To catalyse breakthrough growth, leaders must set bold aspirations, make tough choices, and mobilise resources at scale.
Today, TextileFuture would like to focus on the “Innovation Commitment” that is necessary to lead your company into the future. It is based upon an article by McKinsey Quarterly,by guest authors Daniel Cohen, Brian Quinn, and Erik Roth from McKinsey. Daniel Cohen is an associate partner in McKinsey’s San Francisco office, Brian Quinn is a partner in the Chicago office, and Erik Roth is a senior partner in the Stamford office. We add a particular focus on Europe, entitled “Reviving innovation in Europe” also by McKinsey.
The authors of the first feature wish to thank Matt Banholzer, Danielle Barber, Marc de Jong, Laura Furstenthal, Katie Lelarge, Nathan Marston, and Miao Wang for their contributions to this article.
Here starts the feature:
Seven years ago, we unveiled research highlighting the existence of innovation’s eight “essentials”—a collection of attributes and behaviours that appeared to underpin superior innovation performance. 1 Since then, we have validated the essentials through further research and seen them in action at hundreds of companies. This work has deepened our conviction that not only do the essentials matter but also that mastering them is critical to survival at a time when transformational growth is needed to defend against disruptive rivals (see sidebar, “Defining the eight essentials of innovation”). Simply put, the ability to develop, deliver, and scale new products, services, processes, and business models rapidly is a muscle that virtually every organization needs to strengthen.
Our latest research highlights a growing performance gap separating innovation “winners” from companies that merely muddle along. We recently compared innovation proficiency—based on competencies defined by the eight essentials—for 183 companies against a proprietary, company-level database of economic-profit performance. This analysis showed a strong, positive correlation between innovation performance and financial performance. Our research also shows us that innovation winners are extending their lead most conspicuously in two areas. First is the ability to set a bold yet plausible aspiration for innovation that is grounded in a clear view of the economic value that innovation needs to deliver. And second is the ability to make tough resource-allocation choices about the people and funds required to seize innovation’s value at a scale sufficient enough to make a difference.
This article focuses on these two essentials—aspire and choose—not because the other six are any less important, but because without these two in place, innovation investments often become scattershot and are more likely to disappoint. Setting aspirations and making tough resource-allocation and portfolio choices also are areas where a company’s top leaders play a unique and disproportionate role in creating change. Some leaders are doing this by defining what we call the “green box”—a quantification of how much growth in revenue or earnings a company’s innovation needs to provide in a given timeframe. As we will see, it is a concept that can help animate the aspirations and choices that collectively separate innovation leaders from the rest of the pack.
Setting aspirations and making tough resource-allocation and portfolio choices are areas where a company’s top leaders play a unique and disproportionate role in creating change.
What the numbers say
It bears repeating: simply mastering a few of the eight essentials—for example, by generating and harnessing consumer insights or engaging more effectively with start-ups—is not enough. As the innovation performance curve depicted in Exhibit 1 shows, companies that master five of the essentials enjoy a substantial uplift in economic-profit performance, and there is an even greater uptick with seven or more.
This finding is consistent with our experience, which is that the very best innovators benefit from interdependent, organization-wide activities and practices aimed at delivering innovation. Effective innovation operating models spur companies to generate, prototype, develop, de-risk, deliver, and scale innovation initiatives. A well-integrated system thatis grounded in the eight essentials also challenges leaders to break out of their comfort zones, while giving them visibility into the ongoing portfolio of projects so that they can confidently invest valuable time, people, and funds to their best effect.
Another noteworthy finding is the widening gap we see in two of the essentials: aspire and choose (Exhibit 2). Here, it seems that leaders are getting better while laggards mostly run in place. In our experience, there are many reasons for this gap, starting with the enormous differences we’ve observed in how deeply executives focus—or don’t—on innovation-related activities. A worrying datapoint from our survey is that despite the high importance that executives place on innovation, fewer than 25 percent said they were involved in setting innovation targets and budgets. That figure points to the shift in mind-set—and management approach—that many leaders must make.
Innovation, growth, and the green box
Innovation, at its heart, is a resource-allocation problem; it is not just about creativity and generating ideas. Yet too many leaders talk up the importance of innovation as a catalyst for growth and then fail to act when it comes to shifting people, assets, and management attention in support of their best ideas. The portfolios of these companies tend to go heavy on near-term product improvements and other presumably “high certainty” efforts and much lighter on potential breakthroughs or new business models—forms of innovation that are “less certain” but often hold greater potential to generate sustainable, new sources of growth and outsized returns.
The green box represents the amount of growth that only innovation can produce, after netting out all other possible sources.
For example, we recently analysed a chemical company’s innovation portfolio and found that 65 percent of it was dedicated to small, product-related initiatives. The figure was 80 percent for a global consumer-products company—and many of the initiatives were dilutive, resulting in revenue or earnings growth that was slower than the average for the company as a whole. The pull of this approach is understandable: the individual projects in the portfolio appear “certain to deliver.” The result is often a false sense of security, however, because over time it becomes harder and harder for such projects to achieve ever-rising growth expectations. Even the best-run companies struggle to remain on this type of innovation treadmill. The need for more and more incremental initiatives necessitates investment rates that are unsupportable and that can easily fracture a company’s innovation-delivery system. Teams continually race to meet short-term goals (straining even the strongest company culture), while the organization’s ability to conceive and introduce more ambitious innovation atrophies.
To get off the treadmill, organizations must revisit their growth model—specifically, where and how the company expects to source growth and what role innovation should play in securing it. A concept that can help a company commit, tangibly, to that role is the green box. At its core, the green box is the value the company generates from all forms of innovation—breakthrough and incremental—over a finite planning period (perhaps five years), quantified using metrics such as net new revenue, earnings growth, or both. Critically, the green box represents the amount of growth that only innovation can produce, after netting out all other possible sources (including market momentum, in-year pricing adjustments, distribution and marketing activities, and M&A). This amount is then cascaded into a set of objectives and metrics for the company’s operating units, which reflect them in their own innovation portfolios. When you define your green box, you may not know what specific innovations will fill it (that is why we call it a box) but you know it will require an abundance of new growth ideas (that’s why it’s green) whose potential will guide your resource-allocation decisions (Exhibit 3).
The green box fills a void in many organisations. Consider the experience of a leading global insurer that struggled for more than a decade to stimulate innovation-led growth. The company enjoyed a few sporadic “hits,” but in general its innovation performance was inconsistent. A key reason: most business-unit leaders felt comfortable that they could achieve their performance targets by running their core operations effectively and relying on incremental initiatives. Because more ambitious (and, hence, more uncertain) innovation projects were not necessary, they inevitably slipped down the priority list. To spur more breakthroughs, the company’s frustrated CEO had tried starting a corporate-venture arm, an incubator, and a collaboration space for external partnerships, but none of these moves touched the core problem—that company leaders didn’t truly need innovation to meet their performance objectives.
A well-defined green box helps reverse these dynamics. It keeps innovation front and centre in the planning process—which is where it should be, since big, innovative moves are often drivers of competitive differentiation and strong corporate performance—and serves as a counterweight to less ambitious annual plans built on the foundation of “last year’s performance plus a little bit better.” And, for sceptics worried that analytical, green-box thinking might stifle creativity, we have a simple answer: to think outside the box, you must first have one.
A well-defined green box keeps innovation front and centre in the planning process—which is where it should be, since big, innovative moves are often drivers of competitive differentiation and strong corporate performance—and serves as a counterweight to less ambitious annual plans built on the foundation of “last year’s performance plus a little bit better.”
How to aspire
That said, the first of our eight essentials isn’t “create a green box,” it’s “aspire,” because even though a green box is critical to a well-crafted aspiration it isn’t enough on its own to motivate an organization. You also need to paint a picture of the potential for innovation to transform your company, and your industry. This should encompass a bold and plausible “north star” vision that describes in detail what success will look like, translated into a strategy and key actions that include qualitative and quantitative metrics for measuring progress (including the sizing of the green box), as well as accountabilities for leaders and other key stakeholders to deliver innovation results. All of these elements – collectively – are the aspiration, and they are mutually reinforcing. Inspiring words are necessary but insufficient for ensuring committed, coherent innovation in most organizations – as are goals and metrics alone. You need the total package.
Inspiring words are necessary but insufficient for ensuring committed, coherent innovation in most organisations – as are goals and metrics alone. You need the total package.
Inspiring words are necessary but insufficient for ensuring committed, coherent innovation in most organisations—as are goals and metrics alone. You need the total package.
Here is an aspiration that a consumer-oriented company is using to galvanize innovation:
We aspire to create quintessentially recognizable offerings that responsibly reshape the global market for [disguised], while reinventing our core processes to enable us to deliver [$X billion] in net new earnings by 2025. To achieve this aspiration, we must do the following:
- Predict and adjust to changing customer purchase patterns, using advanced analytics and flexible technology platforms.
- Develop new ways to engage our consumers in new channels.
- Change the delivery of core innovations by dramatically improving the flexibility and efficiency of our process – which we will measure.
This aspiration is bold, specific, and measurable. Teams understand the magnitude of what they need to accomplish, and they are shaping and filling their innovation portfolios accordingly. What’s more, they are not only measuring progress along the way, they are also managing against it—translating the initiatives into discrete goals to ensure that individuals do their part (a vital, and often overlooked, piece of the innovation puzzle).
Although we have talked primarily about financial metrics—revenue or earnings, specifically—there are cases where other metrics, such as the number of subscribers (or patients) or customer satisfaction, may be more appropriate. The key is to pick a metric that serves as a direct proxy for value creation. For example, a leading Chinese insurer sought to innovate in order to access a profit pool associated with 300 million consumers. Because the company’s leaders believed that rapidly achieving scale would be key to the success of its future business model, they encouraged their people to develop innovations that would support the acquisition of millions of new subscriptions. In another context, one of the largest US healthcare payers sought to encourage innovation aimed at improving patient satisfaction and the quality of care. Satisfaction and quality metrics became paramount as the company worked to safeguard itself from disruption by experience-focused attackers such as Oscar Health, and to prepare itself for a shift toward outcomes-based business models.
Nonfinancial innovation targets can be even more important for organizations in the not-for-profit sector. Consider Gavi, a public–private partnership that was founded to save children’s lives and protect their health by increasing access to immunization in poor countries. In the first 14 years since its inception, in 2000, Gavi had prevented seven million unnecessary deaths. But, the organisation began to realize that the low-hanging fruit had been plucked, and the organization would need innovative approaches to scale its efforts further. Gavi’s response was an aspiration to reach another 300 million children and prevent up to six million more unnecessary deaths by 2020.
This bold, specific, measurable, and time-bound aspiration is yielding results.
Returning to the green box for a moment, we would note that in some circumstances it can become a source of inspiration that extends beyond metrics. We were surprised recently to see a small, plastic green box on the desk of every employee of a basic-materials company in Russia that had been working hard to increase its pace of innovation. The CEO had used the green box as a visual artifact when talking about innovation’s role in realizing the company’s potential, and the concept had caught on. It was the best example we have seen of the inseparability of metrics and vision when it comes to setting effective innovation aspirations.
How to choose
As with setting aspirations, prioritizing and choosing innovation opportunities is a top-management task. Senior leaders are best positioned to take a comprehensive look at initiatives and resources across the organization and then to ask tough questions about how to improve the portfolio by changing its composition. These decisions coalesce in portfolio-management approaches that manage the flow and mix of initiatives captured in the green box. The linkage between aspire and choose is very important, as it is virtually impossible to reallocate meaningful amounts of resources if the initiative portfolio and “north star” are not clear.
Avoid false comfort
In the absence of strong aspirations, and sometimes even in contradiction of aspirations that have been articulated, many companies fall back on popular rules of thumb. One is the “70/20/10 rule,” which says that 70 % of innovation efforts should be aimed at the core, 20 % at adjacent step-outs, and 10 % at breakthrough innovation. At the other extreme, we have seen companies that are so bent on “self-disruption” (an ambitious goal but too vague to be an effective innovation aspiration) that they place disproportionate emphasis on risky investments.
Management teams do far better when they avoid the false comfort of averages, crude benchmarks, or pie-in-the-sky dreams.
In our experience, management teams do far better when they avoid the false comfort of averages, crude benchmarks, or pie-in-the-sky dreams. There is simply no substitute for the hard work of clearly linking innovation portfolios and aspirations, on the one hand, with a clear intent for each initiative and the associated resources required, on the other. This is much more than a mathematical exercise, because it starts with a deep understanding of the kinds of opportunities (for instance, related to customers, technologies, or new business models) that are aligned with innovation aspirations. To find new opportunities and determine the appropriate number and mix of initiatives, leaders need to do the following:
- Confirm the total value of the portfolio needed (hint: use the green box).
- Evaluate existing innovation projects based on incremental value delivered, risk (recognizing that not all projects will succeed), and alignment with strategic priorities.
- Determine portfolio sufficiency (the degree to which the existing mix of projects could plausibly deliver the green box).
- Get comfortable with saying “no”: stop projects that are dilutive, and resist the siren song of incremental initiatives (perhaps requested by a customer or two) that are unlikely to pay for themselves.
- Reallocate those resources—including competencies and skills—to new initiatives or to current ones that additional support can accelerate or amplify.
- Identify portfolio gaps and define new initiatives to close them.
Such rigor stands in stark contrast to the innovation practices of many organizations. And, obviously, it is never a one-time act, but rather a constant, dynamic process of assessing the initiatives underway, doubling down on those that are succeeding, quickly killing those that are struggling, and assessing the resulting balance. As companies become more adept, they can start measuring innovation performance in more granular ways. For example, a leading medical-technology organization assessed its innovation-performance track record (including average success rates, incremental earnings, and development cost and time to market for core versus breakthrough initiatives). Such exercises made it possible to more accurately model what a rebalanced portfolio could realistically provide, and helped the company identify the most valuable improvements to make in its innovation system. The value at stake can be huge: the medical-technology company learned that every month of reduced time to market was worth about USD 90 million in earnings for its innovation portfolio.
Avoid bad bets
While we have spent much of our time in this article describing ways to expand your innovation ambitions, we’d be the first to acknowledge that many companies would also benefit from exploring the opposite impulse: namely, recognizing how innovation suffers when bad ideas go too far, leading to failed product launches, disappointment, and subsequent retrenchment. To be sure, risk is intrinsic to innovation; you will never eliminate failures altogether. Still, you can reduce the odds of placing bad bets – or, worse, doubling down on them – through better decision-making processes and closer scrutiny of assumptions.
Management teams do far better when they avoid the false comfort of averages, crude benchmarks, or pie-in-the-sky dreams.
This was the case for a global consumer-packaged-goods (CPG) company that was frustrated that its innovation “funnel” had become a “tunnel” where flawed initiatives proceeded to market despite misgivings from both the teams and leaders, and resources were rarely reallocated between initiatives. In response, the company shifted its governance and resource-allocation approach and borrowed leading practices from venture capital. These included “investor boards” empowered with decision rights on what to fund and what to cut, and metered funding that allocated resources in increments based on demonstrated performance. Within six months, the company redirected 30 percent of its initiatives dramatically and killed another 20 percent (including a nationwide launch that company leaders recognized was highly likely to fail). None of this would have happened without the new governance approach, and it is consistent with our experience that at many companies up to half of all innovation initiatives could be stopped or substantially changed.
High failure rates, in our experience, are often correlated with inattention to assumptions, which underlie all innovation initiatives. Companies often confuse assertions with assumptions, stating confidently what “should be true” for an innovation concept (for example, the price premium that customers will pay) instead of acknowledging that it is merely a strong hypothesis that needs to be validated. We therefore encourage management teams to place assumptions at the heart of the initiative review process: identify what must be true for the initiative to succeed, define a learning-driven development plan to test these assumptions, and run sprints to substantiate or invalidate them. When teams are unable to validate early, critical-path milestones, they should stop their projects or pivot them to a path, that can be supported. We call this approach “assumption-based development”, and, have found, that it dramatically improves innovation performance. When management teams understand the number and uncertainty level of core assumptions, they are better able to compare the relative risk of different initiatives, make trade-offs across the portfolio, and clarify for innovation teams the rationale behind tough choices.
The CPG company we described earlier started paying more attention to the critical assumptions that mattered for each project (and stopped paying attention to standard, stage-gate checklists). To support its more strategic approach, the company implemented a simple review tool that explored the following:
- the initiative’s role against the company’s aspirations (for example, “Unlock snacking occasions that create premium pricing opportunities”)
- the critical assumptions that must be true for its success (“Consumers will pay a 10 percent premium for the new format”)
- how the company would test each assumption through iterative sprints (“We will rely on a mock e-commerce test site”)
- the evidence gathered and the resulting implications (“Consumers will not only not pay a premium but also probably cannibalize our existing product for the new format—so here is our proposed pivot . . .”)
It is no accident, that the review tool links the initiative to a top-level aspiration – another example of how aspirations, metrics, and choices go hand in hand at companies with coherent innovation portfolios.
Executives who wish to carry their organizations across the growing divide between innovation leaders and laggards must start with a commitment to making innovation an essential part of the organization’s growth model and future success – not a vague hope, fall-back option, or happy accident. That means embedding innovation in the heart of their objectives, orienting their resources and organizing accordingly, and holding themselves and their teams accountable for results.
A leader in the financial-services and insurance space is currently seeking to transform its innovation effectiveness by following these practices. It aspires to earn USD 1.5 billion annually in net new growth by 2022 (its green box), has translated this target into clear criteria for evaluating and funding innovation initiatives, and has set corresponding objectives for the leaders of each one. The company also has put in place a new operating model for scaling initiatives, including getting them the talent they need and building the necessary interfaces with the core business. All this work has taken place in about nine months. It is still early days, but the signs are promising: for starters, the portfolio of innovation initiatives will generate a profit in year one. Moreover, four new businesses are on track to generate hundreds of millions of dollars in new top-line growth over the next few years, and the company’s management is crystal clear about the assumptions that must be true for these efforts to succeed.
It is possible, in short, to make real progress toward transforming your innovation performance in a relatively short period of time – provided you take the first step: committing your organisation to innovate.
Reviving innovation in Europe
By guest authors Jacques Bughin, Eckart Windhagen, Sven Smit, Jan Mischke, Pal Erik Sjatil, and Bernhard Gürich from McKinsey Global Institute. Jacques Bughin is a director of the McKinsey Global Institute, where Sven Smit is co-chair and a director, and Jan Mischke is a partner. Eckart Windhagen is a senior partner in McKinsey’s Frankfurt office. Pål Erik Sjåtil is the regional managing partner for Europe, based in Paris. Bernhard Gürich is a consultant in the Hamburg office.
Innovation is of fundamental importance for Europe’s economic and social system. These five paths could build on its strengths and help the continent regain its competitive edge.
Europe, a century ago was a global powerhouse of innovation, but it has started to lose its edge: today, despite some notable exceptions, many innovative companies are found elsewhere. Europe is falling behind in growing sectors as well as in areas of innovation such as genomics, quantum computing, and artificial intelligence, where it is being outpaced by the United States and China.
A discussion paper from the McKinsey Global Institute (MGI), suggests five paths that could help the continent regain its competitive edge. The paper, Innovation in Europe: Changing the game to regain a competitive edge , focuses on ways that Europe could seek to build on its strengths rather than trying to play catch-up, given that it is hindered by fragmentation and lack of scale. This article is a condensed version of the original paper, which draws from MGI research as well as from a recent collaboration with the World Economic Forum.
Europe’s innovation challenge
Given Europe’s relatively high wage costs and low reliance on natural resources, innovation remains of fundamental importance for the continent’s economic and social system. European companies still account for one-quarter of total industrial R&D in the world, but over the past ten years US companies have continued to increase their share, reinforcing their leadership position. China and South Korea have also been catching up. Such competition challenges the ability of Europe to sustain its growth model over the long term.
A survey we conducted of large firms shows that innovators who are first to introduce new products and services to the market experience significantly higher revenue growth. Yet the share of European companies that consider themselves true innovators is notably lower than in the United States (Exhibit 1).
The European economy needs a productivity boost from innovation and new frontier technologies to support growth
The European economy has regained momentum recently after years of sluggish growth, but the short- to medium-term outlook remains fragile, and the continent’s productivity growth has declined sharply over the past two decades. Increasingly, Europe’s economic prospects depend on innovation in general, and especially digital and new frontier technologies, including artificial intelligence, Internet of Things, blockchain, high-power computing, and the integration of biology and engineering. These technologies have the potential to deliver the breakthrough in productivity that Europe needs. We calculate that more than one percentage point of productivity growth could result from exploiting digital opportunities alone.
Innovating in products and services that require new and high-demand skills is an important way to reduce the risk of wage and employment pressure resulting from automation.
We estimate that if European companies were to develop and diffuse AI according to the continent’s current assets and relative position in digital technology in the world, Europe could add €2.7 trillion to its economic output by 2030. Closing the gap with the United States in innovating at the digital frontier and in facilitating faster adoption of AI could add €900 billion, bringing the total potential boost to about €3.6 trillion.
Innovation will also be needed to counter frictions and adjustment challenges in the labour market from automation. According to our analysis, 62 million full-time employee equivalents and more than USD 1.9 trillion in wages might be associated with technically automatable activities in the five largest European economies. Innovating in new products and services that require new and high-demand skills is an important way to reduce the risk of wage and employment pressure. We find that firms anticipating innovative models out of AI have the largest propensity to expand their workforce; companies have a relatively large incentive to upgrade skills in order not to miss out on opportunities.
Europe is falling behind in adopting and investing in general and digital innovation
Europe’s start-up scene is thriving: the number of AI start-ups has tripled in the past three years and is now relatively comparable to the figure for the United States on a per GDP basis. Early-stage start-ups are better financed than ever before. Investment in European tech is at a record high, with USD 23 billion invested last year, a five-year increase of 360 % and an increase of 21 % compared to 2017.
Europe invests significantly less than the United States in intangibles like software and databases, intellectual property, and economic competencies like organisational capital and training, which represent major factors for innovation capacity.
When it comes to talent, too, Europe has long been a research powerhouse. Its research community is larger, but also more diffused, than that in the United States or in China. The tech workforce employed by start-ups is growing; it expanded by about 4 % in 2018. The number of European software developers, a key resource for many innovative technologies, has grown at a rate of 4 to 5 % in the past two years, culminating in a total of 5.7 million professionals today, well ahead of the United States, with 4.4 million professional software developers.
Yet in some key innovation areas, Europe is falling behind. Equity finance as a key driver for innovation and digital investment remains underdeveloped, with 90 % of the European Union’s venture capital funding concentrated in only eight member states. This creates a challenge for European companies that seek funding for fast growth. More broadly, Europe invests significantly less than the United States in intangibles like software and databases, intellectual property, and economic competencies like organizational capital and training, which represent major factors for innovation capacity.
Digital adoption has also been slower in Europe than in competing regions. Both digital attacker and incumbent shares of revenue are significantly smaller than in the United States. Consequently, Europe’s gap in digitization remains at about one-third the level in the United States and has not changed much in recent years. European companies are less mature in their state of diffusion of digital technologies and in their use of these technologies for innovation, namely new services, processes, or business models.
One challenge appears to be Europe’s ability to scale start-ups into major companies. For example, it has transformed digital promises into success with “unicorns”—privately held start-ups valued at more than USD 1 billion – at only about half the rate seen in the United States or even Tel Aviv.
The rise of global platforms and ‘superstars’ drives the need to change the rules of the game
With intangible investment eclipsing the tangible kind, the rise of platforms and the ability to scale and to do so quickly seem to matter more for a significant part of the innovation ecosystem. Despite efforts to establish a Single Market, Europe remains fragmented, with many national legislations and systems of regulations and VAT, which are all hard to change, and many mostly domestic companies.
Today’s superstar firms earn 1.6 times more economic profit on average than superstar firms 20 years ago.
“Superstars,” which we define as the top 10 percent of companies with more than USD 1 billion in annual revenue, as measured by economic profit, are gaining importance. Our research finds that today’s superstar firms earn 1.6 times more economic profit on average than superstar firms 20 years ago. They are seven times larger by revenue than median firms, and have returns on investments that are twice as high. In addition to capturing a greater share of income, they exhibit relatively higher levels of digitization, greater input of skilled labour and a higher innovation intensity, more intangible assets, and deeper integration into global flows of trade, finance, and services than their peers.
Yet Europe has started falling back in its share of superstars. Over the past 20 years, Europe’s share of superstars globally dropped by about 50 percent, while it remained constant for the United States and Canada and increased significantly for the Asia–Pacific region (Exhibit 2).
R&D also is becoming increasingly concentrated, and Europe is losing share, particularly in digital sectors. Just 250 companies generate close to two-thirds of global business R&D investment. In this group, while European automotive players dominate, European companies’ R&D spending by software and computer services firms was only about 8 % of the global total, well below 11 % for Chinese companies and far behind the 77 % for US-based companies in 2018 (Exhibit 3).
Furthermore, the trend is negative. Over the past five years, the global share of European companies’ total R&D spending has declined by more than two percentage points, while the share of US companies climbed by more than two percentage points and the share of Chinese companies by six percentage points. The share of European companies among those newly joining the ranks of the 2500 largest R&D investors decreased to about 12 %, only about half the share of Chinese firms and one-third the share of US companies.
Large US and Chinese tech and platform companies, in turn, are gaining importance. US-based tech companies invest more in R&D than their US peers in the S&P 500, with the six largest—Amazon, Apple, Facebook, Google, Microsoft, and Netflix—spending about EUR 43 billion on R&D in 2018, and EUR 31.6 billion on acquisitions in 2017 alone. Google, the most active among them, spent USD 12.6 billion on acquiring more than 300 start-ups between 2013 and 2018. In contrast, Europe was almost inactive in tech R&D, and possesses only half as many unicorns as the United States, and, none of the large internet platform companies.
Naturally, this impact can be felt in Europe: The largest US tech companies are consistently able to offer higher-than-average salaries in Europe, for example 1.5 times the market average in London in 2017.
Five pathways to change the rules of the game
While no silver bullet exists for Europe to address its structural scale disadvantages, we see five ways that play to Europe’s strengths, capitalize on key trends, and change the rules of the game rather than (or in addition to) playing eternal catch-up on the well-known ingredients of innovation (Exhibit 4).
The five themes are by no means exhaustive; we intend them to add a specific perspective to the many ongoing initiatives as well as to a large and growing body of research on how innovation policies need to change in a more digital context. A common feature of the five themes is that they can help Europe scale up, to meet the challenges of more pervasive innovation.
1. Europe can benefit from its industrial scale
The next playing field of innovation will be more oriented to business-to-business (B2B) than business-to-consumer (B2C) enterprises, with many technological applications centered on diffusion across industries and supply chains. While Europe has fewer superstar firms, the continent can build on its industrial prowess; European manufacturers are among the largest global innovators and the continent also has an edge in B2B and digital in other large sectors such as healthcare and the financial industries. Stakeholders in Europe also have a history of collaborating and navigating the complexities of coordination and standard setting, as for example the automotive industry does with issues related to safety and connected driving.
European manufacturers are among the largest global innovators and the continent also has an edge in B2B and digital in large sectors such as healthcare and the financial industries.
Europe could build on its strong industrial companies and this track record of collaboration to foster cooperation across industry boundaries and even among competing companies in the same industrial sectors. Examples set by the European Automotive Telecom Alliance, which includes telecom operators, vendors, car and truck manufacturers, and suppliers, may be only the beginning, as competitors in the automobile industry combine their research efforts and service offerings to achieve more scale in customer and data access. Similar efforts in other sectors could enable medium-size companies as well as small entrepreneurial firms and start-ups to pilot innovation at a large scale within existing industrial supply chains.
Second, Europe could create dedicated, coordinated testing areas—so-called sandboxes—for key technologies. Local geographies could pick technologies and create safe spaces in which businesses can test innovations on a temporary and geographically limited basis. Sandboxes could help innovative firms cope with regulatory obligations in real-life situations and enter a dialogue with regulators. This has been demonstrated, for example, in the United Kingdom, where the Financial Conduct Authority, the country’s financial regulator, established a safe environment for fintech startups to test products and services—including online platforms, biometrics, and distributed ledger technology (blockchain)—before widely launching them on the market. Subsequently, 90 percent of firms that participated progressed to a wider market launch.
More controversially, the European Union could enable the formation of large European players in many sectors. Clearly, efforts to complete the Single Market will be welcome and will help in that regard, notably in sectors like telecommunications and banking that are still relatively fragmented geographically. Europe could also review market access, subsidies, and investment policies globally where foreign players may have an edge. Less clear are relaxations of antitrust policies or even active formation of European champions like Airbus, which may seem like an obvious response but may come with many undesired consequences for competition and competitiveness.
2. Europe can rethink data and user access and standards
Demands to raise standards for data protection and privacy are increasing, as large internet platforms continue to push into more industries and leverage their network scale. Europe is already considered a leading actor on data governance and privacy protection, with the 2018 General Data Privacy Regulation (GDPR) and, most recently, legislation on the free flow of data.
Such initiatives could not only give companies and research institutions access to anonymized data, but also enable citizens to increase control over what data are captured and how they can or cannot be used, when, and by whom.
Europe could aim to enable secure access for innovators to data pools they do not own and create scale around common standards. Among the options could be to open access to government data in certain strategic sectors, for example transportation, where relevant to smart cities and transport, or in healthcare, where tangible benefits such as increased drug effectiveness could result. Implemented in a smart way, such initiatives could not only give companies and research institutions access to anonymized data, but also enable citizens to increase control over what data are captured and how they can or cannot be used, when, and by whom. The Berlin-based privately funded cross-industry platform Verimi could serve as an example for a data alliance: a digital identity provides easy access for users to visit websites and use other services without the need to enter personal data every time. Instead, they can decide which data they share with whom and manage it transparently. Government-driven examples exist as well, for example in Belgium, Estonia, Finland, and Spain.
More radical options could include standardized interfaces and potential regulations to access private firm-held data, changing the way ownership and location of data are treated. This could help smaller companies use data for the creation of innovative services and thus benefit citizens. At the same time, it could also have severe consequences, including reduced transparency about the kind of data that are used and combined. Such a move would require further testing and experimentation.
Finally, Europe should continue to promote open technology standards, building on a legacy of successful standard setting, for example in GSM.
3. Europe can use its public-sector procurement scale to propel innovation
Europe’s procurement spending on public services and products amounts to 14 % of its GDP annually, equal to about EUR 2 trillion. If leveraged well, smart intervention, coupled with large budgets turned toward innovation, could have significant impact.
To that end, Europe could scale up digital government, as Estonia has done with e-Estonia, and drive European onvergence on standards and open interfaces. This would require a mind-set shift away from national steering and toward a coordinated European and open innovation–focused approach. In some ways, transformation of European governments has already begun: Five of the ten leading countries in e-government are from Europe, according to the United Nations. Examples already under way that could provide some of the technical basis needed for digital innovation in cross-border services include the European electronic Identification, Authentication and Trust Services (eIDAS) initiative, which aims to enable secure transactions between citizens, government agencies, and businesses. In the Netherlands, it has already triggered a large-scale cross-border digital ID project, connecting 200 public services in about 100 municipalities that can be accessed with nationally issued e-IDs from 32 countries. As a result, private businesses are beginning to offer digital IDs to simplify log-in and transactions for customers.
Second, European public procurement spending could create significant scale of innovation demand if coupled with innovation components, for example in sectors such as healthcare, education, and public works. In some instances, this is already happening: Many governments are starting to mandate use of Building Information Modelling for public construction projects.
Third, enhancing public investment in research, innovation, and other intangible assets could help bridge Europe’s current investment gap compared to other economies. This may require rethinking the funding of breakthrough innovation. In addition to paving the way for institutional investors, such as pension funds, the option of creating a publicly financed European innovation scale-up fund to provide financing at scale for key competitive sectors could be explored, with the aim of eliminating the 2018 overall research gap of about EUR 75 billion with the United States.
4. Europe can compensate for its fragmentation with openness and connectedness
Demographic change and a lack of high-skill labour have created a situation in which European businesses struggle to find people with the skills they need. High-skill labour may be a particular challenge. Just over one in four (25.4 %) immigrants coming to the European Union has a high-level education, compared to 35.6 % of the immigrants to other Organisation for Economic Co-operation and Development (OECD) countries.
The “triple helix model” asserts that innovation can be amplified if intermediaries connect and organize universities, industries, and governments to achieve a common goal.
Europe has a history of collaboration across borders, including in EU framework research. Moreover, almost half of the workforce in tech hubs like Berlin and London has come from abroad, and European start-up founders reporting on employee candidates’ willingness to relocate to a new country indicate that Europe is gaining in attractiveness. Location decisions are often driven by factors such as wages and public spending, but also by visa requirements, overall quality of life, and political factors, where Europe holds a competitive edge.
Europe could try to further strengthen collaborative and open innovation. Approaches include networks like Innovate UK, cluster formation like Cap Digital in France, and collaborative research and innovation centres like the EU Science Hub. To further connect different clusters and leverage the strengths of networking, the European Strategic Cluster Partnerships (ESCP) recommends leveraging a “triple helix model” of innovation. This model asserts that innovation can be amplified if intermediaries connect and organize universities, industries, and governments to achieve a common goal. Facilitating the connections among these three stakeholders can open innovation within Europe. An example is TasLabin Trento, Northern Italy, where the local and regional government developed a cooperation cluster strategy with the goal of creating advanced innovation infrastructure. They also created four large-scale open data projects, opened e-government portals, and invested in infrastructure for businesses and citizens (primarily information and communications technology). The TasLab cluster has attracted more than 800 world-class researchers and leading businesses such as IBM, Nokia, and Siemens.
In regard to talent, specifically, Europe could try to leverage its strengths, as well as the geopolitical climate currently geared toward preventing immigration to change flows of high-skill migrants in its favour. This could include encouraging the return of Europeans who work abroad.
International talent could be attracted by creating better pathways for high-skill professionals. For example, opportunities in Europe could be better promoted by leveraging social media. EURES, the European portal for job mobility, already runs a website that lists job vacancies and is active on social media platforms. It could be expanded to target non-European citizens.
Third, the EU could address compensation practices for startups by changing taxation on stock options. Currently, startup employees in the United States have twice as much upside exposure as their European peers. Europe could enable workers to participate more fully in the success of their companies by simplifying the rules and taxation framework for stock option remuneration through a common framework, thereby improving the risk-reward profile for start-up employees. Start-ups in countries such as Germany and Spain report that current taxation schemes make it difficult to set up stock option schemes.
5. Europe can leverage the scale of global firms to its benefit
Regardless of whether Europe succeeds in changing the terms in its favour in a scale-matters world, it could ensure that it derives as much value and benefits from large non-European firms as possible.
One of Europe’s priorities could be to ensure not only that its citizens continue to enjoy the benefits of services delivered by non-European companies, but that these companies also create more Europe-based employment, innovation, customer value, and tax income.
To this end, Europe could engage in identifying key challenges that keep companies from shifting more value creation to Europe and respond with corresponding measures or incentive programs. Benefits would need to be carefully weighed against risks, beginning with potential loss of intellectual property.
Europe possesses many ingredients for successful innovation and adoption of innovation. In a superstar world in which it lacks scale, it needs to find its own innovation model and play to its strengths rather than trying to catch up with the strengths of others. Industry ecosystems, public-sector digitization and demand, data access and governance, talent migration, and attraction of foreign activity could all be parts of a solution. We encourage critical feedback and reactions as well as further research on how Europe can restore its lustre as an entrepreneurial and innovative leader.
Download Innovation in Europe: Changing the game to regain a competitive edge, the discussion paper on which this article is based (PDF—395KB).
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