Who bears the risk of innovation failure?

Innovation is all about novelty, about charting new territory and sailing unknown waters. This implies that the outcome of any innovative endeavour is by no means certain, let alone predetermined. On the contrary, innovation clearly entails risk, and in fact two different types of risk: one is for the innovator, the other for the society he’s working in. With only mild exaggeration, you might consider the first the risk of innovation failure, whereas the other is the risk of innovation success.

I’ve been inspired by two articles I came across in November, each of them tackling one of the innovations risks, with a historic perspective of how things have evolved and an outlook on how the current trends might play out in the future. I’ll leave the risk of success to a future post and focus today’s post on the risk of failure.

On 12 November, the New York Times Magazine, in its Innovation Issue, published Adam Davidson’s article “Welcome to the Failure Age“. While the title might be a little misleading, Davidson offers a rich essay on the risk of innovation failure, how it has been handled in historic time, how things changed from the Industrial Revolution to the early 20th century, and where the journey might take us in the future.

The relentless innovation pace is part of our daily experience: just consider the half-life of the latest smart phone generation. As Davidson expresses it:

The life span of an innovation has never been shorter.

But how did we arrive where we are? How did an essentially risk-averse society actually embrace innovation as something useful, even desirable? How did the perspective of the individual innovator change over time?

In historic times, any creative mind with a novel idea essentially needed to be economically independent in order to make his living (and that of his family) in parallel to working on that innovation: developing it, maturing it, testing it, and implementing it. There was no way to obtain financial support (other than rare cases of patronage), and there was no social security system in case the idea drove the innovator into bankruptcy. Hence if the idea was not to work out, then the innovator and his family were likely to loose their livelihood. Therefore, resistance to change was the logical survival strategy – the risk of failure was solely borne by the innovator (and his dependents), and that price was too high to pay. Consequently, very few things changed over very long periods of historic time.

With the advent of the Industrial Revolution – or largely coinciding with it – several important aspects of that risk equation changed significantly. One was the Revolution of Rights, which redefined the concept of ownership, offered new means to access capital, and in general created the inclusive institutions that allowed for a broader participation in political decision making and economic activity. Society at large became more open to change, and better able to adopt innovation. Almost at the same time, the Scientific Revolution encouraged curiosity and investigation, of questioning conventions and trying new ways, and doing so ever more systematically. Last but not least, the Industrial Revolution itself launched a cascade of inventions around energy production, manufacturing, and transportation. During this truly revolutionary period, the risk of innovation failure was still considerable, and it was still mainly borne by the innovator. Nevertheless, the Scientific and the Industrial Revolution generated lots of new opportunities, while the Revolution of Rights created new incentives to pursue these opportunities. Slowly but surely it became increasingly acceptable to take the innovation risk. This coincidence of three revolutions launched an avalanche of innovations that ultimately touched every aspect of human life.

By the beginning of the 20th century, society had developed an effective risk-mitigation tool to protect the innovator from the formerly existential risk of failure: the corporation. What we tend to see quite simply as a means to organise business is in fact far more; under the hood, the corporation is – somewhat paradoxical – an engine of centralisation and of sharing. The corporation aggregates and pools the resources of its shareholders, i.e., capital, and its employees, i.e., skills. Combined through stringent management, the corporation ensures appropriate task sharing. The innovator has become an employee of the corporation, receiving his task and income from it. And unlike his historic predecessors, the employee innovator enjoys the protection against the risk of innovation failure. At the same time, the shareholder concept spreads the ownership as much as the risk across numerous actors. Of course the return on investment is shared in the same way. In essence you might say that the corporation channels investment and shields the innovator from the risk of failure. These defining characteristics of what the corporation achieves set into motion much of the societal changes and economic growth we have seen in the 20th and into the beginning of the 21st century.

Of course, this aggregation of resources and the centralised control over them present a significant accumulation of power. The corporation has successfully employed that power to promote economic growth through innovation, but without challenging the existance of the corporation itself. Truly transformative, or in Clayton Christensen’s terminology, disruptive innovation is not in the self-interest of the corporation.

For the future, Davidson argues that the centralisation brought about by the corporation, and defended by the corporation, is going to loosen – and ultimately lose – its tight grip over innovation. There are strong signals for a trend towards decentralisation: think about social networks, think about citizen science, think about Massive Open Online Courses, think about Kickstarter, to name just a few examples. New technologies allow for orchestrating the activities of large numbers of individuals (that’s what corporation do) without a strong, formal, hierarchical, centralised organisation (that’s what corporations are). So we’ll be able to do what corporations do without the need to have corporations the way we have known them so far. It would be a disruptive change to shake the very foundation of the corporation. But it has the potential to set free an as yet untapped innovation potential.

A fascinating perspective with many facets that deserve further exploration. I’ll make sure to get back to this idea in a future post …