It was a fitting way to wrap up the first day of IBM's (IBM ) innovation-themed leadership forum, held in Rome in early April. Guests were treated to small group tours of the Vatican Museum, including Michelangelo's frescoes in the Sistine Chapel. They sipped cocktails on a patio in the back of St. Peter's, the vast dome of the basilica outlined by the light of the moon. They dined in a marble-statue-filled hall inside the Vatican. What better place than Italy to hold a global confab on innovation, the topic di giorno among corporate leaders? It was, after all, the birthplace of the Renaissance, another period of great innovation and change. 
The next day, at the Auditorium Parco della Musica, 500-odd corporate executives, government leaders, and academics listened as a diverse group of innovative leaders took the stage. Sunil B. Mittal, chief executive officer of Indian telecom company Bharti Tele-Ventures Ltd., described his radical business model, which outsources everything but marketing and customer management, charges 2 cents a minute for calls, and is adding a million customers a month. Yang Mingsheng, CEO of Agricultural Bank of China, the country's second-biggest commercial bank, spoke of building a banking powerhouse from a modest business making micro loans to peasant farmers.
Their stories echoed a comment IBM CEO Samuel J. Palmisano had made the day before: "The way you will thrive in this environment is by innovating -- innovating in technologies, innovating in strategies, innovating in business models."
Palmisano, to be sure, was making a subtle pitch for IBM and its ability to help the assembled leaders do well in an increasingly challenging business environment. But he also summed up the broad focus of innovation in the 21st century.
Today, innovation is about much more than new products. It is about reinventing business processes and building entirely new markets that meet untapped customer needs. Most important, as the Internet and globalization widen the pool of new ideas, it's about selecting and executing the right ideas and bringing them to market in record time.
In the 1990s, innovation was about technology and control of quality and cost. Today, it's about taking corporate organizations built for efficiency and rewiring them for creativity and growth. "There are a lot of different things that fall under the rubric of innovation," says Vijay Govindarajan, a professor at Dartmouth College's Tuck School of Business and author of Ten Rules for Strategic Innovators: From Idea to Execution. "Innovation does not have to have anything to do with technology."
THE QUICK AND THE BLOCKED
To discover which companies innovate best -- and why -- BusinessWeek joined with The Boston Consulting Group to produce our second annual ranking of the 25 most innovative companies. More than 1,000 senior managers responded to the global survey, making it our deepest management survey to date on this critical issue.
The new ranking has companies evoking all types of innovation. There are technology innovators, such as BlackBerry maker and newcomer Research In Motion Ltd. (
RIMM ), which makes its debut on our list at No. 24. There are business model innovators, such as No. 11 Virgin Group Ltd., which applies its hip lifestyle brand to ho-hum operations such as airlines, financial services, and even health insurance. Process innovators are there, too: Rounding out the ranking is Southwest Airlines Co. (
LUV ) at No. 25, a whiz at wielding operational improvements to outfly its competitors.
At the top of the list are the masters of many genres of innovation. Take Apple Computer Inc. (AAPL ), once again the creative king. To launch the iPod, says innovation consultant Larry Keeley of Doblin Inc., Apple used no fewer than seven types of innovation. They included networking (a novel agreement among music companies to sell their songs online), business model (songs sold for a buck each online), and branding (how cool are those white ear buds and wires?). Consumers love the ease and feel of the iPod, but it is the simplicity of the iTunes software platform that turned a great MP3 player into a revenue-gushing phenomenon.
Toyota Motor Corp., which leapt 10 spots this year to No. 4, is becoming a master of many as well. The Japanese auto giant is best known for an obsessive focus on innovating its manufacturing processes. But thanks to the hot-selling Prius, Toyota is earning even more respect as a product innovator. It is also collaborating more closely with suppliers to generate innovation. Last year, Toyota launched its Value Innovation strategy. Rather than work with suppliers just to cut costs of individual parts, it is delving further back in the design process to find savings spanning entire vehicle systems.
The BusinessWeek-BCG survey is more than just a Who's Who list of innovators. It also focuses on the major obstacles to innovation that executives face today. While 72% of the senior executives in the survey named innovation as one of their top three priorities, almost half said they were dissatisfied with the returns on their investments in that area.
The No. 1 obstacle, according to our survey takers, is slow development times. Fast-changing consumer demands, global outsourcing, and open-source software make speed to market paramount today. Yet companies often can't organize themselves to move faster, says George Stalk Jr., a senior vice-president with BCG who has studied time-based competition for 25 years. Fast cycle times require taking bets even when huge payoffs aren't a certainty. "Some organizations are nearly immobilized by the notion that [they] can't do anything unless it moves the needle," says Stalk. In addition, he says, speed requires coordination from the hub: "Fast innovators organize the corporate center to drive growth. They don't wait for [it] to come up through the business units."
Indeed, a lack of coordination is the second-biggest barrier to innovation, according to the survey's findings. But collaboration requires much more than paying lip service to breaking down silos. The best innovators reroute reporting lines and create physical spaces for collaboration. They team up people from across the org chart and link rewards to innovation. Innovative companies build innovation cultures. "You have to be willing to get down into the plumbing of the organization and align the nervous system of the company," says James P. Andrew, who heads the innovation practice at BCG.
Procter & Gamble Co. (PG ) (No. 7) has done just that in transforming its traditional in-house research and development process into an open-source innovation strategy it calls "connect and develop." The new method? Embrace the collective brains of the world. Make it a goal that 50% of the company's new products come from outside P&G's labs. Tap networks of inventors, scientists, and suppliers for new products that can be developed in-house.
The radically different approach couldn't be shoehorned into managers' existing responsibilities. Rather, P&G had to tear apart and restitch much of its research organization. It created new job classifications, such as 70 worldwide "technology entrepreneurs," or TEs, who act as scouts, looking for the latest breakthroughs from places such as university labs. TEs also develop "technology game boards" that map out where technology opportunities lie and help P&Gers get inside the minds of its competitors.
To spearhead the connect-and-develop efforts, Larry Huston took on the newly created role of vice-president for innovation and knowledge. Each business unit, from household care to family health, added a manager responsible for driving cultural change around the new model. The managers communicate directly with Huston, who also oversees the technology entrepreneurs and managers running the external innovation networks. "You want to have a coherent strategy across the organization," says Huston. "The ideas tend to be bigger when you have someone sitting at the center looking at the company's growth goals."
ASKING THE RIGHT QUESTIONS
Coordinating innovation from the center is taken literally at BMW Group (BMW ), No. 16 on the list. Each time BMW begins developing a car, the project team's members -- some 200 to 300 staffers from engineering, design, production, marketing, purchasing, and finance -- are relocated from their scattered locations to the auto maker's Research and Innovation Center, called FIZ, for up to three years. Such proximity helps speed up communications (and therefore car development) and encourages face-to-face meetings that prevent late-stage conflicts between, say, marketing and engineering. In 2004 these teams began meeting in the center's new Project House, a unique structure that lets them work a short walk from the company's 8,000 researchers and developers and alongside life-size clay prototypes of the car in development.
For many companies, cross-functional collaborations last weeks or months, not years. Southwest recently gathered people from its in-flight, ground, maintenance, and dispatch operations. For six months they met for 10 hours a week, brainstorming ideas to address a broad issue: What are the highest-impact changes we can make to our aircraft operations?
The group presented 109 ideas to senior management, three of which involve sweeping operational changes. One solution about to be introduced will reduce the number of aircraft "swaps" -- disruptive events that occur when one aircraft has to be substituted for another during mechanical problems. Chief Information Officer Tom Nealon says the diversity of the people on the team was crucial, mentioning one director from the airline's schedule planning division in particular. "He had almost a naive perspective," says Nealon. "His questions were so fundamental they challenged the premises the maintenance and dispatch guys had worked on for the last 30 years."
Managers are scrambling to come up with ways to measure and raise the productivity of their innovation efforts. Yet the BusinessWeek-BCG survey shows widespread differences over which metrics -- such as the ratio of products that succeed, or the ROI of innovation projects -- should be used and how best to use them. Some two-thirds of the managers in the survey say metrics have the most impact in the selection of the right ideas to fund and develop. About half say they use metrics best in assessing the health of their company's innovation portfolio. But as many as 47% said measurements on the impact of innovation after products or services have been launched are used only sporadically.
Actually, most managers in the survey aren't monitoring many innovation metrics at all; 63% follow five gauges or fewer. "Two or three metrics just don't give you the visibility to get down to root causes," says BCG's Andrew. Then there are companies that track far too many. Andrew says one of the top innovators on our list -- he's mum as to which one -- collects 85 different innovation metrics in one of its businesses. "That means they manage none of them," he says. "They default to a couple, but they spend an immense amount of time and effort collecting those 85."
The sweet spot is somewhere between 8 and 12 metrics, says Andrew. That's about the number that Samsung Electronics Co. uses, says Chu Woosik, a senior vice-president at the South Korean company. Chu says the most important metrics are price premiums and how quickly they can bring to market phones that delight customers. Samsung also watches the allocation of investments across projects and its new-product success ratio. That, Chu says, has nearly doubled in the last five years. "You want to see it from every angle," he says. "A lot of companies fall into the trap that they thought things were really improving, but in the end, it didn't work out that way. We don't want to make that mistake."
AWARDS AND ETHNOGRAPHY
One of the biggest mistakes companies may make is tying managers' incentives too directly to specific innovation metrics. Tuck's Govindarajan warns that linking pay too closely to hard innovation measures may tempt managers to game the system. A metric such as the percentage of revenue from new products, for instance, can lead to incremental brand extensions rather than true breakthroughs. In addition, innovation is such a murky process that targets are likely to change. "There's a dialogue that needs to happen," says Govindarajan. "Operating plans may need to be reviewed, or you may need to change plans because a new competitor came into your space."
Susan Schuman, CEO of Stone Yamashita Partners, which works with CEOs on innovation and change, says that besides numbers-driven metrics, some clients are adding subjective assessments related to innovation, such as a manager's risk tolerance, to performance evaluations. "It's not just about results," she says. "It's how did you lead people to get to those results."
That's one reason the bastion of Six Sigma-dom, General Electric Co. (GE ), has begun evaluating its top 5,000 managers on "growth traits" that include innovation-oriented themes such as "external focus" and "imagination and courage." GE has also added more flexibility into its traditionally rigid performance rankings. GE will now have to square its traditional Six Sigma metrics, which are all about control, with its new emphasis on innovation, which is more about managing risk. That's a major change in culture.
How do you build an innovation culture? Try carrots. Several companies on our list have formal rewards for top innovators. Nokia Corp. (NOK ) inducts engineers with at least 10 patents into its "Club 10," recognizing them each year in a formal awards ceremony hosted by CEO Jorma Ollila.
3M (MMM ) has long awarded "Genesis Grants" to scientists who want to work on outside projects. Each year more than 60 researchers submit formal applications to a panel of 20 senior scientists who review the requests, just as a foundation would review academics' proposals. Twelve to 20 grants, ranging from $50,000 and $100,000 apiece, are awarded each year. The researchers can use the money to hire supplemental staff or acquire necessary equipment.
Of course, rewards won't help if the inventions aren't focused on customer needs. Getting good consumer insight is the fourth most cited obstacle to innovation in our survey. Blogs and online communities now make it easier to know what customers are thinking. Hiring designers and ethnographers who observe customers using products at work or at home helps, too. But finding that Holy Grail of marketing, the "unmet need" of a consumer, remains elusive. "You need time, just thinking time, to step out of the day to day to see what's going on in the world and what's going on with your customers," says Stone Yamashita's Schuman.
THE WORLD IS YOUR LAB
Try learning journeys. That's what Starbucks Corp. (SBUX ), up 10 spots from 2005 to No. 9, does. While the coffee company began doing ethnography back in 2002 and relies on its army of baristas to share customer insights, it recently started taking product development and other cross-company teams on "inspiration" field trips to view customers and trends. Two months ago, Michelle Gass, Starbucks' senior vice-president for category management, took her team to Paris, Düsseldorf, and London to visit local Starbucks and other restaurants to get a better sense of local cultures, behaviors, and fashions. "You come back just full of different ideas and different ways to think about things than you would had you read about it in a magazine or e-mail," says Gass.
A close watch of customer insights can also bring innovation to even the most iconic and established products. Back in 2003, 3M began noticing and monitoring two consumer trends. One was troubling: Customers were using laptops, cell phones, and BlackBerrys to send quick memos or jot down bits of information. Every thumb-tapped message or stylus-penned note on a personal digital assistant meant one less Post-it note.
The other trend, however, was encouraging: the rise of digital photography. While observing consumers, 3M researchers asked to see their photos. What followed was always a clunky process: Consumers would scroll through screen upon screen of photos or have to dig through a drawer for the few shots they printed. Nine months later a team of one marketer and two lab scientists hit upon the idea of Post-it Picture Paper, or photo paper coated with adhesive that lets people stick their photos to a wall for display. "We listened carefully to what consumers didn't say and observed what they did," says Jack Truong, vice-president of 3M's office supply division.
To get a sense of the value of customer research, imagine you're a Finnish engineer trying to design a phone for an illiterate customer on the Indian subcontinent. That's the problem Nokia faced when it began making low-cost phones for emerging markets. A combination of basic ethnographic and long-term user research in China, India, and Nepal helped Nokia understand how illiterate people live in a world full of numbers and letters. The result? A new "iconic" menu that lets illiterate customers navigate contact lists made up of images.
Other innovative ideas followed. By listening to customers in poorer countries, Nokia learned that phones had to be more durable, since they're often the most expensive item these customers will buy. To function in a tropical climate, it made the phones more moisture-resistant. It even used special screens that are more legible in bright sunlight.
Consumers increasingly are doing the innovation themselves. Consider Google Inc. (GOOG ), our No. 2 innovator, and its mapping technology, which it opened to the public. This produced a myriad of "mash-ups" in which programmers combine Google's maps with anything from real estate listings to local poker game sites.
Google's mash-ups are just one example of the escalating phenomenon of open innovation. These days the world is your R&D lab. Customers are co-opting technology and morphing products into their own inventions. Many companies are scouting for outside ideas they can develop in-house, embracing the open-source movement, and joining up with suppliers or even competitors on big projects that will make them more efficient and more powerful. "When you work with outside parties, they bear some of the costs and some of the risks, and can accelerate the time to market," says Henry W. Chesbrough, the University of California at Berkeley Haas School of Business professor who helped establish the concept with his 2003 book, Open Innovation.
India and China are growing sources of innovation for companies, too. The BusinessWeek-BCG survey shows that they are nearly as popular as Europe among innovation-focused executives. When asked where their company planned to increase R&D spending, 44% answered India, 44% said China, and 48% said Western Europe. Managers tended to look to the U.S. and Canada for idea generation, while a lower percentage looked to Europe for the same tasks. India and China, though, are still seen as centers for product development.
Few companies have embraced the open innovation model as widely as IBM, No. 10 on our list. While the company's proprietary technology is still a force to behold -- Big Blue remains the world's largest patent holder, with more than 40,000 -- the company is opening up its technology to developers, partners, and clients. Last year it made 500 of its patents, mainly for software code, freely available to outside programmers. And in November it helped fund the Open Invention Network, a company formed to acquire patents and offer them royalty-free to help promote the open-source software movement.
Why the generosity? IBM believes that by helping to create technology ecosystems, it will benefit in the long run. "We want to do things that encourage markets to grow," says Dr. John E. Kelly III, senior vice-president for technology and intellectual property at IBM. By helping nurture those markets, says Kelly, "we know we'll get at least our fair share."
GOING OUTSIDE FOR IDEAS
P&G has helped establish several outside networks of innovators it turns to for ideas the company can develop in-house. These networks include NineSigma, which links up companies with scientists at university, government, and private labs; YourEncore Inc., which connects retired scientists and engineers with businesses; and yet2.com Inc., an online marketplace for intellectual property.
Only a CEO can change a business culture at top speed, and in Alan G. Lafley, P&G has its own innovator-in-chief. Lafley sits in on all "upstream" R&D review meetings, 15 a year, that showcase new products. He also spends three full days a year with the company's Design Board, a group of outside designers who offer their perspective on upcoming P&G products. "He's sort of the chief innovation officer," says P&G's Huston. "He's very, very involved."
That sort of support from the CEO is essential, says Jon R. Katzenbach, co-founder of New York-based management consultancy Katzenbach Partners LLC. "The CEO determines the culture," he says. "If the CEO is determined to [improve] the surfacing of ideas and determined to make critical choices, then the chances of an [organization's] figuring that out are much, much greater."
Infosys Technologies Ltd. (INFY ), the Bangalore-based information technology services company that popped up at No. 10 on our Asia-Pacific list, takes a direct approach to making sure management stays involved in the innovation process. Chairman and "chief mentor" N.R. Narayana Murthy introduced the company's "voice of youth" program seven years ago.
Each year the company selects nine top-performing young guns -- each under 30 -- to participate in its eight yearly senior management council meetings, presenting and discussing their ideas with the top leadership team. "We believe these young ideas need the senior-most attention for them to be identified and fostered," says Sanjay Purohit, associate vice-president and head of corporate planning. Infosys CEO Nandan M. Nilekani concurs: "If an organization becomes too hierarchical, ideas that bubble up from younger people [aren't going to be heard]."
Mike Lazaridis, president and co-CEO of Research In Motion, hosts an innovation-themed, invitation-only "Vision Series" session in the Waterloo (Ont.)-based company's 100-seat auditorium each Thursday. The standing-room-only meetings focus on new research and future goals for the company that gave us the BlackBerry.
Lazaridis is likely the only chief executive of a publicly traded company who has an Academy Award for technical achievement. (He won it in 1999 for an innovative bar-code reader that he helped invent that expedites film editing and production.) He has donated $100 million of his own money to fund a theoretical physics institute and an additional $50 million to a university quantum computing and nanotechnology engineering center in Waterloo. He has even appeared in an American Express (AXP ) commercial, scratching complex equations across a blackboard while proclaiming his commitment to the creative process. "I think we have a culture of innovation here, and [engineers] have absolute access to me," says Lazaridis. "I live a life that tries to promote innovation." As the BusinessWeek-BCG survey demonstrates, it is a life every manager around the world must embrace.
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