The smaller the company, the greater the innovation… right? Not so, says an angel investor.

By Jocelyn Goldfein (Angel Investor & Mentor)

When I was a fresh graduate getting my start in the tech industry, I figured big companies were where innovation went to die.

In my mind, the cause-and-effect ran something like this: startups have innovative people; big companies don’t (and can’t attract them). I thought by sticking with small companies and avoiding big companies with their bureaucrats and overhead, I could stay innovative in my own career.

Reality busted a hole in my illusions. Plenty of small companies fail to innovate — we only hear about the ones that succeed. While there was some truth to my observations about big companies slowing down, the more I learned about why, the more I learned useful lessons for companies of all sizes.

It all stems from one basic problem, which is that innovative ideas are roughly indistinguishable from dumb ideas.

Let that sink in. Innovative ideas look just like dumb ideas.

If something seems like a clearly good idea, it is also an obvious idea. So everyone is doing it! The big ideas that fundamentally change the status quo usually have fatal-seeming flaws that keep (almost) everyone from pursuing them: It’s impossible. It’s in poor taste. No one would want it. You can’t make money doing it. It’s too expensive to build.

Make the Leap

Innovation requires a leap of faith that you are right and everyone else is wrong.

OK, OK, so picking good ideas is hard, but that’s what defines great innovators, right? The ability to tell the “crazy” idea from the “crazy awesome” idea? It would be nice to believe that — but empirically speaking, there’s no evidence to support it.

The best track record of repeated technical innovation in high tech is the collective Silicon Valley startup scene. And guess what — 9 out of 10 VC-backed startups fail. The absolute best-of-the-best, most profitable VCs? Maybe a 25% success rate.

If you can tell the brilliant from the baloney even one out of four times, you are at the top of the game. I encourage you to go into investing and print money! For mere mortals — it’s more like one in ten or worse.

Now, the Valley tech scene does just fine with a 90% failure rate, because the win associated with backing successful execution of a really disruptive idea is much more than a 10x return on investment. The good ones return 50x, and the home runs deliver 100x or more. Individual startups succeed and fail, but VCs who consistently hit the 10% ratio do fine, because they have deep enough pockets to fund dozens of ideas.

You know who else has enough resources to employ a portfolio strategy? Big tech companies.

Big companies have the capital, the infrastructure, and the engineering talent to chase dozens or hundreds of crazy ideas — and they have the same incentives as VCs to look for those home runs. In fact, it’s economically irrational for big companies not to fund a ton of new ideas in search of innovation. What could be stopping them? Greed? Incompetence? Inability to project a five year cost-benefit analysis? These are just grossly insufficient explanations for behavior which is so at odds with shareholder interest. If my naive theories about innovative people were off-base, the mystery remains: why aren’t well-established tech companies the source of far more of the industry’s innovation?

I have a new theory to explain at least part of it. It’s you and me. The engineers, the managers, the PMs and designers actually working on the products, and how we’re affected by failure.

The Failure Effect

Have you ever had the experience of working on a project for six months, a year, multiple years… only to see it get shelved? How did you feel afterwards? Ready to dive in on another moonshot?

I sure wasn’t when it happened to me. One of my big bets at VMware was the development of a client hypervisor. VMware had toyed with the idea for years; it was high risk for a number of reasons but if it was successful the impact might be enormous. When I had the chance to take on the project, I was excited. Yeah, it was crazy, but it just might work. We signed a major partnership, I recruited a bunch of the best engineers I knew for the project and we set to work.

Almost a year later, we threw in the towel. It was too costly, it was too complex, the value proposition to users was too unclear. We still believed it might be great technology someday but… not right now.

I promise you, my reaction to the project’s cancelation wasn’t “Too bad, let me find my next longshot!” It was more like grief that a year of my life had been wasted, guilt that I’d wasted the efforts of my team, fear of reputation damage and determination to work on something next time that would actually matter.

As individuals, we have no portfolio strategy — so those 10% odds are no longer palatable. When we fail, most rational people respond by trying to avoid dumb ideas and pick smart bets with clear impact the next time. People who happen to have a hit in their first few tries are even more vulnerable to the belief that they have to succeed every time (and take it harder when subsequent failures inevitably occur.) And that’s it — the dead-end for innovation.

I’ve met a few people who don’t seem to have this reaction (serial entrepreneurs every one of them) and I can’t tell you what makes them react differently or how to learn to be that way. But I do know there aren’t enough of them out there to hire your team exclusively from their ranks.

If you run a small tech company, this should concern you. Avoiding “big company people” isn’t going to save you, because the self-same employees who are innovating and taking risks with you today are going to become risk averse and careful once they start failing — and sooner or later, they (and you) will fail.

Does this mean you have to give up on innovating as your company grows up? Of course not. But the solutions aren’t simple.

How can a Business Keep Innovating?

There’s no magic incentive structure that fixes this problem. If you think startups encourage innovation because early employees are rewarded disproportionately for success, think again. Startups benefit from selection bias — people looking to play it safe don’t take a job with a startup in the first place. So trying to mimic the incentive structure of a startup is a red herring that won’t solve the problem and adds complexity and unfairness. Even if you are a startup — founders who’ve been through a few pivots know that equity isn’t what kept employees by their side through the resets.

“Permission to fail” is also a tricky concept. You don’t want to build your company with people who don’t care if they fail or not. High standards, thirst for impact, “fire in the belly” — those same qualities that make us punish ourselves harshly for failing — those are precisely the traits that make amazing teammates who will put their heart into every project and give you the best chances of success. Those are the people you want in your foxhole — not people who’ve had that spark put out!

You can certainly hire people who’ve never failed; their courage can have a buoying effect on everyone else — but they too will become risk averse over time as they encounter failure, so it’s not a lasting solution. You can (and should) make every effort to fail as fast as possible to minimize the human costs of failure. But that tactic is limited by how long it realistically takes to prove or disprove the kind of ideas you work on. Even ruthlessly optimizing project definition proof of concept, failing fast can still take months or years, especially if your innovation is technical, rather than product- or market-based.

The most lasting way I’ve found to nurture the spirit of innovation is to hire people who hate to fail, and build a culture that picks people up, dusts them off and encourages them to try again when failure occurs.

Try, Fail; Try Again, Fail Better

It’s not enough to say, “Well, we don’t penalize failure.” You don’t have to. Even if you don’t fire employees or dock their bonuses for working on a failed project, the kind of people who care deeply and passionately about their work will penalize themselves, with feelings of shame and loss.

How can you help people move past failure? Success means different things to different people: a soaring stock price or their name in lights or the satisfaction of making an impact. None of those are available when a project fails, so you can’t make someone whole on their opportunity cost. Luckily, you can mitigate the emotional costs of failure — and those turn out to be more significant to most people. You do it by reassuring people that failure is a natural consequence of being bold, that they are capable of greatness, and that most successes come from failing and trying again.

Unfortunately, you can’t wait until a project fails to come up with these sentiments. Not much rings more hollow than “Attaboy! We’ll get ‘em next time!” at the project’s cancellation. As someone who’s tried it, I can tell you it’s the last thing anyone on the team wants to hear, let alone believe. And they’ve also got to hear it from each other — their teammates and peers — not just the boss who wants to send them on the next suicide mission.

So you have to bake resilience into your culture from the very outset. Facebook’s infamous slogan “Move fast and break things” is a good example of cultural back-pressure that supports those who fail. No company writes “Move slow” on the walls. But if you just write “Move fast” by itself, your company will eventually slow down anyway. Moving fast comes at a cost — the cost of making mistakes. If you don’t signal loudly that you are prepared to pay that price, your team will slow down on their own out of completely natural obedience to the rule so universal no one needs to write it on the walls: “Don’t screw up.”

This isn’t to say that your company should be a consequence-free environment. You should have zero tolerance for ethical transgressions (say, user privacy violations, or creating a hostile work environment). You also need to part ways with individuals who don’t have the skills to be successful and aren’t improving.

But you can and should shape the way your employees talk to each other about mistakes, and that starts with you. Posters and slogans like Facebook’s are symbolic reminders, but they don’t do the actual heavy lifting of demonstrating conviction. If all you do is hang posters, expect your employees to receive them with justifiable cynicism. What sets the tone is the way company leaders talk about their own failures, acknowledging what happened and sharing how they and the company are stronger for the lessons they learned. It takes courage and vulnerability to talk about your own shortcomings, and ultimately, that’s what will make a difference to the people who trust you and follow you.

Getting up in front of your team and talking about things you got wrong is terrifying. But if you want your team to be bold, it starts with you.

This post originally appeared on Medium.

Photo credit: bahri altay via Shutterstock.

Has failure spurred you on?