True innovation is a disciplined approach to addressing a vital or valuable market need by building a new or refined form of technology. Some confuse innovation with experimentation. The concept of “experimentation” is a much less disciplined practice, typically intended to adapt an existing technology to a less well understood need in the hope that the experiment unearths a meaningful opportunity. The key difference is discipline. Disciplined approaches seek to avoid waste and maximize efficacy, while experimentation often leads to broader products that are less effective for particular purposes and frequently create confusion.

Changing economic conditions of all kinds alter the ground rules that favor success of one kind or another. When economic conditions are in expansion mode, experimentation becomes far more “affordable.” Entrepreneurs find it easy to raise capital cheaply from investors who need to deploy an ever increasing supply of risk capital to generate the returns their investors expect. The net result is that many somewhat questionable business models wind up being funded as stand-alone entities, or internal projects arise in search of new growth opportunities. In either case, some of these initiatives thrive; many others will fail.

For new firms, the net effect is excess business formation. For established companies, most attempt to expand more rapidly than they would otherwise. In either case, when capital is cheap, why not take a shot at a new market segment or product line expansion. Product management discipline is relaxed with the encouragement of CEOs and boards. And why not, if revenue multiples are high and the experiment works, the company’s valuation increases and everyone is rewarded. If not, just “pivot” and raise more capital.

Whatever the motivation, excess company formation and rampant product experimentation result in lower quality products and inferior product market fit at scale. Most pernicious of all, rampant experimentation causes the cost of everything related to innovation to increase as there is too much capital chasing the same employees, leaders and customers.

But then the party ends.

When economic contractions arrive, the first action almost every company takes is to reduce experimentation and cut extraneous spending. The gist is that discipline of all types returns, and innovative firms begin to net down on known solution areas and focus on making their products more attractive to their core markets.

Although frequently painful to the individuals affected, this shift has the effect of reducing the demand for labor and resources. As a result, the increased available supply, particularly of development resources, causes the cost of labor needed to innovate to at least stabilize (if not reduce), while simultaneously increasing the available quality. It cannot be stated enough that the more skilled the technical resource, the better the innovation outcomes.

The second positive effect of renewed focus is that the core attributes of the product improve more rapidly. In downturns, companies become hyper focused on retaining customers and growing new ones in a capital-efficient way. The best way to deliver both is to accelerate growth in solution utility and value.

The final effect is that weaker technologies become the first to be abandoned or deprioritized. This results in reducing the competition for awareness and customer consideration. Occasionally, bad luck kicks in and those that didn’t raise capital at the right time and in the right amount wind up excessively impacted, but that is less common as most well-advised firms have a sense when the capital party is coming to an end.

The net effect of all of this is that the excessively noisy markets of boom times quiet down, and innovators that can quickly focus on building awesome products garner greater interest in and awareness of the value those products deliver. It also has the effect of increasing the concentration of skilled talent working on meaningful projects.

Factors That Lead to an Innovation Uptick

In the right culture and with the right leadership, something magical happens when existential pressures appear. Teams begin to rally around “North Star” (highest value) goals. Execution becomes much more focused. Time-wasting arguments about ancillary pursuits disappear. Alignment between teams increases. And if the adjustments are communicated transparently and honestly, morale actually improves. All of these factors result in a more effective and nimble organization, which is critical to technical advancement.

Properly aligned organizations then start executing on refined goals. The formula is simple: Greater technical discipline plus stronger talent equals superior innovation outcomes. Moreover, by focusing on delivering value, product efficacy increases more rapidly than a bloated code base that confuses users in an attempt to serve evermore peripheral use cases. The outcome is that users see their needs being addressed more quickly and effectively than when times were perhaps too good.

A final point to consider is that lean times cause innovators to become more scrappy and to dispense with excess work in service of extraneous process. This isn’t to say process is bad in the least, just that all human endeavors that are not routinely examined develop endemic bloat when there is no political will to address. The same introspection that generates product/market focus also causes teams to discard political orthodoxy and begin to examine exactly what is needed to deliver in a more lean and scrappy world. Paring back overhead has the added benefit of creating greater satisfaction among technical talent who often feel stifled by the sort of bureaucracy that evolves during times of excess.

Weathering a Financial Storm

During the Great Recession, I witnessed the above firsthand at Zuora. Before the market fell apart, we had plans to address a number of peripheral opportunities in adjacent markets.

Then Lehman collapsed.

Quickly we focused on the core use cases we knew were going to be valuable no matter the market condition. We also looked at our customer base and realized that we were servicing two distinct segments — small to medium businesses and enterprise scale ones. The problem was the smaller ones were disproportionately affected by the downturn and were either failing entirely or were exiting the more experimental products they were planning to service using our platform. The larger firms did not show this dynamic. They had multiyear horizons, and while there were short term disruptions, their core businesses were solid. So we quickly shifted our focus to enterprises and the product requirements they demanded.

The outcome was a substantial success. We obviously managed to weather the financial storm. We also tailored our contracts so that we could use our customers’ rapidly declining weighted average cost of capital to offer discounts for multiyear prepayments that had the effect of eliminating our short and medium term capital raising requirements. The discounts exceeded our customers’ capital costs but were much cheaper than a dilutive equity raise in the depths of a recession for us.

Innovation and Entrepreneurship Are Crucial for Long-Term Economic Development

Larger firms are freezing new hires, smaller firms are pausing unproven initiatives, and firms that over extended (experimented) during boom times are beginning to trim down to a more sustainable profile.

Financial markets have been described as oscillating between greed (boom time behavior) and fear (downturns). Given that so much of the technology market requires ongoing financing, the industry experiences similar swings, often of a magnified nature. As of this writing, we’re firmly in the fear cycle.

However, as soon as investors begin to circle in on how to value companies in whatever the new market norms look like, capital will begin flowing again. Firms that successfully innovated during down times will start to see others entering their markets. Success always attracts new entrants — some with better mouse traps, others just start to experiment.

Whatever the new pattern looks like, the successful innovators will likely be the emergent leaders in their particular space. Their valuations will form the basis of valuing newcomers, and a new generation of technological advances will become the object models for a new phase of growth.