In 1967 Rollin King sketched a triangle on a cocktail napkin. This triangle, representing Texas air routes and drawn for the benefit of Herb Kelleher, would lead to one of the greatest innovations in commercial air travel.
See also, "Innovation key to growth and jobs".
King and Kelleher went on to found Southwest Airlines, inventing low-cost air travel by using secondary airports and flying customers directly to their destinations, thereby cutting out expensive layovers. They cut out free meals, passing on the savings to their customers. And in a period of precarious jobs, Southwest Airlines offered staff secure jobs and profi t-sharing schemes, thereby cultivating loyalty and satisfaction among employees.
Little did they know it at the time, but Southwest Airlines was making innovation history not only through a radically new business model but also in using information technology to keep costs low, such as by pioneering automatic ticketing in 1974 and introducing online booking two decades later. Southwest Airlines’ innovations led to considerable growth in the air travel industry as other airlines moved into the budget sector and lower prices attracted new fl iers. The US Department of Transportation later gave this innovation-led growth a name, the “Southwest Effect”, to describe the dramatic growth that can take place in a particular sector when a highly innovative company enters a market and, in fact, changes the very market itself.
Forty years on, can companies like Southwest, but also more recent companies such as Amazon and Apple, give us lessons to guide us through today’s economic climate?
Interestingly, Amazon and Apple smashed their earnings records during the 3rd quarter of 2009–the nadir of the US recession–by extracting value from innovations such as the iPhone and cloud computing. Remember also that Microsoft, Nokia and Blackberry (RIM) were all born, or reborn, during a downturn. In fact, over half of the companies on the 2009 Fortune 500 list began during a recession or bear market. In short, downturns can breed innovation and entrepreneurship, and spark new and much needed sources of growth. Enabling this is key for long-term growth.
This is one of the essential lessons in the OECD Innovation Strategy issued to governments this May. Quite simply, those countries that harness innovation and entrepreneurship as engines for new sources of growth will be more likely to pull out and stay out of recession. Governments can help by creating the environment and safeguarding the drivers of innovation, even in diffi cult times. Sure enough, demandside policies, from regulatory and tax reform to public procurement, clearly have a fundamental role to play. But there are specifi c measures too that governments have to consider.
The crisis represents a paradox for the innovation system because, although it creates opportunities as old ways of doing things are replaced by new ones through “creative destruction”, there is at the same time risk aversion and a scarcity of finance that limits the capacity of the innovation system to deliver.
This problem and the importance of innovation as a driver of growth was recognised in many of the stimulus packages that were launched to offset the impact of the crisis. Many countries increased their public investment in education, research and infrastructure to strengthen their growth performance. But now, with the weight of fiscal deficits bearing down, there is a risk of such spending being cut. That would be a mistake. While cuts in such spending may provide short-term fiscal relief, it will hurt growth in the long term, not to mention the ability to deal with challenges such as climate change, hunger and disease, all of which require innovative solutions. Where cuts cannot be avoided, they should be properly targeted to enhance efficiency and strengthen the impact of public spending. Public investment provides the seeds for future innovation and growth and requires a stable and long-term policy commitment if it is to be effective.
In the end, human ingenuity and the entrepreneurial spirit are the essence of innovation. While scientific and technical knowhow are essential for advancing knowledge, more is required. Innovation also relies on broad and relevant education that builds entrepreneurial skills, initiative and creativity, and teaches how to work as part of networked teams. Courses need to be adapted to equip students with the capacity to participate in the creation, diffusion and adaptation of innovations, where learning and applying new skills becomes necessary throughout their lives.
Many governments should rethink the role that universities and public research organisations play in their economies. All too frequently, universities are viewed solely as education providers, and not as essential hubs of innovation. Universities and public research establishments provide links between players– businesses, governments and countries–and are often the anchor that local clusters use to participate in global networks. As cogs in the innovation machine, governments should grant them more independence, promote competition and an entrepreneurial spirit and strengthen their ability to compete at home and abroad.
Take science for instance. This is vital to innovation, especially to generate “step changes”, such as the invention of the transistor or the first vaccine. Fundamental R&D is mostly undertaken and funded by governments and provides the foundation for future innovation. The Internet, which owes much to public investment over the years, is a case in point. Governments should especially avoid cuts in basic R&D directed at social challenges, such as neglected diseases like malaria or renewable sources of energy. These can generate a double dividend of economic growth and improved welfare.
Governments also have to learn from experience, for instance, by asking if their policies really do stimulate entrepreneurship or prepare the ground for possible new areas of growth. Successful innovation policies need to reflect the current environment for innovation. New and young firms– frequently the offshoots of universities or large established businesses–are increasingly important and tend to be the source of radically new, disruptive innovations that upset existing business models and boost both productivity and employment. Think of the German software firm SAP, for instance, which was created by five former employees of IBM Germany. Today it’s the world’s largest producer of business software, employing more than 50,000 people.
This should not be too surprising. Data from the US shows that firms less than five years old accounted for nearly all increased employment in the private business sector over the last 25 years. US companies that survived seven years from the date of their creation were on average 60 times larger than when they started, compared to between 5 to 30 times larger in a number of different European countries.
What can governments do to nurture more of these “gazelles”? For a start, policies must do more than simplify administrative procedures for starting a business; they should promote an environment that enables firms to grow. They must provide portability of social benefits, such as pensions and health insurance, to encourage would-be entrepreneurs to take the risk of setting out on their own to pursue a good idea. Policies must also facilitate access to risk capital, which is all too scarce in the current environment. This is a particular problem for new entrants, since they have no track record and in many cases can only bring the likes of patents and similar intangible assets to the table, which can be difficult for investors to value.
Securing a solid infrastructure for innovation is also critical. Support for platforms that underpin innovation is a key role for governments as they enable more actors to engage in innovation networks. High-speed broadband connections, for example, allow collaboration to take place, ensure access to a wide range of data and information, provide access to powerful analytical tools and facilitate the creation of new value.
Policies to foster innovation will only deliver full results if they take into consideration the wide scope of activities that innovation brings together. Technology is important, but in the OECD’s view, what counts at least as much is how to harness new (and sometimes unintended) knowledge in more productive ways. SMS texting on mobile phones is an example of a major success that few operators had foreseen. Or consider the story of Kenyan mobile company Safaricom.
This firm began offering its prepaid customers a service for sharing minutes with family members in rural areas who found it impossible to buy phone cards. Quickly, the sharable minutes became a form of alternative currency as customers began using them to send money to relatives or pay for services, such as taxi rides. Recognising an opportunity, Safaricom launched M-PESA, a nationwide banking service that allows Kenyans to send money via SMS without the need for a bank account, which many Kenyans don’t have.
Policies that focus only on R&D miss out on such potential. Scientists and engineers are vital for robust innovation to take hold, but as Safaricom shows, governments should look at the potential for innovation and entrepreneurial solutions throughout the economy.
There is no silver bullet to strengthen innovation. The success of policy relies on enhancing the performance of the system as a whole, and ironing out the weak links that can hurt performance. Policies need to recognise that innovation relies on collaboration between a wide range of partners, including both producers and users of innovation. Information and communication technologies, especially the Internet, facilitate this collaboration.
This global aspect will become even more important in the years ahead, as new global players such as China, Brazil, India and South Africa shift the topography of ideas and how they are traded and invested.
To stay ahead in this world, governments must look beyond the crisis and avoid inappropriate policymaking. Many countries have room to improve the efficiency of government policies supporting innovation. A recession may create strains, but is also a good time for reform. The OECD Innovation Strategy does not have all the answers or prescribe a one-size-fits-all approach, but it provides an invaluable benchmark and guide to help navigate these pressured times.
For economies around the world, a good dose of innovation can deliver a double win. It can help drive a sustainable recovery and deliver progress on social and environmental goals. But getting policy right means understanding that innovation in the 21st century is a complex and dynamic game. To succeed, countries will need to make innovation a central pillar of government policy and equip firms, public organisations and citizens to participate and harness knowledge for solutions. There are very few countries that couldn’t use a dose of that “Southwest effect” right now.
OECD (2010), Measuring Innovation: A New Perspective, Paris.
OECD (2010), The OECD Innovation Strategy: Getting a Head Start on Tomorrow, Paris.
OECD (2010), “The OECD Innovation Strategy: Key Findings”, document prepared for the 2010 meeting of the OECD Council at Ministerial level, Paris, 27-28 May.
©OECD Observer No 279 May 2010