We are supposed to like innovations. They drive the world
forward, with effects that range from the pleasant (like the camera on your
phone) to the vital (like portable ultrasound in developing nations). In fact,
many of the heroes in business are known because of their innovations. A
classic example is Steve Jobs launching the multi-function iPhone, which relied
on knowledge of music storage and playoff, as well as internet connectivity,
that previously had not been part of mobile phone technology. This is one of
the two classical stories on how to innovate: combine existing knowledge in new
ways, or create completely new knowledge.
The only problem with the iPhone story is that it makes us
think the world rewards innovation and that firms doing it get Apple-like fame
and fortunes. That happens to be the exception. A research paper by Matt Theeke, Francisco Polidoro, and James Fredrickson in Administrative Science Quarterly has shown that firms using new kinds of knowledge for making
innovations face a surprising form of risk: they may end up getting ignored.
The details of this research help us see exactly what
happens. All kinds of firms want stock brokerage firms to issue analyst reports
on them, because that means investors will pay attention to them, which helps
them gain financing. This is especially important for firms that rely on
innovations, because making innovations means paying money now to get money
later, which is exactly what financing is used for. In fact, there are entire
industries that are so dependent on innovations that analyst reports are
essential. Theeke, Polidoro, and Fredrickson studied medical devices, which is
a good example of an innovation-driven industry. Brokerage firms covering that
industry need to understand research and knowledge use, because otherwise they
cannot estimate future profits well.
So what is the problem?
Well, the brokerage firms have expertise in the conventional use of knowledge,
which means that use of new knowledge – innovative use of knowledge – is
something they understand less well. As a result, firms incorporating new knowledge
are more likely to be ignored, as brokerages drop them from their coverage. The
newer the knowledge is, and the more expertise the brokerage firm has in
covering other firms in the industry using conventional knowledge, the worse
the situation is. Just as expertise makes some firms rigid in their knowledge
use, it makes brokerage firms rigid in their knowledge valuation.
So our tales of heroic unconventional innovators are good
examples of exceptions, because business rewards convention. Does that mean it
is better to follow convention and just make minor improvements? Not really,
because easier access to financing is very different from more successful
product launches. It just means that firms planning to use new knowledge in
making innovations should check their bank accounts first, because they may have
to pay the cost themselves.
