Innovating at Scale in a Successful Company

Large successful organizations have a hard time creating large scale innovations. When a company’s on the brink of death, they entertain many radical alternatives, but economic health is the enemy of change — which is one of Microsoft’s great problems.

Ray Ozzie, now the Chief Software Architect of Microsoft, was at Lotus development when they dominated PC software. According to my friend and Diamond Fellow, David Reed, Lotus was making a lot of money and investing in R&D, but Ozzie wanted to build his own start-up. Because Ozzie had delivered Symphony, an updated version of the 1-2-3 software, Mitch Kapor agreed to help Ozzie find the funding. By late 1984 Ozzie founded Iris corporation, backed by Lotus, because he was convinced that groupware would transform business.

There were a number of interesting features of the deal. First, Lotus agreed to fund Iris’s development efforts as long as Iris was using a best efforts basis to develop the software. Second, after Iris declared the product to be substantially complete, Lotus had a brief window in which to exercise their option. Exercising the option meant that Lotus agreed to pay Iris a pre-negotiated per copy royalty on product sales. Third, Lotus committed to market the product on a best efforts basis — which at the time meant a very big, and legally binding commitment from Lotus. It also meant, that Lotus could not simply buy the option and then kill the Iris product.

This deal structure was radically different than any internal innovation which I have every heard of, and I think there are some very important institutional innovations which Microsoft could learn from.

• First, by structuring the innovation as a separate entity with ownership of the intellectual property, it meant that the funding probably came from the board out of the capital budget, not the operating budget. It took Ozzie longer to develop the product and the market took longer to gestate than he anticipated. Like many innovators, he was a bit too early. If he had been inside Lotus and had been part of the operating budget, this mis-timing might well have have killed the project. His management probably would have been asking for the promised revenue, and his investment level would likely have been cut.
• Second, by being in the capital budget and probably at the board level, he had a completely different organizational dynamic. Each time the senior Lotus executives considered halting the funding, they had to decide if they were willing to let Ozzie and his team take their intellectual capital to a competitor, like Microsoft, and live with their implications of abrogating their contract with Iris. This unleashed the fear that they might regret not investing in this innovation by Ozzie. We know that regret is a much more powerful motivator than fear, as behavioral economists — including Dan Ariely one of our Diamond Fellows — have shown so eloquently.
• Third, by getting Lotus to agree to market Notes on best efforts basis, and simultaneously holding onto the intellectual capital in Iris, the structure removed the development risk from Lotus and it was better for them to spend significantly in the product launch for an already created innovation. Together, these aspects of the deal structure created the organizational equivalent of burning the boats of an army invading from the sea.

Today, the ecosystem for software is much more developed than when 1-2-3 was in its heyday. Nowadays, Microsoft has ample budget to fund internal R&D, something that Lotus did not have, and as far as I know Ozzie is working within the normal operating processes of Microsoft. Even in this more developed ecosystem, I’d suggest that Microsoft could benefit from innovating new ownership structures that might help create institutional momentum behind large innovations. For starters, I’d suggest Microsoft create three separate entities which would be structured just like Iris. They would be independent entities and Microsoft would have the right to fund them, but if they did not fund them, the little firm could walk with the intellectual property. If MSFT did exercise its option to buy them, they would have to spend $100,000,000 or more launching the new product. Here’s three potential areas to create these new companies:

1. a mobile solution company, to compete with Google and Apple;
2. a company for their promising Microsoft Surface product, which could reinvent common spaces;
3. a company to do new types of search. Bing is too tied to the core business.

If they were willing to perform these institutional innovations for ownership and investment, maybe Ozzie could work his magic again. What do you think, could it work?

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Dr. John J. Sviokla tries to help people think differently about the realm of possibility while being sympathetic to the practical realities of economics, organizations, and human nature. He has been a professor at a number of places including a 12 year stint at Harvard Business School; a consultant, for the past 11 years at Diamond Management & Technology Consultants; a frequent speaker, author and advisor to companies large and small.