How Mid-Sized Companies Innovate
CEOs must drive a continual search for new ideas and have the courage to commit resources for the long term.
December 19 2012 by William J. Holstein
When the Great Recession hit in 2008, the bottom dropped out of the furniture business, just as it did for automobiles and many key sectors of the American economy. Ethan Allen Interiors, today a $679 million-a-year manufacturer and retailer based in Danbury, Connecticut, peered over the edge into the financial abyss. It recognized that consumers were putting off decisions about redecorating their homes for economic reasons but also because they were intimidated by too many choices—whether to go with the colonial look or perhaps a more modernist twist. Responding to the crisis, CEO Farooq Kathwari decided to accelerate the development of a new service business—a division that would offer interior decorating advice to potential customers in the comfort of their own homes.
Today, some 90 percent of Ethan Allen’s sales in North America are the result of 2,000 designers, who are on staff (some 600 have been hired in the past three years) and about 3,500 independent designers who contract to bring their customers to Ethan Allen design showrooms. A traditional 80-year-old manufacturer and retailer resorted to a service sector innovation to respond to adversity. “That saved our business,” says Kathwari.
Chief executives of mid-size companies face different challenges when it comes to innovation than do the CEOs of startups, on one hand, and leaders of large multinationals, on the other. CEOs of startups are focused almost exclusively on scaling up a new technology and their entrepreneurial organizations are still relatively simple. They do not yet have multiple divisions, product lines or geographies—all of which can create bureaucratic layers that don’t allow good ideas to bubble up. “As you get bigger, managing innovation becomes more difficult,” says Dan Hendrix, chief executive of Interface, an Atlanta-based maker of carpet tiles that has reached $1 billion in sales.
On the other end of the spectrum, bigger companies, such as IBM, 3M, Corning and Medtronic boast established R&D divisions, often with large budgets, and well-understood innovation channels and processes. CEOs of those companies don’t lose sleep over what is happening in their labs.
But the guys in the middle—particularly those outside the rarefied airs of Silicon Valley in the real economy—face more ambiguous challenges when it comes to innovating. That’s true for technology-based companies such as 3D Systems, Zipcars and A123, as well as more traditional players, such as Ethan Allen Interiors and Interface in carpet tiles. How do they allocate time and money to new ideas at the same time that they are striving to build an existing business? And how do they do more than innovate with their products, but also branch into new services, discover new business models, adopt business process innovations and, in general, keep up the pace of innovation on all fronts?
Forward-thinking CEOs also understand that innovation is not merely the territory of their R&D staffs. CEO Doug Tough of International Flavors & Fragrances—a $2.8 billion business driven by innovative science—backs up his talk with action: this year he bestowed his company’s coveted annual innovation award to his treasury staff for the difference they made in international tax planning.
The key question, says Mark Johnson, senior partner of Innosight, the Boston-based innovation consulting firm he cofounded with Harvard’s Clayton Christensen, is “can a company that is trying to execute itself to be bigger and better at the same time have the vision to separate resources out” for innovation wherever it may be needed within the company? Those activities “don’t have the same business rhythms,” says Johnson. “It takes a lot of leadership and courage to invest in these things that are not going to pay off immediately toward the effort to scale up.”
The precise role that a CEO plays depends in a large part on his or her own skills sets. If she is scientifically adept, she may continue to lead the search for new ideas while ceding some management of day-to day-functions to a chief operating officer or vice chairman. On the other hand, if the CEO is a finance or operations specialist, then he must rely on other innovators within the organization for new ideas. In either case, it is critically important that the company’s culture continues to embrace innovation even as it builds more processes and management levels to accommodate greater size. “The challenge is to balance the spirit that got them started with the corporate culture they’ve had to evolve as they’ve grown,” says Bryan Pearce, who directs Ernst & Young’s Entrepreneur of the Year competition. “They need to find a balance where you don’t become too corporate and still have people who think entrepreneurially.”
As companies grow and enjoy some success, it’s only human nature to seek to institutionalize various functions and settle down into comfortable routines. That impulse has to be resisted. “You have to help create management chaos—that’s my job,” says Kathwari. “I give assignments to people that look like Mission Impossible, but they do it.”
The trick is allowing ideas to compete—but doing it in a more cost-effective way than larger companies with big budgets. “When you are very big, I wouldn’t call it waste, but you spend a lot of time and effort to find a few good ideas that are going to work,” Kathwari says. “At our level, because of our limited resources, we are very focused on what we need to be doing. Innovation means listening and being close to our customers.”
The CEOs of mid-sized manufacturers and retailers highlighted in the pages to follow all found ways to do just that—to address their respective innovation dilemmas while continuing to manage and grow their existing businesses. One failed to innovate fast enough, however, and his company lost its independence as a result. Here are their stories.
3D SYSTEMS SEEKS CONSTANT REINVENTION—OF EVERYTHING
When Avi N. Reichental arrived at 3D Systems about eight years ago as CEO, he found a company with a machine-tool-industry type of culture whose only product was too big and too expensive. The company’s 3D printing machine, which printed layer after layer of a three-dimensional object until completion, was the size of several refrigerators put together and cost tens of thousands. Reichental went to company co-founder, Charles W. Hull, who was acting as chief technology officer, and challenged him. As Reichental recalls it, “I said, Chuck, let’s begin to think how to we make this into the size of a television and put it on a desk. He looked at me and said politely, ’Look, you come from low tech. This is high tech. You have no idea what is possible.’”
Undeterred, Reichental stopped in every morning at Hull’s office for the next 10 weeks asking whether he was making any progress. “One morning, Chuck came to my office with a cup of coffee, his feet floating off the ground, and said, ‘I think I know how to do that,” Reichental recalls.
For many mid-sized companies, achieving the right type of collaboration between a professional CEO and a technologically minded founder is at the heart of innovation. The net result of that collaboration at 3D Systems has been a complete reinvention of the company and a tripling of revenues. The company now boasts seven different types of 3D printers, including one for home use that costs only $1,299. Collectively, its printers can use 100 different plastics, rubbers, composites and other materials to create objects.
Equally important, the company recognized that customers want tools that can help them create the design file that guides the machines and to be able to have 3D Systems make parts for them on demand, a service the company now offers. Aside from hardware, 3D Systems offers software and services as part of an integrated one-stop shop for corporate and individual customers.
The company also relocated from high-cost Los Angeles to Rock Hill, South Carolina, in part to be able to attract the top engineers and executives from around the world and to be closer to its key European markets. Its revenue last year was $230 million and it is telling analysts that the number for this year will be $330 to $360 million. Its strongest markets are automotive, defense and aerospace. Every F18 jet fighter flying today contains parts that 3D Systems’ machines printed and Invisalign, the maker of alternatives to orthodontic braces, uses the company’s technology to print 65,000 clear plastic liners every day.
To reach this point, the company innovated on several fronts simultaneously—it created new products, developed services and changed its business model. “None of it would have been possible without changing the DNA of the company,” Reichental says. “Inventiveness has to become a core competence. Innovation cannot be related to just the technology side of the company. Every function understands that they have to innovate.”
Reichental sees his job as setting the overall direction for the company and defining the product experience customers should have—in partnership with Hull. “I challenge him,” says the Israeli-born CEO. “He comes back and tells me what is and isn’t possible. Then we continue to bend reality until we get what we want.”
INTERFACE: HARVESTING BUSINESS PROCESS INNOVATIONS
Ideas trickle up from below at Interface, the $1.1 billion carpet tile maker based in Atlanta. For example, a European employee of the company read about a crisis afflicting much of coastal Asia—old, abandoned fishing nets were joining with other manmade debris to create ecological nightmares on beaches. The nets were made of the same type of nylon that Interface seeks to recycle and make carpet tiles used in airlines and many office settings. The employee forwarded the information to the company’s head of innovation based in Britain, who, in turn, forwarded it to top management in Atlanta. In short order, CEO Dan Hendrix authorized a test partnership with the Zoological Society of London to seek to acquire old nets in a coastal fishing community in the Philippines and turn them into carpet tiles.
The fact that a good idea can travel across time zones and different cultures to the top of a company with more than $1 billion in sales is a healthy sign. Even healthier is that the CEO decided to fund the idea, at least on a test basis. “One of things you have to do if you want to have an innovative company is have an open mind,” says Hendrix, who worked his way up the ladder as a financial executive. “If your people give you great ideas and you won’t fund them because there is no quick ROI, they quit giving you ideas.”
Of course, Hendrix also has to kill ideas that are not working; but overall, he depends on the idea flow to help him accomplish the company’s central goal—making the carpet tiles with only recycled or biologically available materials and dramatically reducing the company’s dependence on petroleum. The company has long pursued these goals not only because they are ecologically correct, but also because customers demand them and the change can reduce costs, thereby enhancing profitability.
The majority of good ideas are aimed at helping Interface continually transform the business processes used in sourcing materials and making its product. Because it sells in 130 countries and reaps about half its sales outside the U.S., harvesting those ideas is, by definition, an international process. The company has created a global R&D group headed by a chief innovation officer that manages labs in Britain, the U.S. and Australia. It also boasts an Internet-based Innovation Farm, where employees can suggest ideas, much as IBM once hosted an “ideas jam.”
While he lacks a technical background, Hendrix says he is directly involved in innovation efforts. “You’re not sitting in a silo and letting someone else go do it. You’re interacting,” he explains. “The chief innovation officer sits at the table with my whole team and myself. You have to be intimately involved and elevate innovation to a very high position in your company.”
He knows that it doesn’t always work. “You’re going to have some failures—that happens all the time,” Hendrix adds. “But if you don’t get out of the box and fund some of these ideas, you get stuck in the loop of just trying to make your product cheaper and cheaper.” That’s a place few CEOs want to be.
ZIPCAR: EXPERIMENTING WITH A NEW BUSINESS MODEL
When Zipcar was launched in 1999, its founders recognized the potential of a car-sharing company within the U.S., given the wide adoption in Europe. While the startup initially attracted an enthusiastic customer base, the company struggled to achieve profitability and began accumulating debt.
When Scott Griffith came on board as CEO in 2003 he immediately sought to expand Zipcar’s fleet and membership base while also keeping his foot on the gas of innovation. The company pioneered the use of radio-frequency identification technology in Zipcards to activate vehicles, and it became an early mover into the iPhone app space to allow customers to locate cars and manage reservations. As a result, Zipcar disrupted the rental car industry, where leaders like Hertz and Avis had always been focused on airport rentals while ignoring the daily rental needs of millions of other consumers.
Unfortunately, profitability continued to elude the company. When Zipcar went public in April 2011 (in an IPO that raised $175 million), pressure to grow the bottom line intensified. With a customer base of 709,000 members and more than 9,000 cars available for rent, the company finally turned a small profit of $3.9 million in net income in the last quarter of 2011, but investors demanded more.
That’s why Griffith has continued to tweak the company’s business model. Zipcar’s business was founded on the principle that it leased all its cars from manufacturers. Griffith challenged that in February by announcing a $13.7 million investment in Wheelz, a peer-to-peer (P2P) car-sharing service founded on Stanford University’s campus. The big idea is that the customer rents the car of another customer. “We believe P2P could expand the total addressable market for car sharing,” Griffith says. Zipcar also could save a great deal of money because it does not actually pay to lease vehicles or park them when not in use. Wall Street and the car industry are watching closely to see if this latest burst of innovation will finally put Zipcar on the road to high-octane profits.
ETHAN ALLEN: FROM DECOR TO DECORATING
The notion that Ethan Allen should provide a decorating service had existed for a number of years when the company embarked on the transition from straight retail to a service focus, but CEO Farooq Kathwari decided to greatly expand it and hire qualified interior designers, who could no longer survive on their own. Aside from setting up selection and training criteria, Kathwari’s role was to put substance and resources behind the idea and help it grow in a disciplined manner. “Like all good ideas, it needed a razor focus,” he says. “It needed a commitment to do it right and not to compromise on principles for short-term gains.”
His role as CEO also was to overcome resistance from internal constituencies that felt threatened by the emergence of a new sales channel. “There is always resistance to new ideas,” Kathwari adds. “The responsibility of leadership is to create an environment where the resistance goes away from the bottom up, among peers, rather than by dictates from the top.”
That’s one key to how Kathwari pushes change through his organization—reaching several levels down to build consensus. “Peer influence is very important,” he says. “When it’s a dictate from the top, people say ‘we are doing it because we have to;’ but when there is strong acceptance of an idea by a large peer group, then the idea works.” The company also is equipping its designers with iPads so that when they visit a customer’s home, they can show pictures of items, accept credit card payment and schedule delivery.
Having so many interior designers in the field in close touch with customers has yielded an important side effect—ideas for how to change and improve products are flowing back to the design and manufacturing divisions. The result? An impressive 60 percent of Ethan Allen’s current products have been refreshed or introduced within the past year. “You can’t be an 80-year-old company and not reinvent yourself,” Kathwari concludes.