Back to school and more innovations
Posted on September 6, 2011
Evidently, we have been out for a while, preoccupied with long French summer… The good news is that most of our readers have been out as well, so no harm no foul. But it is good to be back to school and back to our blog. In this first post of the new academic year I wanted to talk about a couple of recent innovations that I encountered in the popular press while on vacation, literally lying on the beach. While these stories are quite different, a common theme unites them: they are both about commodities. The reason they caught my eye is that I often teach for oil and gas companies (mostly Russian) and within INSEAD executive development programs we also often have a number of executives from the middle East (thanks to our Abu Dhabi campus). These and other participants often doubt that anything innovative can be done about their commoditized industries: the process of digging for oil, for instance, has not changed much, ever! My answer is that ANY industry can innovate using our principles of the Renaissance innovation and here are a couple of examples.
The Economist recently came out with a short article describing how mining companies can achieve significant competitive advantage by managing risks. Many, if not most, mining companies rely heavily on just a single commodity. What is the risk? Well, evidently, the price of this commodity and it is well-known that commodity prices often fluctuate wildly. What can be done about it? According to the article, at least two things but both are related to risk diversification. One approach is to diversify by geology through digging many different minerals and hedging your bets if prices for one of them go down. This is often the thinking behind mergers in this industry or operating different kinds of mines by the same company. But there is also another kind of risk which has to do with government policies in mineral-rich countries, giving rise to political risks. A way to deal with it is to diversify by geography: mining companies could spread the risk by procuring minerals in different companies. There are plenty of examples of both approaches. BHP Billiton, the largest mining company in the world, is the largest supplier of fertilizer but recently diversified into shale-gas. Anglo American, the company originally coming out of South Africa, now invests heavily into Latin America due to threats of the South African government to nationalize certain assets.
Another interesting article appeared simultaneously in Fortune. The article talks about what companies can do about price fluctuations in another commodity – US dollar – as well as fluctuations in some other commodities. The advice here is, again, to diversify geographically or to minimize risk by reducing reliance on the commodity. For instance, Caterpillar diversifies production by spreading plants throughout the world to be less dependent on any one currency. PepsiCo, which relies heavily on purchased commodities such as sugar, simply hedges up to 80% of commodity purchases using futures markets. Procter and Gamble, on the other hand, takes a completely different approach: instead of hedging commodities, it uses old-fashioned engineering to reduce its reliance on commodities because financial hedges are not cheap. So instead P&G eliminates problematic materials from products.
What kind of impact do these strategies have? P&G reportedly saved $1B last year when commodity prices increased by $2B. This certainly sounds like an innovation to me, and a big one! Like some other innovations we discussed, this last one shows that risk management can start at the point of product design already. These are good examples of how one can achieve serious, innovation-like savings through managing risks: certainly not that many innovative products at P&G resulted in $1B/year profits, and I would not be surprised if there are no such products. Yet, most companies have processes around product and technology innovations but almost none try to innovate business models in any organized way.