ofchanges outside, in the economy, in society, and in knowledge. But they show up inter-nally. The three remaining sources of innovative opportunity are external. They arechanges in the social, political, and intellectual environment.

Of all external changes, the clearest are those that have to do with demographics.Changes in population, its size, age structure, composition, employment, educationalstatus, and income are unambiguous. They have the most predictable outcomes.

They also have known and almost certain lead times:

• Anyone who will be in the American labor force 15 years from now is already aliveby now.

• All people who will reach retirement age in 30 years are already in the labor force.

Demographics have a major impact on what will be bought, by whom, and in whatquantities:

• American teenagers buy a good many pairs of cheap shoes each year; they buy forfashion, not durability.

• The same people, 10 years later, will buy very few pairs of shoes a year — one-sixthas many — but they will buy them for comfort and durability first and for fashionsecond.

• People in their 60s and 70s in the developed countries — that is, people in theirearly retirement years — form the prime travel and vacation market.

• Ten or twenty years later, the same people are customers for retirement communi-ties, nursing homes, and extended medical care.

• Two-income families have more money than they have time, and spend accordingly.

• People who have completed extensive schooling in their younger years, especiallyprofessional or technical training, will become customers for advanced professionaltraining 10 to 20 years later.

Executives, economists, and politicians have always acknowledged the critical importance


of population trends, movements, and dynamics. But they also believed that they did nothave to pay attention to demographics in their day-to-day decisions. Population changes— whether in birth rates or mortality rates, in educational attainment, in labor force com-position and participation, or in the location and movement of people — were thought tooccur so slowly and over such long time spans as to be of little practical concern.

But a number of demographic changes have occurred and will continue to occur rapidly.The basic assumption of our time must be that populations are subject to sudden sharpchanges and that they are the first environmental factor that a decision maker must ana-lyze. For example, few issues will be as critical as the aging of the population in thedeveloped countries and the tidal wave of young adults in the Third World.

Whatever the reasons, over the past century both developed and developing countrieshave become prone to extremely rapid and radical demographic changes, which occurwithout advance warning. For example, in 1938, the most prominent population expertscalled together by Franklin D. Roosevelt predicted unanimously that the U.S. populationwould peak at around 140 million people in 1943 or 1944. Today, the population is twotimes as large. The experts had no way to predict that the U.S. would begin a "babyboom" in 1946 that produced large families, only to just as suddenly in 1964 begin a"baby bust," producing equally small families. The demographers of 1938 were notincompetent; there was just no indication then of a "baby boom."

Similarly, in 1972, the most experienced labor force analysts in the U.S. still acceptedwithout question that the participation of women would continue to decline as it haddone for many years. Ten years later, the labor force participation of American womenunder 50 stood at 64 percent, the highest rate ever.

These shifts are not only dazzlingly sudden. They are often mysterious and defy expla-nation. What explains the "baby boom" and the "baby bust"? What explains the suddenrush of American women into the workforce?

Demographic shifts may be inherently unpredictable, yet they do have long lead timesbefore impact, and these lead times are predictable.

• It will be five years before newborn babies become kindergarten students and needclassrooms, playgrounds, and teachers.

• It will be 15 years before they become important as consumers, and 18 to 22 yearsbefore they join the labor force as adults.

• Populations in Latin America began to grow rapidly as soon as infant mortalitybegan to drop. Still, the increasing numbers of healthy babies did not becomeschoolchildren for 5 or 6 years, and did not become adolescents looking for work for15 or 16 years.

What makes demographics such a rewarding opportunity for entrepreneurs is preciselyits neglect by the experts who do not accept demographic realities that they take forgranted. The lead times are known. The events themselves have already happened. Butno one accepts them as reality, let alone as opportunity. Those who defy the conventionalwisdom and accept the facts — and go actively looking for them — can therefore expect


to be left alone for quite a long time.

For example, in 1961, John F. Kennedy called together a group of leading scholars onLatin America to work out his aid and development program called the Alliance forProgress. Not one of the experts paid attention to the precipitous drop in infant mortal-ity which, within another 15 years, totally changed Latin America's society and economy.The experts also assumed a rural Latin America. They did not foresee its urbanization.

But one business, the American retail chain Sears, Roebuck, had seen it several yearsearlier. The company's chairman, Robert E. Wood, read in the early 1950s that MexicoCity and Sao Paulo were expected to outgrow all U.S. cities by 1975. This so intriguedhim that he went himself to look at the major cities in Latin America.

He spent a week in each of them — Mexico City, Guadalajara, Santiago, Rio, Lima, SaoPaulo, and Bogota. He walked around, looked at stores, and was appalled at what hesaw. He studied traffic patterns. Then he knew what customers to aim at, what kind ofstores to build, where to put the stores, and what merchandise to offer.

As a result, in the mid-'50s, Sears began to build American-type department stores inmajor Latin American cities, designed for a new urban middle class which, while not"rich," was part of the money economy and had middle-class aspirations. Within a fewyears, Sears became the leading retailer in Latin America.

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Source #6: changeS In percepTIon, Mood, and MeanIng

In mathematics, there is no difference between "The glass is half-full" and "The glass ishalf-empty." But the meaning of these two statements is totally different, and so aretheir consequences. If general perception changes from seeing the glass as "half-full" toseeing it as "half-empty," there are major innovative opportunities.

For example, all factual evidence shows that the years since the early 1960s have beenyears of unprecedented advance and improvement in the health of Americans. Whetherwe look at mortality rates for newborn babies or survival rates for the very old, at occur-rence of cancers or cure rates for cancer, all indicators of physical health have beenmoving upward.

Yet, the nation is gripped by collective hypochondria. Never before has there been somuch concern with health, and so much fear. Suddenly, everything seems to cause can-cer or degenerative heart disease or premature loss of memory. The glass is clearly seenas "half-empty." Americans are obsessed with health and fitness, with trying to avoidgetting old, and with a fear of developing a long-term illness.

In 1960, even minor improvements in the nation's health were seen as major steps forward.Now, even major improvements are barely noticed.

Whatever the causes for this change in perception, it has created substantial innova-tive opportunities. It created a market for fitness clubs and health-care magazines,for indoor exercise equipment and running shoes. It created the opportunity for a


substantial number of new and innovative businesses to exploit the fear of traditionalfoods causing irreparable damage.

One firm, called Celestial Seasonings, started as a small business that peddled herbsthat were collected in the mountains near Boulder, Colorado and peddled on street cor-ners in the late 1960s. Fifteen years later, Celestial Seasonings was sold for more than$20 million to a very large food-processing company.

Another change in perception has to do with Americans' perceptions toward eating ingeneral. Traditionally, the way people feed themselves was largely a matter of incomegroup and class. Ordinary people "ate." The rich "dined." This perception has changedover the past few decades. Now the same people both eat and dine. One trend is toward"feeding," which means getting down the necessary means of sustenance, in the easiestand simplest way possible: convenience foods, McDonald's hamburgers, and so on.

But the same consumers have become gourmet cooks. TV programs on gourmet cook-ing are hugely popular and achieve high ratings; gourmet cookbooks have become mass-market best-sellers; and whole new chains of gourmet food stores have opened.Traditional supermarkets, which do 90 percent of their business in foods for "feeding,"have opened "gourmet boutiques" which in many cases are far more profitable than theirordinary processed-food business.

Whether sociologists or economists can explain a change in perception is irrelevant. Itremains a fact. Very often, it cannot be quantified; or rather, by the time it can be quan-tified, it is too late to serve as an opportunity for innovation. But it is not exotic orintangible. It is concrete. It can be defined, tested, and above all, exploited.

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Source #7: new knowledge

Knowledge-based innovation is what people normally mean what they talk of innovation.It differs from all other innovations in its basic characteristics and in the challenges itposes to the entrepreneur.

First, knowledge-based innovation has the longest lead time of all innovations. Thereis a long time span between the emergence of new knowledge and when it becomesapplied to technology. Then there is another long period before the new technologyturns into products, processes, or services in the marketplace.

For example, Rudolph Diesel designed the engine that bears his name in 1897. Everyoneimmediately realized that it was a major innovation. Yet for many years there were fewpractical applications. Then in 1935, Charles Kettering totally redesigned Diesel'sengine, rendering it capable of being used as the propulsion unit in a wide variety ofships, locomotives, trucks, buses, and passenger cars.

The same pattern has occurred for most knowledge-based innovations, from factoryautomation to computers to penicillin: There is typically a long lead time for knowledgeto become applicable technology and to begin to be accepted on the market.


The second characteristic of knowledge-based innovations — and a truly unique one, isthat they are almost never based on one factor but on the convergence of several dif-ferent kinds of knowledge, not all of them scientific or technological.

For example, the Wright Brothers' airplane had two knowledge roots. One was thegasoline engine, designed in the mid-1880s to power the first automobiles built byKarl Benz and Gottfried Daimler, respectively. The other one was mathematical:aerodynamics, developed primarily in experiments with gliders. Each was developedquite independently. It was only when the two came together that the airplanebecame possible.

In most cases, the innovation occurs only when the various kinds of knowledge arealready known, already in use, and already available someplace. In other cases, the inno-vator can identify the missing pieces and then work at producing them. The WrightBrothers identified the pieces of knowledge that were missing — mostly mathematics —and then developed them themselves by building a wind tunnel and actually testingmathematical theories. But until all the different kinds of knowledge needed for a givenknowledge-based innovation have come together, it will not take off.

The two characteristics of knowledge-based innovations that we've just discussed lead tothree key challenges.

First, the entrepreneur has to carefully analyze all of the necessary factors. Theanalysis must identify what factors are not yet available so the entrepreneur can decidewhether those missing factors can be produced, or whether the innovation should bepostponed because it is not yet feasible.

Failure to make such an analysis is a prescription for disaster. Either the knowledge-based innovation is not achieved, or the innovator loses the fruits of his innovation andonly succeeds in creating an opportunity for somebody else.

For example, the British scientists who discovered and developed penicillin did a mag-nificent technical job. They figured out the right substances and the right uses. Yetthey failed to identify the ability to manufacture penicillin as a critical knowledge fac-tor. They could have developed the necessary knowledge of fermentation technology;but they did not even try. As a result, a small American company, Pfizer, went towork on developing the knowledge of fermentation and became the world's foremostmanufacturer of penicillin.

The second key challenge of knowledge-based innovation is to select a clear focus forthe strategic position. There are basically three focuses for this type of innovation:

• The first focus is to develop a complete system that dominates the field: This iswhat IBM did in its early years, when it chose not to sell computers but to leasethem to its customers. It supplied them with software, with programming, withinstructions in computer language for programmers, and with service.

• The second focus is a market focus. Knowledge-based innovation can aim at creat-ing the market for its products. This is what DuPont did with nylon. It did not "sell"nylon. It created a consumer market for women's hosiery using nylon, a market for


B u s i n e s s B o o k S u m m a r i e s

automobile tires using nylon, and so on. It then delivered nylon to the fabricators tomake the products for which DuPont had already created a demand.

• The third focus is to concentrate on a strategic function. By mastering thefermentation process, Pfizer gained the early lead in penicillin. For other knowl-edge-based innovations, the answer may be to focus on marketing or on controllinga key raw material that is needed to make a product or provide a service.

The third key challenge of knowledge-based innovation is to manage risk. To be suc-cessful, an innovation has to be "ripe"; potential customers must be receptive to it. Thisrisk is inherent in knowledge-based innovation. All other innovations exploit a changethat has already occurred. They satisfy a need that already exists. But in knowledge-based innovation, the innovation brings about the change. It aims at creating a want.And no one can tell in advance whether the user is going to be receptive, indifferent, oractively resistant.

There are exceptions, of course. Whoever produces a cure for cancer need not worryabout receptivity. But such exceptions are few. In most knowledge-based innovations,receptivity is a gamble. Before railroads and computers became indispensible, expertspredicted that there would be no market for them. The opposite error is just as com-mon; "everyone knows" that there is a real demand for a new product or service, whenin reality there is total indifference or resistance.

There is no choice. If we want knowledge-based innovation, we must gamble on recep-tivity to it. Yet the risks can be substantially reduced by integrating new knowledge asthe source of innovation with one of the other six sources defined earlier, such as theunexpected, incongruities, or especially process need. In these areas, receptivity haseither already been established or can be tested fairly easily and with good reliability.

The demands on knowledge-based innovators are thus very great, and different fromthose in other areas of innovation. The risks they face are different, too. But if the risksare greater, so are the potential rewards. The other innovators may reap a fortune. Theknowledge-based innovator can hope for fame as well.

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prIncIpleS of InnovaTIon

There are innovations that do not proceed from the seven sources we've just explored.There are innovators who are "kissed by the Muses," and whose innovations are theresult of a "flash of genius" rather than of systematic, organized, purposeful work.

But such innovations cannot be replicated. They cannot be taught and they cannot belearned. There is no known way to teach someone how to be a genius.

The innovation resulting from analysis and hard work is all that can be discussed and pre-sented as the practice of innovation. But this is all that needs to be presented, since itsurely covers at least 90 percent of all effective innovations. The extraordinary performerin innovation, as in every other area, will be effective only if grounded in the discipline ofit.

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A u d i o T e c h

What, then, are the principles of innovation, representing the hard core of the discipline?Let's conclude this summary with five "do's" that have to be done, and three "don'ts" thathad better not be done.

We'll start with the five do's.

1. Begin with the analysis of opportunities. Think through the seven sources ofinnovative opportunities. In different areas, different sources will have differentlevels of importance at different times. For example, demographics may be of verylittle concern to innovators in fundamental industrial processes. New knowledgemay be of very little relevance to someone innovating a new social instrument tosatisfy a need created by changing demographics. But all the sources of innovativeopportunity should be systematically analyzed and studied. The search has to beorganized, and must be done on a regular basis.

2. Go out to look, to ask, and to listen. Successful innovators use both the rightside and the left side of their brains. They look at figures, and they look at people.They work out analytically what the innovation has to be to satisfy an opportunity.Then, they go out and look at the customers to see what their expectations, theirvalues, and their needs are.

3. Keep the innovation simple and focused. It should do only one thing; other-wise, it confuses people. If it is not simple, it won't work. All effective innovationsare breathtakingly simple. The greatest praise an innovation can receive is forpeople to say, "This is obvious. Why didn't I think of that?" Even the innovationthat creates new uses and new markets should be focused on a specific need thatit satisfies, or on a specific end result that it produces.

4. Start small. Effective innovations are not grandiose. They try to do one spe-cific thing. It may be to enable a moving vehicle to draw electric power while itruns along rails — the innovation that made possible the electric streetcar. Or itmay be as elementary as putting the same number of matches in a matchbox,which made possible the automatic filling of matchboxes and gave the originatorsof the idea a world monopoly on matches for almost half a century. Big ideasaimed at "revolutionizing an industry" are unlikely to work.

5. Aim at leadership. A successful innovation does not aim at eventually becominga "big business." No one can foretell whether a given innovation will end up as abig business or as a modest achievement. But if an innovation does not aim at lead-ership from the beginning, it is unlikely to be innovative enough, and thereforeunlikely to be capable of establishing itself. Strategies vary greatly, from those thataim at dominance in an industry or a market to those that aim at finding and occu-pying a small niche in a process or market. But all strategies aimed at exploitingan innovation must achieve leadership within a given environment. Otherwise,they will simply create an opportunity for the competition.

Finally, here are the three important don'ts:

1. Don't try to be clever. Innovations have to be handled by ordinary human beingsand, if they are to attain any size and importance at all, they also have to be handled

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by morons or near-morons. Incompetence, after all, is the only thing in never-end-ing supply. Anything too clever, whether in design or execution, is almost certain tofail.

2. Don't diversify, don't splinter, and don't try to do too many things at once.Stay focused. There has to be a core of unity to innovative efforts or they are like-ly to fly apart. An innovation needs the concentrated energy of a unified effortbehind it.

3. Don't try to innovate for the future. Innovate for the present. It is not goodenough to be able to say, "In 25 years, there will be so many very old people thatthey will need this." An innovator has to be able to say, "There are enough old peo-ple around today for this to make a difference to them — and in 25 years, therewill be many more." Unless there is an immediate application in the present, aninnovation is, at best, nothing more than a brilliant idea.

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ABOUT THE AUTHOR

Peter F. Drucker (11/19/1909 — 11/11/2005) was a writer, management con-sultant, university professor, and self-described "social ecologist," whoexplored the way human beings organize themselves and interact much theway an ecologist would observe and analyze the biological world.

Hailed by BusinessWeek as "the man who invented management" Druckerdirectly influenced a huge number of leaders from a wide range of organi-zations across all sectors of society. Among the many: General Electric,IBM, Intel, Procter & Gamble, Girl Scouts of the USA, the SalvationArmy, Red Cross, the United Farm Workers, and several presidentialadministrations.

Drucker's 39 books, along with his countless scholarly and popular arti-cles, predicted many of the major developements of the late 20th century,including privatization and decentralization, the rise of Japan to economicworld power, the decisive importance of marketing and innovation, and theemergence of the information society with its necessity of lifelong learning.

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Innovation and Entrepreneurship, summarized by arrangement with HarperCollins Publishers, Inc., fromInnovation and Entrepreneurship by Peter F. Drucker. Copyright © 1985, 2007 by Peter F. Drucker.

Innovation and Entrepreneurship

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