Meet the Steve Jobs of the Sap Industry

 01

SAP at 50: The software group is at a crossroads

These days, the town of Walldorf is not really in the mood to celebrate — even though the managers of SAP, which is headquartered there, have every reason to do so. After all, the software giant can look back on 50 years of successful company history. On April 1, 1972, five former IBM employees — Claus Wellenreuther, Hans-Werner Hector, Klaus Tschira, Dietmar Hopp and Hasso Plattner — launched SAP Systemanalyse und Programmentwicklung GbR. The foundation stone for the largest and most successful European software manufacturer was laid.

Half a century is an eternity in the otherwise fast-moving IT and software business. New technologies can sweep established providers from the market overnight and allow new players to rise meteorically. SAP has weathered all the changes and storms on the market and has held its own to this day. As a result, the German software manufacturer plays in the premier league of global IT providers and can even look back on a longer history than the software giants Microsoft (founded in 1975) and Oracle (1977).

So the company should be in party mood for its 50th birthday. However, the current global crisis is putting a damper on SAP’s celebrations, particularly since the software company was quickly caught up in the maelstrom of war following Russia’s brutal attack on neighboring Ukraine, which violated international law. The call for help from the Ukrainian government, led by President Volodymyr Zelensky, also went out to the world’s major software manufacturers — including SAP. Ukraine urgently called on Microsoft, Oracle, SAP, and others to cease doing business in Russia and thus stop supporting the war machine of Russian autocrat Vladimir Putin.

The appeal met with a sympathetic hearing at SAP. Chief Executive Officer Christian Klein strongly condemned the Russian assault: “An act as inhumane and unjustified as this is an attack on democracy and humanity,” he said in early March. “Its consequences affect us all.” Klein stressed the importance of economic sanctions against Russia. “We are in constant exchange with governments around the world, have every confidence in their guidance, and fully support the actions taken so far. We are stopping business in Russia and Belarus aligned with sanctions and, in addition, pausing all sales of SAP services and products in Russia.”

However, the leadership in Walldorf also seemed somewhat overwhelmed by the war situation and the publicity it was generating. The phones wouldn’t stop ringing after Zelensky approached SAP directly, insiders report. Discussions were raised about how far the consequences should go. To shut down the SAP cloud there? What about facilities such as hospitals or drug manufacturers in Russia that run SAP software? Drawing a clear line here was apparently difficult for SAP management. But in view of the brutal actions of the Russian army, the pressure was mounting. That’s why SAP stepped up its game once again and announced at the end of March that it would also discontinue its cloud operations in Russia.  

The software provider announced that it would continue to support the Ukrainian government and aid organizations with its own products. In addition, SAP has already collected more than €3 million in donations. More than 4,000 SAP employees have offered housing and other assistance to refugees from Ukraine. SAP also plans to provide office space to store donations such as medicine and food. “We stand united alongside the global community in all efforts to end this unjust war in Ukraine, and we continue to do everything we can to restore peace,” is the clear message from Walldorf.

Economic uncertainty

However, this may take time. Initially, economic uncertainty is likely to shape future business. Indicators including Germany’s ifo Business Climate Index, consumer sentiment and the forecasts of economic experts on growth prospects in Germany and worldwide are pessimistic. Exploding energy prices, repeatedly interrupted supply chains (as is currently the case due to the COVID-19 shutdown in the Chinese metropolis of Shanghai) and collapsing markets are all currently causing concern, and not just for SAP management.

The Walldorf-based company’s business is still stable, even though growth rates have recently been rather meager. Last year, the manufacturer took in a good €27.8 billion (around US$32 billion) and posted a profit of €5.4 billion — both figures represent an increase of just two percent compared to the previous year’s result. Other software manufacturers, such as Microsoft, Salesforce and ServiceNow, posted double-digit growth.

So there are certainly plenty of reasons to find fault with these figures. However, it should not be forgotten that SAP has an unparalleled growth story to tell over the decades. The only interruptions were during global crises: in 2003 after the bursting of the dotcom bubble (a drop of 5.2 percent in sales), in 2009 during the global economic crisis that followed the Lehman bankruptcy (a drop of 8.5 percent) and in 2020, the first year of the COVID-19 pandemic (a drop of just 1.1 percent).

Since 2000, SAP’s annual revenue has more than quadrupled. Profit even increased by a factor of nine during this period. The number of employees has exploded from just over 24,000 to more than 107,000. In Europe and Germany, no other software manufacturer can hold a candle to SAP. The number two in Germany, Software AG, has been trying for years to finally crack the magic mark of one billion euros in annual sales — so far without success. The entry of Silver Lake as one of its investors at the end of 2021 should now give the Darmstadt-based company the necessary momentum.

Even extending the comparison to Europe, the next largest software manufacturers are nowhere near SAP. The French Dassault Systèmes recently achieved annual sales of just under €4.9 billion euros, while the British Sage Group came in at around £1.85 billion (around $2.5 billion).

Worldwide, however, others have their noses in front. The world’s largest software manufacturer, Microsoft, generated revenue of around $168 billion in fiscal year 2021, which ended in the middle of last year. SAP’s arch-rival Oracle most recently achieved annual revenue of just over $40 billion.

Structural change

Overall, however, the entire software industry is undergoing profound structural change. The cloud and associated usage-based subscription models are gradually replacing the classic license-maintenance business. Oracle boss Larry Ellison boasted several years ago that he could achieve a profit margin of more than 80 percent with software maintenance alone. This did not go down well with many Oracle customers, who had to pay large sums to the company year after year for the maintenance and further development of their software solutions.

With the cloud paradigm, other players are preparing to reshuffle the cards in the global market for business software. A group of software providers that have grown up with the cloud and are not carrying legacy burdens are challenging the incumbents. These include companies such as Workday with its business software in the cloud, workflow specialist ServiceNow, and Salesforce, which started out as a CRM provider and has really annoyed the old software giants with its no-software tagline. Salesforce has been successful too: It has been growing at an unprecedented pace in recent years and has long been breathing down SAP’s neck. It is currently targeting annual sales of $32 billion (€29 billion). SAP wants to achieve revenue of €29.5 billion in 2022.

SAP is still struggling with the move to the cloud, even though the topic has been on the agenda of the German software company for almost two decades. Even the beginnings were complicated. After the turn of the millennium, it became clear that software would have to be structured differently in the future. It had to be modular, a new generation of business applications, flexible and usable via the Internet, based on the new concept of service-oriented architectures (SOA).

SAP launched a mammoth project, with Shai Agassi and Peter Zencke at the helm. The industry was soon abuzz with speculation about Project Vienna and the new A1S product. Sometimes it was said to be software for SMEs, then a modular construction kit for the entire SAP portfolio. In the end, there was much confusion. Disputes between the veteran SAP manager Zencke and the young Agassi, who had joined SAP with the acquisition of the Israeli software startup TopTier and quickly climbed the hierarchy under the wing of co-founder Hasso Plattner, threw the whole project into disarray. Timelines and costs got out of hand.

As a result of these experiments, SAP presented Business ByDesign in 2007, a standardized on-demand ERP package aimed primarily at small and medium-sized businesses. However, technical difficulties and performance problems ensured that the software never really got off the ground. SAP is said to have wasted billions on the development. In 2013, the company finally announced that it would realign its development resources. Business ByDesign disappeared into oblivion. The first cloud attempt had failed.

SAP now pooled all its resources for its new flagship product, the in-memory database HANA, which was to establish itself as the new foundation for the company’s entire software world in the coming years. Previously, SAP’s ERP installations had always required an external database system, mostly Oracle or DB2 from IBM, much to Plattner’s chagrin. Now the software group was able to counter this with its own powerful product and put an end to this dependency.  It also laid the foundation for the new cloud-based product suite, S/4HANA, which was presented to customers at the beginning of 2015 as the successor to the popular Business Suite.

A turning point

The global financial crisis following the Lehman bankruptcy and the first attempts at walking in the cloud marked a turning point for SAP. In the first decades, product and management development proceeded in a calm and orderly manner. The 1980s were marked by the R/2 software generation designed for mainframes, followed by the R/3 client-server system that dominated the 1990s.

In all those years, the founders kept a firm grip on the helm — Dietmar Hopp as CEO from 1988 to 1997, followed by a transitional year with a dual leadership until finally Hasso Plattner took the helm. He immediately brought his protégé Henning Kagermann into the leadership team, and remained in control until 2003. After Plattner’s retirement to the Supervisory Board, Kagermann steered SAP until 2009 — briefly together with his designated successor, the former head of sales Leo Apotheker.

The handover to Apotheker marked the beginning of turbulent times in Walldorf, the aftershocks of which can still be felt today. The new SAP CEO raised maintenance fees virtually overnight, sparking a customer revolt that ultimately cost him the top job at SAP after less than a year. In his wake, two managers from outside Germany took the helm for the first time: the extroverted U.S. marketing specialist Bill McDermott and the quiet Danish technology expert Jim Hagemann Snabe.

With McDermott, who became SAP’s sole CEO in 2014 after Snabe stepped down, the cloud strategy changed: The American dug deep into his pockets and bought one cloud provider after another. Between 2011 and 2018, SAP spent a total of more than $26 billion on SuccessFactors (human resources), Ariba (purchasing network), Concur (travel expense management), Callidus (customer management) and Qualtrics (experience management).

Clash of developers

However, the volume and speed of acquisitions overwhelmed the organization. The heads of the acquired cloud companies who were supposed to show the German software giant the way into the new age — Lars Dalgaard (SuccessFactors), Robert Calderoni (Ariba) and Concur founder Steve Singh — threw in the towel one after the other. This was in part due to the fact that different cultures clashed here: On the one hand, there were the startups, who were willing to settle for an 80 percent solution to keep up the pace; on the other, there was the development team in Walldorf, which was geared toward German engineering precision.

SAP is still working on integrating the many cloud purchases — partly because customers keep demanding it. But the cloud products are still orbiting independently like satellites around the SAP gravitational core.

There have also been massive changes in that SAP core. At the beginning of 2015, SAP introduced S/4HANA, a new product generation that users can choose to run on-premises or in the cloud, private or public. However, the change is still proving to be a tough one. Users have often invested large sums in their existing SAP landscape — the Business Suite and ECC products. So why switch, many ask themselves. Many find it difficult to make a business case for such an elaborate project. Migration would be expensive and take years.

In addition, not all companies want to move their new SAP system to the cloud. The vast majority prefer to remain in their own data center. Attractive offers such as “Rise with SAP” do little to change this. The company introduced the initiative at the beginning of 2021. The intention behind it was to make it easier for customers to move to the cloud with an integrated product and service package and a single contact and contractual partner, namely SAP. How the whole thing is ultimately supposed to work is still unclear to many users, as surveys by the German-speaking SAP User Group (DSAG) have shown.

So all in all, the S/4HANA train is having a hard time getting rolling. When users do get going, it is often of necessity because the end of maintenance for the predecessor software is in sight. The new release is not really generating enthusiasm.

Necessary change

If it wants to continue to play a significant role in the business software market in the cloud age, it will have to change. The days when the SAP system alone was the heart of corporate IT are over.  Today, users want to use the best software from different providers in order to be fast and flexible. Infrastructures are becoming more and more diverse, including on-premises components, a rapidly growing cloud component and, increasingly, computing power at the edge.

SAP has not yet definitively found its position in this new world. The Walldorf-based company never tires of emphasizing how important the cloud is for its own future. But as a provider of cloud infrastructure, they do not play a role in the market. Years ago, like so many competitors, SAP tried to position its own cloud offering. But SAP could not keep up with the pace and investment power of hyperscalers such as Amazon Web Services (AWS) , Google and Microsoft. Today, the German software house cooperates with the major cloud providers, and anyone who wants to can run their S/4HANA solution in their data centers.

Most companies are currently in the middle of the digital transformation. SAP urgently needs to find an answer to the question of how its own software should help its customers in this process. Recently, customers have repeatedly expressed doubts about this. SAP is still important as a backbone in the ERP engine room to keep the company running. But the music of digital transformation is playing elsewhere — not in financial accounting, order processing or materials management, but at the customer interface, the customer experience and workflow management.

SAP has an open flank at these points. In recent years, it has been too busy with the consolidation work following the McDermott era. At the end of 2019, the U.S. executive unexpectedly stepped down from his chief executive post at SAP. The personnel turbulence approached its climax. At the beginning of 2021, Chief Technology Officer Bernd Leukert turned his back on the Group. Shortly thereafter, another long-serving SAP manager, Robert Enslin, announced his departure in April.

A new generation

This marked a generational change. A new guard of young managers had taken the helm in 2019. Christian Klein, 39, was the youngest manager ever to head a one of Germany’s largest publicly traded companies. With Jürgen Müller (37 years old) and Thomas Saueressig (34 years old), young managers took over technology and product development. But since then, there has been no sign of peace in the boardroom. Jennifer Morgan, who had been appointed co-CEO with Klein, had to leave after just a few months. The highly acclaimed and publicly praised appointment of a woman at the top of SAP was thus once again history.

Meanwhile, the exodus of the old generation of SAP managers continued. In February 2020, SAP veteran Michael Kleinemeier and, surprisingly, Chief Human Resources Officer Stefan Ries took their leave. In the latter’s place, SAP brought in Sabine Bendiek, who had previously been responsible for Microsoft’s German business. In the middle of last year, Bendiek took on the post of Chief Operating Officer (COO) in addition to HR responsibility.

Shortly before the company’s 50th birthday, the next surprise followed. CFO Luka Mucic announced his departure, causing quite a bit of irritation on the market. Mucic was regarded as a stability factor within the SAP management team and as the foster father of CEO Klein. Insiders speculate that the manager had to take the blame, sacrificed among other things because of mistakes in the cloud strategy.

Now the youngsters have to prove themselves. How much time they get to set the SAP tanker on a new course will depend on the patience of investors and the protective hand of Hasso Plattner, who is still pulling the strings in the background. The financial markets are looking at SAP with a certain amount of nervousness, especially since Elliott Management, a hedge fund whose head Paul Singer is not exactly known for treating managers with kid gloves, has been sitting at the table since 2019.

In any case, the share price doesn’t really want to take off. After peaking at around €140 in August 2020, the stock plummeted to around €90 in October when Klein had to abandon the growth targets of his predecessor McDermott. Since then, there have been ups and downs.  In the fall of 2021, the share price again reached almost €130, but is currently hovering around €100.

Give and take

SAP CEO Klein is in a dilemma. He needs a future story to be able to surf the wave of digital transformation. At the same time, he has to do his homework and reorganize the existing portfolio. Users have been nagging SAP for years to ensure better integration of the individual software components and data harmonization. In addition, there is still some confusion about the products and their functions. This ranges from the technical basis — NetWeaver, SAP Cloud Platform (SCP) and today Business Technology Platform (BTP) — to the applications, where it is still not entirely clear what the differences are between the various editions of S/4HANA — on premises, private and public cloud.

Klein has promised to meet the needs of his users. From the beginning, he stressed the importance of maintaining a good relationship with his customers. He pointed to SAP’s early days, when developers co-developed the first software versions in customers’ data centers. He wants to revive this spirit. What is good from SAP’s point of view is that many customers depend on SAP and show great patience with the company.

DSAG, the user group, is celebrating its 25th birthday this year, and emphasizes the spirit of partnership as it looks to a shared future. “It’s a constant give and take,” said one greeting on the special anniversary, “and that’s what makes our collaboration so successful. Here’s to another exciting 25 years!”

Translated from an article in our German sister publication, Computerwoche.

02

Unleashing Breakthrough Innovation in Government

(Illustration by Dan Page) 

The innovators who shake up industries the most do so by reimagining how things should look from the ground up. Apple co-founder Steve Jobs imagined a world where everyone owned a computer, not just the corporations that could afford an IBM mainframe. Twitter cofounder Evan Williams imagined a world where everyone could publish content on the Internet, not just the media companies who could afford expensive Web publishing programs.

Incremental innovations occur everywhere, but breakthrough innovations—the kind that leverage new technologies and business models to drive down costs, increase accessibility, and improve services—have tended to remain the province of the private sector. Returnseeking investors and entrepreneurs reap the financial rewards of changing the world by tearing down the structures of old industries.

Fortunately, that type of innovation is beginning to trickle into government as well. Leaders inside the public sector are slowly learning to pursue these major breakthroughs without the benefit of the profit motives that drive entrepreneurs elsewhere. Take, for instance, an innovation pursued in the US capitol by the District of Columbia Department of Transportation (DDOT). The agency envisioned a time when the city would no longer need traditional, coin-operated parking meters and the expensive employees required to collect the coins. In its place, DDOT would create a system in which people simply hit a “pay-my-meter” button on their Internet-connected phones. The system would be easier for drivers to use (no more carrying around bags of change) and less expensive for the city to operate. Despite these obvious benefits, the improvement would also require the city to migrate away from an established system that employed many workers and relied on existing infrastructure—the type of situation that has long made it difficult to implement innovations in the public sector. To the surprise of many, DDOT’s two-year endeavor was successful. In a sector known for special interests, unions, and a lack of competition, the agency successfully pioneered a model that embraced new technology to improve convenience for citizens and drive down costs for the city.

All too often, this kind of success has not been the outcome. Many citizens believe that the public sector is incapable of such innovation because of the absence of competitive forces, lack of incentives for employees, and excessive red tape. And ordinary citizens are not alone in their concern. Government leaders and employees are quick to point toward systemic problems such as outmoded human resources systems, a budgeting process that rewards extraordinary performance by reducing future resources, and burdensome request for proposal (RFP) systems as explanations for their lack of change.

For many reasons, this sorry state of public sector innovation cannot stand. The US economy has stagnated for nearly four years. In 2012, gross domestic product (GDP) was $15.7 trillion, having grown only 0.6 percent in inflation-adjusted terms since 2007. Similar economic conditions exist throughout much of the developed world. At the same time that public leaders struggle to find a means to spur growth, municipal and state governments hurtle toward fiscal crises of unparalleled proportions, carrying billions in unfunded debt obligations. During this time of adversity, government, a sector that accounts for 24 percent of US GDP and one-sixth of employment, needs to be a solution to our problems—not one of the sources.1

Over the past year, our research group at Harvard Business School led an effort to discover how to empower public leaders to drive out unnecessary costs where possible, freeing up capital to help spur economic growth. Our group—supported by contributions from research groups at Harvard Kennedy School, various municipalities, and the Office of Science and Technology Policy of the White House—surveyed hundreds of government initiatives, interviewed public sector innovators, collaborated with academics across the country, and convened some of the brightest minds in the field for a conference at Harvard Business School. We grounded our research in theories of causality from both the studies of microeconomics and the management sciences, such as the theory of disruption.

What we found confirmed our hypothesis: Breakthrough innovation in government is possible.

As we studied instances of successful and unsuccessful innovation in government, we identified scenarios in which leaders were able to drive out costs through the implementation of novel technologies and service models that got the job done better for constituents. As the causal theories suggested, the difference between success and failure was the ability to create or preserve most if not all of these five conditions for breakthrough innovation:

Ability to experiment

Ability to sunset outdated infrastructure

Existence of feedback loops

Existence of incentives for product or service improvement

Existence of budget constraints for end users

For instance, by developing robust feedback loops along with the other conditions into their traditional budgeting process, the government of Hampton, Virginia, was able to survive an 8.4 percent budget gap—including program reductions ranging from 18 to 23 percent for economic vitality and neighborhoods, infrastructure, and leisure services—without experiencing a decrease in citizen satisfaction. Instead of cutting across the board, the feedback loop helped the city of Hampton cut only those programs in which the government was providing taxpayers with luxury services when they were happy to settle for more economical services. In Philadelphia the addition of experimental infrastructure for waste collection empowered the city to identify a new service model that reduced departmental operating budgets by almost 70 percent.

In this article, we illustrate how these five conditions enable breakthrough innovation in the public sector. Though our research focused on municipal service innovation, we suspect that the same principles are true at all levels of government. We will also address some of the practical barriers to creating innovative organizations—knowing what to do is only part of the answer; understanding how to create change is an integral part of the solution. To that end, we will offer recommendations on how public leaders, social entrepreneurs, and non-government organization (NGO) managers can encourage innovation in ways that will not be rejected by the system.

By documenting what empowers successful innovation, we hope to make the process repeatable and scalable. Government progress should not have to rest on the herculean efforts of lone innovators; it must be based on sound theory if it can help us to solve the pressing problems facing our society.

The Five Conditions for Innovation

In the book Seeing What’s Next,2 members of our research group introduced a framework to evaluate innovation systems. The authors suggested that two primary factors set the stage for innovation: ability and motivation. These broad categories simplify underlying economic conditions of market structure and information flow within well-functioning free markets. When both ability and motivation are present in a market, a hotbed of innovation forms—in much the same way as the Internet has led to a deluge of entrepreneurship and innovation. When ability and motivation are not present, innovation stalls.

This framework had one principal limitation, however: The scope of the analysis was limited to the private sector, where access to markets (ability) and the profit motive (motivation) are intrinsically present. In the public sector, by contrast, we cannot assume that entry and exit are as simple as incorporating and declaring bankruptcy, or that profit will serve as the primary motivation.

Our challenge was to discover what underlying conditions inherent to private sector innovation needed to be replicated in the public sector. We found that the ability to innovate is derived from the first two conditions—the ability to experiment and the ability to sunset outdated infrastructure. Fundamentally, innovation requires something new to replace the old. Often, it is difficult for incumbents with a vested interest in the status quo to participate in pushing their own obsolescence. In the public sector where startups do not naturally attack incumbents for market share, leaders must find other methods to preserve these two conditions.

The remaining three conditions—the existence of feedback loops, the existence of incentives for product or service improvement, and the existence of budget constraints for end users—all can motivate government innovators in the right direction. Whereas profit and price work together to drive private sector innovators toward optimal solutions, motivating government innovators toward socially optimal outcomes requires more thoughtful direction.

Together, the five conditions allow public sector innovators to try, test, adopt, and reject new technologies and service models. The conditions ensure that the dramatic transitions to less expensive products, which generally perform worse when compared to incumbents, occur only in situations where customers are over-served by existing solutions. These same conditions ensure that public managers do not pursue unnecessary incremental innovation when constituents do not value it. By thoughtfully creating and preserving the five conditions, public innovators can harness much of the power previously relegated to the private sector.

To illustrate how these conditions affect the innovation process, we will examine each of the five conditions and their influence on the implementation of the mobile-payment parking system in Washington, D.C. (In 2010, the municipal government contracted with the private firm Parkmobile to provide a remotely monitored parking system alongside traditional parking meters. The technology was developed and managed by Parkmobile, and the deployment parameters and budgeting decisions remained in the hands of local government.)3

Ability to experiment | Any organization that wishes to adapt to its changing environment needs a system for experimenting with new technologies and delivery models. Without the ability to develop experimental infrastructure, fundamentally new and different approaches rarely emerge. In the private sector, we see this mechanism arise in both the form of corporate innovation and new entrants in existing industries. Unfortunately, public managers often encounter structural barriers when they attempt to experiment. Instead of eliciting exuberance from voters, deployment of capital for experimental projects draws scrutiny from watchdog groups and regulators alike. Without data to validate an initiative’s existence, the public sector attacks the experimental efforts. Yet the inherent paradox is that in order to generate data, experiments are required. To overcome this dilemma, public leaders must behave like venture capitalists by placing small bets based on a theory about the future and using those bets to guide subsequent action.

In the case of Washington’s parking innovation, the DDOT created a thoughtful methodology for experimentation. In 2010, a year before a full rollout was planned and approved, the city started a pilot program for Parkmobile in a single area of the city. This experiment allowed the municipality to gauge how citizens would react to the new service. The positive reception and uptake of the Parkmobile system indicated that the service had promise and would likely be successful across the city. An important feature of the initial system was that it did not require removing the legacy infrastructure. Instead, the Parkmobile system was overlay as an alternative experimental system, minimizing the disruption to citizens’ lives.

Ability to sunset outdated infrastructure | If an experiment is successful, a new challenge is revealed—namely, phasing out the old product or service. In the private sector, when businesses fail to adopt the appropriate technologies or service models, competitors steal their customers and market forces push laggards out of the market. Most government agencies do not experience this process—just look at the difficulty the US Postal Service is having in cutting back its delivery schedule. In fact, many agencies actually lack the ability to freely remove outdated technology and business models.

Though Parkmobile has been successful as an additional layer of Washington’s transportation infrastructure, the full value of the innovation will be realized only after the old infrastructure and collection system is phased out. It was not possible to phase out the old system until the new one was in place. Thus during the rollout, traditional and mobile-payment technology were duplicated for all of the more than 17,000 parking spots. Now the city can phase out the old parking meters and begin to realize the benefits of the new system.

Existence of feedback loops | Once the experimental infrastructure is in place, it should be no surprise that strong feedback loops between the citizens and public servants are required to motivate investment into and adoption of the right innovations. In the private sector, when products and services fail to meet customer expectations, firms have a natural incentive to improve their offerings: the allure of increased market share and the pursuit of premium prices. The feedback loops offered through free market transactions also help private sector innovators identify when their offerings have exceeded customer desire: At some point customers stop paying for incremental improvements. In government, this sort of signal is often lost. Citizens can express dissatisfaction through votes, but these votes are rarely effective at critiquing the performance of specific programs. Unfortunately, without explicit feedback, it is difficult for managers running these programs to judge when to focus on improving service versus reducing cost.

For the mobile-payment rollout in Washington, D.C., a feedback loop was embedded into the experimental system itself. Municipal leaders captured and analyzed a great deal of data from Parkmobile’s online system. The behavior of people using the system led them to see the value the system created directly. After one year, transactions through the mobile-payment system increased by more than 430 percent. This aggressive adoption rate and widespread usage indicated that parkers preferred the new system, providing justification to sunset the old one. The city also learned that 74 percent of all transactions were occurring through the cell phone application, a fact that allowed the government to extrapolate which geographic areas would be more likely to embrace the system upon full implementation.

Existence of incentives for product or service improvement | Armed with the knowledge of what customers want, suppliers can improve their offerings. They must also, however, have the motivation to make improvements. In the private sector, this motivation often stems from the ability to charge higher prices or reach more customers, thereby increasing profits. Though the profit motive does not exist in the public sector, motivation can still be created. For example, decreasing their budget difficulties through access to increased revenue and reduced costs will incentivize senior managers to innovate. Similarly, individual government employees can be motivated by the mission of the work or by recognition for doing it. The difficulty in public management is not creating motivation—it is ensuring that motivation is appropriately aligned with the goals of the organization.

In Washington, D.C., the motivation to improve performance was twofold. First, municipal leaders saw the mobile payments system as a way to capture savings and increase revenue—thereby decreasing budget burdens on the city. Municipal innovators also had another meaningful motivator: being considered forward-thinking. Adrian Fenty, the mayor of Washington, D.C., at the time of the effort, was known to promote this trait in his managers. Innovators inside the government knew that they would be recognized for their innovative solutions, a public reward that provided a powerful, non-financial incentive.

Existence of budget constraints for end users | In any transaction, customer behavior is affected by budget constraints. Budgets force prioritization. For example, when a person has a limited amount of money, she will probably pay the rent on her apartment before she goes on a vacation. Not only do limited financial resources force people to prioritize, they also create incentives to cut costs. If the same person can find a less expensive apartment, she can use the savings to go on vacation. For breakthrough innovation to take hold, government leaders should ensure that budget constraints exist for end users in order to motivate the appropriate prioritization. In some situations, such as in the case of individually distributed services like postal delivery, those constraints should be placed on the customers themselves. In other situations, such as in the case of defense procurement, the constraint should be placed on the person responsible for acquisition. Regardless of where the constraint falls, it is vital that budget incentives be used to force prioritization.

In the case of Parkmobile, customer time and cash constraints naturally force prioritization. Setting up Parkmobile can be a hassle: the user needs to download an app, create an account, and register her car before she can pay for parking. Fortunately, after the initial set-up, the enhanced functionality compared to parking meters is realized: the ability to pay without quarters; receiving text messages warning that time is about to run out; and the ease of paying for more time when the driver is miles away from the car. The mobile payment story in Washington, D.C., is still unfolding, but it is undeniable that following the five conditions has allowed the city to pursue a breakthrough in a core service. And the US capitol is not an outlier. There are many other examples of municipalities successfully embedding the five conditions for successful innovation. (See “Breakthrough Innovations in Government Across the United States” below.)

 

The five conditions for innovation make continuous change possible. Though many of our examples highlight cities that have embraced new service models and technologies and driven unnecessary costs out of their systems, continuous change also allows for improvements in other areas of government such as transparency, performance-based funding, civic engagement, and measuring social outcomes, each of which provides an even stronger argument for enabling breakthrough innovation in the public sector.

Planning for Breakthrough Innovation

Of course, ensuring that the five conditions are properly embedded in a public service or product does not by itself guarantee successful innovation. Innovation is always an uncertain endeavor—no innovator ever enjoys a 100 percent hit rate. Therefore, ensuring that the system facilitates experimentation even in the wake of failures, identifying what is working through small-scale data gathering efforts, and then scaling up new solutions become even more important. Successful public sector innovators actively shield themselves from the scrutiny and interference that can derail their efforts. Through our study, we identified four best practices to help public leaders succeed.

Identify white space for innovation | Academics often point private sector managers toward innovation in areas lacking competition. Our colleague Mark Johnson codified this sort of thinking in his 2011 book Seizing the White Space.4 By delivering differentiated products and services in underdeveloped segments of the market, innovators can avoid profit-inhibiting competition. Though public sector innovation does not suffer the same competitive threat, the threats of special interests and existing regulation create equally compelling support for innovating in new ways. For instance, Web and mobile application development, bike sharing, and pop-up retail represent burgeoning areas of opportunity for municipal innovators. As each of these areas is relatively novel, little policy has been created that dictates how public leaders can leverage them to affect change. This white space empowers government innovators to test novel solutions to problems on top of existing structures, in some situations generating compelling evidence for how products or services can be further developed.

Minimize expenditure, embed in an existing budget | Watchful public interest groups are always on the lookout for new, unnecessary, or redundant programs that might be evidence of pork barrel spending or waste. Although transparency is generally a good thing, it can make it more difficult for government innovators to launch new programs, especially ones that might seem to replicate existing services (as the D.C. parking program did). One way to avoid such scrutiny is to stay lean, spending the least amount of money to learn the most in any experimental process. The Office of Science and Technology of the White House, for example, created a program called RFP-EZ to solicit solutions from non-traditional sources. Because RFP-EZ is restricted to projects costing below $125,000, a small amount for federal procurement, the executive branch has been able to minimize scrutiny and increase efficiency in the procurement process. Another way to protect programs is to embed them inside existing offices. Boston’s Office of New Urban Mechanics and New York City’s <ahref=”http://wagner.nyu.edu/leadership/leadership_dev/bidf.php”>Innovation Delivery Fellows have both positioned themselves inside mayoral offices in order to provide risk-tolerant spaces for innovators. By minimizing attention in these ways, innovators can ensure that they are not seen as harming so-called sacred cows before they have collected valuable data in support of their hypotheses.

Invest in constituent alignment | Nothing breaks down barriers better than making sure that the people affected by an innovation are aware of and in agreement with the change. Many of the programs and services that we have identified as shining examples of public sector innovation were led by managers who were very conscious of bringing along their various constituencies. In Philadelphia, for example, when a new trash collection system was implemented, municipal employees could have resisted efficiency improvements in fear for their jobs. The mayor’s office, however, made it clear that reductions in workforce would be achieved through natural attrition (retirement), not through layoffs. Employees no longer required by the new system would not be fired, but instead would be redirected toward services that needed additional support. By taking into account employee interests, Philadelphia could roll out its program without resistance.

Validate with data | The best case against the status quo is one grounded in scientific research. When the benefits of new services are speculative—even if supported by pundits and academics—it is easy for stakeholders to resist change. Innovators should know what they are testing for and experiment in such a way that makes their achievement irrefutable. Boston’s Office of New Urban Mechanics, for example, has done so with the Citizens Connect mobile application—what some might consider a quantum leap in 3-1-1 services. By demonstrating quantitatively how much additional geographic coverage is achieved, the group has made it difficult for stakeholders in the legacy call center to resist the city’s investment in the program.

The five conditions we have identified lie at the core of breakthrough innovation, enabling a repeatable process that can overcome the absence of competitive forces, lack of incentives for employees, and proliferation of red tape. We no longer need to think of public sector innovation as an exception to the time-tested rule; in fact, we believe the pursuit of breakthrough innovation in government can turn into a more scientific practice than the art form it resembles today.

Throughout the United States and much of the developed world, governments are on the brink of crisis. They need answers to a paradoxical challenge—how to spur economic growth while simultaneously reducing spending. This can be done only when we find novel solutions to the real problems that we have relied on government to solve. By embedding the five conditions for innovation inside new services and products, public innovators can best position their organizations for success in these trying conditions. Though there is no silver bullet for our problems, ensuring that the ability and motivation to innovate effectively exists throughout the public sector is a vital piece of any solution we develop.

Read more stories by Nikhil R. Sahni, Maxwell Wessel & Clayton M. Christensen.

03

One Leader's Journey Paves The Way For A Business Revolution

The BBC’s Radio 4 has this week aired a short feature, Anti-Establishment and Uber-Capitalist, that looked at some of the young entrepreneurs seeking to meet the challenge of combining radical idealism with running a business. The concept may have only recently come to the attention of the national broadcaster, but in reality that dichotomy has been around for some time.

In the UK, as in many other countries, young people appear more inclined than ever to consider starting their own businesses. This is partly a response to a situation that has seen a sharp contraction in the number of jobs that used to attract new graduates and school leavers. But it is also partly a result of the excitement surrounding such technology pioneers as Apple ’s late chief, Steve Jobs, Google founders Larry Page and Sergey Brin and Facebook’s Mark Zuckerberg. Although all have created organisations as big as and arguably more influential than many traditional corporations, they are still seen – to a greater or lesser extent – as representative of a new, “cooler” way of doing business. If you can go to work in funky buildings, wear what you like and talk about “technology changing the world” then, it appears, business is all right.

However, it is not as simple as that. Technology businesses are not the first to talk of a higher purpose. Companies such as the outdoor clothing supplier Patagonia, the ethical cosmetics company The Body Shop and the fashion retailer People Tree, to name just three, have been talking about – and striving towards – social responsibility for years. Talk to anybody who has been with any of those companies for any time and you will hear how hard it is to pull off.

One who knows just how difficult it can be is Bruce Poon Tip, the founder of the Canada-based travel company G Adventures, who has been in London this week to speak at the Future of Tourism event at the Royal Geographical Society. As he relates in his book, Looptail (published in the UK this month by Piatkus), the company nearly collapsed in the late 1990s – for the simple reason that, while sales were growing fast, a steep decline in the value of the Canadian dollar meant the company’s debt was growing rapidly as well. “The irony of all the attention being lavished on us for our uniqueness as a company while we were struggling to pay the bills wasn’t lost on us,” he writes.

In short, it is hard enough starting and maintaining any business. It is doubly so if you are trying to break convention, too. Quite simply, as Poon Tip acknowledges, businesses that claim to have social goals are held to a higher standard. As it happened, G Adventures’ “financial mess” was a simple result of that old problem of the founder concentrating on building sales and not paying sufficient attention to the operational side of the business.

However, although he got to grips with the operational side – complete with an old-style shake-up of personnel – he did not abandon the ideas with which he had started out in 1990. Just as Patagonia founder Yvon Chouinard – who has endured his share of operational problems in the past – has said that the more the company does the right thing the better it does, so Poon Tip has seen the business focused on offering small-scale trips to some out of the most out-of-the-way destinations for discerning travellers thrive at a time when the travel industry as a whole has been consolidating. Indeed, in the wake of the financial crisis the company grew by 42% while competitors contracted by as much as 40%.

How has he pulled this off? Well, for a start, he is at pains to point out he has not done it all himself. Although he is the founder, Poon Tip chooses not to assume the title of CEO. Instead, in an indication of the importance he attaches to customer service in the new business world he imagines, he has assigned it – slightly adapted to stand for “Chief Experience Officer” - to the people in the company who deal with customers. Poon Tip recognises that it was not a move initially welcomed by all. “I needed people to understand that this wasn’t a gimmick but a way for us to fundamentally change our thinking about who are the most important people in the company. We had to offer the best customer service in the world, and we could only do that if we created a culture of excellence,” he writes. “The first step was getting everyone to understand who we worked for – and that it wasn’t me. It was everyone who delivered on our brand promise. Our CEOS are both the face and the voice of the company.”

But creating a business that seeks to transcend its industry – as Poon Tip puts it in the current terminology – is about more than great customer service. After all, there are a lot of businesses going down this road. G Adventures – originally called G.A.P. Adventures, for Great Adventure People, but also in recognition of an aim to plug the gap between backpacking and being on an all-inclusive tour package – is all about integrity and integration. In fact, he goes so far as to describe the business as a movement. This movement, which he calls the Looptail, centers on one of the teachings of the Dalai Lama, who provides the book’s foreword: “Our purpose in life is achieving happiness”.

Fittingly perhaps for an adventurer, Poon Tip does not really believe in the idea of “work-life balance” because it implies that the two elements can be kept separate. “We need to integrate our work lives and our real, inner lives, and focus ourselves towards a higher purpose,” he writes. “The only way to really transcend your product or what you do is to recognize that work has to be about more than work – it has to be about something greater,” he adds. “By transcending the idea of work being just the daily grind, and by engaging the community around you – both customers and employees – to pursue a higher purpose, the Looptail can truly work.”

It sounds heady stuff. But the signs are it is working. While increasing the company’s commitment to the social side through direct investments in many of the countries to which it sends trips, G Adventures also thrives in the conventional sense. It now operates in more than 100 countries, has 22 regional offices, employs more than 1300 people and serves 100,000 travellers a year. Customer satisfaction rates are very high and translate into repeat business rates of about 60%. Moreover, Poon Tip is in much demand as a speaker at not just travel events, but also at organizations, such as Google and Apple. This suggests that G Adventures is indeed transcending its industry. As Poon Tip says in his book: “There is a social revolution taking place, and I know that the only brands that will matter in the future are the ones that will make people’s lives better.” There’s a challenge for the people in the BBC’s feat