Why Innovate

Innovation for decades has helped businesses grow, whether they be small businesses launching their first product that propels them into greater significance and out of the incubation phase, or big companies growing through sequential new products that build upon their existing offering both in terms of features and also hopefully in terms of income.

Regardless of their size, most companies appreciate that they have to continually develop their offering, add more features, or look for new ways to reduce cost. Through research and development (R&D) grants, governments incentivise companies to invest in innovation in terms of developing their innovation capability and incentivising the adoption of new technology to boost performance. Governments incentivise R&D as they know it grows businesses and, therefore, the economy.

But how can innovation help and support growth?

Innovation and growth are inextricably linked. If you want growth, you must innovate. Innovation seeks to improve the effectiveness and efficiency of an operation by using novel approaches. In time, even the most successful products and business models will atrophy as the market – and the competition – moves on. The ability to innovate, experiment and evolve is, therefore, an essential characteristic of the companies that are most likely to survive and thrive for years to come, as consumers and markets adapt to competitive pressure. 

Innovation is more than just product innovation or developing new products; it’s about being innovative across several functions and at every level. Innovative marketing campaigns to communicate better the product’s features and benefits. Innovative sales channels to better access shoppers and consumers. Innovative manufacturing solutions to make existing products more straightforward and quicker to deliver. Innovative finance tools to allocate resources more efficiently and timely. All of this facilitates growth.

Innovation is not ethereal or an abstract concern; it delivers results for companies around the world. For example, in the UK grocery market, innovation accounts for 7% of the average category turnover, according to AC Nielsen. Without innovation in FMCG, there would barely be any growth, as consumers would be resigned to accept the current offerings. 97% of all growth in FMCG categories comes from innovation. And arguably, even 97% does not show the whole picture of innovation’s value, as this only includes product innovation and does not concern itself with marketing, manufacturing or finance innovation. A 97% growth figure from innovation is a staggering amount of value generated and highlights the need to have innovation as a key capability in any business, especially FMCG organisations. It also highlights how poor sales drivers other than innovation are in generating growth.

The FMCG industry is renowned for developing major brands, with 23 of the top 100 global brands coming from this sector. FMCG companies constantly innovate, building bigger and bigger brands, and generating greater shareholder returns. So much so, in fact, the FMCG industry for the last 45 years has had the second-highest total shareholder returns of any industry. Basically, innovation has driven enough growth for CPG brands to ensure they are big global megabrands, and shareholders are happy with that level of growth, so there has been no pressing need for the process of developing innovation to be changed.

Let’s look at organisations that have failed to have a sustainable culture of repeatable innovation, perhaps resting on their laurels, feeling they have climbed to the summit of their respective category. For whatever reason, they fail at large-scale innovation. They excel at tinkering around the edges of their products and brands, perhaps with brand extensions, flavour extensions or pack size changes – classic EPD. Growth is hard to come by organically, and subsequent activities that show a more promising return on investment than innovation, such as price promotions, are selected.

However, the drivers of category growth are the organisations that don’t rest on their laurels and decide to rethink their culture of innovation. A study by Nielsen in the US found that the 25 largest food & drink brands only accounted for 3% of the growth of their combined categories. 97% of the increase in their categories came from smaller, nimbler brands. In other words, out of the $35bn in sales from new growth in 2019, only $1bn came from those top 25 brands – the rest came from startups or smaller brands.

Big companies like those in the Nielsen US study are being outmanoeuvred across several different areas despite having deeper pockets, more people and a wealth of data. The opportunity cost of not applying a long-term sustainable culture of innovation is effectively no growth, and therefore a loss of market share. 

Because innovation has begun to yield such low returns, many of those big brands adopt behaviours designed to mitigate the risk of innovation failure. They have adopted a practise of launching safe, ‘iterative’ products instead of pushing for bold game-changing innovations. The game-changers currently come from startups, the outsiders who have been prepared to think differently and embrace risk.

From  a highly simplistic point of view, there are incentives for having a long-term sustainable innovation culture – as it creates growth – and there are also penalties for not implementing the long-term sustainable innovation culture, i.e. a loss of market share. 

But how does innovation help drive growth in the FMCG sector?

Product lifecycle

Retailers and distributors just like manufacturers want year-on-year growth, and most are ambivalent as to how they achieve that growth, whether it is through existing or new brands. Over the lifecycle of a product, distributors and retailers all seek to squeeze the manufacturers’ share of the value pool further and further. Manufacturers that have sufficient brand strength are able to deflect the demands of distributors and retailers, thus maintaining their share of the value pool, either by price increases or by resolutely holding to terms of trade.

Innovation helps defend the margin pool of manufacturers, as new products can deflect the retailers’ and distributors’ demands for increased margin by being more motivating to shoppers as well as having fewer promotions, higher growth rates and generally higher prices. In a mature, competitiveretail world , retailers and distributors who want growth are prepared to sacrifice  margin for the growth that comes from new products. Instead, they seek profit generation from existing mature products whose growth is driven by price decreases , and increased promotional spend or calls for increased margin.

Innovation defends manufacturers’ profit pool by attracting shoppers and consumers – but how is innovation motivating for consumers? 

Rational and emotional benefits

Innovation can offer a rational benefit to consumers, such as an appropriate pack size or convenient packaging format. A rational benefit is a demonstrable and tangible feature that meets a specific consumer or shopper need. Let’s take an example of a rational benefit – that of smaller sized toiletries. After the heightened terror threats in the early 2000s, governments around the world mandated a ban on large volumes of liquid in hand luggage. Brands were able to offer a convenient solution with product volumes that were comfortably well below the regulatory requirements, such as 20ml toothpaste tubes or 90ml shampoo bottles. This innovation gave consumers a rational benefit in terms of time and hassle in finding an appropriate container, decanting from the original container into the smaller container, and ensuring it was below the mandated levels. It also was a rational benefit against having to buy new toothpaste or shampoo at every destination they flew into. 

But there are far stronger drivers than rational benefit; the emotional benefit can be more powerful  Emotions drive human beings, and emotions are evident in what we purchase as well as in our everyday lives. Emotional benefits are what people feel when they buy a product. To use a Star Trek analogy, rational benefits are like Mr Spock in that they are logical and reasoned, whereas emotional benefits are more like Captain Kirk, more instinctive and sentimental. Emotional benefits are the differentiator of a brand from a commodity. Emotional benefits tap into our human spirit, attaching feelings to inanimate objects. Emotional benefits are defined by how they make us feel, and are described as such. Examples of emotional benefits are when a product is ‘cool’ or ‘distinctive’, ‘traditional’ or ‘luxurious’. These feelings mean different things in different categories; with milk, for example, being ‘old fashioned’ is seen as more motivating than ‘modern’, according to our research. 

Emotional benefits are valuable for transforming simple homogenised commodities into value-adding brands. Some see that ‘happiness’ transforms a fizzy cola into Coca-Cola. Some view the emotions of ‘fun’ and ‘comfort’ as transforming cocoa beans, sugar and fat into Cadbury’s. Emotions are huge drivers for brands in and of themselves, with the delight of discovering a new product being a key boost in the first place.

Chemistry of new

A Trading Director at Asda said at a conference in the early 2000’s that “New is the second most motivating word for shoppers after FREE”. One in five consumers, according to AC Nielsen, buys a new product simply because it is new in and of itself. In effect, they are buying a new product simply because of the obvious novelty. 

Lab researchers have indicated that experiencing new things, such as a new product, generates a dopamine hit, the pleasure hormone. Consumers feel happy with new products, and attribute that happiness to the product itself when it is actually a physiological reaction to the new stimulus. Consumers are willing to pay more for joy.

Innovation driving margin

In addition to the dopamine effect, an innovation drives more value the more emotionally in tune it is to what people expect. For example, consumers perceive pizza as highly sociable, which makes sense as we share portions with friends and family. Developing pizzas that focus more on the sociability of pizza can have a positive effect. We see that in our research into the number of pepperoni pieces on a pizza, where we found that the optimal number of pieces is nine. The trend for the number of pepperoni pieces was inversely related to the purchase intent for the pepperoni pizza; that is to say, the more pepperoni pieces, the less likely the respondents were to buy the pizza. We saw that even numbers of pepperoni pieces had higher purchase intent than the odd number of pieces either above or below it (e.g. twelve was more motivating than eleven or thirteen). We hypothesise that pepperoni pizzas that appear more sociable and fair are more motivating than pepperoni pizzas that appear more random. This emotional benefit of fairness and sociability drives a higher perceived value to the shopper. 

This propensity for consumers to want to pay more for an innovation that connects emotionally helps companies see innovation as margin accretive. 

Innovation is not only accretive from a price point of view, but innovation also grows profit margins by reducing the investment in price discounting. Generally in the UK new products are not promoted as highly or as aggressively as existing products in the category, as shoppers will forgo discounts for newness – that is to say they trade a rational decision-making process for an emotional ‘dopamine’ effect. 

The ability to charge more for innovation enables companies to generate more profitability, which in turn leads to higher investment back into innovation, resources and growth. 

Innovation drives innovation

Categories that are perceived by consumers as being more innovative than others tend to have more innovation. As part of an innovation study we undertook in May 2017, out of 39 FMCG categories we tested, we found that consumers expect categories like ready meals, crisps & snacks, and nappies & baby food to be more innovative than milk, bottled waters or oils. This consumer expectation of new products means that brands that are in categories perceived as more innovative need to innovate more to meet the expectations of the consumers. Our current hypothesis is that marketeers have programmed consumers to expect innovation in specific categories, in effect creating a cycle where new products are provided, and so expected, and so provided again. 

Innovation also affects different consumers. Older consumers tend to purchase brands that they have trusted for years habitually. Young consumers, on the other hand, want to find products that help them ‘find themselves’ and differentiate them from their parents or older siblings, as well as better meeting their perceived needs versus the standard product. This helps explain why younger consumers tend to look for more innovative products. We’ve seen the innovation of ‘re-introduction’ of many nostaligc products such as Wispa’s, Monster Munch and Pimm’s Number 3 to engage specific older consumers. M&S’s core consumer is the middle-aged to elderly and middle class, but they need to appeal to younger, less affluent shoppers as their core group die out. Whilst the food part of M&S is to some degree achieving this with innovation in food & drink like vegan and food to go ranges, their fashion and homeware are still targeted at middle-aged, middle-class shoppers (I should know – I’m sitting on an M&S sofa whilst wearing M&S clothing, and I am definitely middle-aged!).

But it’s not just younger consumers looking for new products; all consumers’ needs change over time – think about how we used to eat 20 years ago. Over the last 20 years, there has been staggering growth in food and drink from all over the globe as people seek to explore the culinary world from the comfort of their own home – Japanese gyozas, Indian bhajis or Italian arancini. In the last 70 years, we have moved away from meat and two vegs for every evening meal to ‘Taco Tuesdays’ and Vietnamese hot spring rolls. Our research has identified that North African, Filipino, German and Korean cuisines are have been growing rapidly over the last five years in the UK, resulting in opportunities for innovation within these cuisines. Consumers are happy to pay more for the emotional benefit of discovery rather than repetitive traditional meals. These changing consumer needs offer an opportunity for manufacturers and a threat for any manufacturers that do not change. 

For those manufacturers that have an innovation capability, it represents a conundrum for their competition – do they follow with innovation or drive their existing products harder? Innovation can be a definitive competitive advantage if executed well, so if one manufacturer is good at innovation they will accelerate market share gains and multiply their profits than manufacturers who simply discount their brands as consumers flock to products that are more relevant and motivating for them. Therefore manufacturers are incentivised to innovate so as not to be out-competed by their rivals. We see this in highly competitive categories such as soap powder, and see the inverse in categories that are less competitive such as wine (there is limited wide-scale innovation in the wine market, mostly limited to varietals).

Drive for differentiation

It’s not just rivals that are pushing manufacturers to develop more new products. Multiple grocers in the UK have been able to drive growth for decades through improved logistics and store development. As those long-term benefits are now providing diminishing returns, retailers are looking for reasons shoppers should come to their – rather than their competitors’ – stores. Moving or developing stores is an expensive way to drive sales, and gaining a long-term marketing advantage in retail is also tricky, so retailers are now looking for differentiation in their range of products – effectively exclusive products that are not available in any other stores or channels.

This drive for differentiated products from retailers again presents a quandary for manufacturers as to whether they should back retailers with innovative products or drive their existing product portfolio as hard as possible. Given the relative power of retailers in some categories, retail range differentiation can very quickly become a dilemma for manufacturers around whether or not they should innovate for specific retailers.   Manufacturers have to work out whether it is better to work with individual retailers on specific innovations or whether it is better to offer the innovation to all retailers.

Innovation and profit

The compound effect of all of the innovative forces outlined above means that innovative companies tend to enjoy higher profit margins because customers are willing to pay higher prices for more innovative products perceived to offer more value than plain ‘vanilla’ products. A report by BCG in 2019 showed that the ‘Top 25’ most innovative businesses had a higher median profit growth than industry benchmarks (3.4% vs 0.4%). Having higher profit growth, in turn, drives up the valuation from shareholders for future potential. Innovative companies achieved significantly higher total shareholder return premiums ‑ 4.3% higher than their category competitors over three years, according to the same study in 2009.

In our research, we found through investigating UK companies’ annual reports using Companies House data that businesses that invested in R&D five years ago had grown their gross profit by 14.9% over the last five years.

Furthermore, Innovative companies can charge even higher prices for their more innovative value offering (products, services, solutions and experiences) if they also invest in standout design, which further magnifies the perceived value in the eyes of their customers.

And it is not just the direct financial benefits that come from innovation; there are indirect economic benefits such as the City’s perception that companies with long-term sustainable innovation cultures have a higher price-earnings ratio. In 2006, Boston Consulting Group found that innovative companies tend to grow faster, have richer product mixes than their peers, expand into adjacent or new categories (especially if these promise higher margins), and produce more patents than less innovative companies. 

With innovation as a driver of business success, it is not surprising to find that there is a financial metric that looks precisely at the investment opportunity of innovation, namely the ‘price-to-innovation-adjusted-earnings’ ratio. Companies with a long-term sustainable innovation culture tend to have a higher price to innovation ratio, meaning they are better regarded by analysts, investors or potential partners.

Innovation develops people

It’s not just financial benefits that innovation drives, but also softer  benefits such as to your people. Innovation is good for your people’s development, giving new challenges and opportunities for career growth . Working in a successful innovation business makes people feel confident about their employer and their employment prospects. It gives people a reason to stay for the longer term, reducing employee turnover and recruitment costs, and leading to higher productivity.

Innovation drives growth

In summary, Innovation drives growth, and substantial growth at that – for all sizes and types of companies, from start-ups to global megabrands.  Innovation drives higher prices and higher margins as consumers want new products, either just for the sake of having new products or because the emotional and rational benefits  of a new product better meet their needs. Innovation growth drives shareholder value, and metrics exist to help identify efficient, innovative businesses that drive higher earnings per share. Innovation growth drives people and talent growth, helping people develop, and organisations increase capability. In short, innovation and growth, however growth is defined and valued, are inextricably linked.