Harvard's Gary Pisano discusses the importance of balancing strategy, systems and culture at big firms to spark innovation.

Gary Pisano, professor of business administration at Harvard, rejects the narrative that only scrappy startups are nimble enough to innovate. He believes large, established firms can adapt and evolve, but they have to go about it differently than their small-sized competitors.

In his new book, Creative Construction: The DNA of Sustained Innovation, Pisano offers a three-pronged approach for innovation based on more than three decades of research and consulting with companies that stayed a step ahead. He recently joined the Knowledge at Wharton radio show on SiriusXM to talk about his book and explain why innovation for big firms isn’t as simple as “be like Uber.”

Knowledge at Wharton: Innovation has been a common mantra lately, but you point out that it’s been around for a long time. Many of the biggest companies in the 20th century were innovators, correct?

Gary Pisano: Yes. Innovation has been a fundamental part of economic growth in the last couple of centuries. I like to remind people that we’ve been innovating for millennia. It’s something we do as a species that we do better than any other species, presumably. I sometimes hear people saying they’re tired of hearing about innovation, but it’s fundamental to our existence and fundamental to solving the problems that we face. If we don’t innovate, what else do we do?

Knowledge at Wharton: Do you think that more big companies better understand the concept of innovation as they have expanded over time?

Pisano: Large companies today, across the board, in a variety of industries, are thinking about ways that they can invigorate their growth, and they turn to innovation. But the reason I wrote the book — what I found from my research and my teaching and my consulting activities — is that a lot of larger companies struggled to get started. They didn’t know really how to attack the problem, or they would attack it by trying to be just like a startup, which doesn’t work for a larger company.

Knowledge at Wharton: You have examples in the book of companies that have had successes and failures. One of them is Blockbuster, which was doing exceptionally well but did not innovate to meet the needs of the consumers. Can you tell us about that?

Pisano: People forget that, at one point in time, Blockbuster absolutely dominated the video rental business. They put all the mom-and-pop shops out of business. They were a great disruptor of that industry — creating a chain — and could leverage their scale. They were great at leveraging data. But Netflix introduced a new business model. It wasn’t so much about the technology; it was a new business model, and they couldn’t adapt to that. That’s a common story that’s played out time and again.

“The term [innovation] sounds good … but it means kind of everything. As a result, it means nothing.”

Netflix is a great counter-example. They transitioned from [a service that mailed] the traditional DVD in the red envelope [for customers to rent] to video on demand. They did this when they were the leader in the traditional business and were already quite large. They were $7 billion to $10 billion in revenue at the time they started to make that transition, and every theory of innovation basically said, “Well, that’s not going to happen. They will get disrupted. They’ll be too wedded to their own business model. They’re too large. They’re too entrenched, etc.”

That’s the kind of pattern that folks have come to expect. But Netflix is a great example of ‘no, it doesn’t have to be that way.’ Through the right kind of strategy and the right innovation processes and the right culture, a large company can make a transition and be a dominant player. It’s not just about startups being able to do that.

Knowledge at Wharton: What is the DNA that large companies need to have in order to innovate?

Pisano: I use the term DNA very specifically — it means something that’s entrenched. But I was also being a bit ironic because the DNA of an organization is an analogy that we often use. It differs fundamentally from the DNA of humans or living species. By and large, our DNA as humans or as any living species is somewhat immutable, despite new advances in genetic modification. Our DNA is what it is, and we’re stuck with it.

People have always thought that once companies have the equivalent of their organizational DNA, which is embedded in their systems and their processes and their culture, that’s it. They’re stuck. There’s inertia. They’ll never be able to change.

Yet the DNA of organizations is mutable. That’s the fundamental difference. The reason companies often fail in their attempts to become innovative again or to keep their innovative capacity is due to three factors. One is strategy. For a larger company with an existing business, you need an explicit strategy around how you allocate resources to the new versus the old.

The second is getting the right systems in place. Very different kinds of innovation and problem-solving processes go on when you’re trying to do something transformative versus routine innovation.

The third element of that DNA is their culture. There’s got to be the right kind of culture. In the book, I go into detail into each one of those elements.

Knowledge at Wharton: For most companies, there are probably patterns that have developed over time that help build out strategy. But with innovation, there’s an expectation of the unknown. How do you build out an innovative strategy then?

Pisano: You have to be quite explicit about it. The term ‘innovation’ is sort of everywhere and people talk about it. One of the problems that companies run into is that the term sounds good, it means something good, but it means kind of everything. As a result, it means nothing.

Everybody in the organization has a different view. One of the first steps for senior leaders is to start to define the types of innovation and their choices, and to think about the different ways they’re going to allocate resources to those. Just being explicit about the difference between, say, routine innovation versus radical innovation versus disruptive innovation versus architectural innovation.

Those are fundamentally different types of innovation. Being clear about what you want to do and how you want to allocate your resources to those is critical. And it’s a different answer for every company, depending on their competitive circumstances and where they are in their technology cycles.

Take a mature company like Goodyear, which is well-run but they’re in a slow-growing business. For them to grow, they’re going to need to do something. While they need to put resources into the tire business because it’s core to them, their growth is going to come from fundamentally new business models.

But if you’re Google, and your core advertising business is still growing at something like 30% a year, you put a chunk of your money into that core business. That’s fine. Now, it doesn’t mean all or nothing. Google also invests in those moonshots, which are outside their routine quadrant.

Again, it’s an issue about the portfolio and getting the right balance, rather than all or nothing. There’s no standard formula to say every company should do X percent in this category, X percent in that. It’s a little more complicated than that.

“Was it inevitable for Sears to disappear? No, I don’t think it was inevitable.”

Knowledge at Wharton: I would think that innovation is difficult for a company like Goodyear because they focus on one thing – tires. Where does innovation take them?

Pisano: The advantage and the reason you see companies like Amazon and Google and even Apple becoming these mega companies is they have platforms, and platforms lend themselves to exploiting lots of different options in a lot of different businesses.

Some companies are inherently more confined by what they’ve done or by their history. But still, if you’re a company like Goodyear in a mature business, you need to think about how to reinvigorate that. How do you find new business models? Goodyear’s a good example. They have auto servicing, right? So, ‘we don’t just sell tires anymore. We’ll service your car. We’ve got that connection to the customer.’

It’s certainly possible to take businesses and reinvigorate them. Sometimes you do it through technology. Sometimes you do it through a new business model. Think about what’s going on today in shaving products, men’s personal care. A razor blade [can only get so sharp], so continued technological innovation to make your razor blade shave closer has diminishing returns.

As I like to point out in the book, you want your shave to be [only so close]. On the other hand, there’s convenience. Think about companies like Dollar Shave Club or Harry’s, which have created essentially new ways to reach the customer through an online model. There are a lot of different choices for companies, even in so-called mature businesses, to reinvigorate their business through innovation.

Knowledge at Wharton: Let’s talk about Sears, a major American retailer now on the brink of shutting down. What would you say about Sears’ inability to innovate?

Pisano: The question I would ask is, was it inevitable for Sears to disappear? No, I don’t think it was inevitable. This is where leadership has to take the blame in terms of what were the strategies? How were they thinking about what the customer wanted? Was there a transition to doing something online that they could have done while preserving their core strengths? Were they sizing the company the right way?

I’m always amazed at retailers today. Every time I go to a store, I think of five more reasons why I never want to go to a physical store because they don’t understand strategy. I recall going out with my wife to buy some plates. We had just moved, and we were having a dinner party and realized we needed to have 12 plates. We went to a department store. It wasn’t Sears, but it was another big department store. We found plates.

We couldn’t find anybody to help us. I literally could not find anybody to help us buy the thing because they had cut back on their staffing so heavily to save costs. We ended up ordering the same set of plates from Amazon because they could deliver it the next day. So, you could see how Amazon created value for me. That store was creating no value. It was holding literally tens of millions of dollars in inventory.

That’s a case where a retailer doesn’t understand what it is that brings somebody to a store and what you have to do to enhance that experience. A physical retailer is never going to be as cost-efficient as an online provider. You’re not going to compete with Amazon on cost. You have to compete in a different way, and that gets lost. That’s where you go back to strategy and innovation strategy. What kinds of innovations are going to create a different experience here for our customer so that they’ll want to be in the store? And for those things that they don’t want to be in the store for, that’s going to go to online. Get that balance right.

“We went to a department store.… We couldn’t find anybody to help us.”

Knowledge at Wharton: We’ve talked about creating that strategy, but what about the design of the system?

Pisano: Strategy is great, and it’s fundamental. It’s a starting point. But the way you go about finding those transformative ideas and developing them and testing them is fundamentally different from building on your core business. That’s the second way that companies fail in their attempt to reinvigorate their innovation capacities.

A big mistake is they use the same system for all types of innovation. When you get into transformative innovation, you’re really in unknown territory. You’re not building off what you know, so it’s a much less linear process. You need to be experimenting a lot more. You need to be prototyping a lot more. You need ways to incubate ideas in a very different fashion. You have to search for ideas in a different place.

I’ll ask companies where they get ideas for innovation from, and they’ll say, “We get them from everywhere.” But then as you probe more deeply, you realize they get them from the same sources, the same customers, the same suppliers. If you’re talking to the same people all the time, you’re going to get the same ideas that you had last year or the year before. You’re not going to get anything new. Ask yourself who you’re not talking to. What suppliers are you not talking to? What regions are you not listening to? Start to open up that funnel a little bit more.

Knowledge at Wharton: Don’t some companies get stuck because they keep doing what has worked for them in the past?

Pisano: Absolutely, 100%. We all fall into that trap. If you’ve been in an organization that has been successful doing something a certain way for a long period of time, a certain cognitive dissonance can set in, and then you can convince yourself that you don’t have to change that much. Or you’ll tweak. You’ll see little tweaks rather than thinking through, “Wait, is there something fundamentally different?”

I know we have lots of new tools and big data analytics and technologies to help us do innovation. But at the end of the day, it’s people who innovate. Innovation is an intensely human activity. It does come back to leaders and people throughout the organization who can think a little differently, who can draw connections between areas, who can say, “Here’s something going on in another business that is very relevant to ours.”

Reed Hastings [co-founder and CEO of Netflix] always talked about how he got the idea for a subscription model by going to the gym one day. What does the gym business have to do with the video rental business? On the surface, nothing. But there is a common way to think about the business model. This is using analogies and arbitraging ideas across sectors.

You need people in your organization who can do that. Sometimes, companies that have been successful in a certain way have hired the same kind of people over and over again. They’ve hired from the same schools, the same disciplinary backgrounds. They just replicate that kind of pattern of thinking that they’ve always had. Therefore, we shouldn’t be surprised they don’t come up with anything new.

Knowledge at Wharton: Can you talk about the third element, culture?

Pisano: Culture is an area that I find really fascinating and perhaps the most misunderstood when it comes to innovation. Culture is like the software of the organization. If you can get the right strategy and the right systems, it’s like having the right hardware. But if you don’t have the right culture, it’s not going to work.

But culture is an area where companies struggle because, first of all, changing culture in general is hard. It has been particularly problematic with innovative cultures. And I think they’re fundamentally misunderstood.

What I mean by that is that there’s been a tendency to focus on a lot of the desired behaviors of innovation that are very palatable to people. We’ll hear the same things over and over again. What does it take to be an innovative company? Well, you have to have a tolerance for failure. Let’s celebrate failure. Let’s have a big willingness to experiment — great. Let’s have a lot of psychological safety so people can speak up and challenge — terrific. Let’s be collaborative — fantastic. All that stuff is really terrific, and everybody seems to want to do that. Then the puzzle for me is, if these are behaviors that lead to innovation and everybody seems to want to do it, why isn’t it being done?

“Innovative companies set incredibly high standards. They have intolerance for incompetence.”

I run seminars at companies, and I’ll ask, “How many of you want to work in an organization like that?” And everybody raises their hand. And then I say, “How many of you work in an organization like that?” And nobody raises their hand. Wait a minute, you just described a world to me in which ice cream is good for you, and not everybody is eating ice cream. So, what’s going on? What I found in my work is that there’s another side that’s equally important. I call it a darker side or a tougher side, depending on when you were born. You might think of it, rather than the ice cream side, as the cod liver oil side or the kale version.

You need a tolerance for failure, absolutely. But innovative companies set incredibly high standards. They have intolerance for incompetence. So, we tolerate failure; we don’t tolerate incompetence. And they draw that distinction. A willingness to experiment? Absolutely, but they’re super disciplined, so when they do an experiment, the data speaks for itself, and that’s it. The data is sacred.

Psychological safety, everybody can speak up — terrific. But you also need people in the organization who can tolerate the kind of candor that comes with it. I use the phrase, “It’s a brutally candid organization.” I don’t mean people are brutal in a personal sense. It’s just these are tough organizations to work in. Every day you’re challenged. Nobody lets anything slide. There’s a lot of collaboration, but there’s huge personal accountability. And you need accountability to make decisions. You need individual accountability to make decisions quickly, and that’s key to innovation.

What I have found is very often companies and people in the organizations are less comfortable with that other side of the innovation culture ledger, if you will. They love tolerance for failure. They love willingness to experiment and psychological safety and collaboration. There’s a lot less taste for, “Well, we’re going to actually hold people personally accountable for the decisions they make. We’re going to set really high standards.” Innovative cultures are tough. They’re very tough.