Economics For Entrepreneurs: Entrepreneurial Initiative Beats Corporate Innovation Process Yet Again. When Will They Ever Learn?
According to the Wall Street Journal, Altria, maker of Marlboro and other cigarettes, is planning to invest in Juul, maker of a cigarette alternative which vaporizes nicotine-containing liquids. These devices are often called “vapes” and the practice of using them, “vaping”. A company dedicated to addicting people to smoking burning tobacco is now adding to its portfolio a company dedicated to terminating that addiction. At the same time, Altria has made a $1.3 billion investment in Canadian cannabis company Cronos Group, Inc. It will all make for interesting portfolio management.
However, for entrepreneurs, the most important aspect of the investment combination of Juul and Marlboro is what it tells us about innovation and who is capable of delivering it. Altria has been aware for a long time of the evidence that the long term future of the cigarette market is threatened by external trends, including the subjective lifestyle preferences of consumers (and the non-consumers who dislike the “second hand smoke” problem), but also including regulation, taxation and the resultant deterioration in the price-value proposition.
Faced with such negative long term trend signals, the good and wise corporation, prompted by the business school community that has populated the executive ranks in addition to marketing its tools through consulting, seminars and books, initiated an internal innovation process. This produced the idea of so called e-cigarette products, like MarkTen and Green Smoke, devices in which tobacco is heated but not burned, which purportedly makes smoking less risky. The process also produced a device called iQOS, developed in partnership with Philip Morris International, which is a sister company spun out of Altria to sell cigarettes in international countries outside of the glare of the US legal profession and its alliance with state and federal regulators.
Philip Morris International took the lead in marketing iQOS and claimed some early success in Japan, so much so that the company diverted significant resources from conventional cigarettes to the heat-not-burn “breakthrough”. After initial growth, Motley Fool in October 2018 reported “disappointing earnings” at Philip Morris International attributable to a “significant slowdown in the e-cig’s primary market, Japan”. Motley Fool reported some early trial among a younger demographic, but “a wall of resistance among older cigarette smokers”.
It looks as though Altria has seen the warning signs as an indication of failed corporate internal innovation, and has swerved to the alternate lane of acquisition of the innovative ideas of external independent entrepreneurs.
Its investment of $12.8 billion for a 35% stake in Juul Labs Inc suggests a roughly $38 billion valuation, making Juul one of the most valuable private companies. The Juul team has created this much value in about three years, while Altria and Philip Morris international were destroying value in their failed attempts at internal innovation.
The Failure Of Centrally Planned Innovation Processes.
They should have known. Corporate innovation processes are doomed to failure. That’s because innovation is not a process. It can’t be centrally planned by executive wing geniuses, no matter how much they spend on consulting and business school seminars. Innovations like Juul are emergent results of marketplace experimentation by entrepreneurs and consumers. The consumers become dissatisfied with the current set of offerings available to them — that particular phenomenon is strikingly apparent in the cigarette market. They begin to experiment with alternatives — they might try nicotine chewing gum, or patches, or snus (tobacco pouches placed in the mouth) or even iQOS. They are not yet declaring their loyalty to a new solution, but simply looking round at alternatives.
Entrepreneurs are dissatisfied with the supply side of the market. They sense the consumer dissatisfaction and match it with their producer dissatisfaction. They, too, experiment. There have been many such producer experiments in the cigarette market, and Juul is the one that has, for the moment, risen to the top. Why? It’s usually random luck combined with a co-creation collaboration with the consumer — continuously adding and changing features and attributes and measuring consumer response until the best combination emerges. There are so many experiments among so many producers and so many consumers that one combination eventually emerges as the most preferred. The outcome can not be predicted, it can’t be modeled, and it can’t be managed. The genius of the market is that all of the failed experiments result in very small losses and a lot of learning. The one successful experiment eventually incorporates all the learning, attracts a large number of customers, creates a lot of value in a short period of time, and generates a huge amount of economic progress far in excess of the losses from the failures.
The scale and reach of this experimentation, the rapid exchange of knowledge and learning in the network of entrepreneurs and consumers, the flexible adaptiveness that allows for the rapid abandonment of the resources committed to failed paths and the agile transfer of resources to the path of success, can not be matched by a centrally planned corporate innovation process. Decision-making in hierarchical structures can’t reproduce the emergent properties of interconnected knowledge-sharing networks. Processes with their stages and gates can not compete with the spontaneous order of free experimentation. Corporate investment guidelines can not compete with entrepreneurial risk-taking.
The Future Of Innovation Lies With Interconnected Individuals.
The future of innovation lies squarely in the initiatives of the independent, interconnected entrepreneur. As new technologies like A.I. and global idea exchange platforms augment individual capacity, the trend towards individually ideated innovation will accelerate.
This does not mean that corporations will not try to suppress it rather than adopt it. Glaringly, in a follow-up report in the Wall Street Journal, we learned that one of the results of the Altria investment in Juul will be collaboration between the two companies’ regulatory teams. Speaking of cronying up to government regulators, the Altria CEO was quoted as saying, “We have years of experience” in such regulatory negotiating and another spokesperson spoke proudly of Altria’s possession of “a level of sophistication they (Juul) need”.
This reveals a downside of capitalism. Altria has enough money to invest in Juul Labs, and enough left over to smother it in corporate process and bind it with regulatory collaboration. While there is no inherent objection to scale, it usually brings with it the insidious integration with government that is anathema to further economic progress. Not to worry; the independent entrepreneurial network will nurture new innovations through its experimentation and co-creation activities faster than incumbent corporations can capture the emergent value through M&A.
Originally published at Center for Individualism.