P&G's New Innovation Model

3/20/2006
For decades, Procter & Gamble fueled its consumer products engine from R&D inside its own
walls. But as its markets have matured, P&G has directed its search outward. An excerpt from
Harvard Business Review.

by Larry Huston and Nabil Sakkab

Editor's note: Procter & Gamble has operated one of the greatest research and development
operations in corporate history. But as the company grew to a $70 billion enterprise, the global
innovation model it devised in the 1980s was not up to the task. CEO A. G. Lafley decided to
broaden the horizon by looking at external sources for innovation. P&G's new strategy, connect
and develop, uses technology and networks to seek out new ideas for future products. "Connect
and develop will become the dominant innovation model in the twenty-first century," according
to the authors, both P&G executives. "For most companies, the alternative invent-it-ourselves
model is a sure path to diminishing returns."

This excerpt from a March 2006 Harvard Business Review article focuses on the company's
assessment of its aging innovation process and the development of connect and develop.

From R&D to C&D

Most companies are still clinging to what we call the invention model, centered on a bricks-and-
mortar R&D infrastructure and the idea that their innovation must principally reside within their
own four walls. To be sure, these companies are increasingly trying to buttress their laboring
R&D departments with acquisitions, alliances, licensing, and selective innovation outsourcing.
And they're launching Skunk Works, improving collaboration between marketing and R&D,
tightening go-to-market criteria, and strengthening product portfolio management.

But these are incremental changes, bandages on a broken model. Strong words, perhaps, but
consider the facts: Most mature companies have to create organic growth of 4 percent to 6
percent year in, year out. How are they going to do it? For P&G, that's the equivalent of building
a $4 billion business this year alone. Not long ago, when companies were smaller and the world
was less competitive, firms could rely on internal R&D to drive that kind of growth. For
generations, in fact, P&G created most of its phenomenal growth by innovating from within—
building global research facilities and hiring and holding on to the best talent in the world. That
worked well when we were a $25 billion company; today, we're an almost $70 billion company.

By 2000, it was clear to us that our invent-it-ourselves model was not capable of sustaining high
levels of top-line growth. The explosion of new technologies was putting ever more pressure on
our innovation budgets. Our R&D productivity had leveled off, and our innovation success rate
—the percentage of new products that met financial objectives—had stagnated at about 35
percent. Squeezed by nimble competitors, flattening sales, lackluster new launches, and a
quarterly earnings miss, we lost more than half our market cap when our stock slid from $118 to
$52 a share. Talk about a wake-up call.
 The world's innovation landscape had changed, yet we hadn't changed our own innovation model
since the late 1980s, when we moved from a centralized approach to a globally networked
internal model—what Christopher Bartlett and Sumantra Ghoshal call the transnational model in
Managing Across Borders.

We discovered that important innovation was increasingly being done at small and midsize
entrepreneurial companies. Even individuals were eager to license and sell their intellectual
property. University and government labs had become more interested in forming industry
partnerships, and they were hungry for ways to monetize their research. The Internet had opened
up access to talent markets throughout the world. And a few forward-looking companies like
IBM and Eli Lilly were beginning to experiment with the new concept of open innovation,
leveraging one another's (even competitors') innovation assets—products, intellectual property,
and people.

As was the case for P&G in 2000, R&D productivity at most mature, innovation-based
companies today is flat while innovation costs are climbing faster than top-line growth. (Not
many CEOs are going to their CTOs and saying, "Here, have some more money for innovation.")
Meanwhile, these companies are facing a growth mandate that their existing innovation models
can't possibly support. In 2000, realizing that P&G couldn't meet its growth objectives by
spending more and more on R&D for less and less payoff, our newly appointed CEO, A.G.
Lafley, challenged us to reinvent the company's innovation business model.

It was clear to us that our We knew that most of P&G's best innovations had come from
invent-it-ourselves model was connecting ideas across internal businesses. And after studying the
not capable of sustaining high performance of a small number of products we'd acquired beyond
levels of top-line growth. our own labs, we knew that external connections could produce
highly profitable innovations, too. Betting that these connections were the key to future growth,
Lafley made it our goal to acquire 50 percent of our innovations outside the company. The
strategy wasn't to replace the capabilities of our 7,500 researchers and support staff, but to better
leverage them. Half of our new products, Lafley said, would come from our own labs, and half
would come through them.

It was, and still is, a radical idea. As we studied outside sources of innovation, we estimated that
for every P&G researcher there were 200 scientists or engineers elsewhere in the world who
were just as good—a total of perhaps 1.5 million people whose talents we could potentially use.
But tapping into the creative thinking of inventors and others on the outside would require
massive operational changes. We needed to move the company's attitude from resistance to
innovations "not invented here" to enthusiasm for those "proudly found elsewhere." And we
needed to change how we defined, and perceived, our R&D organization—from 7,500 people
inside to 7,500 plus 1.5 million outside, with a permeable boundary between them.

It was against this backdrop that we created our connect and develop innovation model. With a
clear sense of consumers' needs, we could identify promising ideas throughout the world and
apply our own R&D, manufacturing, marketing, and purchasing capabilities to them to create
better and cheaper products, faster.
The model works. Today, more than 35 percent of our new products in market have elements
that originated from outside P&G, up from about 15 percent in 2000. And 45 percent of the
initiatives in our product development portfolio have key elements that were discovered
externally. Through connect and develop—along with improvements in other aspects of
innovation related to product cost, design, and marketing—our R&D productivity has increased
by nearly 60 percent. Our innovation success rate has more than doubled, while the cost of
innovation has fallen. R&D investment as a percentage of sales is down from 4.8 percent in 2000
to 3.4 percent today. And, in the last two years, we've launched more than 100 new products for
which some aspect of execution came from outside the company. Five years after the company's
stock collapse in 2000, we have doubled our share price and have a portfolio of twenty-two
billion-dollar brands.

According to a recent Conference Board survey of CEOs and board chairs, executives' number
one concern is "sustained and steady top-line growth." CEOs understand the importance of
innovation to growth, yet how many have overhauled their basic approach to innovation? Until
companies realize that the innovation landscape has changed and acknowledge that their current
model is unsustainable, most will find that the top-line growth they require will elude them.

Reproduced with permission from "Connect and Develop: Inside Procter & Gamble's New
Model for Innovation," Harvard Business Review, Vol. 84, No. 3, March 2006.

[ Buy the full article ]

Larry Huston (Huston.la@pg.com) is a vice president from innovation and knowledge at P&G
in Cincinnati.

Nabil Sakkab (sakkab.ny@pg.com) is the senior vice president for corporate R&D at P&G in
Cincinnati.

http://hbswk.hbs.edu/archive/5258.html
How Google and P&G Approach New
Customers, New Markets
10:18 AM Monday March 2, 2009

When I worked with entrepreneurs and leaders in Europe, I often heard complaints like:
"American companies have a habit of coming into Europe full of ambition, searching for big
markets, but without fully understanding what it takes to sell a product, build a brand, or forge
partnerships in each country."

It seems obvious: our assumptions become less valuable the farther our experiences are
from our decisions and customers. Yet, these cultural traps always seem to cause frustration
and agony and, regularly, steep losses or strategy restarts. Local hiring is just the beginning- we
have to make sure we are solving the right problems for customers.

Leading companies such as Procter & Gamble and Google have realized that the more clearly
you understand your customer or partner, and their context(s), the more likely you will be able to
offer the right solutions, build the right business models and win through global expansion - in
India, Mexico, China, Russia, or beyond.

Three approaches - bringing together strategy concepts and the emerging field of design thinking
(being advanced notably at the Hasso Plattner Institute of Design at Stanford) - can help all firms
grappling with these issues.

The three approaches:

1. Proactively understand customer needs and cultural norms unique to each country.

2. Use those insights to run low-fidelity, strategic experiments.

3. Use the resulting assumptions to drive the development of local business models, including
product development, marketing and branding, sales and distribution, and manufacturing.

Google wrestles with these challenges every day around the world. Imagine searching for
information on Google in China, where the character set is extensive. You can't just drop the
United States product in - people wouldn't use it. So, Google uses ethnographic methods to
understand users' needs, including shooting video tape of people searching. It learned how hard it
was for the Chinese to get satisfactory search results, so they started experimenting with
potential solutions. They built "Google Suggest" that would start to pop up search suggestions so
that users would not have to finish typing queries, or by asking users, "Did You Mean?" They
found that users really valued these tools and added them to their offerings. These innovations
were the direct result of Google's consumer observation, understanding, and insight gathering
methods, as well as their capability to run experiments.

Meanwhile, Proctor & Gamble's target market in Latin America is often low-income people, the
middle 60% of wage earners - a far cry from its marketing employees, not to mention P&G
execs. Perhaps not surprisingly, P&G experienced a number of product failures there during the
1980s. In one case, featured in the Game Changer by CEO A.G. Lafley and Ram Charan, the
company launched a detergent line in Mexico that marketers assumed would be a big hit because
it saved customers money and valuable storage space. The product flopped. Why? Many of its
customers there did manual labor and were very sensitive to perspiration odors as they bussed
home from work. What gave them confidence that their clothes were getting clean was seeing
their detergent foam - something the new product lacked.

Under Lafley, P&G launched a program to have its managers actually live with
representative customers called "Living It." Dubbed "immersion research," P&G managers and
even senior leaders spend time in low-income homes around the world in order to understand
what matters to their customers in life, as well as their desires, aspirations, and needs. P&G has a
bevy of statistics to suggest that improved insights and assumptions have led to more effective
innovations - including laundry detergent with more noticeable suds.

These approaches are straightforward and make common sense, but they often run counter to
established management norms. Importantly, consumer or partner insight gathering is very
different from market research. The weaknesses of market research are by now common
wisdom. Yet, understanding the sometimes-hidden needs of the market through customer
observation through live-in immersion or video observation is just coming to the fore--and not a
moment too soon.

Have you seen other examples of companies taking this anthropological approach? Where has it
worked and where has it fallen short?

http://www.sramanamitra.com/2010/01/10/cio-priorities-procter-gamble/

CIO Priorities: Procter & Gamble

• Comments (6)
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Sun, Jan 10, 2010

By Guest Author Narayanan Raman

In this post I speak with Filippo Passerini, CIO of Procter & Gamble (P&G), one of the most
reputed global consumer goods firms. Filippo discussed two salient aspects of his approach.
First, he said that ideally, any IT endeavor should start from the IT strategy layer of the IT stack,
as this is the layer that maximizes business value. If you do not have an IT strategy that is in
alignment with the overall business strategy, then the lower layers of the IT stack, such as like
applications and infrastructure, do not even matter. Second, Filippo said that deciding what is
core and non-core to an organization and innovating on the core, value generating initiatives are
key to formulating a good IT strategy.

For this very reason, P&G outsources most of its infrastructure management to leading players in
this field. Doing so helps P&G in two ways: by lowering costs and improving service. For
example, P&G outsources most of its data center management to Hewlett-Packard (HP) and
network management to British Telecom. In addition to outsourcing infrastructure management,
P&G is making strategic investments in this layer. Over the years, Filippo has focused on a video
collaboration strategy through high-quality video collaboration rooms, not only to lower costs,
but also to enable global teams to be more collaborative and work faster and better.

Having taken care of the infrastructure layer, a non-core area for P&G, primarily through an
outsourcing strategy, Filippo uses digitization, visualization, and simulation capabilities to create
value in one of the core areas of P&G’s business, product leadership. A typical new product
development cycle consists of mock-up creation, gaining customer feedback on the product
mock-up, its packaging and other attributes, and incorporating the feedback into the next
iteration. Each iteration could take about seven weeks, with the product mock-up being built
physically. After going through several iterations, the product is finalized, built, and taken to
market. Customers are then invited to give input after-launch aspects such as placement of a
product on a supermarket shelf. This process is typical and has been in place for decades. In
order to make this process more effective and efficient, P&G is now harnessing the power of
virtual reality, using virtual product mock-ups and virtual supermarket shelves. This helps to
reduce iteration cycle times from seven weeks to days or probably hours. This approach not only
helps to decrease the iteration cycle times, but also helps to evaluate various permutations and
combinations of mock-up attributes. The ability to run various permutations and combinations
helps the company to understand customer requirements better, which leads to better product
development and product positioning strategies, which is of course core to P&G’s business.

Filippo discussed three trends that he is seeing in the consumer packaged goods industry. First,
consumers and employees are expecting more one-on-one connections, and technology is
helping enable better consumer interaction and employee collaboration. Second, virtualization
(which in this context refers to virtual reality and product simulations, not the virtualization of IT
infrastructure) is becoming fundamental to gaining a competitive advantage, increasing the speed
of product innovation, and decreasing time to market. This trend means that some of the the
physical work processes in the consumer packaged goods industry must be remodeled and
virtualized. Finally, there is in general an increased push to use newer technologies and tools to
increase P&G’s efficiency and effectiveness.
To sum up, Filippo discussed the concepts of IT–business alignment and IT strategy and the
importance of differentiating core and non-core activities in formulating an IT strategy, points
that could be applicable to any industry. For the consumer packaged industry specifically,
Filippo helps us to understand the importance of harnessing virtual reality to decrease time to
market and gain competitive advantage through product leadership.

This segment is a part in the series : CIO Priorities

. Accenture . Deloitte Consulting . MindTree . Burger King . City of Miami . BMC . Xerox
Corporation . Procter & Gamble

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Rajesh R Naik · 41 weeks ago

Using virtual reality is really an innovative approach to compress "New Product

Development" lifecycle.

However, am curious on implementation. Some thoughts are - Do companies invite

consumers to such virtual store? What is incentive for them to participate? Also, are
there any success stories of usage of virtual shelves in the industry?

Regards, Rajesh

Reply

0 Vote up Vote down

Narayanan Raman · 41 weeks ago

P&G invites customers to their innovation centers, which house digitized, simulated
versions of their new product offerings, for their feedback ... But my gut feel is that
such simulations (well, at least some parts of it) could soon take place over the web
as well, once we are even more confident of the security and speed aspects of the
internet ...

Regarding incentives, I believe there are many ways to incentivize customers ...
product giveaways, coupons, etc ... Not sure of the exact route being followed by
companies today ...

Success stories ... I believe P&G, with their ability to reduce new product
development cycles from weeks to probably even hours, is a great success story ...
New product development and its time to market could have never been so fast
without virtual reality ...

Reply
0 Vote up Vote down

Narayanan Raman · 41 weeks ago

With respect to virtual shelves, I do not have specific data on how much they
contribute to success of a product launch ... But I am sure they would be very
crucial to a successful product launch ...

For example, Product packaging and placement strategy may be totally different in
a mom-and-pop store, a supermarket store and a wholesale store. How should a
product's packaging be? What size? What color? What shape? Where should a
product be placed? Is it safe to place it against a competitor's product?

Using virtual reality to try out these permutations and combinations would definitely
help come up with a better strategy, faster ...

Reply

0 Vote up Vote down

Paul May · 41 weeks ago

It's interesting that P&G is embracing virtual representation to model products,

though this is a logical extension to time-honoured clay modelling or dummy pack
approaches. I notice though that there's no mention of running simulations of
product manufacturing, distribution or retailing. The focus stays on customer
reception - and it's hard to argue with that. But P&G may be missing a trick here.

It's not too difficult to transition the statics of business (ie goods) to the virtual
realm, but I don't find many people outside of finance and public transport using
virtuality to explore the dynamics of business (ie services and service). If we're
serious about matching IT strategy to business strategy, then let's hope that leaders
like P&G start to make more use of simulation for the process side of life.

Reply
0 Vote up Vote down

Edgar Nuñez · 40 weeks ago

There is so much more to do in using virtual vehicles to connect better to

consumers, but P&G is already doing some, using both central locations (virtual
homes and labs) and through web platforms. I am not sure that the company is
leading the pace on this front, but certainly taking advantage of such technologies
to avoid both unpleasing and overpleasing consumers with elements that they are
not willing to pay for.

Good article, Narayanan!

Reply

0 Vote up Vote down

J. Ben Fuqua · 38 weeks ago

Great article Narayanan!

I have been a simulation practitioner for 19 years now and was researching how
P&G is using simulation. The extent of their use is very broad: from the physical
properties of their product design, to the layout of their facilities and equipment
operation, to the design of their supply chains and business rules. The virtualization
of the customer experience in retail environments as a means of shortening the
product design to shelf life cycle makes a lot of sense. I might ask the question, how
long will it be before we dress our avatar up to go out shopping only to drive to the
grocery to pick up our pre-selected groceries?