The Disruptive Engine - Innovation and the Capitalistic Dream
By Sam Vaknin
Author of "Malignant Self Love - Narcissism Revisited"

On 18 June, 2002 business people across the UK took part in Living
Innovation 2002. The extravaganza included a national broadcast
linkup from the Eden Project in Cornwall and satellite-televised
interviews with successful innovators.

Innovation occurs even in the most backward societies and in the
hardest of times. It is thus, too often, taken for granted. But the
intensity, extent, and practicality of innovation can be fine-tuned.
Appropriate policies, the right environment, incentives, functional
and risk seeking capital markets, or a skillful and committed
Diaspora - can all enhance and channel innovation.

The wrong cultural context, discouraging social mores, xenophobia, a
paranoid set of mind, isolation from international trade and FDI,
lack of fiscal incentives, a small domestic or regional market, a
conservative ethos, risk aversion, or a well-ingrained fear of
disgracing failure - all tend to stifle innovation.

Product Development Units in banks, insurers, brokerage houses, and
other financial intermediaries churn out groundbreaking financial
instruments regularly. Governments - from the United Kingdom to New
Zealand - set up "innovation teams or units" to foster innovation
and support it. Canada's is more than two decades old.

The European Commission has floated a new program dubbed INNOVATION
and aimed at the promotion of innovation and encouragement of SME
participation. Its goals are:

a.. "(The) promotion of an environment favourable to innovation
and the absorption of new technologies by enterprises;
b.. Stimulation of a European open area for the diffusion of
technologies and knowledge;
c.. Supply of this area with appropriate technologies."
But all these worthy efforts ignore what James O'Toole called
in "Leading Change" - "the ideology of comfort and the tyranny of
custom." The much quoted Austrian economist, Joseph Schumpeter
coined the phrase "creative destruction". Together with its twin -
"disruptive technologies" - it came to be the mantra of the now
defunct "New Economy".

Schumpeter seemed to have captured the unsettling nature of
innovation - unpredictable, unknown, unruly, troublesome, and
ominous. Innovation often changes the inner dynamics of
organizations and their internal power structure. It poses new
demands on scarce resources. It provokes resistance and unrest. If
mismanaged - it can spell doom rather than boom.

Satkar Gidda, Sales and Marketing Director for SiebertHead, a large
UK packaging design house, was quoted in "The Financial Times" in
June 2002 as saying:

"Every new product or pack concept is researched to death nowadays -
and many great ideas are thrown out simply because a group of
consumers is suspicious of anything that sounds new ... Conservatism
among the buying public, twinned with a generation of marketing
directors who won't take a chance on something that breaks new
ground, is leading to super-markets and car showrooms full of me-too
products, line extensions and minor product tweaks."

Yet, the truth is that no one knows why people innovate. The process
of innovation has never been studied thoroughly - nor are the
effects of innovation fully understood.

In a new tome titled "The Free-Market Innovation Machine", William
Baumol of Princeton University claims that only capitalism
guarantees growth through a steady flow of innovation:

"... Innovative activity-which in other types of economy is
fortuitous and optional-becomes mandatory, a life-and-death matter
for the firm."

Capitalism makes sure that innovators are rewarded for their time
and skills. Property rights are enshrined in enforceable contracts.
In non-capitalist societies, people are busy inventing ways to
survive or circumvent the system, create monopolies, or engage in
crime.

But Baumol fails to sufficiently account for the different levels of
innovation in capitalistic countries. Why are inventors in America
more productive than their French or British counterparts - at least
judging by the number of patents they get issued?

Perhaps because oligopolies are more common in the US than they are
elsewhere. Baumol suggests that oligopolies use their excess rent -
i.e., profits which exceed perfect competition takings - to innovate
and thus to differentiate their products. Still, oligopolistic
behavior does not sit well with another of Baumol's observations:
that innovators tend to maximize their returns by sharing their
technology and licensing it to more efficient and profitable
manufacturers. Nor can one square this propensity to share with the
ever more stringent and expansive intellectual property laws that
afflict many rich countries nowadays.

Very few inventions have forced "established companies from their
dominant market positions" as the "The Economist" put it recently.
Moreover, most novelties are spawned by established companies. The
single, tortured, and misunderstood inventor working on a shoestring
budget in his garage - is a mythical relic of 18th century
Romanticism.

More often, innovation is systematically and methodically pursued by
teams of scientists and researchers in the labs of mega-corporations
and endowed academic institutions. Governments - and, more
particularly the defense establishment - finance most of this
brainstorming. the Internet was invented by DARPA - a Department of
Defense agency - and not by libertarian intellectuals.

A recent report compiled by PricewaterhouseCoopers from interviews
with 800 CEO's in the UK, France, Germany, Spain, Australia, Japan
and the US and titled "Innovation and Growth: A Global Perspective"
included the following findings:

"High-performing companies - those that generate annual total
shareholder returns in excess of 37 percent and have seen consistent
revenue growth over the last five years - average 61 percent of
their turnover from new products and services. For low performers,
only 26 percent of turnover comes from new products and services."

Most of the respondents attributed the need to innovate to
increasing pressures to brand and differentiate exerted by the
advent of e-business and globalization. Yet a full three quarters
admitted to being entirely unprepared for the new challenges.

Two good places to study routine innovation are the design studio
and the financial markets.

Tom Kelly, brother of founder David Kelly, studies, in "The Art of
Innovation", the history of some of the greater inventions to have
been incubated in IDEO, a prominent California-based design firm
dubbed "Innovation U." by Fortune Magazine. These include the
computer mouse, the instant camera, and the PDA. The secret of
success seems to consist of keenly observing what people miss most
when they work and play.

Robert Morris, an Amazon reviewer, sums up IDEO's creative process:

a.. Understand the market, the client, the technology, and the
perceived constraints on the given problem;
b.. Observe real people in real-life situations;
c.. Literally visualize new-to-the- world concepts AND the
customers who will use them;
d.. Evaluate and refine the prototypes in a series of quick
iterations;
e.. And finally, implement the new concept for commercialization.
This methodology is a hybrid between the lone-inventor and the
faceless corporate R&D team. An entirely different process of
innovation characterizes the financial markets. Jacob Goldenberg and
David Mazursky postulated the existence of Creativity Templates.
Once systematically applied to existing products, these lead to
innovation.

Financial innovation is methodical and product-centric. The
resulting trade in pioneering products, such as all manner of
derivatives, has expanded 20-fold between 1986 and 1999, when annual
trading volume exceeded 13 trillion dollar.

Swiss Re Economic Research and Consulting had this to say in its
study, Sigma 3/2001:

"Three types of factors drive financial innovation: demand, supply,
and taxes and regulation. Demand driven innovation occurs in
response to the desire of companies to protect themselves from
market risks ... Supply side factors ... include improvements in
technology and heightened competition among financial service firms.
Other financial innovation occurs as a rational response to taxes
and regulation, as firms seek to minimize the cost that these
impose."

Financial innovation is closely related to breakthroughs in
information technology. Both markets are founded on the manipulation
of symbols and coded concepts. The dynamic of these markets is self-
reinforcing. Faster computers with more massive storage, speedier
data transfer ("pipeline"), and networking capabilities - give rise
to all forms of advances - from math-rich derivatives contracts to
distributed computing. These, in turn, drive software companies,
creators of content, financial engineers, scientists, and inventors
to a heightened complexity of thinking. It is a virtuous cycle in
which innovation generates the very tools that facilitate further
innovation.

The eminent American economist Robert Merton - quoted in Sigma
3/2001 - described in the Winter 1992 issue of the "Journal of
Applied Corporate Finance" the various phases of the market-
buttressed spiral of financial innovation thus:

1.. "In the first stage ... there is a proliferation of
standardised securities such as futures. These securities make
possible the creation of custom-designed financial products ...
2.. In the second stage, volume in the new market expands as
financial intermediaries trade to hedge their market exposures.
3.. The increased trading volume in turn reduces financial
transaction costs and thereby makes further implementation of new
products and trading strategies possible, which leads to still more
volume.
4.. The success of these trading markets then encourages
investments in creating additional markets, and the financial system
spirals towards the theoretical limit of zero transaction costs and
dynamically complete markets."
Financial innovation is not adjuvant. Innovation is useless without
finance - whether in the form of equity or debt. Schumpeter himself
gave equal weight to new forms of "credit creation" which invariably
accompanied each technological "paradigm shift". In the absence of
stock options and venture capital - there would have been no
Microsoft or Intel.

It would seem that both management gurus and ivory tower academics
agree that innovation - technological and financial - is an
inseparable part of competition. Tom Peters put it succinctly
in "The Circle of Innovation" when he wrote: "Innovate or die".
James Morse, a management consultant, rendered, in the same tome,
the same lesson more verbosely: "The only sustainable competitive
advantage comes from out-innovating the competition."

The OECD has just published a study titled "Productivity and
Innovation". It summarizes the orthodoxy, first formulated by Nobel
prizewinner Robert Solow from MIT almost five decades ago:

"A substantial part of economic growth cannot be explained by
increased utilisation of capital and labour. This part of growth,
commonly labelled 'multi-factor productivity', represents
improvements in the efficiency of production. It is usually seen as
the result of innovation by best-practice firms, technological
catch-up by other firms, and reallocation of resources across firms
and industries."

The study analyzed the entire OECD area. It concluded,
unsurprisingly, that easing regulatory restrictions enhances
productivity and that policies that favor competition spur
innovation. They do so by making it easier to adjust the factors of
production and by facilitating the entrance of new firms - mainly in
rapidly evolving industries.

Pro-competition policies stimulate increases in efficiency and
product diversification. They help shift output to innovative
industries. More unconventionally, as the report diplomatically put
it: "The effects on innovation of easing job protection are complex"
and "Excessive intellectual property rights protection may hinder
the development of new processes and products."

As expected, the study found that productivity performance varies
across countries reflecting their ability to reach and then shift
the technological frontier - a direct outcome of aggregate
innovative effort.

Yet, innovation may be curbed by even more all-pervasive and
pernicious problems. "The Economist" posed a question to its readers
in the December 2001'issue of its Technology Quarterly:

Was "technology losing its knack of being able to invent a host of
solutions for any given problem ... (and) as a corollary, (was)
innovation ... running out of new ideas to exploit."

These worrying trends were attributed to "the soaring cost of
developing high-tech products ... as only one of the reasons why
technological choice is on the wane, as one or two firms emerge as
the sole suppliers. The trend towards globalisation-of markets as
much as manufacturing-was seen as another cause of this loss of
engineering diversity ... (as was the) the widespread use of safety
standards that emphasise detailed design specifications instead of
setting minimum performance requirements for designers to achieve
any way they wish.

Then there was the commoditisation of technology brought on largely
by the cross-licensing and patent-trading between rival firms, which
more or less guarantees that many of their products are essentially
the same ... (Another innovation-inhibiting problem is that)
increasing knowledge was leading to increasing specialisation - with
little or no cross- communication between experts in different
fields ...

... Maturing technology can quickly become de-skilled as automated
tools get developed so designers can harness the technology's power
without having to understand its inner workings. The more that
happens, the more engineers closest to the technology become
incapable of contributing improvements to it. And without such user
input, a technology can quickly ossify."

The readers overwhelmingly rejected these contentions. The rate of
innovation, they asserted, has actually accelerated with wider
spread education and more efficient weeding-out of unfit solutions
by the marketplace. "... Technology in the 21st century is going to
be less about discovering new phenomena and more about putting known
things together with greater imagination and efficiency."

Many cited the S-curve to illuminate the current respite. Innovation
is followed by selection, improvement of the surviving models, shake-
out among competing suppliers, and convergence on a single solution.
Information technology has matured - but new S-curves are nascent:
nanotechnology, quantum computing, proteomics, neuro-silicates, and
machine intelligence.

Recent innovations have spawned two crucial ethical debates, though
with accentuated pragmatic aspects. The first is "open source-free
access" versus proprietary technology and the second revolves around
the role of technological progress in re-defining relationships
between stakeholders.

Both issues are related to the inadvertent re-engineering of the
corporation. Modern technology helped streamline firms by removing
layers of paper-shuffling management. It placed great power in the
hands of the end-user, be it an executive, a household, or an
individual. It reversed the trends of centralization and
hierarchical stratification wrought by the Industrial Revolution.
From microprocessor to micropower - an enormous centrifugal shift is
underway. Power percolates back to the people.

Thus, the relationships between user and supplier, customer and
company, shareholder and manager, medium and consumer - are being
radically reshaped. In an intriguing spin on this theme, Michael Cox
and Richard Alm argue in their book "Myths of Rich and Poor - Why We
are Better off than We Think" that income inequality actually
engenders innovation. The rich and corporate clients pay exorbitant
prices for prototypes and new products, thus cross-subsidising
development costs for the poorer majority.

Yet the poor are malcontented. They want equal access to new
products. One way of securing it is by having the poor develop the
products and then disseminate them free of charge. The development
effort is done collectively, by volunteers. The Linux operating
system is an example as is the Open Directory Project which competes
with the commercial Yahoo!

The UNDP's Human Development Report 2001 titled "Making new
technologies work for human development" is unequivocal. Innovation
and access to technologies are the keys to poverty-reduction through
sustained growth. Technology helps reduce mortality rates, disease,
and hunger among the destitute.

"The Economist" carried last December the story of the agricultural
technologist Richard Jefferson who helps "local
plant breeders and growers develop the foods they think best ...
CAMBIA (the institute he founded) has resisted the lure of exclusive
licences and shareholder investment, because it wants its work to be
freely available and widely used". This may well foretell the shape
of things to come.


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AUTHOR BIO (must be included with the article)



Sam Vaknin ( http://samvak.tripod.com ) is the author of Malignant
Self Love - Narcissism Revisited and After the Rain - How the West
Lost the East. He served as a columnist for Global Politician,
Central Europe Review, PopMatters, Bellaonline, and eBookWeb, a
United Press International (UPI) Senior Business Correspondent, and
the editor of mental health and Central East Europe categories in
The Open Directory and Suite101.

Until recently, he served as the Economic Advisor to the Government
of Macedonia.

Visit Sam's Web site at http://samvak.tripod.com