These days, almost every company worth its balance sheet insists that it invests in "innovation." But does it make or lose money on these investments? That is a tougher question--and one that James Andrew and Harold Sirkin tackle in their new book, titled Payback: Reaping the Rewards of Innovation.

According to the authors, who are senior vice presidents and directors of the Boston Consulting Group (BCG), a new idea is just an invention--and not a true innovation--unless it generates financial returns. "Thousands of good ideas exist within every organization, even those that don't think of themselves as innovative," they write. "The real problem these companies have is how to turn their ideas into cash."

That is where Payback hopes to help. Andrew and Sirkin believe that in order to profit from their innovations, companies need to develop a process to collect, screen and nurture new ideas, and "commercialize and realize them in a way that achieves payback." They explain concepts such as the "cash curve," which lets companies track and manage the innovation process, and the "cash trap," which refers to supposedly innovative products that perpetually hemorrhage cash.

In an interview with Knowledge@Wharton, Sirkin discusses these and several other challenges that companies face as they seek to innovate and--with any luck--make a few bucks along the way.

Knowledge@Wharton: Why is it so hard for companies to generate returns on their investment in innovation?

Sirkin: It's very hard because most companies think about the idea--the invention, as opposed to the innovation. By innovation, we mean an idea that is driven to the profitability of return on investment. Most companies focus on invention. They focus on the ideas. They spend a lot of effort looking at ideas, sorting through ideas and trying to generate ideas.

But very little of the process that they go through is focused on [then] turning those ideas into something that delivers payback. They spend little time screening those ideas for the ones that would be commercially viable or technically feasible before they move forward with them. They spend little time focusing on how they're going to develop them. And they spend very, very little time thinking about how they're going to manage them over the life cycle.

What they don't have is the fundamental discipline of operating the entire process. They get enamored with the invention, but not with the process of making it work. Therefore, they don't focus on innovation--and by not focusing on innovation, they don't achieve payback.

Knowledge@Wharton: So it's not that they lack imagination or resources. It's mainly an understanding of the process to move it from one step to the next?

Sirkin: Exactly. We think most companies are putting in at least twice as much of what they need to spend and getting about half the value of what they should be achieving because their focus is in the wrong place. It's very rare that we go into companies and find that there aren't good ideas. In most companies, when we do some research, we find out that they have five or 10 times as many good ideas as they can possibly move forward. The problem is that they're often trying to move all those ideas forward at the same time.

Knowledge@Wharton: Your book discusses how many companies have products that lose money, and they become what you call cash traps. How exactly does that work and how do you identify a cash trap?

Sirkin: Cash traps are obvious when you see them, although in most companies it's hard to find them right away. A cash trap is a product that just fundamentally does not, has not and will never make money. It survives either because it's viewed as a core product in the operation of a company, or a core product line in an operation. No one does the accounting that would show on a cash basis that these products lose money.

Identifying them is pretty simple. You can often see them because they tend to not grow very fast. They tend to take a lot of resources and continue to demand even more and more resources. You can start to look at those and ask if they are really worth the investment. We find that many companies are riddled with capital cash traps. By just removing those cash traps, you can improve the productivity of innovation.

Knowledge@Wharton: Which other companies (besides Microsoft) do this well?

Sirkin: There are many companies. P&G [Procter & Gamble] is another great example of an innovative company. BMW is a very innovative company. They all do it in very different ways, but they are all very, very focused on not just the idea, but how you drive that idea to reality--and a reality that earns a return, not just a reality that produces a product.

Knowledge@Wharton: Even if an innovation doesn't quite make money, there may be some other intangible benefits that a company might derive from that product or service. This, in turn, helps other parts of the company to make money and establish payback. How does that process work, and do you have some examples?

Sirkin: We think there are several different kinds of indirect benefits that you can have. One is knowledge--technical knowledge. Another is brand: You may decide to spend money and create a cash trap with the goal of building a brand. Of course when you do that, there's a point in time when you've built the brand and you need to turn the cash trap off. And that's where people make the mistake [of not doing that].

You may think about an ecosystem. A lot of what Apple does with the iPod is they've built an ecosystem around it for all the products that go with it. This helps Apple make more money in that area.

The last reason is you may do it for organizational vitality. For example, Toyota invests in racing cars. They're not going to make money in racing cars, but it's part of the organizational vitality of Toyota. It's something to rally around and of course it also gives them more knowledge, because you put those cars under a lot more stress.

So there are many reasons why you would have businesses that don't earn cash, or that don't earn payback. But what you have to keep coming back to is making sure that those things are valuable because those indirect benefits have got to eventually yield payback.

Knowledge@Wharton: You've pointed out that many companies look for organic growth these days mainly through innovation as opposed to, say, mergers and acquisitions. But isn't M&A coming back with a vengeance?

Sirkin: Well, it's a balance question. It's not that you would do one or the other. You would want to do both at the same time because the stock market rewards growth of any kind that achieves a high return.

Organic growth through innovation, if you do it right and you manage your process right, will achieve a high return, so you do both. We're not saying that you can't do M&A. We're not saying that M&A is a bad thing at all. What we are saying is that most companies have taken some of the easy routes through M&A and that they're missing opportunities through innovation.

Knowledge@Wharton: There's a section in your book about what models companies use for innovation. For example, some companies are integrators while others orchestrate innovation. Could you give some examples of the models of innovation and how they work for different companies?

Sirkin: Sure. An integrator tries to do most of everything on its own. A great example of that is Seagate, the disk drive manufacturer. The company specifically chose to be an integrator.

It had considered being an orchestrater, which is an organization that works with a lot of outside parties. But they realized that different pieces of the disk that needed to be put together have to work in tandem in an incredibly important way. And, if they were going to put a lot of those on the outside, they could never get the coordination to work. So, they made a decision that it would actually be faster to produce a quality product by integrating.

Other companies have made an orchestrater decision when they recognize that they can't do everything internally, and it's actually faster, lower cost and a lower risk to have things done outside. Boeing is a company doing more and more orchestration and having its suppliers provide more of the value-added content. They are focusing on the engineering and manufacturing of the actual plane itself, but outsourcing systems. It becomes more and more an orchestrater.

Perhaps the ultimate orchestraters are people in the apparel business who often have a brand, outsource the design and outsource just about everything else in terms of manufacturing, including the supply chain. They are responsible just for bringing the product to market.

Knowledge@Wharton: Is orchestration the same as outsourcing, or is there a difference?

Sirkin: [There is a difference between the two.] Outsourcing can be a piece of it. Orchestration is when you put a lot of the value added on the outside. If you take low value operations and you give them to somebody else, you can still be an integrator. When you're an orchestrater, you are taking a lot of the value and putting it outside, recognizing that you will get benefits from it. The benefits could be reduced risk because you're not taking all of it on yourself, faster time to market because they can do a lot of it faster and other factors that are very important in terms of those decisions.

Knowledge@Wharton: If a group of CEOs were to come to you for advice on how to get started on getting some payback on their ideas, so they could turn them into innovations in which the investment pays off, what advice would you give them?

Sirkin: The first thing we would say is let's draw a cash curve. Let's take a look at the profile of several of your ideas that you tried to take to innovation and let's see what happened. Let's see where you invested, how you invested and let's take a look at the ones that you feel didn't work so well, and see if they could have worked had you done things differently.

This is because we think the big problem often isn't with the idea--although there are many ideas that are not the right ones to take forward--but with how you take the idea forward. And for many ideas that have failed and never become innovations, when you go back and take a look at what happened, they could have been successful had you chosen to do things differently. So we ask people to go back and look at the cash curve and see what it was and what could it have been if they had done it differently. That is often a good place to start.

The other place where we ask people to start is to look at the portfolio of what they're doing and ask, Can you really move all these ideas forward? Do you really have the resources? Are you underfunding some and should you not be funding others? And oftentimes we help them sort that portfolio down to a portfolio of about a third to half the size. But the result is that the right project is being funded with the higher probability of getting them out the other side, in a reasonable period of time with a reasonable amount of cost, which gives them a good chance of becoming innovations.

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