The Discipline of Innovation

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How much of innovation is inspiration, and how much is hard work? If it’s mainly

the former, then management’s role is limited: Hire the right people, and get out

of their way. If it’s largely the latter, management must play a more vigorous role:

Establish the right roles and processes, set clear goals and relevant measures, and

review progress at every step. Peter Drucker, with the masterly subtlety that is

his trademark, comes down somewhere in the middle. Yes, he writes in this arti-

cle, innovation is real work, and it can and should be managed like any other

corporate function. But that doesn’t mean it’s the same as other business activi-

ties. Indeed, innovation is the work of knowing rather than doing.

Drucker argues that most innovative business ideas come from methodically

analyzing seven areas of opportunity, some of which lie within particular com-

panies or industries and some of which lie in broader social or demographic

trends. Astute managers will ensure that their organizations maintain a clear

focus on all seven. But analysis will take you only so far. Once you’ve identified

an attractive opportunity, you still need a leap of imagination to arrive at the

right response – call it “functional inspiration.”

by Peter F. Drucker

Despite much discussion these days

of the “entrepreneurial personality,”

few of the entrepreneurs with whom

I have worked during the past 30 years

had such personalities. But I have

known many people – salespeople, sur-

geons, journalists, scholars, even musi-

cians – who did have them without

being the least bit entrepreneurial.

What all the successful entrepreneurs

I have met have in common is not a

certain kind of personality but a com-

mitment to the systematic practice of

innovation.

Innovation is the specific function of

entrepreneurship, whether in an exist-

ing business, a public service institution,

or a new venture started by a lone indi-

vidual in the family kitchen. It is the

means by which the entrepreneur either

creates new wealth-producing resources

or endows existing resources with en-

hanced potential for creating wealth.

Today, much confusion exists about

the proper definition of entrepreneur-

ship. Some observers use the term to

refer to all small businesses; others, to all

new businesses. In practice, however, a

In business, innovation

rarely springs from a

flash of inspiration. It

arises from a cold-eyed

analysis of seven kinds

of opportunities.

The Discipline

of Innovation

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great many well-established businesses

engage in highly successful entrepre-

neurship. The term, then, refers not to

an enterprise’s size or age but to a cer-

tain kind of activity. At the heart of that

activity is innovation: the effort to cre-

ate purposeful, focused change in an en-

terprise’s economic or social potential.

Sources of Innovation

There are, of course, innovations that

spring from a flash of genius. Most in-

novations, however, especially the suc-

cessful ones, result from a conscious,

purposeful search for innovation op-

portunities, which are found only in a

few situations. Four such areas of op-

portunity exist within a company or in-

dustry: unexpected occurrences, incon-

gruities, process needs, and industry and

market changes.

Three additional sources of opportu-

nity exist outside a company in its social

and intellectual environment: demo-

graphic changes, changes in perception,

and new knowledge.

True, these sources overlap, different

as they may be in the nature of their

risk, difficulty, and complexity, and the

potential for innovation may well lie in

more than one area at a time. But to-

gether, they account for the great ma-

jority of all innovation opportunities.

Unexpected Occurrences

Consider, first, the easiest and simplest

source of innovation opportunity: the

unexpected. In the early 1930s, IBM de-

veloped the first modern accounting

machine, which was designed for banks.

But banks in 1933 did not buy new

equipment. What saved the company –

according to a story that Thomas Wat-

son, Sr., the company’s founder and

long-term CEO, often told – was its ex-

ploitation of an unexpected success: The

New York Public Library wanted to buy

a machine. Unlike the banks, libraries in

those early New Deal days had money,

and Watson sold more than a hundred

of his otherwise unsalable machines to

libraries.

Fifteen years later, when everyone be-

lieved that computers were designed for

advanced scientific work, business un-

expectedly showed an interest in a ma-

chine that could do payroll. Univac,

which had the most advanced machine,

spurned business applications. But IBM

immediately realized it faced a possible

unexpected success, redesigned what

was basically Univac’s machine for such

mundane applications as payroll, and

within five years became a leader in the

computer industry, a position it has

maintained to this day.

The unexpected failure may be an

equally important source of innovation

opportunities. Everyone knows about

the Ford Edsel as the biggest new-car

failure in automotive history. What very

few people seem to know, however, is

that the Edsel’s failure was the founda-

tion for much of the company’s later

success. Ford planned the Edsel, the

most carefully designed car to that point

in American automotive history, to give

the company a full product line with

which to compete with General Motors.

When it bombed, despite all the plan-

ning, market research, and design that

had gone into it, Ford realized that some-

thing was happening in the automobile

market that ran counter to the basic as-

sumptions on which GM and everyone

else had been designing and market-

ing cars. No longer was the market seg-

mented primarily by income groups;

the new principle of segmentation was

what we now call “lifestyles.” Ford’s re-

sponse was the Mustang, a car that gave

the company a distinct personality and

reestablished it as an industry leader.

Unexpected successes and failures are

such productive sources of innovation

opportunities because most businesses

dismiss them, disregard them, and even

resent them. The German scientist who

around 1905 synthesized novocaine,

the first nonaddictive narcotic, had in-

tended it to be used in major surgical

procedures like amputation. Surgeons,

however, preferred total anesthesia for

such procedures; they still do. Instead,

novocaine found a ready appeal among

dentists. Its inventor spent the remain-

ing years of his life traveling from den-

tal school to dental school making

speeches that forbade dentists from

“misusing”his noble invention in appli-

cations for which he had not intended it.

This is a caricature, to be sure, but it

illustrates the attitude managers often

take to the unexpected: “It should not

have happened.” Corporate reporting

systems further ingrain this reaction,

for they draw attention away from un-

anticipated possibilities. The typical

monthly or quarterly report has on its

first page a list of problems–that is, the

areas where results fall short of expec-

tations. Such information is needed, of

course, to help prevent deterioration

of performance. But it also suppresses

the recognition of new opportunities.

The first acknowledgment of a possible

opportunity usually applies to an area

in which a company does better than

budgeted. Thus genuinely entrepreneur-

ial businesses have two “first pages” –

a problem page and an opportunity

page – and managers spend equal time

on both.

Incongruities

Alcon Laboratories was one of the suc-

cess stories of the 1960s because Bill

Conner, the company’s cofounder, ex-

ploited an incongruity in medical tech-

nology. The cataract operation is the

world’s third or fourth most common

surgical procedure. During the past 300

years, doctors systematized it to the

point that the only “old-fashioned”step

left was the cutting of a ligament. Eye

surgeons had learned to cut the liga-

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Peter F. Drucker is the Marie Rankin Clarke

Professor of Social Science and Manage-

ment at Claremont Graduate University’s

Peter F. Drucker Graduate School of Man-

agement in Claremont, California. He has

written more than two dozen articles for

HBR. This article was originally adapted

from his book Innovation and Entre-

preneurship: Practice and Principles

(Harper & Row, 1985).

ment with complete success, but it was

so different a procedure from the rest

of the operation, and so incompatible

with it, that they often dreaded it. It was

incongruous.

Doctors had known for 50 years

about an enzyme that could dissolve the

ligament without cutting. All Conner

did was to add a preservative to this en-

zyme that gave it a few months’ shelf

life. Eye surgeons immediately accepted

the new compound, and Alcon found

itself with a worldwide monopoly. Fif-

teen years later, Nestlé bought the com-

pany for a fancy price.

Such an incongruity within the logic

or rhythm of a process is only one pos-

sibility out of which innovation oppor-

tunities may arise. Another source is

incongruity between economic realities.

For instance, whenever an industry has

a steadily growing market but falling

profit margins – as, say, in the steel in-

dustries of developed countries between

1950 and 1970 – an incongruity exists.

The innovative response: minimills.

An incongruity between expectations

and results can also open up possibili-

ties for innovation. For 50 years after

the turn of the century, shipbuilders

and shipping companies worked hard

both to make ships faster and to lower

their fuel consumption. Even so, the

more successful they were in boosting

speed and trimming their fuel needs,

the worse the economics of ocean

freighters became. By 1950 or so, the

ocean freighter was dying, if not al-

ready dead.

All that was wrong, however, was an

incongruity between the industry’s as-

sumptions and its realities. The real

costs did not come from doing work

(that is, being at sea) but from not doing

work (that is, sitting idle in port). Once

managers understood where costs truly

lay, the innovations were obvious: the

roll-on and roll-off ship and the con-

tainer ship. These solutions, which in-

volved old technology, simply applied

to the ocean freighter what railroads

and truckers had been using for 30

years. A shift in viewpoint, not in tech-

nology, totally changed the economics

of ocean shipping and turned it into

one of the major growth industries of

the last 20 to 30 years.

Process Needs

Anyone who has ever driven in Japan

knows that the country has no modern

highway system. Its roads still follow the

paths laid down for – or by – oxcarts in

the tenth century. What makes the sys-

tem work for automobiles and trucks

is an adaptation of the reflector used

on American highways since the early

1930s. The reflector lets each car see

which other cars are approaching from

any one of a half-dozen directions. This

minor invention, which enables traffic

to move smoothly and with a minimum

of accidents, exploited a process need.

What we now call the media had its

origin in two innovations developed

around 1890 in response to process

needs. One was Ottmar Mergenthaler’s

Linotype, which made it possible to pro-

duce newspapers quickly and in large

volume. The other was a social innova-

tion, modern advertising, invented by

the first true newspaper publishers,

Adolph Ochs of the New York Times,

Joseph Pulitzer of the New York World,

and William Randolph Hearst. Adver-

tising made it possible for them to dis-

tribute news practically free of charge,

with the profit coming from marketing.

Industry and

Market Changes

Managers may believe that industry

structures are ordained by the good

Lord, but these structures can–and often

do – change overnight. Such change

creates tremendous opportunity for

innovation.

One of American business’s great

success stories in recent decades is the

brokerage firm of Donaldson, Lufkin &

Jenrette, recently acquired by the Equi-

table Life Assurance Society. DL&J was

founded in 1960 by three young men,

all graduates of the Harvard Business

School, who realized that the structure

of the financial industry was changing

as institutional investors became domi-

nant. These young men had practically

no capital and no connections. Still,

within a few years, their firm had be-

come a leader in the move to negotiated

commissions and one of Wall Street’s

stellar performers. It was the first to be

incorporated and go public.

In a similar fashion, changes in in-

dustry structure have created massive

innovation opportunities for American

health care providers. During the past

ten or 15 years, independent surgical

and psychiatric clinics, emergency cen-

ters, and HMOs have opened through-

out the country. Comparable opportu-

nities in telecommunications followed

industry upheavals – in transmission

(with the emergence of MCI and Sprint

in long-distance service) and in equip-

ment (with the emergence of such com-

panies as Rolm in the manufacturing of

private branch exchanges).

When an industry grows quickly –

the critical figure seems to be in the

neighborhood of 40% growth in ten

years or less – its structure changes. Es-

tablished companies, concentrating on

defending what they already have, tend

not to counterattack when a newcomer

challenges them. Indeed, when market

or industry structures change, traditional

industry leaders again and again neglect

the fastest growing market segments.

New opportunities rarely fit the way the

industry has always approached the mar-

ket, defined it, or organized to serve it.

Innovators therefore have a good chance

of being left alone for a long time.

Demographic Changes

Of the outside sources of innovation op-

portunities, demographics are the most

reliable. Demographic events have known

lead times; for instance, every person

who will be in the American labor force

by the year 2000 has already been born.

Yet b ecause policy makers often neglect

demographics, those who watch them

and exploit them can reap great rewards.

The Discipline of Innovation

THE INNOVATIVE ENTERPRISE august 2002

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The Japanese are ahead in robotics

because they paid attention to demo-

graphics. Everyone in the developed

countries around 1970 or so knew that

there was both a baby bust and an edu-

cation explosion going on; about half or

more of the young people were staying

in school beyond high school. Conse-

quently, the number of people available

for traditional blue-collar work in man-

ufacturing was bound to decrease and

become inadequate by 1990. Everyone

knew this, but only the Japanese acted

on it, and they now have a ten-year lead

in robotics.

Much the same is true of Club Med-

iterranee’s success in the travel and re-

sort business. By 1970, thoughtful ob-

servers could have seen the emergence

of large numbers of affluent and edu-

cated young adults in Europe and the

United States. Not comfortable with

the kind of vacations their working-

class parents had enjoyed – the sum-

mer weeks at Brighton or Atlantic City–

these young people were ideal custom-

ers for a new and exotic version of the

“hangout” of their teen years.

Managers have known for a long time

that demographics matter, but they

have always believed that population

statistics change slowly. In this century,

however, they don’t. Indeed, the inno-

vation opportunities made possible by

changes in the numbers of people –

and in their age distribution, education,

occupations, and geographic location –

are among the most rewarding and least

risky of entrepreneurial pursuits.

Changes in Perception

“The glass is half full” and “The glass

is half empty” are descriptions of the

same phenomenon but have vastly dif-

ferent meanings. Changing a manager’s

perception of a glass from half full to

half empty opens up big innovation

opportunities.

All factual evidence indicates, for in-

stance, that in the last 20 years, Ameri-

cans’ health has improved with unprec-

edented speed – whether measured by

mortality rates for the newborn, survival

rates for the very old, the incidence of

cancers (other than lung cancer), can-

cer cure rates, or other factors. Even

so, collective hypochondria grips the

nation. Never before has there been

so much concern with or

fear about health. Suddenly,

everything seems to cause

cancer or degenerative heart

disease or premature loss of

memory. The glass is clearly

half empty.

Rather than rejoicing

in great improvements in

health, Americans seem to

be emphasizing how far away they still

are from immortality. This view of

things has created many opportunities

for innovations: markets for new health

care magazines, for exercise classes and

jogging equipment, and for all kinds of

health foods. The fastest growing new

U.S. business in 1983 was a company

that makes indoor exercise equipment.

A change in perception does not alter

facts. It changes their meaning, though–

and very quickly. It took less than two

years for the computer to change from

being perceived as a threat and as some-

thing only big businesses would use to

something one buys for doing income

tax. Economics do not necessarily dic-

tate such a change; in fact, they may be

irrelevant. What determines whether

people see a glass as half full or half

empty is mood rather than fact, and a

change in mood often defies quantifica-

tion. But it is not exotic. It is concrete. It

can be defined. It can be tested. And it can

be exploited for innovation opportunity.

New Knowledge

Among history-making innovations,

those that are based on new knowl-

edge – whether scientific, technical, or

social – rank high. They are the super-

stars of entrepreneurship; they get the

publicity and the money. They are what

people usually mean when they talk of

innovation, although not all innovations

based on knowledge are important.

Knowledge-based innovations differ

from all others in the time they take, in

their casualty rates, and in their pre-

dictability, as well as in the challenges

they pose to entrepreneurs. Like most

superstars, they can be temperamental,

capricious, and hard to direct. They

have, for instance, the longest lead time

of all innovations. There is a protracted

span between the emergence of new

knowledge and its distillation into us-

able technology. Then there is another

long period before this new technology

appears in the marketplace in products,

processes, or services. Overall, the lead

time involved is something like 50 years,

a figure that has not shortened appre-

ciably throughout history.

To become effective, innovation of

this sort usually demands not one kind

of knowledge but many. Consider one of

the most potent knowledge-based in-

novations: modern banking. The theory

of the entrepreneurial bank – that is, of

the purposeful use of capital to generate

economic development – was formu-

lated by the Comte de Saint-Simon dur-

ing the era of Napoleon. Despite Saint-

Simon’s extraordinary prominence, it

was not until 30 years after his death in

1825 that two of his disciples, the broth-

ers Jacob and Isaac Pereire, established

the first entrepreneurial bank,the Credit

Mobilier, and ushered in what we now

call finance capitalism.

The Pereires, however, did not know

modern commercial banking, which de-

veloped at about the same time across

the channel in England. The Credit Mo-

bilier failed ignominiously. A few years

later, two young men – one an Ameri-

can, J.P. Morgan, and one a German,

Georg Siemens–put together the French

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Knowledge-based innovations

can be temperamental,

capricious, and hard to direct.

theory of entrepreneurial banking and

the English theory of commercial bank-

ing to create the first successful modern

banks: J.P. Morgan & Company in New

York, and the Deutsche Bank in Berlin.

Ten years later, a young Japanese, Shibu-

sawa Eiichi, adapted Siemens’s concept

to his country and thereby laid the foun-

dation of Japan’s modern economy. This

is how knowledge-based innovation al-

ways works.

The computer, to cite another exam-

ple, required no fewer than six separate

strands of knowledge:

• binary arithmetic;

• Charles Babbage’s conception of a cal-

culating machine, in the first half of the

nineteenth century;

• the punch card, invented by Herman

Hollerith for the U.S. census of 1890;

• the audion tube, an electronic switch

invented in 1906;

• symbolic logic, which was developed

between 1910 and 1913 by Bertrand

Russell and Alfred North Whitehead;

• and concepts of programming and

feedback that came out of abortive

attempts during World War I to de-

velop effective antiaircraft guns.

Although all the necessary knowl-

edge was available by 1918, the first op-

erational digital computer did not ap-

pear until 1946.

Long lead times and the need for con-

vergence among different kinds of

knowledge explain the peculiar rhythm

of knowledge-based innovation, its at-

tractions, and its dangers. During a long

gestation period, there is a lot of talk and

little action. Then, when all the elements

suddenly converge, there is tremendous

excitement and activity and an enor-

mous amount of speculation. Between

1880 and 1890, for example, almost

1,000 electric-apparatus companies were

founded in developed countries. Then,

as always, there was a crash and a shake-

out. By 1914, only 25 were still alive. In

the early 1920s, 300 to 500 automobile

companies existed in the United States;

by 1960, only four of them remained.

It may be difficult, but knowledge-

based innovation can be managed. Suc-

cess requires careful analysis of the

various kinds of knowledge needed to

make an innovation possible. Both J.P.

Morgan and Georg Siemens did this

when they established their banking

ventures. The Wright brothers did this

when they developed the first opera-

tional airplane.

Careful analysis of the needs – and,

above all, the capabilities – of the in-

tended user is also essential. It may

seem paradoxical, but knowledge-based

innovation is more market dependent

than any other kind of innovation. De

Havilland, a British company, designed

and built the first passenger jet, but it

did not analyze what the market needed

and therefore did not identify two key

factors. One was configuration –

that is, the right size with the right

payload for the routes on which a

jet would give an airline the great-

est advantage. The other was equally

mundane: How could the airlines

finance the purchase of such an ex-

pensive plane? Because de Havil-

land failed to do an adequate user

analysis, two American companies, Boe-

ing and Douglas, took over the com-

mercial jet-aircraft industry.

Principles of Innovation

Purposeful, systematic innovation be-

gins with the analysis of the sources of

new opportunities. Depending on the

context, sources will have different im-

portance at different times.Demograph-

ics, for instance, may be of little concern

to innovators of fundamental industrial

processes like steelmaking, although the

Linotype machine became successful pri-

marily because there were not enough

skilled typesetters available to satisfy a

mass market. By the same token, new

knowledge may be of little relevance to

someone innovating a social instrument

to satisfy a need that changing demo-

graphics or tax laws have created. But

whatever the situation, innovators must

analyze all opportunity sources.

Because innovation is both concep-

tual and perceptual, would-be innova-

tors must also go out and look, ask, and

listen. Successful innovators use both

the right and left sides of their brains.

They work out analytically what the in-

novation has to be to satisfy an oppor-

tunity. Then they go out and look at po-

tential users to study their expectations,

their values, and their needs.

To be effective, an innovation has to

be simple, and it has to be focused. It

should do only one thing; otherwise it

confuses people. Indeed, the greatest

praise an innovation can receive is for

people to say, “This is obvious! Why

didn’t I think of it? It’s so simple!” Even

the innovation that creates new users

and new markets should be directed

toward a specific, clear, and carefully

designed application.

Effective innovations start small.They

are not grandiose. It may be to enable

a moving vehicle to draw electric power

while it runs along rails, the innovation

that made possible the electric streetcar.

Or it may be the elementary idea of

putting the same number of matches

into a matchbox (it used to be 50). This

simple notion made possible the auto-

matic filling of matchboxes and gave the

Swedes a world monopoly on matches

for half a century. By contrast, grandiose

ideas for things that will “revolutionize

an industry” are unlikely to work.

In fact, no one can foretell whether a

given innovation will end up a big busi-

ness or a modest achievement. But even

if the results are modest, the successful

innovation aims from the beginning to

become the standard setter, to deter-

mine the direction of a new technology

or a new industry, to create the business

that is–and remains–ahead of the pack.

If an innovation does not aim at leader-

ship from the beginning, it is unlikely to

be innovative enough.

Innovation requires

knowledge, ingenuity,

and, above all else, focus.

THE INNOVATIVE ENTERPRISE

august 2002

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The Discipline of Innovation

Above all, innovation is work rather

than genius. It requires knowledge. It

often requires ingenuity. And it requires

focus. There are clearly people who are

more talented innovators than others,

but their talents lie in well-defined areas.

Indeed, innovators rarely work in more

than one area. For all his systematic in-

novative accomplishments, Thomas Edi-

son worked only in the electrical field.

An innovator in financial areas, Citibank

for example, is not likely to embark on

innovations in health care.

In innovation, as in any other en-

deavor, there is talent, there is ingenuity,

and there is knowledge. But when all is

said and done, what innovation requires

is hard, focused, purposeful work. If dili-

gence, persistence, and commitment are

lacking, talent, ingenuity, and knowl-

edge are of no avail.

There is, of course, far more to entre-

preneurship than systematic innova-

tion–distinct entrepreneurial strategies,

for example, and the principles of entre-

preneurial management, which are

needed equally in the established en-

terprise, the public service organization,

and the new venture.But the very foun-

dation of entrepreneurship is the prac-

tice of systematic innovation.

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