Are you playing offense or defense?
These two distinct types of innovation should be present in your portfolio
Innovation efforts can be classified into two categories: offense and defense
Offensive innovation include ideas that radically change the status quo and are likely to upend the competitive balance in a market or define a new one
Defensive innovation include incremental improvements and efficiencies that reinforce the status quo and help deepen a competitive advantage over others
Offensive innovation efforts are riskier bets; they often have an uncertain ROI
Defensive innovation efforts are safer bets, but do not produce outsized returns
A good portfolio of innovation efforts should include a mix of both categories
The return from defensive innovation efforts should pay for offensive efforts, providing you with enough financial and political capital to take on riskier bets
Two approaches to innovation
If you are looking for a good summer read, I highly recommend The Founders by Jimmy Soni, a new book that recounts the history of the founding of PayPal. Originally a story of two startups, Confinity and X.com, the firms later merged when it became apparent that payments solutions to enable e-commerce benefitted greatly from network effects. Among early employees were the subsequent founders of some of the most successful Silicon Valley startups including YouTube, Yelp, Tesla, SpaceX, LinkedIn and Palantir; other went on to top positions at Google, Facebook and leading VC firms.
Confinity originally focused on offensive innovation; the founding team focused on encryption and security for PalmPilots, one of the earliest handheld devices, and created the capability to “zap” money from one device to another using an infrared port. X.com focused more on defensive innovation; founded by former ScotiaBank intern Elon Musk, it sought to offer a wide range of traditional banking and financial products digitally, but do it better than slow-moving incumbents. Initially, the two firms were focused on different opportunities. Both firms later independently discovered a growing audience that was not well-served by existing offerings in the form of sellers on a new website called eBay who were not traditional merchants. Both startups fought hard to win over these customers using bonuses and incentives that came at a high cost, which prompted the desire to merge into a single firm.
One of the most interesting parts of the book is the hiring of Bill Harris, a former CEO of Intuit, to be the CEO of X.com. Harris and Musk end up disagreeing on the vision for the firm. Harris has a more traditional view of the financial services industry, its complexities and myriad of regulations; Musk is more of a radical who views people with banking experience as being slow to move and not innovative. Ultimately, PayPal finds a niche of enabling small e-commerce merchants and customers to make payments using bank transfers and using existing credit card networks such as Visa and Mastercard.
There has been speculation that PayPal might have actually gone down a different path and initiated a move to embrace decentralized finance (DeFi) and cryptocurrency much earlier had it more forcefully embraced offensive innovation, rather than the defensive innovation favored by more established executives with experience leading at traditional firms. The book talks about the initial trend in Silicon Valley to bring in an experienced executive to be CEO for startups that were scaling - an “adult in the room” (think of John Sculley coming from Pepsi to lead Apple, replacing Steve Jobs). Soni cites the experience of PayPal as marking a turning point in this trend; later, the conventional wisdom changed to place more importance on keeping founders with their firms during scale-up to retain the firm’s creativity and vision. (In fact, PayPal co-founder Peter Thiel later started Founders Fund, a VC firm that touts a major selling point as being that they never replace a founder.)
Offensive innovation: high risk, huge potential
The term “disruption” is overused when discussing innovation. Some people see disruption as a positive force, others see it as a threat. Regardless of your view, offensive innovation can be synonymous with disruption. The intent is to make a big bet on the future that is radically different than anything in the market today. In many cases, history is not an adequate guide to whether an offensive innovation venture will be successful because the effort is unprecedented. The development of the personal computer, the rise of the Internet, and the advent of e-commerce certainly fall into this category. Any analogies made to the Sears catalog or other mail-order retail at the time were tenuous at best. Given this brand new environment, determining what payment solution(s) would win out was not obvious. While PayPal was initially formed from the merger of Confinity and X.com, there were many other startup payment solutions in the marketplace at the time, some even started by established banks. After the merger, PayPal received a new funding round of $100M right as the dot-com crash of 2000 happened. Any delay in combining the two firms and both might have easily ended up as failed ventures. Of course, PayPal ended up becoming wildly successful, resulting in an IPO and subsequent acquisition by eBay (who later spun it back out).
Offensive innovation entails high risk, but also holds huge potential if successful. These types of innovations can seriously harm incumbents or even put them out of business. We generally associate these types of risky bets with startups, not existing firms. This does not mean they cannot occur within a larger firm, only that they often face significant headwinds. The amount of capital needed, the risk-adverse attitude of employees, the high prospect for failure and lack of ability to quantify a return on investment (ROI), and the inherent politics and bureaucracy that can drag out decision-making all combined to make these efforts particularly challenging. Some firms set up “skunk works” efforts that enjoy a significant amount of autonomy and develop out of the watchful eye of senior executives to help spur the type of radical rethinking that characterize offensive innovation efforts. These types of “out of the box” efforts generally benefit from outsiders who do not have preconceived notions of “how things work”. By contrast, subject matter experts can struggle to think big enough. Offensive innovation also requires smaller teams that are more agile: fewer meetings and quicker decisions are critical to staying lean and on track without losing critical momentum. Finally, these efforts need to be closely tied to your firm’s long-term strategy and have more than one champion in order to ensure beyond any changes in leadership or your organizational chart. If, instead, offensive innovation efforts are seen only as “sacred cows”, they will not last beyond the leader that launched them.
Defensive innovation: keeping a competitive edge
In contrast to offensive innovation, defensive innovation efforts are designed to reduce the amount of risk and are often characterized as enabling the “adjacent possible”. Such efforts might include a new product, service or feature that complements the existing set of products and services. They might also describe incremental innovation efforts designed to improve efficiency and/or reduce expenses such as automation. As I previously wrote in describing the gate agent problem, employees who are subject matter experts often are quite effective at identifying these opportunities. They work within a set of systems and processes and see areas where improvement is possible; they may even identify unmet needs and desires if they are customer-facing which can provide a lot of value to your firm.
Defensive innovation opportunities are generally clearer and more straightforward to comprehend: they also are easier to project the ROI for. Even large-scale efforts that can cost significant time and money such as core system replacements or digital transformation journeys can fall into this category. It’s not the size of the effort but the scope of the ambition and departure from the status quo that impacts whether an innovation is properly classified as offensive or defensive. A defensive innovation effort can provide new capabilities, but generally these are not a radical departure from the existing suite of products and services your firm offers: they are complementary.
What does a balanced innovation diet look like?
So what type of efforts should your firm prioritize: offensive or defensive innovation? I believe the answer is a mix of the two, with your strategic goals and corporate culture dictating the balance between the two. Defensive innovation efforts are more likely to provide a positive return for your organization. They also provide success that your team can build upon and rally around. Most importantly, they allow for learning when the stakes are smaller because outright failure is less likely.
The measurable returns and successes of your defensive efforts should serve as a basis for investments you make in offensive innovation efforts. The stakes are higher for offensive efforts because failure is more likely, as is the potential return if you do ultimately succeed. Even if you do fail in offensive efforts, however, the learnings that are gained can be exceedingly valuable and the ambition to date greatly can be motivational. Striving to accomplish big things sets a tone in your organization that you set the bar high for achievement.
Unfortunately, most organizations I know do not classify their portfolio of innovation efforts this way. By failing to examine the current mix of initiatives in this way, firms are missing out on finding a healthy balance between the two types of innovation. A simple action step I recommend is going through the exercise of classifying your current and planned efforts to gauge whether you have the right mix between offensive and defensive innovation. After, I recommend informing senior executives and possibly your board of directors of the results and engaging them in a discussion of what their preferred mix is so that you can strive to find the optimal balance moving forward.
Does your firm tend to favor offensive or defensive innovation efforts Does your organization has a culture of risk-taking and tolerance for failure to support offensive innovation? What are your greatest competitive threats today? What types of innovation efforts can best protect your organization while also helping you gain a lasting advantage?
Note: the next edition of Forestview will be on Friday, July 8th.