Dartmouth’s Vijay Govindarajan on Innovation Strategy

By Scott Kirsner |  April 18, 2016

InnoLead: Why don’t you start by describing what the Three Box model is? What’s in the three boxes?

Vijay Govindarajan: I take everything an organization does and put them in three boxes. How many of the activities are in Box 1? Box 1 is about managing the present. It’s about improving the performance of your current business the way they’re configured today.

How many of your activities are in Box 2? Box 2 is about selectively forget the past. How many of your activities are in Box 3? Box 3 is about create the future. What I find working with organizations is they over-focus on Box 1.

InnoLead: I was just going to ask that. Box 1 is everybody’s job, 99 percent of their time, right?

Govindarajan: Yes. Box 1 is important, but Box 2 and Box 3 are also equally important. I say Box 1 is competition for the present. It’s all about efficiency — improving performance of your current business.

Box 2 and Box 3 are all about competition for the future. They’re all about innovation. The reason this is tough is that what it takes to succeed in Box 1 is very different than what it takes to succeed in Box 2 and Box 3.

Take your own industry, publishing. There are print magazine in Box 1. Then, digital technologies create fundamental changes. You need to experiment with new business models online. Managing those two conflicting businesses is the tough challenge.

The Challenge of Forgetting

InnoLead: Explain Box 2 a little bit — forgetting the past. What’s in that, aside from executives who are going to say, “Yeah, we tried that 15 years ago and it didn’t work then, so let’s not try it ever again.”

Govindarajan: Box 2, I find, is the toughest of the three boxes.

InnoLead: To understand or to do?

Govindarajan: To do. Of course, even to know what you have to forget is tough, but forgetting, that is really tough. If you really think about it, there are a lot of books written on learning organizations, but nothing written on forgetting organizations. Perhaps you may need to forget your culture, some performance management systems.

Assessing what you need to forget requires you to first understand how the future will unfold. Therefore, we give the example of Hasbro.

If you go back to the mid-1990s, some of the forgetting challenges for Hasbro would be, “We’d better forget we are a physical product company. We’d better forget we’re an American company. We’d better forget our only distribution channel is brick-and-mortar stores.” Those were the rules by which they were winning in the mid-1990s. The forget challenge is to say that some of the rules by which you are winning today are not relevant for the future. Therefore, you must forget.

The reason why forgetting is a huge problem is you have to forget things which will create your future weakness, but they’re your current strengths. Therefore, they’re supporting your Box 1 today, but they could become future weakness.

We give the example of Microsoft. Part of the reason Microsoft has struggled a lot is not that they didn’t understand digital music, or search, or all these things. They are smart people. The problem is knowing that those big changes are happening is one thing. [But] for them to migrate to that world, they have to forget one thing, which is sales of PCs… That’s where they are making their money — in Windows.

InnoLead: Would you talk about a mechanism for forgetting, because I guess hitting someone on the head with a two-by-four probably isn’t acceptable in most organizations. Yet, I think everybody’s been in one of these meetings where you have the CEO or the COO who says, “I remember 30 years ago, I used to call on this kind of customer, and they told me X.” They still think X is true 30 years later, when you might need to forget X.

Govindarajan: There are two fundamentally different approaches one can take for forgetting. One is to sell off those businesses. There are certain industries that don’t fit your future anymore.

When P&G starts selling off their beauty businesses, and [GE’s] Jeff Immelt sells off their finance business, essentially it’s saying, “These are not bad businesses, but they don’t fit our future.” That’s one way you forget.

The second and the more difficult one [is to keep people] inside the organization, but make them forget. That means you’ve got to change people’s mindsets. The best way to effect that is when you’re executing a Box 3 initiative, create a dedicated team.

The dedicated team should be separate and distinct from the Box 1 performance engine. …If you constitute the team correctly, the kind of people you recruit, the processes you have — they will be able to forget the rules by which the performance engine is run.

How Hasbro ‘Expanded the Pond’

InnoLead: Talk a little bit about Hasbro, because you discuss them in the book as one of your case studies. Having written a little bit about the toy industry 15 years ago, it seemed like they were trapped a little bit in that Coke versus Pepsi, Hasbro versus Mattel, Hyatt versus Marriott [mindset] — just duking it out like crazy with Mattel for who was going to have the hit toy this Christmas. How did they get out of that?

Govindarajan: That’s a good characterization of Hasbro in the ’90s. The competition was between G.I. Joe and Barbie. There was a book somebody wrote about it —

InnoLead: “Toy Wars.”

Govindarajan: Hasbro has — particularly under [CEO] Brian Goldner — expanded the pond to go into areas which are adjacent but quite different from their historical focus, like digital gaming, going into the Hollywood movie business, going into Universal theme parks.

When you go into those areas, your competition is not Mattel. Suddenly, it becomes Disney, because Disney is more of a full-fledged entertainment player as compared to Mattel. I would say Disney’s a better characterization of Hasbro’s competitor, but also, Hasbro has a lot of competition with a lot of small players in technology games. Technology games are something a Silicon Valley start-up could quickly put together.

InnoLead: Angry Birds — some company, Rovio from Finland, comes out of nowhere.

Govindarajan: Exactly. In technology-based games, the entry barriers are so low that you can introduce new games. Every time you open your iPhone, there will be a new version of Angry Birds popping up. It’s not like the Monopoly board game, which had a long product life cycle,. You can have a lot of competitors. Many of them you wouldn’t even know who they are, because they can pop up.

Hasbro has expanded [its thinking about] the people they compete with, the kind of distribution channels they go after, the kind of customers they deal with. Therefore, I would say that mindset has significantly changed. If you walk into Hasbro today, it feels, smells, very different than the toy and game product maker of the ’90s.

Creating a ‘Future Now’ Group

InnoLead: He has this team you write about called “Future Now.” That is a future-of-the-business team and not, “How do we sell more Monopoly boards this year?”

Govindarajan: Exactly, and he also has processes by which he says, “How are we succeeding today in Box 1? What are the rules by which we are succeeding in Box 1? Are there weak signals that are telling us there are going to be changes in those rules?”

in the future, Box 3, you respond to weak signals. Box 1 you are responding to clear signals. The question, therefore, is how do you plan for a future you cannot predict? Therefore, I say that the focus in Box 3 has to be prepare, not plan. You can’t plan for the future…

The way you prepare for the future is to observe the weak signals — the emergent trends in technology or customers — and ask the question, “Will those emergent trends affect my success formula today? If it is going to, then I’d better start an experiment somewhere to see whether this will happen actually.”

Tuning in to Weak Signals

InnoLead: Weak signals are so hard for big companies, in a way, because you can see a weak signal that really is going to be an important new business. Yet, it just looks so small. If you’re a multibillion-dollar company, you’re looking and you’re saying, “This is a hundred thousand dollar business today, or a million dollar business. Why should we, Hasbro, or we, GE, be messing around in this small market?”

Govindarajan: That is exactly the problem why Box 3 is so difficult. Any progress that you make on Box 3, the impact is going to be very small today.

In fact, one of the metaphors is that a Box 3 activity [is like doing] exercise every day. If you do exercise every day, you’ve got good health in the year 2020.

The reason why individuals don’t do exercise every day is…because you can always give some excuse. “I’ve got too much work here, I’ve got to talk to Scott and then prepare, I’ve got emails to check.” If you don’t do exercise today, your health does not decay today. It decays in the year 2020. That’s why you postpone.

By the way, your health decays today, but the decay is so small, so invisible, it doesn’t bother you.

Similarly, when there are weak signals, you say, “If I’m going to act on those weak signals, I make only a couple million dollars in sales.” For a $6 billion company, it doesn’t move the needle. Therefore, they may not bother with it. “Let me jump into the game when the game becomes really big.”

That is all the more reason it is the CEO’s job to say, “When I look ten years from now, [videogames] look like a phenomenal opportunity. For me to participate in that, I have to start today.” The…future’s not in the future. The future comes in daily doses.

It is a question of small bets forming a bigger bet. If you have that discipline, I think you can get over this. This is the job of the CEO.

Short executive tenure

InnoLead: One of the things that, to me, is like a puzzle that’s really hard to solve, and I think is hard for a lot of executives below the CEO to solve, is that CEO tenure can be really short nowadays.

Do you think it is true that consistency wins, and when you have companies that have a lot of turnover, or a “strategy of the year” that changes every year, those companies fall behind?

Govindarajan: The short answer is yes. When you look at a CEO like Brian Goldner [of Hasbro], he has been around now for at least 15 years. …Any of these strategies take time for fruition.

If the board is impatient, and makes the [CEO’s] tenure short, and, as a result they start to focus on short-term things, then I say the problem is with the board. They need to give enough time, but enough time alone doesn’t do it if the CEO doesn’t… really lay out a three-box balance.

Building the Future versus Buying It

InnoLead: I want to ask you about buying the future versus building the future internally. You talk about Keurig in the book. When it was just called Green Mountain Coffee Roasters and they were up in Burlington, Vermont, they acquired the Keurig coffeemaker technology, and that became the engine of their growth for like eight years or so. It was a fantastically well-performing stock, and that was just a smart acquisition. Then, they tried to develop internally the Keurig 2.0 coffeemaker and, more recently, this Keurig KOLD beverage maker, neither of which seemed to really do that well.

Do you think there’s a lesson in there about how challenging it can be to organically develop the next big thing?

Govindarajan: There are three lessons in that Keurig story that one needs to highlight. First of all, Green Mountain Coffee Roasters, they were a roasting company, that’s all. They roasted coffee beans and sold it to the wholesale market. They knew how to make a good cup of coffee.

When Keurig came along, initially, [Green Mountain was] one of the investors in that start-up, along with others. My first lesson, therefore, is you don’t have to do all the Box 3 yourself. Sometimes it is such a nascent field, such an embryonic idea, you may [be] only assuming risks…if you start it in-house. I would say it is a very good idea to go and take equity positions in start-ups in those nascent areas.

Lesson #2 is, at some point, they saw enough merit in Keurig, especially when they saw it in the office market. They were able to establish a foothold. [Offices were] a smaller market compared to B2C. B2C was the vision. In 2006, they acquired Keurig and brought it in-house.

…It was still a small player with still enormous amounts of unknowns in the business model in terms of product, distribution channel, etc.

Second lesson is at some point, you will bring that…start-up in-house. Keep it separate. Do not bring it close to your performance engine, because your performance engine is the coffee-roasting business which you know how to do. Keurig is still an evolving business.

From 2006 to about 2012 [they had] record growth.

InnoLead: They left Keurig here in Boston. The rest of the company was up in Vermont.

Govindarajan: Exactly. They were still leveraging some assets in [Vermont], which is how do you make a good cup of coffee, etc., but the Keurig itself was developing as a Box 3.

This goes to my lesson #3. They followed all the rules I suggested. The third important lesson is the three-box lesson. Three-box balance is not a one-time activity. It is a recurring, continuous, rhythmic activity. Where I fault Keurig is in 2012 when the patents expired on the K-Cup [coffee pod], they introduced a brewer version which would prevent anybody who simply copied the [K-Cup design] to make coffee in that brewer.

That, to me, is not Box 3. It was simply defending their Box 1, the Keurig system. This was a very successful, wonderful business model, [and it had] moved from Box 3 to Box 1 now.

Three Traps: Complacency, Cannibalization, Competency

InnoLead: I want to see if you could talk about two other elements of the book that I really enjoyed. One is the three traps that you talk about: the complacency trap, the cannibalization trap, and the competency trap.

Govindarajan: Those three traps are what keeps you in Box 1. The reason why companies go into the preservation mode is because of those three traps. One of the three traps, the competency trap, essentially says, “When you are successful in Box 1, you try to build competencies and perfect competencies that continue to make you successful in Box 1.”

If you’re highly successful, if you’re Hasbro and making board games, your human resource function requires more people who are good at making better board games, whereas that competency, almost by definition, is not useful for your Box 3, because Box 3 requires new competencies. Breaking out of that is what leadership involves.

The complacency trap is when you are successful in Box 1, you somehow assume it validates the past.

That’s what complacency’s all about. You interpret today’s success for validation of the past. Your think about future is to discuss to more of the past. That’s the complacency trap. The cannibalization trap is the fear that if you try something new it will destroy the machine that is paying big dividends for you.

The fact that you’re building defenses doesn’t prevent somebody else [from doing] that cannibalization for you.

These are the three traps. These are human cognition and feelings that trap you in the present.

‘Conflicts are Going to be There.’

InnoLead: I feel like a lot of people are trying to figure out what is the right structure to set up one of these “Future Now” kinds of teams, or innovation labs, or new R&D organizations. Is there a one-size-fits-all solution, or for every company is it going to be a different closeness to the headquarters, and a different composition of people?

Govindarajan: The answer is both. There are some generalizable principles I can offer for every company. How those principles should be applied is so contextual [that] there is no one formula. The three important principles in succeeding in Box 3 is, Principle #1, you must create a dedicated team for Box 3.

The dedicated team should be constructed for the job at hand, which is to build this Box 3 business. Therefore, it can have different people, different processes, different metrics. The dedicated team should be constructed differently than your Box 1 performance engine.

InnoLead: You don’t like the model of saying to employees, “Oh, you can have five percent of your time to think about the future.”

Govindarajan: No. That can be helpful in coming up with an idea, but it’s not helpful in executing. You must have a dedicated team. Principle #2 is that the dedicated team should have some separation from the Box 1 performance engine.

It cannot be isolated from the performance engine, because there are some assets on the performance engine that can benefit this dedicated team. The…dedicated teams should be connected to the mother-ship. When it is connected to the mother-ship, there will be tremendous conflicts.

Conflicts are real. Conflicts are going to be there. If there are no conflicts, you are either telling me you are in denial, or you’re telling me there is no connection between the dedicated team and the performance engine.

All of that is problematic. Therefore, the right approach is manage the conflicts down so that there is a partnership.

The third principle is that Box 3 is an experiment. It’s a bet on the future. Therefore, treat it as an experiment. Spend a little, learn a lot. Test assumptions one at a time. When you are testing assumptions, the golden rule is spend a little, learn a lot.

Keep the cost of experiment low in testing assumptions, because if the cost of experiment is low, the cost of learning is low. The cost of failure is low.

Funding the Future

InnoLead: The last thing I want to ask, just because you got me thinking about it, is, where does the funding come from for the future team? At a lot of companies we talk to, it’s like, “Oh, the future team comes up with an idea and they go to the business unit, and ask ‘Hey, do you guys want to fund this idea for us?'”

Govindarajan: This is a job of the CEO, whether you’re Jeff Immelt or Brian Goldner at Hasbro…They have three important jobs in this three-box solution.

Job #1 is when they ask for projects from the business units, they must say, “Give me your strategic plan separately for Box 1 and Box 3. Give me your initiatives, and put them in these two buckets.”

Principle #2 is, I’m going to allocate resources separately for these two buckets. Once they allocate resources for Box 3, they will be a protected class of resources. They’re not going to be redirected to Box 1 — ever.

Principle #3 is, I’m going to evaluate Box 3 differently than Box 1. Box 1 is the performance engine. Box 3 is an experiment, so it should be treated as an experiment. It should be [have] accountability for learning, not accountability for results. As a CEO, if you follow these three [principles], then the Future Now [group] doesn’t have to go begging [for funding] to a business unit. The funding comes from the top, and is earmarked for future.

Below is a video overview that Dartmouth’s Tuck School of Business created about the new book: