(Part 1 of 2)

You say this is the time to invest when many of the input costs are low, but what about companies with serious cash flow problems that can't borrow in this tight credit market?
DeGraff: That's when you go to the federation. You get wide. There are low-cost Internet companies that connect the person who has the challenge or opportunity with the person who can provide a solution. Virtual innovation site Innocentive is a good example. But this approach raises a lot of concerns about intellectual property. Who owns the rights to an idea in a global matrix? Really, it's putting enormous pressure on the old system of innovation, complete with portfolio processes and a plethora of lawyers, and I believe it will eventually destroy it.

But, okay, the economy is really bad and you can't do everything. But here's what you have to understand. What most leaders do is try something that's just a little different than what they do now, but they try to do a lot of it. They turn innovation into a continuous improvement process. They try to optimize something that's a little better. This is the kind of thing they picked up from their quality controls training.

The breakthrough innovation game is the exact opposite. You take lots of shots on goal, each highly different from the next. These experiments are bold and have a very low success rate, but since they don't require a great deal of capital, there is little risk in failure. This is how venture capitalists quickly separate the wheat from the chaff. In a federation, where many members are starved for capital, the experiments are like mini-joint ventures or hybrid collaborations. You're trying to quickly and cheaply figure out what works and what doesn't work.

The more radical the innovation, the greater the failure cycle. There is always a failure cycle, and the trick is to accelerate it; not avoid it. You don't spend a lot of money on the first version. The first version is going to need a lot of work. So you experiment in succession with versions 1A, 1B, 1C, etc., until you have some real data on the technology, competency, and market, and can begin to shape and integrate the product, service, or solution into an initial offering. Of course you are burning some resources to run these experiments and proof the concept, but you also are plotting a solution much faster than a protracted design approach where the risk of failure is often cataclysmic because of the consequences of a "big miss." You're arriving at the market faster than somebody who is trying to perfect it.

Innovation has both a forward and aft position. In the forward position, it is imperative that a firm experiments to the full extent of its capability and ambition. In the aft, the firm needs to operationalize, streamline, and scale the innovation. You're trying to churn and create forward momentum, quickly learn what works and what doesn't, and integrate these insights into the full-scale development.

I've worked with a lot of clients on a lot of projects that became very successful innovations. It's the handoff between the forward and aft positions where most innovations are fumbled. Nobody wants to be associated with failure, so most leaders are unwilling to look at something objectively and ask why it didn't work. After-action reviews are mission-critical to success but they require a lot of honesty and courage particularly in a down market. I tell students that successful innovators never bet on one horse to win but rather bet on three horses to show. It's never the one you expect that brings a good pay day.

What are some other common pitfalls companies make?
DeGraff: Here's the challenge for all of us who advocate for radical innovation. When will the dollar go up? What will healthcare reform look like? What's going to happen in the Middle East next year? There's an important thing to understand -- innovation pays in the future where there is no data. It's an epistemological problem. The only thing you can really measure are enablers: things that help you get to the future. This is the classic trap everybody falls into. Leaders love to measure innovation by looking backwards. It tells them a lot about last year but little about the market today or next year. The year 2008 was so disruptive that it laid most of these types of metrics to waste. These types of measure are not going to be predictive and they may actually be counter-predictive. Measuring the pathway to today could be the worst thing you could possibly do. So when we start measuring how to get to the future, we're not going to measure the future. We're going to measure things like the diversity of our product pipeline, technology adaptation rates, and markets we are speculating.

Once you have a handle on what's really happening now, you can begin to optimize and employ more efficient measures. How you innovate is what you innovate! And the same is true for how you measure it. When you don't, when it becomes discontinuous, you hedge. You hedge not just for typical business school reasons (to mitigate risk), you hedge to prospect upside opportunity: Where's the new market? I'll tell you who's done a great job with this: Google. Google makes 97 percent of its profits on a single item, Adwords. Now go to the Google beta page and you'll see dozens of beta products. Consider their foray into phones and other new technology, which is very exciting. Why would Google spread out like that? They are trying to get a line of sight as to what's next. People often say Google is trying to turn all these initiatives into winning products. Not so. They're just trying to find the next one that breaks big.

How much of a barrier can corporate culture be to innovation?
DeGraff: I think culture is infinitely more powerful than strategy. Just because you have the right strategy doesn't mean you have the right culture to pull it off. An innovation culture has to be sufficiently flexible to promote enlightened trial and error and sufficiently inclusive to encourage diverse skills and points of view. Virtual innovation requires linking disparate functions, like finance with HR or marketing with manufacturing.

The culture needs to support the four key elements of innovation. One, you have to have high-quality targets. Innovation rookies read the latest "you can do it" business book and try to boil the ocean. On the other hand, you get leaders beaten down by years of bureaucracy and "no-no-no" bosses who say you are powerless to do anything fresh. You have to get that magnitude and speed right. You have to set a target you can hit, something beyond the incremental and short of the inconceivable. That requires understanding how to spot an opportunity. The way to do that is to pay attention to what moves. Just like in real life, the more animate something is the more alive it is. It's searching for power, progeny, or pleasure. If it is moving less, it's in decay, decline. Innovation happens where the world is growing. People think they create growth. You ride these big trends, these big movements. They're not created by any one person or any one government and no one person or government can stop it.

The second element is deep and diverse domain expertise. Innovation happens at the edges of disciplines. It happens in between business and engineering, medicine, and law. It doesn't just happen in them, it happens in the space between them. So if you're going to make this work, you need experts from a variety of fields relevant to your endeavor.

Innovation is not an amateur sport. It may be true that Larry Paige and Sergey Brin built Google in a garage in Palo Alto. But they were two PhD students in computer engineering at Stanford. Do they sound like amateurs to you? If you're building a new business model for financial services or designing an artificial heart valve, you need experts; not amateurs. Put together a diverse advisory team. These should be people who do not always agree with you because the death of innovation is homogeneity and too much alignment. Constructive conflict is good. It produces productive tension. Alignment is overrated. Biodiversity is underrated.

The third element of innovation is to take multiple shots on goal, which we have already discussed. The first version won't be very good, but you keep learning with each version as you quickly move through that process.

The fourth element is that you learn from your mistakes through after-action reviews. You have to get smart. A lot of people take shots on goal and they remain in the dark about why things are not working. Pay attention to the mistakes, because that's where you're going to find the next set of questions, and if you're lucky, a few answers. Find out how you created a solution and who was involved.

That raises another interesting point. Companies love to bet on innovation processes. What you discover in a down market is that it's people and projects that connect organizations. So who are your innovators? And it's not your inventors. It's the person who knows how to navigate the system, someone who can get through the capital committee and hire some smart folks outside the traditional gene pool.

What are your client companies asking you most about right now?
DeGraff: The first big thing they're asking me is how they can develop innovation black belts. They love Google, they love Genetech, they love IDEO, but what they really want is their own capability to do that. The craft of innovation is no different than learning to play an instrument or speak a language or become a doctor: See one, do one, teach one. Innovation leaders need to be apprenticed, given tools, coaching, and the practical experience that comes from working on real innovation projects. To be honest, not everyone can do it. You can be a great innovator playing many different positions, but you definitely have to have some of the self-authorizing behavior and field of view to do this.

Second, which product and service companies are racing to remake themselves as solution companies? This partially comes from these federated agreements. They are looking to connect with the supply chain, with customers, with universities, and thread them together as valuable bundles. The great news is that they have all of these technologies, but the real challenges are the cultural elements, and how to monetize solutions. People are trying to put this cross-boundary form of innovation together but none of the traditional mechanisms really fit.

We have to re-invent the apparatus. In the old days, the intellectual property was run by the legal division. They basically told you that you couldn't do anything. Now try to develop a solution with a dozen businesses in a federation. If a peer has the same restrictions, it'll take you a year to make that deal. So people are now going around these traditional functions and approaches. They're creating these deals that say, if it's the source code or platform, we all own it, and we all kick in X amount to fund it. If it's an application built on top of it, we own the Y part of that and of course our specialty is Z, so we're going to make that proprietary and use it as our competitive advantage.

Finally, clients are asking us to create integrated innovation systems for them based on what we have learned from this array of projects, people, and solutions. The trick is to create the integrated system last. That's because you don't know what you don't know yet. As they say in the Nike ads, "Just do it."