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Natural Innovation: A Theory Of Innovation For Larger Firms In Financial Markets

Financial markets are awash with innovation – new fintech funding stories make the headlines every day. As a result, many of the established players have been forced to sit up, listen and worry about how they might suddenly get ‘uber-ised’ by some upstart coming straight out of left field. This had led many to create innovation labs, incubators, startup committees and other bureaucratic paraphernalia to try and beat the fintech challengers at their own game. But the odds in the fintech stakes seem to favour the little guys. After all, they come armed with nimble business models and are unencumbered by legacy technology, clients or process. But is that really the case?
In this paper Steve Grob looks at how larger firms can, and are, shifting the odds back in their own favour with a different approach; one that borrows ideas and thinking from the most creative, innovative process of all time.
Steve Grob1The ultimate innovator
The most effective form of innovation can be seen all around us, every day. Charles Darwin taught us that any random mutation that favours a particular species’ survival is automatically selected and makes it through to the next round of evolution.
This extraordinarily simple, yet powerful, construct has led to an unimaginable variety of species that can solve almost any problem, often in the most simple and elegant manner.
Nature, then, when powered by natural selection, is the ultimate innovator.
Mother Nature cheats, though, because she gets to bet on every option and the currency which she uses to place those bets, time, is in unlimited supply. Nevertheless, some of the deeper principles and implications of natural selection are allowing the more forward thinking firms to turn the tables on their smaller competitors.
Before we look at this in more detail, let’s first explore the challenges involved in successful innovation and how, at first glance, the odds really do seem stacked in favour of the smaller players.
The rules for winning in innovation
Winning in innovationMost innovation focuses on either emerging or growth categories. The difference between the two is that an emerging category is still seeking universal acceptance of its legitimacy (e.g. Blockchain), whilst a growth category, already acknowledged as a legitimate space, has nowhere near reached mass adoption (e.g. derivatives post-trade automation). Both are typified by the fact that there is no leader that dominates the supply in that particular category and so the race is on. The winner gets to exert pricing power in their chosen category, whilst the losers will become increasingly marginalised or even forced to move to less profitable terrains. This leads to a struggle of almost primeval technical and commercial savagery. It is played by two rules that are summed up well by Geoffrey A. Moore in Escape Velocity‘.

  1. Must be present to win (you have to be in the race to win, regardless, which leads to the codicil rule of ‘go ugly early’); and
  2. Best offer carries the day (which is fundamentally a deployment strategy that vows not to lose the deals, regardless)

These two rules, however, are hard to follow for many large firms which, by nature of their success, operate to almost opposite principles:

  1. Brand reputation is vital (which leads to a “it will be done when it’s ready” approach); and
  2. Maximise customer revenues (i.e. “we’ve earned the right to maximise our returns from our hard won and well cared for customers”)

Small firms have the advantage here as they are able to develop and deploy product faster (ofter this may be no more than just advanced prototypes) and then iterate and improve upon them on site. Also, customers tend to be more forgiving of their smaller, new suppliers than they are of their established partners from whom they expect every shipment to work first time, every time.
Smaller firms have greater flexibility commercially, too, as they operate from smaller cost bases and are prepared to fight – almost literally – as if their lives depended upon it. Conversely, selling into emerging or growth categories does not come easily to established firms. Their account managers are naturally more focussed on maximising each customer relationship over the long term. Smaller companies simply don’t care about this because if they cannot win in the here and now, nothing else matters.
Faced with these conundrums, the natural reaction of many large firms is to try and play better or harder at the rules. Unfortunately, this is completely the wrong thing to do.
The first knee-jerk reaction is to go and acquire small innovative firms and so capital markets are littered with stories of small, highly innovative firms that have been acquired by larger ones. But the results have generally been disappointing as the small firm’s great technology often gets swamped by the daily operating and commercial rules of the acquiring firm. Almost by magic the innovation, alternative thinking and dynamism gets sucked out of these firms overnight and all that is left is disgruntlement on both sides.
Innovation committees, incubators and labs are another approach, but these can suffer a similar fate too. As soon as an idea is conceived and brought into ‘real world’ operating conditions, it is all too easily strangled by the bureaucracy, rules, process and generally diminished risk appetite that is essential to keep the established business lines operating well. New ideas are simply not mature enough to fight for scarce resources against established business lines that, by definition, have learnt to play the corporate game effectively.
A third approach is to set up separate investment business to provide finance to new firms. Whilst this can work well, it indicates a corporate shift into venture capital which is a domain that operates with a very different risk/reward dynamic that may not fit well with the higher corporate goals of the organisation.
The solution for larger firms, then, lies in playing by entirely different rules. Rules that favour scale and that can amplify the natural advantages of the big guys.
Natural innovation
Pretty much all industries have to operate within a set of regulations that are aimed at ensuring the proper functioning of the underlying market. Nowhere is this truer than in finance which operates within one of most convoluted and changing regulatory environments. This is compounded by the fact that, despite being a globally intertwined business, it has multiple regulatory bodies opining on market structure and participants’ behaviour.
The governing principles of natural selection
Natural selection
Winning in a fintech emerging or growth category is a particularly daunting prospect, then, and it is this fact that enables large firms to leverage Darwinian principles of natural selection to their advantage. Key to this is adopting a principle of self-directed evolution which allows firms to increase their chances of being successfully innovative.

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