China is a complex and highly fluid business environment. The changes that are occurring in technology, markets, and customer needs and preferences - along with the very intense competition - are unprecedented. Underlying this complex market environment is an emerging economic system with nascent laws on intellectual property rights, consumer rights, R&D, competitive behaviour, and the acquisition and use of human capital. Professor Haiyang Li of Rice University and I have argued that the market environment in China is characterised by dysfunctional rather than functional competition. However, for the creative person or company this rather gloomy assessment of the Chinese business environment is actually indicative of the tremendous opportunities that it has to offer. Think of the rapidly developing middle class, the sustained growth of the economy, the highly qualified and talented but relatively inexpensive labour force in manufacturing, and, perhaps more importantly, in science and technology. Your ability to take advantage of these opportunities depends on your ability to innovate.

WHAT DO I MEAN BY INNOVATION?

Here, I mean innovation with both a small "i" and a big "I". By innovation with a small "i", I mean any new product, process, service or business activity that creates a unique and compelling solution valued by customers. By innovation with a big "I", I mean innovation in management - an organisational culture and mindset that promotes the creation of new value from customers along the entire value chain of a business. Innovation involves more than just new products and services; it is a culture that values the creativity of all employees and an organisational competency that sees the possibility of new value creation in all stages of the value chain. Unfortunately, many foreign and local firms in China tend to view innovation only in terms of the small "i". Consequently, they neglect innovations in marketing, manufacturing, distribution, and customer service; innovations in building business and personal relationships, selecting and dealing with partners, and developing and implementing business models; and innovations in human resources management, in hiring, rewarding, and retaining key employees.

However, the picture is not completely gloomy. Some local companies recognise innovation as a company-wide competency that involves every function and every manager. For example, Mr. Baoguo Zhu, the Chairman and CEO of Shenzhen Taitai Pharmaceutical Industry Limited, stated:

"Innovation, to me, has two meanings. The first refers to product and technology innovation, and the second to innovation in management. ... I emphasise innovation every time we hold a management meeting. I tell every manager that we need innovation and that they must take risks. If a firm does not innovate, then it will be out of business. ... I ask managers to make progress every year in their strategic plans. For instance, a few days ago the sales director submitted sales strategies for 2000. Although there were some changes, the strategy was very similar to that of last year. I returned it to the director and asked him to put in some new ideas and new methods. He asked: 'Why?' and I said: 'Because the market in 2000 will be different.'"

THE GRANT PARADOX OF INNOVATION

In recognising innovation as the key to the success and survival of his company, Mr. Zhu is in good company, because in a survey of firms in China, 95% of CEOs agreed that the future success and survival of their companies depended on innovation. Unfortunately, only 15% agreed that they had a vision and strategy for innovation, processes for the management of generating and managing new ideas, the facilities to train managers in cross-functional teambuilding skills, the necessary formal metrics to assess the creativity and innovativeness of employees, performance metrics for innovation, and most tellingly, formal reward and recognition systems for innovation. In short, in almost each of the essential elements for building a supportive environment for innovation, many companies in China, both local and foreign, appear to fall short. This is the grand paradox of innovation in China. Although recognising that innovation is invaluable to the survival of their companies, most CEOs pay more attention and put more resources into other elements of the business which may actually impede innovation. In particular, many CEOs believe that success in China largely depends only on cost efficiency and productivity gains. These will certainly remain important parameters for business success, but research shows that a company will gain little in the long run in this rapidly changing environment if it neglects innovation. What is the cause of this malaise? Not many CEOs will admit to this, but I think that the major cause is what I call the FUD factor ? fear, uncertainty, and doubt:

The fear of the unknown in terms of national and local government policies, local dysfunctional competition, piracy, counterfeits and imitations;

The uncertainty about the changing nature of the Chinese market, customers, and technologies;

The doubt about current and potential partners, in addition to self-doubt about the company's own ability to navigate the turbulent economic and political landscape in China.

Many CEOs and their companies know that innovation in China is right for them, but fear doing what is right. As Confucius said: "To see what is right and not to do it is a want of courage." Emerging from this FUD epidemic that is afflicting corporate China are a few more innovation management paradoxes which I will briefly describe. Managing these paradoxes effectively lies at the root for corporate innovation and competitive advantage in any industrial economy.

R&D STRATEGY PARADOX ? EXPLOITATIVE AND EXPLORATORY RESEARCH

For many firms, the Chinese marketplace is ripe for the taking merely through the exploitation of their current R&D competencies. To the extent that new competencies are developed they are aimed at adapting current products to the Chinese market. The paradox here is that too much of a focus on adaptive research blinds a firm to the emerging needs of the increasingly sophisticated Chinese consumer, the cultural and behavioural nuances that shape consumer choice, and, perhaps most tellingly, the ability to build new competencies for the future environment. R&D exploitation needs to be balanced by R&D exploration that is geared toward the development of entirely new technological, marketing, and other competencies for the future.

My recent research on this issue in China was published in the world's leading marketing journal ? the U.S. Journal of Marketing. I found that firms in China tend to focus more on exploiting their current competencies in innovation than on developing new competencies. However, the study also suggests that firms that are able to strike a mutually reinforcing balance between exploitation and exploration in innovation are more likely to succeed in producing the appropriate new products and services that Chinese consumers want. Companies such as Huawei ? with its cost-effective R&D model, Philips ? with its open innovation strategy, and P&G ? with its customer intimacy approach to the study of customer needs - are examples of emerging best practice in China. Why are these companies able to achieve this while others are not? The reasons are many, but my study suggests that the most likely answer lies in the differential abilities of companies such as these to understand the Chinese customer, their competitors, and the complex Chinese environment, and, more importantly, their ability to interpret the market information that they obtain as an opportunity, rather than a threat. My study suggests that best practice companies that tend to interpret customer and competitor information as an opportunity become more risk-seeking, develop greater internal political support for new investments, and therefore invest resources to develop the new internal and external R&D competencies that are necessary to discover and meet existing customer needs and to create new business models that ensure the success of the new products. In contrast, companies that interpret the Chinese market environment as threatening develop an environmental risk aversion mentality that places status quo efficiency over innovation. The issue of courage is clearly revealed here. A good example of this lack of courage is the ambivalent attitude of GE to the Chinese market over the years. If you consider entering an entirely new market as an innovation ? and you should ? then you will see what I mean. The world's most admired company has consistently been scared of the Chinese market. In spite of many exploratory visits by the top brass of GE in the 1980s, it did not make a major investment here until sometime in the late 1990s.

CLOSED AND OPEN INNOVATION

A close cousin of the R&D paradox is the paradox of closed versus open innovation. More often than not, the FUD factor causes companies to develop closed innovation strategies in which all of the research, design, development, and marketing are done in-house. However, in an increasingly global world, not all the smart people will be working for you. Particularly, in China the ability to access the capabilities of local scientists and engineers, universities, and local companies is a key driver of innovation success. Forming mutually beneficial relationships in China will ensure that you are at the forefront of developments in local research and knowledge, because you gain access to Chinese problem-solving expertise and research opportunities. This explains why Philips has invested around $50 million in the Phillips Innovation Campus in Shanghai in partnership with the Shanghai Science and Technology Commission and the Shanghai High-Tech Park United Development Limited. As with most best-practice open innovation companies, Philips believes that achieving innovation across the entire value chain, not just in products, requires the courage to share knowledge and competencies with universities and other industrial partners. This proactive and exploratory approach to innovation management is rare in China, where there is a constant moaning about intellectual property being stolen by local partners. The interesting thing is that emerging research in the West is increasingly suggesting that you safeguard your intellectual property more securely by sharing, rather than by putting it in an anti-nuclear bunker, but that is another story.

This is not a new paradox and is by no means symptomatic of the Chinese environment. It has been examined by several people in several countries. Indeed, I completed my doctoral studies examining this paradox and its potential solutions among engineering firms in Australia. What is new and perhaps surprising is that although everyone agrees that internal R&D is vital but is only one piece of the innovation management puzzle, few companies have developed appropriate strategies on when and how to appropriately deploy an open innovation strategy. Again, one core reason is the fear of patent infringements and other intellectual property rights issues in China. However, I suggest without a portfolio approach to innovation involving markets, time, and sources that sees intellectual property not as a defensive wall but as a currency, a company's success in China will be limited. With an open innovation approach, internal R&D is managed in concert with inward and outward licensing efforts within corporate innovation culture that understands that the "voice of the customer" cannot be heard and responded to by one company alone. This leads me on to the next paradox, which is the paradox of responsive versus proactive customer orientation.

THE PARADOX OF RESPONSIVE AND PROACTIVE CUSTOMER ORIENTATION

We all know the three key factors for success in real-estate investment: location, location, and location. As it happens, innovation has something in common with real-estate investment: the success of innovation is also driven by three factors: customer, customer, and customer. Time and again companies are advised by academics, the business press, and consultants to start and end the innovation process with the customer, and CEOs everywhere champion a customer-focused corporate culture. Even Enron claimed to put the customer first! Businesses conduct numerous customer satisfaction studies, and it would appear that the customer really is king. But is this really the case? It seems that when it comes to innovation, customers are given less than royal treatment, as can be demonstrated by abundant examples in China and elsewhere. Research carried out some years back in China showed that the key success factor for new products in China is product quality, yet every firm that you talk to will say that they produce products of the highest quality that customers want. If this is true, then product quality should be a neutral driver of new product success in China. The question is: Why is product quality a driver of the success of a new product both in China and elsewhere? The answer is that many companies merely pay lip service to the product quality needs of the customer.

Why? Because listening to the "voice of the customer" involves one of the most intriguing paradoxes in innovation management. Should you respond to the needs and desires that are articulated by customers, or attempt to be proactive in discovering and satisfying needs of which customers are as yet unaware? Business research has found that firms that balance between being responsive and proactive to customers have better innovation performance than those that lack such a balance. The problem is that the responsive and proactive approaches to meeting customer needs require different organisational processes, and each approach requires different internal and external conditions for successful innovation to take place. It is likely that in China the situation may be more complicated still, given the rapid expansion of the market and the continuing fluidity of the economic and institutional environment.

Again the key to this managerial paradox is to have processes that allow a firm to stay close to the customer while at the same time ignoring the customer. For example, P&G scientists and cross-functional teams live with customers to understand their unarticulated needs and preferences. They watch people doing their laundry at home or brushing their teeth aboard a bus with specially designed bathrooms. Did you know that Chinese customers like different toothpaste flavours? That they want a lot of foam in their mouths, but at the same time want the foam to dissipate quickly? That when washing their clothes most Chinese prefer suds to be generated and removed at rates that is different from those of detergents that are sold in the U.S.? You get to know the deeper needs of customers through proactive customer-oriented techniques, yet few firms train their R&D and marketing staff in the use of market research tools that uncover the latent and difficult-to-articulate needs of customers.

The insight here is one of balancing the approaches, or of taking a middle path. You need to carefully balance your focus on the articulated needs of your market and paying attention to emerging and unarticulated needs. To do this, managers need to refine their thinking on how to conduct and evaluate their R&D in China. Over-emphasising technical product performance, patents, and other measures of internal R&D efforts, rather than perceived customer value, is a mistake. When you have a research centre in China, you should emphasise performance measures that ensure R&D and marketing collaborate effectively to uncover emerging trends in the customer's deepest wants and desires, as they vary across market segments and regions. It is the only way that you can be both responsive and proactive to the needs and problems of customers and be able to move slowly and quickly at the same time in your market access plans in this rapidly changing marketplace.

Your company's capacity to move simultaneously slowly and quickly to meet market needs in China requires attention to yet another paradox: value creation versus value appropriate.

PARADOX OF VALUE CREATION AND VALUE APPROPRIATION

As I have argued earlier, companies that put great emphasis on innovation often focus on innovation with a small "i" and neglect many aspects of innovation with a big "I". In doing so, their strategies for value creation become disconnected from their strategies for value appropriation. We have all heard stories of companies coming up with innovative products but losing the market to followers. The classic example is Apple, which has a habit of pioneering new products and creating new markets but is usually unable to appropriate the value that it has created for itself and for its stakeholders ? the PC and pen-based computing are examples that readily come to mind. It would seem that Apple has learnt its lessons with iPod and iTunes, but don't hold your breath ? the vultures at Wal-Mart, Sony (despite its current troubles) and Microsoft are circling above waiting for Apple to slip up once again. Why is it that some companies that create very useful innovations for customers manage to get frozen out of the markets that they create? The answer lies in their inability to recognise the importance of the difference between value creation and value appropriation. The paradox is that it is possible to pursue technical or product innovation at the expense of business model innovation that ensures the lasting success of the business, that is, new ways and processes of distribution, marketing, pricing, promotion, and branding that allow the effective appropriation of value from technical innovations. I suggest that in China firms that think through their business model innovations alongside their technical innovations will reap the greatest benefits and profits from the new products and services that they produce.

Is bottled water an innovation? You bet it is! Contrast Nestl¨¦ and Danone's business models in the bottled water market, which started around 1997, with the increasing health consciousness of the growing Chinese middle class. Nestl¨¦ set up its own water-bottling plant in China and added a second in 2000. Initially, it stuck to the high price end of the market and emphasised the same meticulous approach to quality as it uses for milk. It sets up a chain of retail shops and delivered water jugs to homes and offices using its own fleet of trucks. However, it is only seventh in the market ? why? It pursued the wrong business model in a business in which low costs and an instant response are crucial to market dominance. Now let us look at Danone. It tapped into local resources through the establishment of joint ventures with two local companies. It quickly gained control of 17 bottling plants, which generated benefits such as economies of scale, efficient delivery systems, lower prices, and the No. 1 spot in the market. In 2002, Nestl¨¦ scrapped its original business model. Thinking of business model innovation brings to mind another paradox in innovation management, which I call the paradox of the value at the bottom and top of the pyramid

VALUE OF THE BOTTOM OF THE PYRAMID

The market in China can be viewed as a pyramid that reflects the size and purchasing power of segments of the population ? high income, middle income, and low income. Of course, like any emerging market economy the bottom of the pyramid constitutes the largest potential market. This segment contains aspiring customers who desire the same products and brand experiences as the other two segments but has a totally different value curve. The experience of profitable low-cost airlines shows that, given the differences in value curves of airline customer, it is possible to make money by looking after the needs and problems of the bottom of the pyramid. Yet, many companies tend to ignore this market in their innovation process and marketing strategy as unprofitable and unwanted. Because of this neglect, any successful innovation in China or elsewhere is likely to be quickly imitated or pirated by companies who understand the value curves of this market segment. If this is not the case, then how can you explain the frequent moaning that counterfeits (illegal) and imitations (legal) drain billions of sales from branded ? mainly foreign ? products in China?

I read in the Bloomberg recently an opinion that China's capacity to innovate and its ability to create jobs for millions of people depends on its ability to protect the ownership of innovative products and associated intellectual property rights. The same article argues that clamping down on imitations and counterfeits is hard for the authorities because, among other things, the factories that produce and sell such products provide jobs and livelihood for millions of people. You see the dilemma of the analyst. What is the key issue here? It is the lack of recognition of the value of the bottom of the pyramid during the innovation process among companies in China. I submit that until corporate China, in particular foreign firms, recognises the value at the bottom of the pyramid and develops business models that successfully provide the brand experience to which this group aspires at affordable prices, the counterfeit problem will persist. In a country such as China, the bottom of the pyramid has problems, needs, and aspirations that will be satisfied one way or another, and the ingenious company should find innovative and profitable ways of responding to this. Remember that not long ago the music industry was wringing its hands over the billions of dollars stolen by users through free downloads on the Internet. Then Apple came up with iTunes, which many observers see as its first foray into business model innovation. In essence, iTunes is a novel marketing, distribution, and pricing arrangement that allows users to pay for songs, rather than stealing them. This innovation convinced the recording industry to support digital music delivery. I suggest that managing innovation in China requires the creative interplay of internal and open R&D. It also requires careful development of a business model that allows you to ensure appropriate degree of market coverage. This is because your ability to develop a new product with differentiated value propositions at attractive price points for the different levels of the pyramid is your ticket to success in protecting your intellectual property rights. Nothing more and nothing less! The marketing function has a crucial role to play here, as indeed it has in the entire innovation process. This process requires a collaborative cross-functional creativity and a diversity of perspectives on the market environment, which leads to the last important paradox: the paradox of human capital in innovation.

THE PARADOX OF HUMAN CAPITAL

We all know that the success of innovation and all other activities comes about through the use of human capital. Specifically, innovation relies not only on individual creativity, but also on cross-functional diversity, which means allowing strategic disagreement, debate, and creative analysis in interpreting market and technology developments and customer requirements to design and develop new products. The paradox is that in a culture that values and places interpersonal harmony and consensus over conflict and open debate, the potential for strategic disagreement or debate to spiral into personal, emotional, and relationship conflict is very high. This is exactly what Haiyang Li and I found in a study of R&D and marketing teams in high-technology firms operating in Haidian District in Beijing, which was reported in the November 1999 issue of the Journal of Product Innovation Management. We found that when there was conflict in the teaming process, marketing people adopted several strategies to influence their R&D counterparts. Unfortunately, the least effective of these strategies, such as appealing for the intervention of the top boss and persistent pressure, were more frequently used than the more effective strategies, such as recommendation. This occurred because although companies spend millions on developing the technical expertise of their scientists, designers, product development, and marketing personnel, they tend to give little thought to the development of the management skills that are necessary to obtain the maximum value from the innovation processes. Most managers with strong technical capabilities appear to lack basic training and knowledge in how to manage cross-functional team processes, how to manage conflicts during product development, and how to harness a diversity of perspectives to enhance creativity in innovation.

In China, this is not helped by inadequate control and reward systems for R&D teams and for the people who sell new products. For example, we reported in another paper that was published in the Journal of Marketing in July 2002 that the control systems, attention and help that sales managers use to build a trusting relationship with salespeople are the very same factors that led these salespeople to shirk their responsibilities in selling a new product in China. The key lesson for innovation in China is that the creativity of R&D, marketing people and other personnel is harnessed through effective controls. Contrary to conventional wisdom, you get more creativity out of your employees when they know clearly the boundaries within which they are supposed to apply their ingenuity.

INNOVATION MANAGEMENT: THE NEW CEO AGENDA IN CHINA

I suggest that China itself, "Zhong Guo", "the middle kingdom" by definition is a paradox. Managing innovation is a complex undertaking in any business environment requiring the integration of technology, marketing, and management. However, the complexities and problems that are associated with the management of innovation in developed economies in Europe, North America, and elsewhere are multiplied tenfold in paradoxical China. Nevertheless, these problems are not insurmountable. To succeed in China, a CEO must lead the innovation effort and put political, financial, and moral muscle behind the development of a supportive environment for innovation. To ensure a balanced focus on efficiency for today and innovation for tomorrow, you have to be like the Roman god Janus. You need two sets of eyes: one pair that is focused on what lies behind and the other on what lies ahead. You must constantly look backward to attend to the products and processes of the past to ensure efficiency and productivity, but at the same time you should gaze forward to build the organisational environment and competencies that are necessary for the creation of innovations that will define the future of your business in China.

Remember also that an innovative product (the small "i") can win you awards but does not generate growth by itself: only innovation in management (the big "I") can achieve this. So, take a more balanced approach to developing innovation management skills. Technical R&D capabilities are important, but the management of innovations in marketing, manufacturing, building personal and organisational relationships, and attracting, developing, training, and retaining human capital are the generators of the growth potential that is inherent in the end-products of R&D. In other words, pay attention to business model innovation and don't be an Apple of yesterday ? great at creating technical innovations but lousy at value-driven business models.

Finally, you have to have courage. Building an innovative enterprise is risky, costs a lot of money and is politically demanding. However, you probably haven't got much choice. As Peter Drucker told us a long time back - innovation is the only core competence of any business organisation. If you agree, then you should start your innovation building effort today. There is no time to waste. It will define your ability to lead a workforce that is comfortable with managing paradoxes. If you are successful in this endeavour, you and your company will be able to give a positive and persuasive answer when the Chinese customer asks "What's new from your company and why is it good for me?"

(Professor Atuahene-Gima is Professor of Marketing and Innovation Management at CEIBS. The article is adapted from his speech delivered for the BENELUX Business Association in Shanghai on October 13, 2005.)