By Rob Sher
Originally published in the Harvard Business Review April 9, 2021.
Because they’re smaller than large companies and less encumbered by bureaucracy, midsize companies have an opportunity to take advantage of the market changes that will persist post-Covid (some permanently). The ones that delay risk permanently losing their market position. Big companies can inadvertently stymie innovation, whereas midsize firms have an ideal mix of sufficient financial strength, diverse customer bases, and nimbleness.
To be successful in a changed landscape, midsize companies must harness those advantages and commit to these three capabilities:
• Continual investments in innovation (systems, people, and capital)
• Extensive information gathering throughout the marketplace to discover opportunities and threats
• Innovation managed as a team sport — not as eureka moments of brilliant individuals
Here’s how these capabilities have allowed one midsize company to pivot in the face of new and changing demands.
Investing in Innovation
Kern Oil & Refining Co. (a client of mine), founded in 1934, is an independent oil refinery in Bakersfield, California. With 155 employees, it’s a quarter of the size of the average refining company in the U.S. What’s more, it doesn’t extract oil from the ground or distribute it. It only processes it in its refinery.
While it pales in comparison to the likes of Chevron or Exxon, Kern uses its size and agility to its advantage. It purchases oil mostly from local producers in California’s Central Valley (Kern County). It refines and sells fuel at wholesale, mostly for use in the Central Valley. And it has become adept at developing and producing clean transportation fuels, such as renewable diesel and blended biodiesel.
On Sept 23, 2020, California Governor Gavin Newsom ordered that all new cars and passenger trucks in the state be zero-emission by 2035. One thing was clear: Refiners like Kern would have to evolve quickly to meet changing consumer patterns and an aggressive regulatory environment.
Kern had been here before. In 2007, when the U.S. Environmental Protection Agency issued new renewable fuel standards, company engineers had an idea. Could they make renewable diesel by co-processing tallow (i.e., animal fat)?
There was no guidance from the American Petroleum Institute on how to process tallow — nobody knew how to do it. And it would be risky to outsource the creation of an entirely new refining system on an unproven feedstock.
But due to the company’s size, its technical experts were close enough to ownership to get quick approval to experiment. So, Kern invested $75,000 in basic filtration equipment and a few tanks, and it used a spare pump to run a test batch. Samples from this initial batch were run through test engines to check emissions and gain EPA approvals. Kern then developed a more complex test protocol, processed a larger batch, and repeated the emissions testing, eventually ramping up into regular production at the end of 2009.
In the end, nine months after they started, Kern had invested about 1,000 hours of time into making this work, and it became the second U.S. refinery to make renewable diesel by co-processing tallow. Ongoing investment over the next few years represented approximately 30% of Kern’s typical year’s capital budget; co-processing tallow has substantially increased the cost of production. However, the resulting value of the renewable diesel justifies that additional ongoing expenditure.
Disruptive innovation means pursuing potential marketplace changes before they’re known to be feasible and encouraging experiments that fail more often than they succeed. It means spending hundreds of hours thinking and working on initiatives that may or may not blossom. It’s very hard to mix this sort of work with the urgencies of daily execution.
Midsize companies have money to invest, but not frivolously. At midsize scale, innovation must be a process whereby opportunities are discovered, evaluated, and incrementally de-risked. This is often called an “innovation funnel.” Opportunities can be categorized, analyzed, and valued. The progress of innovation efforts overall can be measured and assessed. With a systemic approach, budgets can be used to direct capital toward the right objectives. Midsize companies often struggle to spend on innovation, feeling uncomfortable spending capital on projects that have no clear return on investment. But on-schedule investment is required to adapt while unmet demand exists.
Kern’s projected path toward that adaptationincludes opening up two positions to support a faster pace of innovation: A process engineer to assist in evaluating new feedstocks and technologies, and a fuels and climate change specialist to navigate the regulatory process. They’re developing budget detail to allocate dedicated funds toward carbon footprint reductions, which can have clearer payback periods, and more disruptive innovation focused on negative carbon intensity fuel development via feedstocks like agricultural or municipal waste.
Gathering Valuable Marketplace Intelligence
Too many smart people think that the best ideas start within their mind or within their companies. But that’s one of the most inefficient approaches to innovation. The best way to start is with what the market needs but can’t yet find. Curtis R. Carlson, former CEO of SRI International, a famous research center, developed and popularized an approach called NABC; N, the first and most important step, stands for “need.” Identifying shifting demand and new needs comes from externally facing activity, such as talking with customers, suppliers, and other players in industry and scrutinizing what moves competitors are making.
Typically, most midsize companies’ external activities have to do with selling and marketing, telling the world about their wares. Innovation’s external activities are much more about listening and looking for early signs of change, then homing in to listen even more carefully. Many innovations are the result of partnering with other organizations with different core competencies, each of whom deliver part of the value chain.
Kern is considering several partnering opportunities focused on innovative equipment that converts wet organic wastes, forest and agricultural residues, and even municipal solid wastes into renewables. Kern brings value as the catalyst and incubator, helping pilot test technologies that can become “the next big thing” in the effort to produce cleaner-burning fuels. They network within the industry and with R&D organizations. Kern has assembled Team Yosemite, a group of six led by its head of renewables. The team is staffed by two process engineers, a supply-side expert, a fuels market expert, a regulatory specialist, and the senior VP of operations. Together, they rapidly prioritize projects on a renewables roadmap.
Innovation isn’t something that happens in isolation in some R&D lab — that’s basic research. For the most part, midsize companies are using existing know-how in new ways, which means cross-functional innovation teams are a must. Marketing is involved in understanding the market need; R&D tests; engineering builds the pilot test; manufacturing ensures feasibility; finance validates potential profitability; and sales collects customer feedback. For the early visioning stage of innovation, this team should be a handful of people who understand their department’s perspectives. For those innovations nearing execution, the teams will grow significantly.
But teamwork isn’t limited to those inside the company. More people, and likely different people, will be required. The existing teams in midsize companies are always busy and have ongoing job duties. While some companies employ people eager to think differently, there must be significant time dedicated to the innovation effort that’s walled off from normal day-to-day activities.
Teamwork between partners up and down the supply chain is critical. Few midsize companies solve for demand shifts on their own. Collaboration between separate entities requires negotiating how costs and benefits will be shared, role definitions, and timelines. They must be formalized in writing to justify investment and ensure alignment. In Kern’s case, any changes involve R&D, raw materials sourcing, plant and equipment modifications, government compliance, and sales. Kern prioritized collaboration by creating an oversight team to drive change and opened new positions dedicated to the effort, all with executive sponsorship from the CEO.
The pandemic has accelerated change that will significantly affect demand trends. Despite the step-up in urgent needs during the pandemic, such as safety and managing remote employees, forward-thinking midsize companies must understand the change in demand patterns and adapt through innovation.
Midsize companies in every industry can have a big role in making the future better. But their work must begin now, fueled by systematic investment in innovation, information-gathering activities, and teaming.
Robert Sher leads CEO to CEO, a consulting firm of former chief executives that improves the leadership infrastructure of midsize companies seeking to accelerate their performance. His most recent book is Mighty Midsized Companies: How Leaders Overcome 7 Silent Growth Killers. He can be reached at R.Sher@ceotoceo.biz and @RobertSher.