"Aussie firms caught with baffling new performance-enhancing substance".

This would be the tabloid headline for my presentation today of the key intelligence from the Australian Business Foundation's body of research over eight years into innovation and business competitiveness.

Contrary to conventional wisdom, innovation is not restricted to novel inventions and frontier technologies, scientific discoveries and research breakthroughs. Nor is it just the province of intellectual elites, techno-whizz kids or large corporations and venture capitalists.

The Australian Business Foundation's research points to a more widespread pattern of innovative behaviour across Australia's entire business landscape, both in traditional and emerging industries. Rather than a divide between the new and old economies, we contend that the new knowledge economy is exactly like the old industrial economy – only faster, more interconnected, with blurred boundaries and with more diverse ways for enterprises to create value and wealth from their know-how and know-who.

Let me set the context, first with a brief pen picture of the kind of economy that Australia is and the role played in it by knowledge-rich, technology-based businesses.


Industrial Structure

• Australia's economy is still heavily dependent on commodities. While only 5% of the total Australian working population are employed in mining and agriculture, these sectors represent over 29% of our total exports by industry and 9 per cent of GDP.
•  84% of employed Australians work in the services sector, a sector which is showing continued steady growth in exports and now makes up over 72 % of GDP. The largest service industry is finance, property and business services (17.5% of GDP) while communications has grown the most rapidly with average growth of 6.4% p.a. 
•  Manufacturing on the other hand continues to decline, with an industry share of GDP under 13%. The latest data from DITR shows manufacturing's industry share in both employment and exports declined by 5% in 2003-04, continuing the long-term trend.

Recent Economic Success

• Australia has enjoyed 13 years of uninterrupted growth, which is forecast to continue for at least the medium term, with forecast economic growth of 3.8% for 2005 and 3.6% for 2006. Australia continues to expand more rapidly than most other OECD nations.
• Australia's recent strong economic performance, regular budget surpluses, falling public debt, low inflation, high productivity and low levels of unemployment have earned plaudits from the World Bank and the IMF.
• Economic reforms of the 1980s and 1990s and one of the developed world's highest levels of ICT adoption have delivered excellent productivity dividends. In 2004 the World Competitiveness Yearbook ranked the Australian economy as the most resilient in the world for the 3rd consecutive year.
• Strong urban growth worldwide continues to mean good news for Australia's economy, as commodity prices rise to historically high levels. As the world's urban population increases by 60 million people a year, Australia has been enjoying incredibly strong demand for raw materials, with infrastructure bottlenecks the only concern for fully capitalising on the boom.
  

R&D and related performance

• Australia's publicly funded scientific research level is at 0.33% of GDP, which is above the OECD average of 0.25%.
• However business expenditure on R&D (BERD) is half the OECD average and a quarter the level of top-performing Sweden.
• BERD is equally distributed between manufacturing and service industries, each accounting for 45% of BERD, with mining making up 10%.
• In terms of broad fields of research, engineering and ICT account for over 80% of BERD, but within engineering the largest field of research is in communication technologies. Furthermore, half of the top eight fields of research are in the ICT area.
• In terms of major industries engaged in R&D, computer services leads the field, followed by mining, resource products manufacturing (i.e. coal, petroleum, chemical products), motor vehicle and parts manufacturing, and communication services.
• Australian business places a strong emphasis on experimental development rather than basic and applied research. The Federal Government's 2003 Science and Innovation Mapping Study noted that in 2000-2001, 70% of Australia's business R&D expenditure was on the D.

Notwithstanding some limits and fragility in our R&D spend, the message is essentially one in the vernacular of "she'll be right". Identifying the "hurt" to be cured or the opportunities for Australia to capitalise on against this backdrop of strong economic performance and productivity improvement, is the challenge we all share.

I wish to highlight two key insights from the Australian Business Foundation's research work which I believe helps us understand more about the connections between business innovation and advances in productivity, and suggests action to boost Australia's business capabilities and our place in existing and emerging global growth industries.

The two key pieces of research intelligence can be summarised as:

• Knowledge Economy – smart application of knowledge is a driver of economic growth.
• Business Innovation – business transformation is the key to achieving innovation.

Potency & Reality of the Knowledge Economy

ABF's early studies on innovation like The High Road or the Low Road? by Professor Jane Marceau et al and the 2000 scenario-planning study, Alternative Futures for Business in Australia to 2015 with GBN Australia substantiate the changing reality of the globalised, connected and fast-paced knowledge economy.

ABF's research points to fundamental shifts in the business environment reflected in what has been called the new knowledge economy where what you know is more important than what you own and use. The knowledge and relationships that firms have are increasingly significant in how they can deliver value to customers and make money from their businesses.

Knowledge does not equate with high technology. Businesses succeed in a knowledge economy not by "building a better mousetrap", but by using their brains, know-how and intelligence.

Today assets are mobile, so what makes you distinctive really counts – market intelligence, 'ownership' of customers, tacit know-how and skills and lessons from past mistakes. Fundamentally different competitive strategies, based on innovation and knowledge, are vital for a competitive edge.

Intangible assets can create wealth too. Firms and nations can capture value not only from exporting products and services, but also from leveraging capabilities and ownership of global assets and intellectual property.

The reality and potency of knowledge being an increasingly decisive business resource is demonstrated in the widespread evidence of companies across sectors finding new imaginative ways of doing business and performing better than their competitors. ABF's own intelligence was well captured by Stan Davis and Christopher Meyer in their 1998 book called "Blur" – the speed of change in the connected economy", where they discerned new business models that were re-defining notions of innovation. Mass production, segmented pricing, neat supply chains, standardised jobs and one dimensional buyer-seller relationships giving way to merged offers of products and services, customers making production decisions, floating prices set by online auction and real time information, employees who are also entrepreneurs and messy economic webs of buyers, partners and stakeholders which involve not just economic returns, but value generated from the information and emotional attributes of the business offering.


Hidden Realities of Business Innovation

Against this backdrop of the knowledge economy, ABF is uncovering evidence of often unrecognised patterns of transformation in business models and the competitive behaviour of firms. Our analysis leads us to challenge the contention that the only innovation worth its name is radical or disruptive and technology-based, and to put the case for the power of market-driven incremental innovation as a vital ingredient for sustained long-run business performance and capability-building in Australia.

The story is told best in ABF's study entitled Selling Solutions: Emerging Patterns of Product-Service Linkage in the Australian Economy by Professor Jane Marceau et al at AEGIS at the University of Western Sydney.

Evidence of transformations of competitive business activity were marshalled in this study in the form of both manufacturing and service firms bundling together products and services into packages to meet total customer needs. This, plus customised once-off large scale infrastructure and construction projects were reported as widespread and driving businesses in the discovery and implementation of novel solutions for customers, and generating new mixes of technical, managerial and collaboration skills in the process.

Let me give one case example to illustrate – that of Brevini Australia.

Brevini Australia is a Western Sydney based modern, high performing company that both sells and services planetary gear boxes to customers mostly in the mining, agriculture and construction industries in Australia and offshore. Chris Bayliss, Managing Director, tells the story of Brevini taking a hard look at how it could ensure its survival and growth in a climate of intense competition, of customers with little loyalty buying on price and the company's profitability becoming marginal.
Brevini changed their approach, transforming themselves from a manufacturer of a single product to a unique and customised total package service provider. They first added value to their gearboxes with new features and capabilities. They then engaged further with their customers in understanding the end uses of the gearbox and became involved in problem-solving and design. They then added services to the package, including maintenance and upgrades.

Brevini's journey proved successful, though not easy. It required a cultural shift in management, sales team changes, major efforts to win customer confidence, a commitment to forming alliances and reorganisation of the capabilities of the business so they could consistently offer a high quality total package of solutions to customers.

The Selling Solutions study's findings highlight the importance of customer problem-solving as a prime motivator of business innovation. A study on Australian Innovation Systems led by Don Scott-Kemmis of ANU, in which ABF is a partner, confirms this pattern in Australia of innovation by problem-solving, which ANU says is boosting the global competitiveness of traditional sectors like agriculture and mining, showing some success in areas like biotech and pharmaceuticals and strengthening capabilities in key service industries like consulting engineering and advanced commercial services.

Professor Keith Smith of the European Commission Joint Research Centre, writing on Innovation & the Knowledge Economy for the Australian Business Foundation, suggests that unrecognised forms of knowledge and innovation are driving today's economic transformations and growth.

Professor Smith points to strongly performing and growing firms, many in traditional old industries, that are low on R&D, but high on knowledge. Their knowledge comes from learning by doing, by using technology and equipment which gives them new capabilities, and by interacting with others like universities, research and professional bodies, consulting engineers or standards organisations.

While acknowledging the importance of investment in scientific research and development, Professor Smith notes that innovation driven by scientific discovery is a rarity. Rather, firms seek to develop new concepts for products and services based on learning and customer problem-solving. Firms use their knowledge of markets, consumer preferences and demands and customer feedback to create viable and valued business offerings that are superior to their competitors and for which customers worldwide are prepared to pay.

In short, the key driver for business innovation is what customers demand, not what scientists, researchers or technologists supply. More importantly, how deft a firm is at reading, responding, anticipating and systematising action to serve this customer demand is where money is to be made and growth to be sustained from business innovation.

This applies equally to businesses that are technology-based and those that are not.

This brings us to the concept of market-driven, incremental innovation – the unsung hero. This involves firms doing business more intelligently, engaging better with their customers, learning from experience and keeping track of that new know-how, detecting early and responding swiftly to changing market conditions, trends, and consumer preferences and continuously adapting and improving business offerings accordingly.

Such incremental business innovation which involves competency-building and learning by firms is far more than a matter of entrepreneurial attitudes and commercial flair. It rests on deliberate and long term strategies that support investment in the enterprise's tangible and intangible assets, eg training and skills acquisition, recruitment, organisational design, technology transfer, sales and marketing proficiency, specific production and managerial capabilities and so on.

The significance and impact of incremental innovation is demonstrated in a series of case studies prepared for the Federal Government's Science & Innovation Mapping Study by Dr Lyndal Thorburn of Innovation Dynamics (then called Advance Consulting & Evaluation) and Dr John Langdale of Macquarie University, entitled Embracing Change - Case Studies on How Australian Firms Use Incremental Innovation to Support Growth, September 2003.

Firstly, their definition of the elements of incremental innovation from Koberg et al (2003) are informative; they identify four elements:

• procedural – management-determined innovations in rules and procedures.
• personnel-related – innovations in selection and training policies and in human resources management
• process – new methods of production or manufacturing.
• structural – modifications to equipment and facilities and new ways in which work units are structured.

The case study companies had all introduced one or more of the foregoing elements of incremental innovation over the past two years. Most had introduced innovations in at least three of the four areas.

They were motivated to do so by customer demand, the need to manage growth, the desire to expand markets, to differentiate themselves from their competitors or to improve their internal operations.

The principal direction of the resultant innovation for most of the case study firms was higher quality or customised products and services, followed by niche markets and taking a lead on new products or services.

Let me give a few cameos to illustrate these types of incremental innovation in action.

• Codarra Advanced Systems in Canberra is a technology and management consulting company in communications, IT and software engineering mainly for the defence industries. Codarra spent $1million to develop an Unmanned Aerial Vehicle for reconnaissance and surveillance in the field to differentiate itself from its competitors. It does not theorise, like most consultants, but practices what it preaches. It added a manufactured product to its services business – not because of customer demand, but because the company's knowledge of the market and its skills identified an unmet need that they could fill and serve to build new markets and position themselves as industry leaders at the same time. Similarly, Codarra started training programs (bundling additional services together) to position themselves as experts and to have a ready market of those they had trained to come back and buy consultancy services from them.
• Forest Enterprises Group, Tasmania was primarily a management investment company for plantations. Their incremental innovations took the form not only of improving the investment product in response to expressed needs of their customers and financial planning advisors (with a single payment upfront and no management fees), but by creating new business entities, one a state-of-the-art saw milling facility allowing greater value added downstream wood processing and the other a joint venture in a timber export processing plant. Their business developments took them closer to the end user where they could realise more value and take advantage of their vertical integration for competitive pricing of their timber.
• One World for Children in North Geelong, Victoria is a child care centre, which has innovated in a highly-regulated industry by adding new attributes to their service that met an unmet and unarticulated customer and community need. One World for Children has introduced longer daily operating hours; opened on Saturdays as a play centre and meeting place for parents and children offering specialist programs like music and baby massage; revolutionised the grouping of children into family groups in rooms of 20 kids, not the norm of segmenting by age group with designated carer ratios; added kindergarten sessions for 3 year olds and 4 year olds which can be used independently of the child care; offers a highly interactive website for online enrolments and data update, chat room for parents and e-training for TAFE students; and now provides consultancy services to other child care centres on its family group model. These innovations have deepened the company's skill set and capabilities, added to their financial viability by working their resources and facilities harder, and demonstrably differentiated their services from their competitors, which also has resulted in them accessing new markets and revenue generators.
• Soft Edges in Port Macquarie NSW manufactures high performance swimwear and sportswear garments for elite athletes including the Australian Olympic womens hockey and basketball teams, winning contracts for Atlanta and Sydney and now exporting to North America. The drivers of their competitiveness are high quality and customisation, backed by a computer system that avoids previous high error rates in translating customer specifications to the final product, together with major investment in their sales and marketing operations. They have by-passed retail outlets, where their product could not compete against cheap imports. They consider themselves now not just a manufacturer, but a manufacturing/ marketing hybrid serving a personalised clientele.
• The Bureau, in Adelaide, South Australia, started life as a typesetting and graphic design company and in the face of a declining printing industry and the rise of digital print technology often introduced by machine manufacturers, they morphed their business into on-demand publishing. Innovators in a traditional industry, The Bureau used their more extensive industry knowledge to identify gaps suited to the new digital printing medium. Their on-demand publishing innovation allows anyone who writes a book to have it published. The Bureau targets Writers Clubs, retirees telling their own life stories and publishers who want to outsource. They have taken a lead in the reinvention of their business model and perhaps of their industry.
• There are a myriad other case study examples of incremental innovations in new staffing structures or quality systems to focus on individual expertise not hierarchy; use of IT systems, knowledge management systems and customer relationship management tools for efficiency, new capabilities and lifting the ceiling on capacity; partnering with the customer and doing R&D in-house to fine tune products to better meet customer needs or operate in niche markets; and differentiating business offerings by superior technical proficiency and customised solutions.

These examples are reinforced by ABF's 2003 study by Dr Richard Hall of acirrt at the University of Sydney on Knowledge Management in the New Business Environment which explores the role of knowledge and knowledge management in the business performance of a selection of successful SME's and large enterprises in Australia, like contract electronics manufacturer, GPC Electronics, which successfully competes with cheaper competitors by its superior project management and customer relationship knowledge and systems.

The end game for all these firms is to respond to internal and external cues and to innovate extensively as a result. Customers are key sources of innovative new ideas and possibilities. The right staff, well-handled, are crucial to innovation and growth. New facilities and equipment are commonly used to support change and extensive and intelligent use of ICT is integral to long lasting business improvements. Perhaps, most importantly, is an enterprise's ability to learn, ie to create, discover, use and re-use knowledge and turn it into distinctive capabilities that solve a real problem imaginatively and in a way that generates resources to sustain the enterprise's growth.

So, the next time you are tempted to dismiss incremental innovation as just tinkering at the edges or you hear a politician or government official boast that they are funding innovation when they are just spending on research, set them straight.

Hidden innovation is indeed a performance-enhancing substance being discovered and used not just by the usual suspects, but by a wide range of Australian enterprises in both mature and emerging industry sectors.