What is innovation?

August 17, 2022 | Article

Article (6 pages)

If products alone aren’t the full story, what is innovation? In a business context, innovation is
the ability to conceive, develop, deliver, and scale new products, services, processes, and
business models for customers.

MOST POPULAR INSIGHTS

1. McKinsey Global Private Markets Review 2023: Private markets turn down the volume
2. Actions the best CEOs are taking in 2023
3. Global Economics Intelligence executive summary, February 2023
4. The times for multiples: Why value creation always comes first
5. Stepping up: Becoming a high-potential CEO candidate

Successful innovation delivers net new growth that is substantial. As McKinsey senior
partner Laura Furstenthal notes in an episode of the Inside the Strategy Room podcast,
“However you measure it, innovation has to increase value and drive growth.”

As important as innovation is, getting it right can be challenging. Over 80 percent of executives

surveyed say that innovation is among their top three priorities, yet less than 10 percent report
being satisfied with their organizations’ innovation performance. Many established companies
are better operators than innovators, producing few new and creative game changers. Most
succeed by optimizing existing core businesses.

Why is innovation important in business?

Some companies do succeed at innovation. Our research considered how proficient 183
companies were at innovation, and compared that assessment against a proprietary database
of economic profit (the total profit minus the cost of capital). We found that companies that
harness the essentials of innovation see a substantial performance edge that separates them
from others—with evidence that mastering innovation can generate economic profit that is 2.4
times higher than that of other players.

Learn more about our Strategy & Corporate Finance practice.

How can leaders decide what innovations to prioritize?

Successful innovation has historically occurred at the intersection of several elements, which
can guide prioritization efforts. The three most important elements are the who, the what, and
the how:
 1. An unmet customer need (the ‘who’): Who is the customer and what problem do they
need to solve? Are macrotrends such as automation driving changes in customer needs?
2. A solution (the ‘what’): Is the solution compelling and can it be executed?
3. A business model that allows for the solution to be monetized (the ‘how’): How will the
solution create value? What is the business model?

Successful innovation requires answers to each of these questions.

An example from inventor and businessman Thomas Edison helps illustrate the concept. “In
every case, he did not just invent the what, he also invented a how,” says Furstenthal in a
conversation on innovation. “In the case of the light bulb, he created the filament and the
vacuum tube that allowed it to turn on and off, and he developed the production process that
enabled mass production.”

How do organizations become better innovators?

McKinsey conducted research into the attributes and behaviors behind superior innovation
performance, which were validated in action at hundreds of companies. This research
yielded eight critical elements for organizations to master:

1. Aspire: Do you regard innovation-led growth as critical, and have you put in place
cascaded targets that reflect this?
2. Choose: Do you invest in a coherent, time- and risk-balanced portfolio of initiatives, and
do you devote sufficient resources to it?
3. Discover: Are your business, market, and technology R&D efforts actionable and capable
of being translated into winning value propositions?
4. Evolve: Do you create new business models that provide defensible, robust, and scalable
profit sources?
5. Accelerate: Do you develop and launch innovations quickly and effectively?
6. Scale: Do you launch innovations at the right scale in the relevant markets and
segments?
7. Extend: Do you create and capitalize on external networks?
8. Mobilize: Are your people motivated, rewarded, and organized to innovate repeatedly?

Of these eight essentials, two merit particular attention: aspire and choose. Without these two

elements, efforts may be too scattershot to make a lasting difference. It’s particularly crucial to
ensure that leaders are setting bold aspirations and making tough choices when it comes to
resource allocation and portfolio moves. To do so successfully, many leaders will need to shift
their mindsets or management approaches.

Learn more about our Strategy & Corporate Finance practice.

What are examples of successful innovators?
Real-world examples of successful innovation, related to some of the eight essentials listed, can
highlight the benefits of pursuing innovation systematically:

 Mercedes-Benz Group invested extensively in digitizing its product development system.

That allowed the company to shorten its innovation cycles significantly, and its
capabilities for personalizing cars have improved, even as assembly efficiency rose by 25
percent.
 Gavi, a public–private partnership founded to save children’s lives and protect their
health by broadening access to immunization, used nonfinancial targets to help drive its
innovation efforts—and this helped the organization broaden its aspiration for impact in
a way that was bold, specific, measurable, and time bound.
 Lantmännen, a large Nordic agricultural cooperative, faced flat organic growth.
Leadership created a vision and strategic plan connected to financial targets cascaded
down to business units and product groups. Doing so allowed the organization to move
from 4 percent annual growth to 13 percent, on the back of successfully launching
several new brands.
 The information services organization RELX Group brought discipline to choosing its
innovation portfolio by running ten to 15 experiments in each customer segment in its
pipeline every year. It selects one or two of the most successful ideas from the portfolio
to continue.
 International insurance company Discovery Group mobilized the organization around
innovation by creating incentives for a thousand of the company’s leaders using
semiannual divisional scorecards. Innovation isn’t a choice; it’s a requirement and a part
of the organization’s culture.

These examples aren’t necessarily what you may think of when you imagine disruptive
innovation—which calls to mind moves that shake up an entire industry, and might be more
associated with top tech trends such as the Bio Revolution. Yet these examples show how
committing to innovation can make a sizable difference.

How can my organization improve the volume and quality of

new ideas?
Steps to help aspiring innovators get started include the following:

 Hold collision sessions: Cross-functional groups gather in a structured process to think

through the intersection of unmet customer needs, technology trends, and business
models, bringing creativity and specificity to the process of idea generation. Then, a
venture panel considers these ideas and iterates on them, prioritizing what to do.
  Challenge orthodoxies: Participants gather and describe beliefs that are common but
that prevent the organization from innovating for customers. Examples of these
orthodoxies include statements such as “budgets are limited” or “we don’t have the
digital capabilities to pull it off.” Once the orthodoxies are laid out, teams brainstorm
after being prompted to consider if the opposite of the statement were true.
 Make analogies to other industries: A team might create a list of companies with unique
value propositions. Then, they systematically apply these value propositions to their
ideas to see if the analogy can create new sources of value or fresh opportunities.
 Apply constraints: Rather than searching for blue-sky ideas, tighten the constraints on
an idea’s business or operating model and explore potential new solutions. What if you
served only one type of customer? What if the only channel you could access was
online?

In the words of chemist Linus Pauling, “The way to get to good ideas is to get lots of ideas and
throw the bad ones away.”

Learn more about our Strategy & Corporate Finance practice.

What is an innovation portfolio?

An innovation portfolio is a thoughtfully curated bundle of potentially innovative initiatives,
with clear aspirations and required resources defined for each. Managing the portfolio this way
helps find new opportunities and determine the appropriate number and mix of initiatives,
including the following:

1. confirming the total value of the portfolio needed

2. evaluating existing innovation projects based on incremental value delivered, risk, and
alignment with strategic priorities
3. getting comfortable saying “no” to stop projects that are dilutive, and resisting the siren
song of incremental initiatives that are unlikely to pay for themselves
4. reallocating resources—including competencies and skills—to new initiatives or to
current ones that additional support can accelerate or amplify
5. identifying portfolio gaps and defining new initiatives to close them

How to measure innovation?

One way to measure innovation is to look at innovation-driven net new growth, which we call
the “green box.” This phrase refers to how you quantify the growth in revenue or earnings that
an innovation needs to provide within a defined timeframe. This concept can help clarify
aspirations and influence choices on the innovation journey.

While many imagine that innovation is solely about creativity and generating ideas, at its core,
innovation is a matter of resource allocation. To put it another way: it’s one thing to frame
innovation as a catalyst for growth, and another to act upon it by refocusing people, assets, and
management attention on the organization’s best ideas.

The green box can help to solidify a tangible commitment by defining the value that a company
creates from breakthrough and incremental innovation, on a defined timeline (say, five years),
with quantifiable metrics such as net new revenue or earnings growth. Crucially, the green box
looks at growth from innovation alone, setting aside other possible sources such as market
momentum, M&A, and so forth. And once defined, the growth aspiration can be cascaded into
a set of objectives and metrics that the company’s various operating units can incorporate into
its individual innovation portfolios.

It’s useful to note that some organizations may find that measures not solely financial in nature
are more appropriate or relevant. For instance, metrics such as the number of subscribers or
patients—or customer satisfaction—can resonate. What’s critical is selecting a metric that is a
proxy for value creation. A large US healthcare payer, for example, looked to spur innovation
that would improve patient satisfaction and the quality of care.

Separate from the concept of the green box, two simple metrics can also offer surprising insight
about innovation vis-à-vis the effectiveness of an organization’s R&D spending. Both of these
lend themselves to benchmarking, since they can be gauged from the outside in, and they offer
insight at the level of a company’s full innovation portfolio. The two R&D conversion metrics are
as follows:

 R&D-to-product conversion: This metric is calculated by looking at the ratio of R&D

spending (as a portion of sales) to sales from new products. It can show how well your
R&D dollars convert to actual sales of new products—and it might reveal that spending
more doesn’t necessarily translate into stronger performance.
 New-products-to-margin conversion: This metric considers the ratio of gross margin
percentage to sales from new products. It can indicate how new-product sales
contribute to lifting margins.

While no metric is perfect, these may offer perspective that keeps the focus squarely on returns
from innovation and the value it creates—often more meaningful than looking inward at
measures of activity, such as the number of patents secured.

Learn more about our Strategy & Corporate Finance practice.

How do you create a high-performing innovation team?

Innovation is a team sport. Experience working with strong innovators and start-ups has helped
identify ten traits of successful innovation teams. Those fall into four big categories: vision, or
the ability to spot opportunities and inspire others to go after them; collaboration, which
relates to fostering effective teamwork and change management (for instance, by telling a good
innovation story); learning or absorbing new ideas; and execution, with traits that facilitate
snappy decision making even when uncertainty arises.

Being strategic about the composition of an innovation team can help minimize failures and
bring discipline to the process.

What innovation advice can help business leaders?

One broad piece of advice centers on creating a culture that accounts for the human side of
innovation. When people worry about failure, criticism, or the career impact of a wrong move,
it can keep them from embracing innovation. In a recent poll, 85 percent of executives say fear
holds back their organization’s innovation efforts often or always—but there are ways
to overcome these barriers.

Additionally, the Committed Innovator podcast and related articles share perspectives from

leading experts who have helped their organizations tackle inertia and unlock bold strategic
moves. If you are looking for words of wisdom, their insights can help spark inspiration to
innovate:

 Naomi Kelman, CEO, Willow. “Creating a safe environment for innovation is really what
you need to do to get the greatness out of the people who work with you, which is
ultimately what drives growth.”
 Safi Bahcall, author, Loonshots. “Most of the important breakthroughs failed many
times before they succeeded. That is where ‘fail fast’ goes wrong. Most companies are
too impatient.”
 Amy Brooks, chief innovation officer, National Basketball Association . “You can use data
or examples to convince people about what is working in the market or what other
industries are doing. We like to share best practices within our own leagues and within
sports, but we also pay attention to every other industry that sells to consumers.”
 Tanya Baker, global leader, Goldman Sachs Accelerate . “If someone knowledgeable
thinks what you are doing is a bad idea, make sure they have a seat at the table. Put
them on your board; make them one of your advisers so you don’t have any blind
spots.”
 Neal Gutterson, former chief technology officer, Corteva. “[A] key skill is being able to
hold two divergent thoughts and approaches in your brain and in your team at the same
time. The great companies will be ambidextrous innovators, able to disrupt themselves
in the future while serving the core [business] today.”
 Anjali Sud, CEO, Vimeo. “What keeps me up at night is execution and, within that, focus.
Because when you are in a market like ours, at a time like now, the opportunity is huge.
We are this nimble, fast-growing, fast-moving company, and everywhere I look I see
opportunity. But am I providing enough focus for my teams so that we can truly be great
at something? You don’t want to miss a big boat, and it’s hard sometimes to say no to
valid, exciting ideas that could be transformative.”
For more in-depth exploration of these topics, see McKinsey’s insights on Strategy & Corporate
Finance. Learn more about McKinsey’s Growth & Innovation work—and check out innovation-
related job opportunities if you’re interested in working at McKinsey.

Articles referenced include:

 “Fear factor: Overcoming human barriers to innovation,” June 3, 2022, Laura

Furstenthal, Alex Morris, and Erik Roth
 “Innovation—the launchpad out of crisis,” September 15, 2021, Laura
Furstenthal and Erik Roth
 “The innovation commitment,” October 24, 2019, Daniel Cohen, Brian Quinn, and Erik
Roth
 “Fielding high-performing innovation teams,” January 17, 2019, Matt Banholzer, Fabian
Metzeler, and Erik Roth
 “Taking the measure of innovation,” April 20, 2018, Guttorm Aase, Erik Roth, and Sri
Swaminathan
 “The eight essentials of innovation,” April 1, 2015, Marc de Jong, Nathan Marston,