BY LIISA VALIKANGAS AND GARY HAMEL

Introduction

ver the past few decades, Silicon Valley has become the "poster child" of innovation, creating generation after generation of new technologies, products, and services, and inventing whole new industries in the process. Drawn by the lure of success and profit, people and organizations around the world have looked to Silicon Valley as a model of success in the hyper-competitive global economy, and have tried to discover the key elements that make it so economically robust. For example, Saxenian's (1996) study of regional advantage in the technology industry contrasted Silicon Valley's uncanny ability to reconfigure assets and build informal networks to the old workhorse companies like Digital along Boston's Route 128. Seen from a regional perspective, what makes Silicon Valley unique is its dense networks of technical experts and entrepreneurs with access to startup capital who dynamically organize around radical new ideas.

This open market for ideas, capital, and talent is a fertile environment for spawning new businesses and industries and, admittedly, is occasionally susceptible to irrational exuberance (Schiller, 2000). But despite the recent Internet bubble — by no means the first of its kind — the wealth created in the Valley is enormous. During 2000, $80 billion of share options were exercised in California, amounting to 10% of the state's total wages and salaries. Since 1992, Silicon Valley has experienced a net increase of more than 300,000 jobs . It is one of the top metropolitan export regions, and has grown, on average, by over 4% annually in the 1990s — more than double the U.S. growth rate according to the Regional Financial Review.

For most corporations, the open market for innovations characteristic of Silicon Valley is nothing like how their company operates. While the basic elements of ideas, capital, and talent exist to some degree in organizations, there is typically little of the entrepreneurial activity that has made Silicon Valley famous. Just ask: How many new business ideas does an average vice president see during the course of a budgeting year? Probably two or three at most. A Silicon Valley venture capitalist reviews some 50+ business proposals a day. But then, a typical vice president in a Fortune 500 company does not see his or her task as new business creation but running the existing business to meet its annual growth and cost reduction targets. Innovation of the kind we are familiar with in the Silicon Valley is not likely to be on the leadership agenda. When we ask Strategos Institute member companies about innovation, the following barriers are named with remarkable consistency:

• there are few rewards for risk-taking and entrepreneurship;
• resource allocation systems are backward-looking and biased toward legacy rights of existing businesses;
• strategic planning and capital budgeting processes are calendar-driven and do not easily accommodate the pace of emerging opportunities for innovation;
• old mental models about the business dominate and come in the way of new; and
• innovation is often avoided as a competitive threat to the existing business (Strategos Institute, 2000).

One interpretation of these views is that managing the legacy business is the thing for a corporation to do. One may well argue that this is what corporate hierarchies are built to do: they perpetuate past success by institutionalizing its form (cf. DiMaggio and Powell, 1983, Scott and Meyer, 1994). Shin and Stulz (1998) found, for example, that corporations tend to allocate assets based on a business unit's past cash flow rather than on any assessment of future growth opportunities. In the short term, this may be an entirely reasonable strategy but in the long term, it is likely to accelerate corporate failure. We believe that hierarchies as corporate governance forms are partly to blame for such an under-investment in the future. In this paper, we will explore hybrid arrangements — we call them internal markets — that offer promise for ameliorating some of the more obvious hierarchical shortcomings in innovation.

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