Why this is something you should definitely develop
It goes without saying that businesses want to make profits. Therefore, incentive systems, more often than not, reward people for successes but punish them for failures. From an entrepreneurship and innovation point of view, this can be an extremely dangerous approach.
A while ago, I did an experiment during a management seminar. The event was to be attended by 20 managers, and I put a written question to all of them beforehand. “Imagine you could choose to take overall responsibility for one of the following two projects in your company:
Which project would you choose?”
It is easy to calculate that project B can be expected to earn the company 380,000 euro (500,000*0.8-100,000*0.2), compared to 200,000 euro for project A. Hence, in risk-neutral terms, project B is 90% better. Moreover, in business, risks balance out, so it would be desirable for all managers to choose projects of type B.
I asked the CEO of the company which side of the fence he expected his R&D managers to come down on. “Roughly 50:50,” he replied cautiously. But, to his horror, ALL managers chose project A, the low-risk, low-profit option. When we discussed the result, one manager offered a trenchant analysis of the problem: “Achieving success is something good. It doesn’t matter how successful you are. People praise you, and that’s all that counts. But you had better make sure your project doesn't fail! Because if it does, you are in real trouble at our company.”
The manager's comments show that this company lacks a culture of failure. There is a stigma attached to mistakes and failures, and people get punished excessively hard for them. The employees have adapted to this culture. They steer clear of anything that is potentially risky. This has catastrophic consequences for the company: In our example, it would have lost 3.6 million euro in profits (20*180,000). These figures are, of course, hypothetical, but the finding is real. Not having a culture of failure can result in seriously misguided decisions.
Opportunities and risks are part and parcel of the innovation game. When you start something new, you hope to succeed. But no matter how meticulous you are in your planning, testing and forecasting, things may always take unexpected turns. Innovation invariably entails risks that cannot be avoided, including client risks, technological risks and competitive risks. Assumptions may turn out to be wrong. Unforeseen events can put paid to all your plans. “It is difficult to make predictions, especially about the future,” Mark Twain once said.
It is, of course, possible to reduce risks, for instance by means of early market tests, numerous iterations or flexible project structures. But these measures are complex and expensive, and, what is more, they never solve the problem completely. You simply cannot eliminate all the risks. Research evidence shows that the flop rate, i.e. the proportion of unsuccessful innovation projects, is between 30% and 80%, depending on the industry. A simple, dangerous method of reducing risks is to make projects less innovative. The less innovative a project, the smaller the risk it entails. This explains why so many businesses produce only incremental innovation, that is innovation along the lines of “new, now available in blue”. They lack a culture of failure, which, in the long run, entails a much bigger risk—the risk of being driven out of the market either by innovative competitors or as a result of disruptive innovation. There is a dangerous paradox at work: Striving to avoid risks will put a company's long-term viability all the more at risk.
What can businesses do about the problem? It goes without saying that mistakes and failures are never good. In a perfect world, there would be no mistakes. But the world is not perfect, which is why it is important to distinguish between two kinds of mistakes: silly mistakes and intelligent mistakes. Silly mistakes are mistakes you make although you know—or should know—that they will have clearly negative consequences. Calling your clients bad names is a dumb mistake. Not involving users in the innovation process is another silly mistake. Making the same mistake 3 times is a thoughtless mistake. You will get punished for silly mistakes—and deservedly so. There is a lot to lose but absolutely nothing to gain.
An intelligent mistake, by contrast, may happen, for instance, if you choose project B in our example, and your project turns out to be one of the 20% that fail. In hindsight, opting for project B was a mistake. But it was still the right decision, provided there was no way to anticipate the unfavorable outcome. The mistake was an intelligent one. There was something to lose but more to gain.
Businesses need to make an effort to develop a sound culture of failure. Some time ago, I compared notes with the CEO of a highly innovative small-to-medium-sized company. He told me about his approach. He expects his employees to make at least three intelligent mistakes per year. During performance appraisal meetings, he reviews these mistakes with the employees in great detail. Of course, this CEO considers mistakes to be something undesirable. But he is clever enough to know that if you make three mistakes, you are very likely to get ten other highly profitable things right.