Embedded below is the video of a talk given by Dan Ariely, the author of Predictably Irrational, at a recent TED Conference.  It's worth watching.

I've always been a little wary of many who profess marketing expertise.  I think it's because I'm suspicious of anyone who makes claims of predictability in the context of any dynamic, social process.

On the other hand, I've been fortunate to work with some very fine marketers who a) understand that stimulating the sales of anything substantially new and different is fraught with uncertainty that cannot be resolved analytically and b) the best approach to resolving such uncertainty is through experimentation.  As Al Ries might say, experiment until you find a sales tactic that works, then build a marketing strategy around that tactic.

Mario Schulzke is such a marketer.  In new new blog, Scrappy Marketing, Mario writes:

To a lot of people, marketing is a science. I disagree.  Marketing is the ultimate science experiment.  While through learning and past experience marketers can make some pretty good guesses about what might work and what won’t, it ultimately comes down to testing a variety of different ideas and then scaling the ones that do work.

In order to run a successful marketing experiment, you have to be able to do two things. Test and Fail. Then repeat.

Nasim Taleb, the author of The Black Swan, offered this advice to managers of non-financial companies in a recent McKinsey Quarterly interview:

Be hyperconservative when it comes to downside risk, hyperaggressive when it comes to opportunities that cost you very little.  Most people have the wrong instinct.  They do the opposite...Don't fear being aggressive if that only costs you a little.  Do more trial and error.  Learn to fail with pride, comfort, and pleasure.  But try to have less downside exposure by building more slack into your system through redundancy, more insurance, more cash, and less leverage...My idea is to base your navigation on fragility.

His advice is grounded in his experience with, and careful analysis of, "black swans."  Per Taleb,

My black swan is an event with three properties.  Number one, its probability is low and based on past knowledge.  Two, although its probability is low, when it happens it has a massive impact.  And three, people don't see it coming before the fact, but after the fact everybody saw it coming.

Taleb and others have made the compelling case that "in the historical and socioeconomic domain, black swans are everything."  For example, the unexpected growth of the Internet and the sudden collapse of global debt, equity, property, and commodity markets are two such events--one positive and one negative--that have dominated the economy over the last decade. 

We can't predict black swans.  Nevertheless, we can be confident black swans will continue to occur.  What Taleb is saying is that we can do a better job preparing for their appearance.  That is, we can hedge against the unlikely, but potentially devastating, negative black swan while we make numerous, relatively small investments in opportunities that offer at least a small chance of a large reward.

For instance, the practice of open innovation has the potential to provide companies with the ability to make relatively small investments in highly uncertain, but promising, concepts for new products.  Most companies, however, under-invest in the possibility of catching a ride on the rare positive black swan and, as a consequence, are over-exposed to the rare, but potentially deadly, negative black swan.

Let me give you an example:

My colleagues and I know of a multi-billion dollar company that makes very common household products.  Its brands typically have a #1 or #2 market share.  Over the years, the company has grown through acquisition and assiduously cut redundant costs (such as R&D capacity).  Its manufacturing operations are efficient.  In other words, there is much to be admired about this company.

However, the company's management is anxious.  As the company has focused on efficiency, it has constrained its ability to experiment.  There is little slack in the system.  Consequently, the rate of new product introductions has been very sparse.  As its core products have matured, they have been commoditized.  Capable, private label competitors have taken market share.  Major retailers have consolidated their vendor relationships.  Volatile raw material costs drive margins.  Ominously, the company has seen a double-digit decline in the sales of its traditional, branded product line over the last several months.

With a leading position in mature, commodity markets, this company faces a lot of downside and probably not much upside.  Its manufacturing efficiencies are already top-tier; it has no market power over the cost of its raw materials; and the evidence clearly suggests that the power of its brand is rapidly eroding.

Betting on the resurgence of its core business might be a viable strategy.  On the other hand, it might make a lot of sense for management to hedge such a big bet by making several small investments in promising new products.  These could be internal R&D projects, licenses, investments in new ventures, and acquisitions of promising young companies.

However, the company seems to be closing its doors to such opportunities.  It has actually withdrawn new products from the market in order to focus on its core business.  In relative terms, management appears to have decided to eliminate low cost/high opportunity options in favor of "doubling down" on its existing businesses, which are (for the moment) large but offer little upside.

Like Taleb, we see this pattern of behavior repeatedly.  Uncertainty is confused with risk.  Managers inadvertently take risk under the false assumption that large investments in "proven" business are safe.  Most days they are right.  However, the black swan lurks, and tomorrow could be a disaster.  By investing solely in familiar businesses, management trades potentially crippling downside for limited upside.  Meanwhile, managers tend to be overly cautious when it comes to making small investments in uncertain, but promising opportunities.  Consequently, they fore-go the chance for transformational upside.

The execution of Taleb's advice requires courage, tenacity, and a system that supports continuous, inexpensive failure in the hunt for occasional, highly rewarding success.  It's the rare company that has what it takes.

Malcolm Gladwell's latest book, Outliers, is entertaining and well told.  His message isn't new, but the re-telling is worthwhile.

The essence of the book is that the incidence of success is a function of expertise and opportunity.  Both are shaped by dispositional and situational factors.  As a general rule, we tend to underestimate the time and effort it takes to develop true expertise and to undervalue the role of context (time, place, family, and culture).  Such bias too often leads to an under-investment in skills and the shaping of our environment.

As K. Anders Ericsson and others have revealed through their research, world class expertise requires 10 to 20 years of accumulated, deliberate practice.  Due to the powerful dynamics of feedback and accumulations, even small differences in initial endowments and conditions can lead to dramatic differences in outcomes.  After the fact, we are prone to attribute achievement with "talent" and "genius" and, in the process, fail to do justice to hard work and good fortune.

As much as I appreciate Gladwell's storytelling, it seems to me that he fails to appropriately highlight how the magnitude of success is subject to extreme variance of the "winners take most" variety (see Art De Vany, for instance).  While the cultivation of expertise can increase the chance of success, it does not guarantee success, nor is there a simple, causal relationship between the degree of expertise and the magnitude of achievement.  Such extreme variance seem to be the result of supply side factors (see Chris Anderson) and demand side circumstances (see Duncan Watts).

While we too often neglect situational factors in favor of attributions based on disposition (real and imagined), it's tough to observe, measure, and shape our situation.  We have no control over when, where, and to whom we are born, for instance.  While it sounds old-fashioned, the most direct ways for us to influence our success are dispositional:

• We can take responsibility for the cultivation of our own expertise.  Hard, sustained, self-critical effort is the key.  Don't demean the achievement of others, and don't let yourself off the hook, by too readily making attributions of superior talent.  Differences in endowments are real, but are too often excuses rather than reasons.
• We can learn humility.  Achievement and success is not random, but chance plays a much bigger role in our success and failure than most of us would like to acknowledge.  By being humble about our own successes, we might find it easier to sympathize with the failures of others.
• We can learn courage.  Years of deliberate, often painful, practice is required to compete.  That provides us with the chance of success, but guarantees nothing.  Even when we succeed, the skewed distribution of rewards often make it hard to perceive the difference between success and failure (ask the person who takes 4th place in an Olympic event).  It takes courage to persevere.  As Winston Churchill said, "Success consists of going from failure to failure without loss of enthusiasm."

It is convenient for us to attribute invention to an individual.  For starters, it takes less time in conversation.  My experience lately has reinforced my recognition of the inconvenient truth that invention and innovation is usually a complex and sustained social phenomenon.  In all but the most trivial cases:

• Somebody must identify an under-served need and propose a solution that is typically a recombination of technologies already in use in other contexts. So, even this most basic form of invention is historically contingent and, thus, dependent upon the prior work of others.
• An initial proof-of-concept prototype must be developed in the lab or workshop.
• "Works like" prototypes must be translated into near-production designs and made in "garage scale" in some kind of pilot plant.
• Full-scale production, for a new and different product, usually requires new kinds of production equipment and methodologies.
• Innovation is what people adopt.   New products very often require new packaging, distribution, sales tactics, and marketing strategies.
• Consumer acceptance is often the inherently unpredictable result of socially contingent decision making.

Innovation requires all of these things to happen. One person cannot do it all. There is no one inventor just as there is no one entrepreneur. Those of us who aspire to play a role in the process of innovation are well served by acknowledging these are labels of convenience.

Truly new and different consumer products are unavoidably characterized by uncertainty.  Consequently, making a major, irreversible commitment to the development, production, and marketing of such a product can be very risky.  On the other hand, new products represent desirable growth opportunities for companies in ever-changing markets.

So, how do companies manage risk and reward?  Unfortunately, it appears that most established companies, most of the time, avoid the risk, and fore-go the opportunity to create new value, through inaction.  In the face of uncertainty, they freeze.

Uncertainty is not the same thing as risk.  Risk is a function of the size of the bet made in the face of a given amount of uncertainty.  The odds of "winning" a game of Russian roulette are as high as 5 in 6, while the odds of winning the lottery are often less than 1 in a million.  The former is more risky.

A tried and true way to manage uncertainty is through phased investment  That's the way venture capitalists manage risk; they make a series of  investments as uncertainty is resolved.  High uncertainty-low investment rounds (sometimes) lead to lower uncertainty-higher investment rounds.  In other words, VCs invest in a series of call options:  the right, but not the obligation to make subsequent investments in growth opportunities over time.

There are at least two keys to using phased investments to manage risk:

• The size of each bet should be relatively small when compared to the potential size of the prize.
• To be an option, the holder/investor must be willing to abandon the right to make subsequent investments in the growth opportunity.  You have to be willing to walk away.

Most big companies, however, can't seem to even contemplate the prospects of abandoning a once-promising growth option (particularly one that looked very promising a scant few months previously).  As a result, they can't effectively implement phased investment.  That typically leaves them with a binary approach to dramatically new products:

• Do nothing.
• Make a big, blind commitment in the face of high uncertainty and hope for the best.

In that context, it's not surprising that conscientious decision-makers opt for the status quo.

I suspect that there are at least three reasons that established companies find it hard to manage risk in high uncertainty situations through effectively phased investment:

• Companies recruit smart, analytical, and conscientious employees, and the best become decision-makers.  They don't like to fail, and they don't like to quit.  Wait a minute...aren't those strengths?  Of course they are, but those same employees can be the least prepared to deal with failure of any scale or scope.  And, many small failures are the price of entry to a strategy of phased investment.
• Most big companies are hierarchical.  Hierarchy can help a big organization move quickly when need arises.  But hierarchy can also mean that the rewards of success and costs of failure are distributed asymmetrically. 
• Established companies, particularly public ones, tend to use net present value (NPV), variations of the capital asset pricing model (CAPM), and other related tools to estimate "shareholder value."  Implicit in these tools, however, is that investments are commitments.  Increased uncertainty means a higher discount rate, which decreases the present value of future cash flows.  But that understates option value, which increases in the face of uncertainty.  Consequently, these valuable tools can lead to systematic under-investment in early stage growth options. 

Discouragingly, it's a rare organization that can effectively apply a staged investment approach to new product development. I suspect that it takes courageous senior management who will commit to investment in numerous growth options over time, are willing to walk way from sunk costs without regret when uncertainty is resolved unfavorably, and who will, in effective, take the heat for unavoidable losses in order to enhance the organization's chances to identify winning growth options over time.

A couple of years ago, researchers at the University of Amsterdam made a rather startling assertion:

Contrary to conventional wisdom, it is not always advantageous to engage in thorough conscious deliberation before choosing...

Although we investigated choices among consumer products in our studies, there is no a priori reason to assume that the deliberation-without-attention effect does not generalize to other types of choices--political, managerial, or otherwise.  In such cases, it should benefit the individual to think consciously about simple matters and to delegate thinking about more complex matters to the unconscious.

(Dijksterhuis et al, "On Making the Right Choice: The Deliberation-Without-Attention Effect," Science, Vol 311, 17 February 2006, 1005-1007.)

One science editor summarized (and elaborated a bit, on the way):

Scientists have discovered the best way to make a decision is to collect the information you need, forget about it, and then trust your instincts to get it right.

Many of us find that hard thinking about complex decisions is, well, hard.  So the idea that we'll make better decisions if we just go with our gut or, better yet, take a nap has some appeal.  Unfortunately, we may not be off the hook:

Neither snap judgments nor sleeping on a problem are any better than conscious thinking for making complex decisions, according to new research.

The finding debunks a controversial 2006 research result asserting that unconscious thought is superior for complex decisions, such as buying a house or car.  If anything, the new study suggests that conscious thought leads to better choices.

Do the hard work of critical thinking; get a good night's sleep; make a decision; and act.  Don't worry, there will be a new, difficult, complex decision to face tomorrow.

Over the weekend, Andrew Hargadon made one of his typically thoughtful observations:

Anything can be hard work if you let it: running in circles can take just as much time and energy as moving forward. And in this way, most perspiration in innovation is misplaced—spent perfecting what inventors and entrepreneurs are already comfortable working on. If they're engineers, that means perfecting the mousetrap; if they're managers, it means more planning. Hard work, but not necessarily the right work for turning a new idea into a new business.

One of the core principles in the Business Development Programs at the Center for Entrepreneurship is to instill in our science, engineering, and business students a bias for action. That means, first and foremost, identifying the right actions: the activities that will move a new venture forward rather than run it in circles.

In a post titled The E-Myth, Uncertainty, and the Evolution of Entrepreneurs, I noted the importance of thinking and acting, a trick that is made doubly difficult by our propensity to do that with which we are most comfortable.  We tend to stick with what we know and do what affirms our personal sense of competency.  So, analysts analyze, and engineers engineer.  We fail to close the learning loop: observe-orient-decide-act.  Effective learning requires that we make iterative trips around the learning loop.

Nevertheless, in the context of innovation, I believe that Hargadon's emphasis on action is appropriate.  Companies, in particular, are staffed with capable analysts and managers skilled in observing-orienting and (sometimes) deciding.  However, when something is truly new and different, there is little valid data to analyze—data has to be generated through experimentation.  Unless we generate valid information, we're just sculpting fog.  Resolving uncertainty, learning, and progress require a bias for experimental action.  Action primes the pump and makes our analysis and decisions more effective.

I just finished an entertaining new book, The Drunkard's Walk: How Randomness Rules Our Lives, by physicist Leonard Mlodinow.  Besides reminding me of my inability to assess probabilities, The Drunkard's Walk touches upon some familiar themes regarding uncertainty, highly variable outcomes, and psychological bias.

"[F]or the sake of their own santity," people overestimate the degree to which ability can be inferred from success...

"[M]any of life's failures are people who did not realize how close they were to success when they gave up"...

What I've learned, above all, is to keep marching forward because the best news is that since chance does play a role, one important factor in success is under our control: the number of at bats, the number of chances taken, the number of opportunities seized...

[W]e ought to identify and appreciate the good luck that we have and recognize the random events that contribute to our success...[A]ppreciate the absence of bad luck, the absence of events that might have brought us down, and the absence of the disease, war, famine, and accident that have not--or have not yet--befallen us.

In the new product invention and development game, we can become more skilled and work more effectively with time, practice, and effort.  Competence will improve the odds of success, but guarantees nothing.  The quality of inventions may be distributed more or less normally.  However, in many or most consumer markets it seems that market rewards are highly skewed.  In this business, persistence in the face of failure and humility in success are admirable traits.

I first came across Mlodinow's writing a couple of years ago, when I read an article he had written about how Hollywood genius is ephemeral.

The widespread adoption of a new product can be agonizingly slow for at least a couple of reasons:

• Users tend to be biased toward the status quo, which means that a prospective innovation typically must offer a compelling relative advantage.
• The perception of advantage is a function of familiarity.

Innovation is a hard game, in part because it tends to require insight and superior product design and manufacturing execution and effective marketing.

My friend and colleague, John Funk, is living that multi-dimensional challenge.  Recently, he formed Long Tail Pet Products to launch the DogPause bowl, the healthy dog bowl for dogs that eat too fast (based on an invention developed by, and licensed from, our firm, Evergreen Innovation Partners).

The 9X Effect

In Eager Sellers and Stony Buyers, John Gourville asserts:

There's a fundamental problem for companies that want consumers to embrace innovations: While developers are already sold on their products and see them as essential, consumers are reluctant to part with what they have.  This conflict results in a mismatch of nine to one between what innovators believe consumers want and what consumers truly desire..

In part, that's because prospective consumers are reasonably satisfied with the status quo and, consequently, fail to see the need for the new product.

Noticeable Difference

The 9X effect seems to hold true even when the new product really does offer a dramatic difference in performance.  That is, of course, because the difference has to be perceived before it can motivate a change in the behavior of consumers.  Because most consumers won't be intimately familiar with the context for which the new product is designed, they are less likely to notice an actionable difference.

Bill Buxton of Microsoft Research explains:

I've decided to name a new law "GGR," or the law of gradual granularity refinement...JND significance ~ 1 / familiarity.  The term JND (just noticeable difference)...asks, "What is the smallest level of differentiation that you can perceive as being significant?"  The tilde character (~) means "varies with."

Hence, the law says that the granularity at which we distinguish meaningful differences gets finer the more our familiarity with a subject grows.  Conversely, it also says the less familiar we are with something, the coarser the granularity will be before we can distinguish differences as being significant.

So, we aspiring innovators face a dilemma:  In order to increase the odds of breakthrough success, it helps if we identify and develop products that are really new and different.  However, because of the their newness, prospective buyers won't be familiar with such products and are, consequently, less likely to notice an actionable degree of difference on their own.  That means we have to find creative ways to accelerate familiarity.

Reasons to Believe

Doug Hall has deconstructed the elements of effective marketing communication into a framework he calls marketing physics.  Assuming a clearly articulated benefit (e.g., "The Healthy Dog Bowl"), it is the marketer's responsibility to provide real reasons to believe the claim.  After all, what makes the DogPause bowl healthy?  Does the bowl offer enough of a difference to my dog's health to matter to me enough to buy the product?

Big companies have an advantage in that they have the capacity to use mass advertising to build consumer awareness of a new product's difference.  On the other hand, as Amar Bhide has shown, that capacity has a high opportunity cost, and opportunity cost translates into risk, which tends to inhibit big company's willingness to launch really new and different products.

Small companies (like Long Tail Pet Products) are more likely to launch new and different products, but they don't have the resources to launch carpet-bombing marketing campaigns.  Guerrilla marketing is more their style, but it can take longer to achieve results.

Check out the DogPause web site to see how John is using the elements of kitchen logic, personal experience, pedigree, testimonials, and a guarantee to provide reasons to believe in order to accelerate consumer's understanding of why the DogPause bowl deserves to be purchased.  Here is a sample: