When should you spawn an innovation?

Ulrich Hege, Professor of Finance - January 15th, 2014
eggs and innovation - When should you spawn an innovation?

Each time an idea for an innovation emerges in a company, a question arises: Should you exploit it internally or is it better to let its creator develop it in his or her own firm? It all depends on the parent company’s ability to develop it, according to Ulrich Hege, Michel A. Habib, and Pierre Mella-Barral.

Ulrich Hege ©HEC Paris

Doctor of Economics from Princeton, Ulrich Hege is Director and Professor of TSE (Toulouse School of Economics) since January 2016. Prior to joining TSE, he was Professor of (...)

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Major innovations are not all born in a garage or a university. Most Silicon Valley start-ups are in fact spinouts of existing companies, firms created by engineers who left their companies to create their own. Fairchild Semiconductor, for example, created by eight engineers from Shockley Semiconductor Laboratory, itself spawned Intel and many other high-tech companies. Why do the original companies in these cases lose out on the profitable innovations that their talents leave to develop elsewhere?


WHY COMPANIES WOULD WANT TO RETAIN AN INNOVATION…

On the one hand, the innovator can have an interest in developing his or her concept in the company that saw it come to life. It is reassuring to have the financial, marketing, and commercial strength of a big company, using its expertise and support functions (legal, logistics, finance, and so on). As for the company that loses an innovation, it separates itself from a potential growth opportunity and takes the risk of letting a competitor emerge. It also loses the skills of employees who leave. More importantly, as Habib, Hege and Mella-Barral illustrate, the parent company denies itself of all the spinoff innovations that may arise from the new activity. This parameter, which the researchers included in their model, has a major impact: each innovation is a pathway to future innovations. Denying it limits growth and reduces profit opportunities, as the researchers’ model shows. Should leaders therefore force themselves to keep all the innovations that emerge in their companies?


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Spawning certain innovations is a source of internal creativity.



…OR ON THE CONTRARY LET IT LEAVE

Starting a company based on a key innovation can be very efficient. Although the investment in resources is considerable, spinouts benefit from an organization that is radically different from the parent company and is better adapted to the new product/ service. It may be difficult for an existing business to understand and integrate, at all organizational levels (from leaders to more operational roles) a new concept, a new market approach and a new way to set prices and increase sales. If, at one point or another in the manufacturing or sales process, the organization is not suited to the product/service, it is relevant to consider developing it elsewhere, in an ad hoc structure. Because when an innovation is adopted by an inadequate company, everyone loses: the product/service is not compelling and average profitability decrease. According to Hege, there is a threshold of organizational “fit,” where it is of greater interest to stay focused on your core activity and to limit the development of innovations internally.


SPINOUTS: A SERIOUS COMPETITIVE THREAT?

If spawning an innovation can lead to a new market rival, are companies that retain all their innovations immune to competition? Certainly not, responds Hege, who explains that all companies are characterized by the same maturation cycle: the more a company grows, the less it innovates. Young companies are always more innovative, they invest more in R&D and the average profitability of their innovations is greater.


WHEN SPAWNING AN INNOVATION STIMULATES INTERNAL CREATIVITY

Finally, Hege and his co-authors observed that spawning certain innovations is a source of internal creativity. Young engineers are stimulated by the prospect of finding the idea or product that will make them successful and allow them to create their own company. Young companies are also more innovative because researchers, who are generally close to the leader, know that their opportunity to innovate and to become an entrepreneur in their own right is greater than it is elsewhere.

When should innovators leave their employer and start their own company? Everything depends on what is required to best develop the innovation. If it can fit in the parent company’s strategy and adapt to its organization while drawing on its support functions, it is advisable to stay. If, however, the innovation requires a different vision, it needs a new organization. In other words, if the resources to be implemented for the innovation’s success are more important than the existing support functions and strength of the parent company, then it is in the innovator’s interest to create a new structure.


Based on an interview with Ulrich Hege and the article “Entrepreneurial Spawning and Firm Characteristics,” co-written by Michel A. Habib and Pierre Mella-Barral (Management Science , December 2013).

PRACTICAL APPLICATIONS
PRACTICAL APPLICATIONS

The study, led by Michel A. Habib, Ulrich Hege, and Pierre Mella-Barral, helps to understand the dynamics of innovative companies and their evolution. The researchers show that the decision to spawn or to retain an innovation depends on the company’s size, age, profitability, strength of attraction, and, most of all, adaptability for the rollout of the innovation. The study provides a framework for leaders who question whether to develop an innovation internally, sell it off by letting its creators leave, or to outsource research through the acquisition of start-ups or innovative spinouts


METHODOLOGY
METHODOLOGY

The researchers developed a theoretical and dynamic model that draws on management theory, finance theory, and microeconomics contract theory. The model enables the analysis of the impact of an innovation on the nature of a company: its size, growth, diversification, outsourcing of activities, and so on. In particular, it accounts for potential future innovations that may stem from each original innovation