Innovation and IPO

Of all business processes, innovation is arguably the riskiest and most unpredictable; the rate of failure of innovation projects is shockingly high compared to other corporate programs and initiatives. Identifying factors that would make innovation more sustainable is therefore critical.

Business ownership is not a factor that comes to mind first when speaking about innovation. Yet available data suggest that it may play important role in the firm’s ability to innovate.

For example, although family-owned firms have smaller R&D budget than other firms of similar size (either public or private), they are more innovative as judged by the number of patents, new products, and revenues generated with new products.

Why? Because of family owners, who, due to their long relationship with the firm, have a deep knowledge of the industry, the firm, and its stakeholders. They spend considerable time with the organization and communicate frequently with employees, clients, and other stakeholders. Moreover, their close relationships with suppliers, customers, and other partners help family-owned firms develop more creative ideas, products, and processes.

Does that mean that the public ownership of a firm impedes its ability to innovate? Or, more specifically, does that mean that a firm going for IPO may jeopardize its innovation output? A research conducted by Shai Bernstein of Stanford shows that the answer to this question is (somewhat surprisingly) “yes.”

Bernstein compared firms going public with firms that were about to go public but held back because of market volatility (firms that filed the IPO registration with the Securities and Exchange Commission but later withdrew it for reasons unrelated to their innovation strategy and remained private). Innovation output was measured by using the number of patents granted to a firm and the number of future citations received by each patent. The former number captures the quantity of the firm innovation and the latter its quality.

The results of this comparison were striking: going public means a 40% decline in patent quality in the five years immediately following listing. Moreover, Bernstein found that following the IPO, the firms’ innovation becomes more incremental.

What happens? It turns out that the IPO event leads to an increased likelihood (18%, to be exact) of employees cashing out their stock and moving to new start-ups. This might not be a bad thing for the whole economy because innovation is still occurring, just at a different firm, but it’s definitely harmful to the newly-listed firm because employees who leave are likely to be exactly those who were responsible for the key innovation at the firm in the IPO pre-period.

An additional factor impeding innovation in the post-IPO firms is the stock market pressure which may dissuade managers from taking much risk and force them to pursue more incremental innovation.

Of course, concerns for the future innovation outcomes should not prevent firms going public. Yet they must be aware of its protentional consequences and adjust their innovation strategy and operations accordingly. For example, they may encourage future innovations by adopting optimal employee incentives that would include a combination of tolerance for failures in the short term and reward for success in the long term.

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The dose is everything: how much labor protection is good for innovation

theoretical concept proposed by Gustavo Manso in 2011 (I wrote about it here) postulates that the optimal combination of incentives that motivate employees to innovate must include tolerance for failure in the short term and reward for success in the long term.

This concept is supported by academic studies showing that corporate innovation is fostered by labor laws that limit firms’ ability to discharge employees at will. These studies provide empirical evidence to the idea that the best way to encourage risk-taking andexperimentation is not “celebrating failures,” but removing the proverbial Sword of Damocles of punishment for them, something that every organization can do by modifying its termination policies.

Do the above data mean that there is a proportional relationship between employee protection and firm innovation–the more, the better, so to speak? No, it appears that this relationship is rather “inverted-U-shaped.” That means that when the level of protection is too small, increasing it through the adoption of wrongful discharge laws (WDL) provides job insurance against failure risks, which spurs innovation. On the other hand, providing too much protection—forced, for example, by the trade unions–seem to stifle innovation instead.

The role that unions play in corporate innovation has been a topic of a considerable debate. It does appear that when worker’s jobs are protected with union membership, the workers feel more motivated to innovate. Besides, some data suggest that the declining numbers of people in unions contribute to income inequality, which in turn negatively affects innovation. These findings indicate that unionization may have some positive effect on corporate innovation.

However, empirical data contradict this hypothesis. In 2015, Daniel Bradley and co-authors published a paper where they analyzed how creating a union affects firms’ patent activity. The authors show that within three years following unionization, firms experienced an 8.7% decline in the number of patents and 12.5% decline in their quality. Among the factors leading to diminished innovation were a reduction in R&D expenditures caused by higher wages lobbied for by unions (a phenomenon described by other authors, too), reduced workers’ productivity, and departure of innovative employees.

The negative effect of unionization is evident in both manufacturing (where most unions form) and non-manufacturing industries but is statistically insignificant in firms located in states where unions have less bargaining power.

As they say, “the dose makes the poison.” It appears that this basic principle of toxicology is perfectly applicable to the effects of labor laws on innovation, too.

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The “labor law” of innovation

One might assume that pro-worker labor laws, due to their association with lower levels of investment, productivity and output, would have a negative effect on innovation. In fact, academic studies indicate that more stringent employment laws help firms and their employees pursue value-enhancing innovative activities.

The credit for pointing to a positive role labor laws play in the innovation process belongs to Viral Acharya of New York University Stern School of Business. In a 2010 paper, “Labor Laws and Innovation,” Acharya and co-authors explore how the legal framework governing the relationship between employees and their employers affect innovation output. The innovation output was measured by using the number of patents granted to a firm and the number of future citations received by each patent. The former number captures the quantity of the firm innovation and the latter its quality.

Acharya et al. first analyze the innovation output in five countries—the U.S., U.K., France, Germany, and India–which accounted for 72% of all patents filed with the USPTO between 1970 and 2006. This cross-country comparison shows that stronger labor laws positively correlate with a country’s innovation output. Interestingly, this effect is more pronounced in innovation-intensive industries, such as medical devices, than in more “traditional” industries, such as textile. Equally importantly, Acharya et al. find that the only dimension of labor laws that has a tangible impact on innovation is the “regulation of dismissal” component.

The authors further analyze the consequences of the WARN Act (Worker Adjustment and Retraining Notification Act), a federal law enacted by the U.S. Congress in 1988. The WARN Act requires most private employers with 100 or more employees to give a written notice to affected workers and local government 60 days before the date of a mass layoff or a plant closing. Employers who violate the WARN Act are liable for damages in the form of back pay and benefits to affected employees. The requirement of the Act increases the hurdles faced by employers when dismissing employees—and as such, have the same effect as dismissal laws. Acharya et al. show that the strengthening of dismissal laws via WARN had a positive impact on U.S. firm-level innovation: firms affected by WARN experienced increases in patents and patent citations by 43% and 71%, respectively, over the next five years when compared to firms that were not affected by WARN.

In a follow-up paper, “Wrongful Discharge Laws and Innovation,” published in 2014, Acharya and co-authors study the impact on innovation of the U.S. wrongful discharge laws (WDL). These laws provide employees with greater protection than employment-at-will, where employees can be terminated with or without just cause. The staggered passage of WDL across the U.S. states created a “natural experiment” assessing their impact on the innovation output. And this impact turns out to be quite impressive: the adoption of WDL results in a rise in the annual number of patents and patent citations by 12.2% and 18.8%, respectively, the effect starting to emerge two years after the WDL passage.

Moreover, the effect of WDL is evident not only at the firm but also at per employee level as evidenced by the increase of patents and patent citations by 12.3% and 19.0%, respectively, in states that adopted the laws vis-à-vis states that didn’t. As in the previous work, the positive impact on innovation is significant only in highly innovation-intensive industries.

Taken together, the data presented in both studies indicate that innovation is fostered by laws that limit firms’ ability to discharge their employees at will. Acharya and co-authors call this phenomenon an “insurance effect”: feeling increased protection from negative consequences of failure, employees are more committed to engaging in risky innovative projects.

These findings are fully consistent with a theoretical concept proposed, in 2011, by  Gustavo Manso (I wrote about it in my previous post) postulating that the optimal incentives motivating employees to innovate must include a combination of tolerance for failures in the short term and reward for success in the long term.

They also strongly suggest that the best way to encourage risk-taking and experimentation is not to “celebrate failures,” but to remove the proverbial Sword of Damocles of punishment for them, something that any organization can easily do by modifying its termination policies.

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Innovation and failure: from words to deeds

The idea that innovation involves experimentation—and experimentation often results in failures–has gradually crawled to the forefront of our thinking about the innovation process. It became fashionable to quote Amazon’s Jeff Bezos as saying that high tolerance for risk and failure accounts for his company’s spectacular performance.

What troubles me in our newly-acquired passion for innovation failures is the deafening silence on the issue of how this positive attitude towards failure is to be promoted within organizations. We don’t send firefighters to extinguish fires without providing them with protective gear. We don’t send cops on the street without giving them tools of defense against dangerous criminals. Why then do we ask our employees to put their careers at risk by taking part in failure-prone innovation projects without assuring them that they won’t be punished should these projects fail?

I believe that instead of endless (and largely hollow) talks about “promoting risk-taking” and “celebrating failures,” we must design specific policies that would make it safe–or, better yet, attractive–for employees to engage in corporate innovation activities.

Academic research provides enough guidance with respect to what these policies should be. Theoretical analysis conducted by Gustavo Manso in 2011 showed that that the optimal incentives motivating employees to innovate must include a combination of tolerance for failures in the short term and reward for success in the long term. Tolerance for early failures allows the employees to take risks at the initial stages of the innovation process without incurring the negative consequences of failed projects. The reward for long-term success encourages the employees to explore risky ideas that may allow them to achieve innovation breakthroughs in more distant future.

Subsequent empirical studies have confirmed Manso’s theoretical reasonings. For example, Viral Acharya and co-authors analyzed the impact of the so-called wrongful discharge laws on corporate innovation. These laws provide employees with greater protection than employment-at-will when employees can be terminated with or without just cause. The authors have shown that the wrongful discharge laws, particularly those that protect employees from termination in bad faith, foster innovation by increasing the employees’ motivation and effort.

On the reward side, a recent work by Xin Chang and co-workers has provided evidence that companies offering stock options to non-executive employees are more innovative. The positive effect of stock option grants on innovation is more pronounced when options are granted to a wide range of employees and when the average expiration period of options is longer. Very importantly, the analysis reveals that the employees involved in innovation activities treat stock options as an incentive to risk-taking rather than an award for superior performance.

The above findings suggest that the firms should change they way they treat employees engaged in strategic innovation activities. Here, I want to offer two specific recommendations:

  1. To place employees involved in strategic innovation projects on fixed-term employment contracts (as opposed to employment-at-will). Alternatively, tenure-like positions may be created for the same employees. Whatever the arrangement, employees should be assured that they have a fixed “window of opportunities”—say, five-six years—to make progress in their projects before any administrative decisions regarding their employment will be considered.
  2. To make stock option grants the principal incentive for engagement in innovation projects–as opposed to cash bonuses and multiple non-monetary recognition and rewards.

I fully realize that the proposed recommendations will require firm-specific adjustments. But both are perfectly testable. Large firms may try an A/B test of sorts by implementing these specific policies in some divisions but not others and later comparing the innovation outcome in both groups.

The bottom line is that we must finally move from words to deeds when dealing with innovation failures. Providing people with immunity from failures is much better than “celebrating” them.

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How to Cultivate Innovation in the Workplace

Innovation is what most businesses aim for no matter what industry. In fact, a lot of today’s most successful businesses were founded on innovation. Look at Apple and Microsoft; both companies started from ideas that seemed impossible at the time they were established. However, the inventors stayed faithful to their unique concepts and persevered, leading to two technology giants that define the tech industry. reported that back in 2009, 22% of manufacturing companies had one of more product innovations according to the National Science Foundation. The same percentage was also found among businesses that experienced process revolution from 2006 – 2008. Their data shows that innovation continues to be a driving force among industries. Today, a lot of companies seek to create a culture encouraging creativity, which will allow people to come up with new ideas and develop them for the benefit of the business.

Hire Like-Minded Individuals

One of the most important things to have in a company is synergy, especially if you’re looking to assemble people with strong ideas. Forbes magazine suggests hiring like-minded individuals to foster innovation. It’s important that you and your co-workers have the same vision moving forward. However, they stress that this doesn’t necessarily mean you’re only hiring people who simply just agree with you. It’s healthy for a company to sometimes have opposing views, as long as they all have aspirations to attain the same end goal.

Promote Diversity

Hire people from different backgrounds, passions, and capabilities in your company. By having a diverse workforce it provides the company with a number of different perspectives. These will lead to a variety of ideas and different approaches to problem-solving. Employees can even brainstorm with each other to come up with a better concept or a more-rounded solution.

Celebrate Ideas

People are oftentimes scared to share their new ideas because of social ridicule or even possible retribution. Over time, this social norm has blocked multiple breakthroughs from coming to fruition. Inc magazine advises companies to celebrate ideas to encourage creativity among employees. You can do so different ways, from salary raises, bonus checks, or simply verbal praises.

Focus On the Big Picture

Despite your day-to-day tasks, you have to remember that your new idea is what will get you and the company ahead. Business Insider stressed the importance of the bigger picture when it comes to innovation in the workplace. Leaders have to steer their team to focus on accomplishing the end goal. They also explained that a company should not be complacent once they’ve achieved something. Businesses should never underestimate their competitors because brilliant concepts can come from anyone and anywhere.

Attend Business Conferences

BFS Capital suggests attending some conferences and seminars this year. Startup companies can benefit greatly from going to these events by gathering tips on how to ascend the business ladder. Some might even find inspiration to come up with fresh ideas that can push their companies to greater heights. One of their recommendations is the Small Business Expo, held in over 18 different cities across the US. Ranked # 1 in small business conferences by Intuit, people get to network, learn from various workshops, and build professional relationships here.

Even though it’s difficult to be original nowadays, people are still pushing themselves to create something new or revolutionize a concept. To help them, businesses have to provide the right environment and culture where innovators will be inspired to work on their ideas. They will soon see that such an undertaking will have greater benefits in the long run.

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Don’t “fiddle” with the crowd — ask it better questions instead

(This post originally appeared on

As the examples of successful use of crowdsourcing to address complex technical, business and social issues grow in numbers, so do the instances of failed crowdsourcing campaigns. To make crowdsourcing a widely recognized idea-generating and problem-solving tool, it’s imperative to understand the reasons for why this tool can fail or underperform.

Why do crowdsourcing campaigns fail?

In my experience, crowdsourcing campaigns fail for two major reasons. The first is using its sub-optimal version, which I call the bottom-up model of crowdsourcing. I wrote about this model and its shortcomings here, here, here, here and, most recently, here.

The second reason is the lack of understanding that the most crucial factor that defines the ultimate success or failure of any crowdsourcing campaign is the ability to properly identify, define and articulate the problem that the crowd will be asked to solve. I call it the “80:20 rule”: 80% of unsuccessful crowdsourcing campaigns I’m aware of failed because of the inability to properly formulate the question to be presented to the crowd; only 20% did so because of a poor match between the question and the crowd.

Blaming the crowd

Unfortunately, too often when a crowdsourcing campaign fails to deliver, it is the crowd that gets most of the blame. As a result, instead of improving the efficiency of the problem-definition process, organizations begin to fiddle with their crowds. For example, a recent HBR article suggests switching to “carefully selected” crowds, the ones composed of employees or suppliers (the “experts”), rather than consumers (the “amateurs”).

This is a bad advice. The idea that you can cherry-pick the best participants for your next crowdsourcing campaign has no basis. To begin with, if you go to a large external crowd–by using external innovation portals or open innovation intermediaries–selecting a perfect “sub-crowd” becomes either cost-ineffective or outright impossible. And yes, working with internal crowds of employees is a solid approach; however, the usefulness of internal crowds—as opposed to external—has its limits.

Even more importantly, the widespread belief that only people with relevant knowledge and expertise can solve your problem is plain wrong. The history of many successful crowdsourcing campaigns proves that great ideas can come from completely unexpected sources. Moreover, research shows that the likelihood of someone solving a problem actually increases with the distance between this person’s own field of expertise and the problem’s domain. However paradoxically it may sound, packing up your problem-solving team with experts—as opposed to using a large and diversified crowd of “amateurs”—will make your problem-solving process weaker, not stronger.

 How to make crowdsourcing campaigns more effective?

The want for smaller and carefully selected crowds is driven by a fear that large crowds would generate a lot of low-quality ideas, evaluating which would be a huge burden for the organization running a crowdsourcing campaign. However, there is an effective way of generating higher-quality responses with a crowd of any size: to perfect the question you’re going to ask. Providing the crowd with a list of specific, precise and, ideally, quantitative requirements that each successful submission must meet will have a dramatic positive effect on the submission quality. Besides, this will substantially decrease the burden of the proposal evaluation because low-quality submissions will be easily filtered out.

My recommendation to organizations that want to increase the efficiency of their crowdsourcing campaigns is two-fold. First, use as large and diverse crowd as you only can get and then let qualified members of the crowd to self-select based on their own assessment of the problem and their abilities. Second, master the art and the science of formulating a question that you’ll ask your crowd—by both properly defining the problem and describing a “perfect” solution to it.

Remember: the beauty of crowdsourcing is that you don’t need to look for solutions to your problem. You just post your problem online, and then a right solution will come to find you.

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Does crowdsourcing need “rethinking”?


(This post originally appeared on Edge of Innovation)

An article in the latest issue of Harvard Business Review describes a product development study by Reto Hofstetter, Suleiman Aryobsei and Andreas Herrmann (Journal of Product Innovation Management, forthcoming). What caught my attention was the article’s title: “Rethinking Crowdsourcing.”

Why does crowdsourcing need “rethinking”?

Hofstetter and co-authors reviewed 87 crowdsourcing projects run by 18 companies on Atizo360o, a Swiss-based platform. The projects in question appear to have been typical “idea generation campaigns” that asked consumers to come up with new product development ideas. For example, in one of the campaigns, consumers were asked to propose new flavors for drinks manufactured by a Swiss soft drink company.

Each campaign analyzed by the Hofstetter team generated on average 358 responses. Because evaluating such considerable number of ideas is time- and resource-consuming, managers at the companies took advantage of the Atizo platform’s functionality allowing participants to “like” each other submissions. So now, instead of sorting through all ideas, managers could focus only on the most “likable”—at least, as a first screen.

The Hofstetter team has identified a serious flaw in the process: the apparent value of some ideas was overinflated by reciprocal “likes” by connected contributors who would prop up each other’s contributions. When submitted proposals were assessed by independent evaluators, no correlation has been found between most “likable” ideas and those that led to successful products.

Hofstetter and co-authors have concluded that “[o]neline consumer votes are unreliable indicators of actual idea quality.” The HBR article’s own verdict was even more damning: “It can be unwise to rely on the crowd.” Ouch!

To those folks who believe it’s unwise to rely on the crowd—or, worse, that “crowds are stupid”—I have a clear message: crowdsourcing doesn’t need rethinking. What needs rethinking is the way we use it. Crowdsourcing is, first and foremost, a question that you ask a crowd; the quality of the question is the most crucial factor determining the quality of the answer. You ask the crowd a smart question–you have a chance to get a smart answer. You ask the crowd a stupid question–the answer will almost certainly be stupid.

I have two specific comments on the HBR article.

  1. Crowdsourcing “ideas” is a bad idea.

Characteristically, all criticism of crowdsourcing—whether blaming it for the downfall of Quirky, choosing the wrong name for a research ship or the low-quality product ideas in the above study—is targeted against a particular “idea generation” version of it, which I call the bottom-up model of crowdsourcing. As I argued very recently, the bottom-up model has multiple flaws. One of them is that the burden of evaluating submitted ideas usually falls on business units that already have a full load of their own research projects. Faced with the need to find resources for “newcomers,” managers begin to cut corners and push the responsibility of evaluating submitted proposals back to the crowd—exactly as described above. Having only a vague (at best) understanding of what the managers really need, the crowd chooses the most “likable”—and usually very conventional or even trivial—ideas. Hardly surprising therefore is that the efficiency of “idea generation” campaigns is extremely low: barely 1-2% of the original ideas lead to eventual implementation.

There is a plausible alternative to the bottom-up approach: the top-down model. In the top-down model of crowdsourcing, the focus is on problems. These problems are identified and formulated by the managers who then ask internal or external crowds to find solutions to these problems. This approach is remarkably efficient. For example, InnoCentive, a crowdsourcing platform utilizing the top-down model, boasts up to 85% success rate of their projects.

I’m not saying that the bottom-up model has no right to exist. In innovation-mature organizations it can be successful–and I covered such a success story in the past. But for organizations that are at the very beginning of the innovation journey—and let’s face it, we’re talking about most of organizations–the top-down must be a model of choice.

  1. Voting for “ideas” is a bad idea, too.

Many folks seem to believe that they do crowdsourcing when they join online hundreds or even thousands of other folks and start exchanging “ideas” and opinions about them. (“Crowdsourcing on Facebook” is becoming a cliché.) Unfortunately, these folks confuse crowdsourcing with another problem-solving tool: brainstorming. Adding to this confusion is the fact that almost every commercially available “idea management” software provides functionalities allowing contributors to comment on each other’s ideas and vote for them.

But crowdsourcing is different from brainstorming in one important aspect: it requires independence of opinions, a feature of crowdsourcing underscored by James Surowiecki in his classic book “The Wisdom of Crowds.” When you run a crowdsourcing campaign, you should make sure that the members of your crowd, either individuals or small teams, provide their input independently of the opinions of others. It’s this aspect of crowdsourcing that results in the delivery of highly diversified, original and even unexpected solutions to the problem–as opposed to brainstorming that almost always ends up with a group reaching a consensus. That’s why I completely agree with the Hofstetter team that the number of votes is not an indicator of the quality of ideas; moreover, I believe that voting for ideas has a net negative effect on their quality.

However, as I mentioned before, managers resort to voting to relieve the pain of the evaluation process. Is there anything they can do to reduce this burden while maintaining the idea quality? Yes. Managers must start at the other side of the “crowdsourcing equation”: the question. Instead of asking crowds for open-ended suggestions (“Bring us something and we’ll tell you whether we like it or not”), managers must be very precise about what kind of ideas they’re looking for. For example, they can provide a list of specific (and, if appropriate, quantitative) requirements any successful idea must meet. Even more useful would be a request to conclude every submission with a point-by-point account how the proposed idea matches every listed requirement. This may not automatically result in increased quality of ideas, but it will undoubtedly help managers easily weed out a low-quality “noise.”

Reiterating my key point, crowdsourcing doesn’t need “rethinking.” It’s an extremely powerful problem-solving tool, but as any other tool, it requires knowledge and experience to be properly used. Those who know how to use it will succeed in harnessing the proverbial wisdom of crowds. Those who don’t, won’t. It’s this simple.

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