Entrepreneurial Initiative Beats Corporate Innovation Process Yet Again. When Will They Ever Learn?

According to the Wall Street Journal, Altria, maker of Marlboro and other cigarettes, is planning to invest in Juul, maker of a cigarette alternative which vaporizes nicotine-containing liquids. These devices are often called “vapes” and the practice of using them, “vaping”. A company dedicated to addicting people to smoking burning tobacco is now adding to its portfolio a company dedicated to terminating that addiction. At the same time, Altria has made a $1.3 billion investment in Canadian cannabis company Cronos Group, Inc. It will all make for interesting portfolio management.

However, for entrepreneurs, the most important aspect of the investment combination of Juul and Marlboro is what it tells us about innovation and who is capable of delivering it. Altria has been aware for a long time of the evidence that the long term future of the cigarette market is threatened by external trends, including the subjective lifestyle preferences of consumers (and the non-consumers who dislike the “second hand smoke” problem), but also including regulation, taxation and the resultant deterioration in the price-value proposition.

Faced with such negative long term trend signals, the good and wise corporation, prompted by the business school community that has populated the executive ranks in addition to marketing its tools through consulting, seminars and books, initiated an internal innovation process. This produced the idea of so called e-cigarette products, like MarkTen and Green Smoke, devices in which tobacco is heated but not burned, which purportedly makes smoking less risky. The process also produced a device called iQOS, developed in partnership with Philip Morris International, which is a sister company spun out of Altria to sell cigarettes in international countries outside of the glare of the US legal profession and its alliance with state and federal regulators.

Philip Morris International took the lead in marketing iQOS and claimed some early success in Japan, so much so that the company diverted significant resources from conventional cigarettes to the heat-not-burn “breakthrough”. After initial growth, Motley Fool in October 2018 reported “disappointing earnings” at Philip Morris International attributable to a “significant slowdown in the e-cig’s primary market, Japan”. Motley Fool reported some early trial among a younger demographic, but “a wall of resistance among older cigarette smokers”.

It looks as though Altria has seen the warning signs as an indication of failed corporate internal innovation, and has swerved to the alternate lane of acquisition of the innovative ideas of external independent entrepreneurs.

Its investment of $12.8 billion for a 35% stake in Juul Labs Inc suggests a roughly $38 billion valuation, making Juul one of the most valuable private companies. The Juul team has created this much value in about three years, while Altria and Philip Morris international were destroying value in their failed attempts at internal innovation.

The Failure Of Centrally Planned Innovation Processes.

They should have known. Corporate innovation processes are doomed to failure. That’s because innovation is not a process. It can’t be centrally planned by executive wing geniuses, no matter how much they spend on consulting and business school seminars. Innovations like Juul are emergent results of marketplace experimentation by entrepreneurs and consumers. The consumers become dissatisfied with the current set of offerings available to them – that particular phenomenon is strikingly apparent in the cigarette market. They begin to experiment with alternatives – they might try nicotine chewing gum, or patches, or snus (tobacco pouches placed in the mouth) or even iQOS. They are not yet declaring their loyalty to a new solution, but simply looking round at alternatives.

Entrepreneurs are dissatisfied with the supply side of the market. They sense the consumer dissatisfaction and match it with their producer dissatisfaction. They, too, experiment. There have been many such producer experiments in the cigarette market, and Juul is the one that has, for the moment, risen to the top. Why? It’s usually random luck combined with a co-creation collaboration with the consumer – continuously adding and changing features and attributes and measuring consumer response until the best combination emerges. There are so many experiments among so many producers and so many consumers that one combination eventually emerges as the most preferred. The outcome can not be predicted, it can’t be modeled, and it can’t be managed. The genius of the market is that all of the failed experiments result in very small losses and a lot of learning. The one successful experiment eventually incorporates all the learning, attracts a large number of customers, creates a lot of value in a short period of time, and generates a huge amount of economic progress far in excess of the losses from the failures.

The scale and reach of this experimentation, the rapid exchange of knowledge and learning in the network of entrepreneurs and consumers, the flexible adaptiveness that allows for the rapid abandonment of the resources committed to failed paths and the agile transfer of resources to the path of success, can not be matched by a centrally planned corporate innovation process. Decision-making in hierarchical structures can’t reproduce the emergent properties of interconnected knowledge-sharing networks. Processes with their stages and gates can not compete with the spontaneous order of free experimentation. Corporate investment guidelines can not compete with entrepreneurial risk-taking.

The Future Of Innovation Lies With Interconnected Individuals.

The future of innovation lies squarely in the initiatives of the independent, interconnected entrepreneur. As new technologies like A.I. and global idea exchange platforms augment individual capacity, the trend towards individually ideated innovation will accelerate.

This does not mean that corporations will not try to suppress it rather than adopt it. Glaringly, in a follow-up report in the Wall Street Journal, we learned that one of the results of the Altria investment in Juul will be collaboration between the two companies’ regulatory teams. Speaking of cronying up to government regulators, the Altria CEO was quoted as saying, “We have years of experience” in such regulatory negotiating and another spokesperson spoke proudly of Altria’s possession of  “a level of sophistication they (Juul) need”.

This reveals a downside of capitalism. Altria has enough money to invest in Juul Labs, and enough left over to smother it in corporate process and bind it with regulatory collaboration. While there is no inherent objection to scale, it usually brings with it the insidious integration with government that is anathema to further economic progress. Not to worry; the independent entrepreneurial network will nurture new innovations through its experimentation and co-creation activities faster than incumbent corporations can capture the emergent value through M&A.

Here’s How Small Business Will Take Over The Planet.

Small business generates about 45% of US GDP, provides close to half of the jobs in the US Economy, and, in a typical year, accounts for more than 60% of the new job creation.

That all adds up to big economic impact. And the news is that small business impact is going to get bigger. In fact, small business will grow to dominate and take over the economy as the problems of managing big business compound.

Big Technology Comes To Small Business.

We have become habituated to the idea that big business deploys technology at scale to achieve reach, coverage and efficiency that small business can’t match. Giant telcos have vast, expensive networks; cable companies have their wired infrastructure; amazon has warehouses and airplanes and unlimited computing power. Today, all infrastructure is variable rather than fixed. It can be rented by the minute and on demand, so that small business can use big technology at the time and in the amounts and for the highly targeted purposes it is needed. Big technology can be downloaded from the internet, and economies of scale are no longer the barriers to entry or to efficient operation that they used to be. Flexibility, agility and timeliness are far more important economic attributes for a winning business, and small business has a good shot at not just competitiveness but at superiority on those dimensions.

Science Comes To Small Business.

We may traditionally think of small business as the product of hard work, super-specialization and local relationships rather than as a child of advanced science. Artificial intelligence and adaptive machine learning will change all that. Small businesses will be able to employ the cognitive assistance of software and robotics to personalize and tailor their services for individual consumers. Aestheticians will be able to offer and implement individually tuned facial treatments and cosmetic procedures. Landscapers can design and manage plantings and gardenscapes and irrigation systems customer by customer. Vehicle fleet owners will pick up and deliver at precise times door-to-door for their local and global clientele. Lawyers will have the searchable data from every relevant case, judgment and law text at their disposal with a robot paralegal who is smart and fast and productive: the best in the world at what they do. Personalized medicine can be practiced by the local doctor, and the local dentist will be able to implant the latest in dental construction and architecture into their patient’s mouth at the neighborhood clinic. Rapid prototyping and fast-turnaround micro-testing will be fully available to small businesses and keep them on the leading edge.

New Organizational Forms Favor Small Business.

The age of bureaucratic management is coming to a close. Bureaucracy has always been a problem for business. Big business needs it to exercise control over far flung organizational outposts, over budgets, over project management and resource allocation and HR policies. But bureaucracy slows response times down in an era when agile responsiveness is a requirement to maintain customer loyalty, and it alienates talented employees in an era where individual creativity is becoming the most important tool to manage in-market performance.

The replacement for bureaucratic management is small, agile, customer-obsessed networked teams with unrestricted autonomy for responding to customer requests and marketplace changes. There is no waiting for HQ approval. There’s no actual organizational model – every company is capable at arriving at its own form of organization that works best for its customers in its geography and its business. Therefore this organizational style is not mediated by business school-imposed standards or consultants’ print-outs. As a result, it’s hard for big business to adopt, which is one reason why small business will take the lead in organizational innovation.

Small Business Will Win With Humanity.

It’s remarkable how many people complain about their jobs in large corporation. Gallup’s global survey (2016 edition) on the subject of employee engagement (whether employees find their jobs meaningful and look forward to their work) indicates that only 13% of employees worldwide say they are engaged. The rest actively hate their jobs or merely put up with them. If they can’t engage with their jobs, how can they engage with customers? Gallup calls it an engagement crisis.

Entrepreneurial small businesses operate on empathy. They are tasked with understanding their customers’ needs and responsively designing services that meet those needs and are simpatico with customers’ values and are able to compete with every other offering that’s available. Small businesses depend on their humanity to succeed – their success in matching values with their customers in an extended and deep relationship depends on it. Digital tools can help in tracking the state of the relationship, but it is the subjective, emotional, and idiosyncratic elements in business exchanges that will be the mark of future winners. Big business will find that they can’t be successful on these dimensions.

People Prefer To Deal With Small Businesses.

We live in a time when people’s tolerance for unresponsive, insulated institutions is at a low point. This is true for political institutions like Congress and the Presidency. NPR reports that only 8% of Americans have a great deal of confidence in Congress, 19% in the Presidency, and 22% in the Supreme Court. The number for big business is 12%. If you let people down, and don’t act with humanity, you lose trust. Small business has a much greater incentive than a bureaucratic management team to be human, to engage, to respond and to earn customers’ trust.

In a 2017 Public Affairs Council poll, 41% of respondents expected small business owners to exhibit high honesty and ethical standards and only 5% expected them to have low standards in those departments. For employees of major companies, there was an expectation of high ethical standards among only 18% of respondents, and that number declined to 9% for big company CEO’s.  (Only elected officials in Washington polled lower: 7% of respondents expected high honesty and ethical standards there!)

People prefer to deal with those they know, like and trust. Small business can win big on these three fronts. More and more customers will make the choice to buy from small business, especially now that technology, science, efficiency and organizational effectiveness are no longer reserved to big business.