A Theoretical Physicist (and Entrepreneur) on Why Companies Stop Innovating

AI is transforming the world, and it starts with the right compute. ARM is the AI compute platform trusted by global leaders, proudly NASDAQ listed, Built for the future. Visit arm.com discover. Welcome to the hbr ideacast from harvard business review. I'm kurt nickish. For a while there, Nokia was the poster child of an innovative company. The Finnish conglomerate went from manufacturing rubber boots and toilet paper to building the first cellular network. In the early 2000s, Nokia was selling half the mobile phones around the world. CEO Jorma Olila pinned the success on culture. Y. You're allowed to have a bit of fun, he told Fortune magazine. To think unlike the norm, to make a mistake. Think unlike the norm is what a team of Nokia engineers did in 2004. They pitched a phone with a color touch screen and an app store to go with it. But company leadership shot the ideas down. Well, Apple launched those three years later, and the rest is history. So how did Nokia go from being a company where innovation is taking off, everyone is nimble, and things just seem to click to one that seemingly overnight gets stuck in old ways? Our guest today compares this sudden shift in business to a phase transition in chemistry, like when a glass of water freezes, becoming ice. And he believes companies need to understand the forces working against them. Just like adding salt to water to lower its freezing temperature. He says companies can add things like better incentives to maintain an innovative structure. Our guest today is Safi Bahcall. He's the former CEO of the biotech company Cinta Pharmaceuticals. He's the author of the book how to Nurture the Crazy Ideas that Win Wars, Cure Diseases and Transform Industries. And he wrote the HBR article the Innovation Equation. Safi, thanks for coming on the show.

Thanks for having me. Delighted to be here.

Now, you came to business from science. You actually got a doctorate in a hard science, and your parents were actually disappointed that you went into business from there. Tell us about that.

Sure. Both my parents are scientists. They're actually both in theoretical astrophysics.

Yeah, serious stuff.

Yeah. Not kidding around. Actually, my mother works in cosmology and she every now and then when she's sitting on a plane next to somebody, she says, oh, I'm a cosmologist. And they start discussing beauty tips and makeup. Yeah, exactly. Not really that kind of cosmologist. That would be cosmetology. But no, I grew up in hard science and did kind of physics and math, and that's what I was sure I was gonna be doing. Until you get into your 20s and later 20s and you start to really think Is this what I wanna do for the rest of my life? And I don't think I'd set foot off at university until I was 28 or 29. But I just noticed I wanted to the world was a lot bigger than the world of quarks, gluons, string theory. There was a lot more. And most of the people I would meet actually were not experts in quarks, gluons and string theory. And I just got very curious because the people that I encountered, I thought they were as smart as anybody in academia, if not more so. They were just solving different kinds of problems. But rather than have kind of infinite time like you do in a graduate program and limited resources, it was the other way around. They had limited time and practically infinite resources.

It's funny that you left kind of this theoretical academic space to go into business and now you're writing a book that takes business and tries to make scientific comparisons to it. So I'm just curious like what about your background got you into thinking about business differently than the people you were working with?

I think I heard one physicist describe it pretty well. One of the things that you learn is how to see through noise. When I first started a company, a biotech company developing new cancer drugs. I was in my early 30s and I was a first time CEO trying to read everything I could drinking from a fire hose. All the articles and books, things fell into kind of two general buckets. One was the sort of CEO biography. The second one was the sort of more academic. We surveyed 50 or 100 or 1000 or whatever companies and the most successful companies seemed to do this and the ones who were less successful seemed to do that. Therefore you should do more of this and not the problem with that. And that's probably where my first physics, some more scientific training came in was that suppose you do a survey and found that look at total return to shareholders across X companies and you find that CEOs who drank scotch outperformed CEOs who drank bourbon. You're like oh, okay, so I should be drinking scotch, let's go shift and I'll get three points up. No, that's not really the methodology there doesn't really.

So you as a scientist were looking at a lot of the management advice books that were out there and just saw weak empirical thinking in a lot of them. And you were troubled by that?

Yeah, no, I just wanted more. It's like you're hungry, you want something that would really help you out. You're trying to build a great team, build a Great company. You're trying to achieve a noble big mission. You're trying to get good returns for your shareholders, for your stakeholders. You're trying to do all that. So you want something useful, but you also want the foundation of what you get to be solid. So if you're gonna take advice and takeaways, you kind of want some confidence that it's real. It's not like, oh, you should drink bourbon. Cause we did this analysis, and you want something a little more solid. So I was a little frustrated with that. I mean, I think there's this mindset of it's all about the CEO and the culture. So you read a lot of these management books and say, well, the CEO must be the cio, the chief Incentives Officer. Just pound the table that you love innovation. And the problem is that doesn't work. There's so many books about culture, but I don't think we've been spending enough time thinking about structure.

Tell me more about that.

All right, I might start with a weird example, but bear with me. Imagine you have a glass of water, and you stick your finger in the glass of water. You can swirl it around. Everything just sloshes around. And that's always true, except as you gradually lower the temperature, all of a sudden, the behavior completely changes. You can't stick your finger anymore. It freezes. It becomes completely rigid.

In science, this is a phase transition.

It's called a phase transition chemistry. But the molecules inside are exactly the same. So why do they suddenly change behavior? How do they know to suddenly change behavior? There's no CEO molecule with a bullhorn saying, all right, let's be liquid now. And then, oh, I think the temperature's changed. Let's be solid tomorrow. There's no CEO molecule. There's no leadership. There's no cultural discussion. It just suddenly changes. And that's what I mean by structure. Those sudden changes have to do with the dynamics of the interaction. They arise collectively from the dynamics of the interaction. And so I sat down at some point and I said, is there some way that this could potentially be applicable to teams and companies and organizations in a more systematic way? And it turns out if you write down what is sort of the mathematics of incentives for people, you find something that you see in the glass of water or that you see in any phase transition, any sudden change, which. Which is that any sudden change in nature is due to two competing forces. So in the case of water, you have. Molecules want to run around and be free. That's entropy. And they also want to lock Rigidly in place. Those are two competing forces. And the relative strengths of those forces depends on temperature. The desire to run around and be free dominates at high temperature. And at low temperature, the binding energy wins. So somewhere between the two, as you lower temperature, boom, those two things cross. @ a break, even water freezes, the system.

Snaps. Now you're talking here about fundamental natures of molecules, right? They follow laws. And making the comparison to teams of people, the way people work in an organization, which is much more complex, does that. I don't know. Can you make that.

Comparison? That's a great question. The idea of a phase transition applies to a system whenever you have dynamics of interacting.

Agents. And we do talk in business about ecosystems, right too. So I can see that. But it's also much more, it feels much more complex than two competing.

Forces. It's a different mindset. But one thing to think about is that whenever you organize people into a group, and it's a pretty general principle, you always get two forms of incentives. If you've run a company or run hr, you might call it cash and equity. Cash has to do with base salary, like your level inside an organization. As you get promoted, you get more and more base salary. Equity has to do with your stake in the project or the stake in the team's project. Now you might be able to see where this is going. When you run a really small company, how do those forces balance out? Let's say you're running a small biotech company, your stake is enormous in the drug, whereas the perks of rank are sort of irrelevant. If there's 10 people in the company, and are you the team member or the team captain, it's a small change in base salary. But if the drug works, everybody's a millionaire and a hero. And if the drug fails, everybody's unemployed. So when you have very small teams and companies, one of those forces.

Dominates. That's the equity side, that's your binding energy.

Essentially. That's right. Now let's say you're at Pfizer, same you, same project. Now it's 100,000 person company, same project. What's your equity? Well, a really good Drug might sell 500 million in sales, but what's Pfizer's revenues? It's about 50 billion. So your stake in equity, your stake is about 1%. But if you could sound smart at committee meetings and making kind of sarcastic remarks about the flaws in any early stage project, you might get promoted. And if you get promoted, what.

Happens? You get a big bump, you.

Get a Big bump, you might get 30% or 50. So now they've completely switched. Just like the two forces in a glass of water, where you have one phase in which everybody unites around these crazy ideas to save them because their equity is so high, and another phase where everybody's just focused on politics and promotion and career because the incentives are all about getting promoted and the equity incentive is much.

Less. Is this your way of explaining why some companies that have been very innovative become risk averse and stop.

Innovating?

Sure. For example, I ran a small company and we eventually got to about 200 some people. Everybody's super motivated and working really hard. When you're a small company now, what about what happens when you grow bigger? Everybody kind of knows intuitively that something changes. You know that in your gut and you can see that, and around you, people start caring a little bit less. Okay, well, what do you do with that? There are many interesting things that follow. If you actually can sit down and work that out. For example, when it snows at night, what do you sprinkle on your.

Sidewalks? Well, a lot of people did this in Boston very recently, you put salt out. You put salt out essentially to lower the freezing.

Temperature. Exactly, you lower the freezing temperature. So that's called a control parameter. When you really start to understand those forces, you can start to identify little tweaks that you can make that adjust the system. And that's what you can do with teams and companies. Once you sit down and think this through and write down the incentives, you can make similar tweaks. You can identify what do you do to adjust the incentives that can design more innovative teams and companies just like you can make liquids that stay liquid longer. I'll give you another example. When you take iron, raw iron is actually a pretty weak metal, but you add a tiny little bit of carbon and it becomes solid steel. Those are the small changes in structure, and you add a little bit more tungsten and nickel and becomes these super strong alloys you use inside jet engines. So the interesting thing, and what is new here, is that you can identify these small changes in structure, like adding a little salt or a little carbon, that will design more innovative teams. And that's where it becomes.

Practical. I saw Drew Houston, the CEO of Dropbox, speak recently, and he described the growth of that company as like surfing a tidal wave. And then it stopped. And then it's just kind of organic growth. And everybody's looking around like, where's the next tidal wave? And it's a different company at that point. I Can see that this is a common problem for companies that have been innovative, have reaped the rewards of it, and then are basically in a different place and are trying to recapture that spirit. So what are your ways of adding salt and carbon to a company at that point to.

Try? I sympathize having been there and having a lot of friends who are in the same situation. You're like, if you're the CEO, you have this enormous equity stake and you care passionately. And as soon as you cross a certain number, people's equity stuff goes down, yours actually stays very large. And then it just becomes very frustrating. How come they just seem to be working to get promoted rather than for passion in the.

Project. And that's because you can't get.

Everybody. You can't give everybody half your company anymore. There are only so many halves of the company you can get. So one of the levers you can do is change what you might call return on politics. Just to think about that qualitatively, if your average employee spends the last an hour a day on lobbying his or her boss, by what incremental likelihood do they increase their probability of promotion? Sounds a little technical. But I'm saying that to emphasize that you can work this out. And what you see is, not surprisingly, companies where the systems are such that if you spend a lot of time lobbying your boss, you might actually improve your promotion. What do you think people do? They spend a lot of time on politics. They talk about how great their idea is and how bad the idea is of the person down the hall. Well, so what can you do about that? Turns out those don't reward those people. Well, it's a deeper question because you can't tell. Managers don't pay attention to lobbying. Everybody's susceptible to lobbying. But some Companies, let's take McKinsey's one example, Google's another example. There are a few other companies, they do something more radical, which is they take promotion and bonus decisions out of the hands of managers. So if you're a manager and you have a number of people working for you, you actually don't get to decide their fate. In fact, they have. It's expensive, but it's inexpensive. They have an independent person coming from, let's say, a different office and a different group who may not know either the manager or the employee and do some interviewing and really research the question about this person's performance just like a real problem and fact checking exercise and then fly out when that exercise is done. So in that kind of situation, what do they, do they just reduce the return on politics? Say there's 10 peers who are all competing for one spot. All of a sudden those 10 peers get nothing out of lobbying their vice president or their boss. The return on politics is very low. Why? Because that guy has nothing to do with the.

Decision. Right. What else can you.

Do? So another thing is project skill fit. So imagine you have someone working on a project who's just not really particularly great at that project. You'd say, why are they still on that project? Well, sometimes there's a lot of resistance. Managers want to keep people or people don't want to go or they're comfortable or whatever and you don't want to. Well, the more they work on their project, they're not getting any more return because they're just not very good. So the extra incremental work that they do is not really on the project is not doing much for them. On the other hand, they could spend that time on politics and lobbying and that might help them. They might get promoted or they might get people to forget about how not quite great their project is. So what you find is across a lot of companies, there aren't really systematic processes for saying, is this person really good in their role? Is this person stretched? But not too much and not too little. Because if they're also, if they're not stretched at all by their role, then they're done with their great project. You know, if you have a guy building a coffee machine design or something and he's like, you know, he's an award winning designer, he's done in two hours. But if you have him on that project for two months, what's he going to do with the rest of his time? So you'll find some of the really good companies at this have an independent group. That's all they do is they scan the organization. Why not the manager? Well, sometimes the person who's, let's say running design is not the person to say, oh, this guy would be a great salesperson, he doesn't know, or this guy would be a great product marketing person. You want somebody independent who has the eye of, who's scanning the whole organization says, I don't think this person fits here. And that manager, that's not his or her job to understand where he or she might fit.

Better. It's interesting that some of these ideas are taking management decisions out of the hands of.

Managers. That's.

Right. Rather than trying to help managers make better decisions, you're almost saying, let's just realize that this is flawed and we'll have other people make these decisions and let you focus on something.

Else. Well, it's ultimately trying to take politics out of the organization. And if managers are responding to lobbying, which is kind of an inevitable human characteristic, then you're just encouraging.

Politics. One of your suggestions is to appoint a chief incentives officer, which is interesting because you're kind of saying that if that's the nature of people, is to really respond to incentives, you need to pay much closer attention to incentives. Incentives to get them to work for whatever you're trying to get the company to.

Do. Right. There's something analogous, I think, in economics. For many years, up until about 10 or 20 years ago, there were this view that people were perfectly rational and they would respond like a computer to the systems around them. And then these ideas of Kahneman and Tversky and a number of others brought the ideas of psychology that people are not perfect computers. People do respond in ways that are quite surprising to the design of the environment and how they're presented with choices and subtle aspects of their incentives, which is more sophisticated. What I'm trying to get at here is that we've thought about incentives in the same way inside companies for decades. And to the extent that we say, yeah, it's important for people to have equity, we say, let's give everybody a stock option as an example. Well, that's kind of a lazy answer and not a great answer because let's say you're at a 50,000 person company and I give you a stock option. Well, how much does your project really move the stock of the company? For most people? Not very.

Much.

Right. So what is that stock option doing? It's basically kind of wasteful. In economics, you would call it a free rider problem. You might as well just sit back and if the stock goes up, enjoy it. And if.

It. Because other people work.

Hard. Exactly. That's a free ride. So we're not even touching the surface of structure because we just write a blank check. Oh, it was a good year. Everybody gets 10% bonus, let's say cash or gets a stock option, they should be happy. But that doesn't really work. Anyone who's a practical manager or a practical leader and has run, you know, having been a CEO for 13 or so years, you know, I would meet with my head of HR weekly, quarterly, annually, and we would talk about compensation. And it's tough, especially if you're busy. You know, you got tons of fires to put out, tons of problems to solve, and it's easy to say, you know what, let's just give everybody this or just get everybody that and move on. But that doesn't work very well. So the point is, let's take that up a level. If we want to motivate Joe or marry, how do we create a system that's really aligns what Joe and Mary are doing and how much value they're creating for the business with their incentives? How do we make it so they couldn't care less if they're.

Promoted? How does this work in the context of a competitive landscape where Joe could go and work for another company and get that extra 10% just kind of automatically each year without having to do the extra effort or come up with the ideas that you're trying to incentivize in your.

Own. That's a great question. So who do you think you'll attract if you have those kind of incentives in place where you're encouraging people to have big stakes in their idea? You're going to attract the more innovative.

People. Yeah. And the people who are looking to coast are going to.

Leave. Exactly. So now you're getting right at the heart of it. It may sound a little technical, but ultimately the message is very simple. You've been spending all this time thinking about culture, culture, culture. Just spend some time thinking about structure and maybe the return on investment of, let's say, hiring a chief incentives officer. Just thinking about it more professionally, more systematically instead of spending one hour every quarter just saying, well, our stock option pool will be this, which is what you do with a comp committee and a board and have every VP or every manager say this is my pool and I'm going to distribute like that and I'm done. Instead of having that be a one, spend a day or spend two days and have a team saying in each group, what are the appropriate metrics and incentives we want in place? So you really want a professional who is thinking about this very intensely take that job again, as we say, out of the hands of the managers, where it's the 19th thing on their priority list, and into the hands of, of a professional. So will it cost you more money? Yeah. You'll need a more sophisticated and higher level HR group and chief incentives officers than you have today. Most of those in most companies today are kind of rubber stampers. Now here's the thing. How important is it for you to have a properly motivated and incentivized workforce? Is it as important that everybody has the latest computer and gadget? The point is that the return on investment of getting a better, more thoughtful system where you're aligning people better to the goals of the company is going to be very high. At least as good as making sure Everybody has the iPhone 10 rather than the iPhone.

9. How do you know if your system's.

Working? How do you know if your system's.

Working? Yeah, how do you know if you've turned your company from ice back into.

Water? Or if you walk the hallways and you hear people talking about careers and promotion, that's a bad sign. If you walk the hallways and you hear people pounding the table excited about the next wild or crazy idea, you've done the right.

Thing. Safi, thanks for coming on the.

Show. Thanks for having.

Me. That's Safi Bahcall. He is the author of the book how to Nurture the Crazy Ideas that Win Wars, Cure Diseases, and Transform Industries. He also wrote the article the the Innovation Equation. It's in the March April 2019 issue of Harvard Business Review and@hbr.org this episode was produced by Mary Dew. We get technical help from Rob Eckhart. Adam Buchholz is our audio Product manager. Thanks for listening to the HBR IdeaCast. I'm Kurt.

Nickish.