Embedding Innovation to Drive Growth

1. July 2012 Embedding Innovation to Drive Growth

2. Outline Understanding the Growth - Global Innovation as an Enabler of Growth Enabling Innovation IBM’s Approach to Innovation Appendix

3. Successful organizations grow faster than their competitors and convert their growth into value, outperforming their peers Revenue & Total Shareholder Return* Growth S&P Global 1200, 2001 to 2010 “Successful Growers” (No of Companies Qualified :339 Companies) “Prudent Managers” ((No of Companies Qualified : 204 Companies) Median CAGR: 7.3% Median TSR : 5.5% “Unsuccessful Growers” ((No of Companies Qualified :193 Companies) “Shrinkers” ((No of Companies Qualified :345 Companies) * Total Investment Return (TSR) is calculated by Datastream as follows for all industries: (Market Price Year End + Dividends Per Share + Special Dividend -Quarter 1 + Special Dividend-Quarter 2 + Special Dividend-Quarter 3 + Special Dividend-Quarter 4) / Last Year's Market Price-Year End - 1) *100.

4. When it comes to growth, an organization’s neighborhood does not necessarily dictate its destiny Strong performers outgrow their industry by wide margins: Top performers in the slow-growth financial markets and insurance industry outpaced median growth rates for the high-growth Education and Pharma/Life Sciences industries. Amongst the top 10 sub sectors, Steel has emerged as the highest growth sector while Industrial Machinery has lowest median growth rate Industry Strong performers outgrow their geography by wide margins: Top growers in the slow-growth Japanese market outperformed the median growth rates in other high-growth Asian markets Geography Revenue growth is not a function of company size: Size is not a constraint. Larger companies can grow revenue as fast as smaller companies. TSR tends to diminish as company size increases, but successful growers overcome this tendency, and grow both revenue and TSR irrespective of company size Company size Successful growers may not report growth of revenue each year above median but have the resilience to bounce back and deliver superior growth over a longer period: No one succeeds all the time. What distinguishes successful growers is not perfection, but the courage and conviction to recover from imperfections Resilience

5. Innovation as an Enabler of Growth The ability to manage fundamental change is key to growth - history shows that failure rates are extremely high S&P 500 in 1957 (year 1 for the index) S&P 500 in 2010 (year 54 for the index) Of the 500 S&P companies in 1957, only 14% remain on the 2010 S&P 500 list Source: S&P Guide 2010 and S&P Library for 1957 data

6. Innovation as an Enabler of Growth Companies must meet growth expectations …but that is easier said than done Organic Acquisitions Innovation • Organic methods provide necessary but incremental growth • Gains are often hard-won and therefore not always profitable • Successes are easily copied making gains short-lived • Already more than accounted for in stock valuations • Acquisitions have historically failed to create value • Gains are elusive at best • Takeovers have destroyed more than $200 billion in shareholder value in the US over the past 20 years* • Innovation is the best opportunity for sustainable growth • Gains are more profitable and longer lasting • Sustainable advantage • Differentiation • Pricing power *Source: The National Bureau of Economic Research

7. Innovation as an Enabler of Growth Innovation is not ‘incrementalism’ and must create value Innovation is “new ideas that add value” • “new ideas” refers to the issue of novelty or originality, whether it be ideas extrapolated from other circumstances, industries or contexts • “add value” refers to the necessity for innovation to benefit people, whether they be customers, shareholders, employees or society as a whole; innovation that does not add value is generally futile • Change that does not add value is not considered innovation within IBM’s definition • For IBM, innovation is not: • Change that does not benefit anyone: this often constitutes change for the sake of change which can be costly and can dilute value • Adopting leading practice: this is often good for business but is generally directed toward avoiding loss of value to more sophisticated competitors, instead of capturing new value • Value creation that does not comprise the application of new ideas: this can be good for the business, but falls within a context of incremental, ‘business as usual’ Incrementalism is innovation’s worst enemy” - Nicholas Negroponte, MIT Media Lab Source: IBM Research

8. Being perceived as an innovation leader does not always translate into leadership in shareholder returns Innovation as an Enabler of Growth : Bloomberg Businessweek Survey Bloomberg Businessweek 25 Most Innovative Companies Business Executive Rank, 2010 Bloomberg Businessweek 25 Most Innovative Companies Re-ranked by Shareholder Equity Growth, 2010 Top 5 BW Innovation should translate into “Value” for customers and shareholders Source: Bloomberg Businessweek, BCG Research and Reuters. Businessweek, 2010. Financial Statement data for each company for 2006-2009 from Businessweek.com * Revenue and operating margin growth is annualized based on 2006-2009 fiscal year earnings before interest and taxes, as a percent of revenues as they were originally stated. ** Stock returns are annualized, 12/31/06 to 12/31/09, and account for price appreciation and dividends. *** Shareholder Equity CAGR based on 2006-2009 fiscal years. Tata Group and Virgin Group removed due to lack of financial data

9. Companies pursue three main types of innovation Innovation as an Enabler of Growth : Types of Innovation Innovation is “new ideas that add value” “Innovation occurs at the intersection of invention and insight. It’s about application of inventions to solve problems” - Sam J. Palmisano, Former IBM CEO and Co-Chair of the National Innovation Initiative

10. Innovation as an Enabler of Growth : Innovation Examples A few examples of innovation across industries P2P Free VoIP Application iPhone CEP Bank • To transfer fund to non-bank account holder, go online, type in your cell phone number, their cell phone number and the $ amount • VoIP product/service by Skype allows to offer cheap, customizable telephonic services over the Internet • The user interface is built around the device's multi-touch screen, including a virtual keyboard rather than a physical one Shared Services & Establishing COEs Toyota Production System Cross - docking • Movement to shared services of end-to-end processes that cut horizontally across functional areas • Examples such as reporting, risk analysis, components of underwriting and claims etc. • Goods trucked to a distribution center from suppliers are immediately transferred to trucks bound for stores—without ever being placed into storage. • TPS is comprised of two pillars, Just-in-Time and jidoka Direct to Customer Model Peer to Peer Lending Revenue Model • Peer-to-Peer Lending dis-intermediated established banks to promote lending between individuals • Dell redefined the PC value chain and industry model by using a direct to customer sales model • Customization of the PC could be done on the web and the same would be delivered to the customer custom made • Gillette innovated the pricing model by giving away razors and making money on the blades

11. Innovation as an Enabler of Growth : Product, Service / Go-to-market Innovation Product / service / go-to-market innovation brings to life new ways to solve the customer's problem • Product & Service • Innovation • Enter new product categories • Build services around products • Innovate faster/better • Diversification • Extend into new products and new markets simultaneously New Products • Customer Intimacy & Market Penetration • Increase customer loyalty • Improve price realization • Gain wallet share • Attract new customers • Refresh products/services • Increase geographic depth • New Markets & • Channels • Extend into new customer segments • Enter new geographic/ global markets • Enter new channels Traditional Traditional New Markets

12. Innovation as an Enabler of Growth : Operational Innovation Operational innovations drive growth, boost profitability, set new standards and redefine how an enterprise competes…. • Operations • Innovation • Focuses on innovation applied to core business operations, business processes and supporting Information Technology to improve effectiveness, efficiency, and quality. • Core operations • Go-to-Market / Customer facing processes • Procurement / Suppliers / Logistics • Product / Service Development • General / Administrative (G&A) processes • Collaboration and Partnering • Collaboration has become an essential underpinning of innovation for business/enterprise and operations improvements • World class collaboration is no longer informal, unstructured, or localized, but rather aggressively driven by a strategy, encouraged by corporate culture, enabled by a technology-based infrastructure, is cross functional, and extends beyond the organization • For example, P&G has focused supply chain efforts on developing deeper relationships with major retailers and distributors, and they have begun initiatives to consolidate manufacturing in order to increase flexibility • Intersection of Business Insight and Technology • Dramatic and differentiating innovation occurs not when technology is simply applied as an enabler or support mechanism, but rather when technological capabilities and business/enterprise opportunities are highly integrated early in the envisioning stage of improvement lifecycles • Operational improvements, which have the potential to truly differentiate an organization, result from creating an operational environment that is not only efficient, but also has the ability to “sense and respond” to ongoing dynamic business/enterprise drivers, and to also provide key data mining capabilities to identify ongoing improvement opportunities

13. Prod / svc / mkt Operational Business model Innovation as an Enabler of Growth : Business Model Innovation …But enterprises that have a greater focus on Business Model Innovation tend to outperform their peers over time More than two thirds of the CEO’s interviewed have indicated towards having a strong BMI focus CEOs report that out-performing businesses tend to have a greater focus on business model innovation Shareholder value can be enhanced significantly for out-performing firms engaged in business model innovation Business model Operations Products/services /markets Under- performers Out- performers Median operating margin growth in excess of peers by businesses engaged in type of innovation, 5 year CAGR Focus of innovation efforts Under-performers and out-performers compared to peers By focusing on business model innovation, companies are more likely to become out-performers Source: IBM CEO Study

14. Innovation as an Enabler of Growth : Business Model Innovation Business Model Innovation is focused around 3 areas, with Enterprise Model Innovation gaining more focus with the CEO’s Changing the way your industry works or changing your value chain Industry Model Innovation • Changed the value chain in the home furnishings • It pushed final construction back to the customer to facilitate ‘ready to sell’ packaging Business Model Innovation Revenue Model Innovation Changing your value proposition or the way you price for products or services • Movie rental costs and late return fees were high • Moved from rental to a subscription revenue basis Enterprise Model Innovation Changing what you do and where you collaborate • illycaffé has partnered with various other companies along its value chain, such as manufacturers of coffeemakers and others, to improve the overall coffee-drinking experience

15. Enabling Innovation : Innovation Archetypes Innovation models (Archetypes) are a unique mix of cultural and operational traits that represent how the companies innovate An IBM research study of 174 organizations across 24 countries and a broad set of industries, identified four unique innovation models (or archetypes) that represent how companies innovate Marketplace of Ideas The Visionary Leader Innovation Archetypes Innovation through Rigor Innovation through Collaboration A company’s innovation culture and archetype needs to be fully understood to embed innovation Source: IBM Innovation Archetype research and analysis

16. The nature of an organization, its innovation archetype, will determine how innovation structures are embedded Enabling Innovation : Innovation Framework implications across Archetypes Marketplace of ideas Visionary leader Innovation through rigor Innovation through collaboration Archetype Overview Archetype Characteristics Source: IBM Innovation Archetype research and analysis

17. Envisioning itself as “The Innovation Company of the 21st Century” IBM made innovation pervasive . . .

18. . . . By developing a philosophy and operating approach . . .

19. . . . Seeing every IBMer as an innovator . . . Innovation Accountability and Responsibility in IBM • Ginni Rommetty champions and advocates IBM innovation • There is no single executive reporting to the CEO with innovation accountability • Innovation is part of every business unit’s strategic focus and every employee’s responsibility • We are lowering the center of gravity – shifting our resources and decisions closer to the client Ginni Rometty IBM CEO Innovation Responsibility Innovation Accountability Corporate • Strategy • Marketing • Finance • Human Resources • Communications • Legal Enterprise-wide • Sales & Distribution • Corporate Technology and Manufacturing • Integrated Supply Chain Lower center of gravity All levels Global Services Systems and Technology Group Software Employees Employees Employees

20. ThinkPlace Global Technology Outlook And establishing innovative programs for idea generation and innovation management that are models for our client work Institute for Business Value Innovation RESEARCH SERVICES & “FIRST OF A KIND”

21. Innovation as an Enabler of Growth In summary, innovation creates value by operating at the intersection of invention and opportunity and can be managed • Successful innovation creates sustainable growth for organizations • There are core capabilities and processes that are common to all successful innovators • Successful innovators have clear archetypes that represent how they innovate … • Marketplace of Ideas • Visionary Leadership • Innovation through Rigor • Innovation through Collaboration • … and regardless of how they innovate, they all focus on: • Senior Management involvement in innovation • High client satisfaction & use of client ideas • Ways to leverage internal — and external — ideas • Use of staged processes to track innovations and pilot before launch • Effective use of cross functional teams

22. Outline Understanding the Growth Innovation as an Enabler of Growth Enabling Innovation Starting the Innovation Journey Appendix

23. There are structures (activities, processes, enablers, linkages, etc.) that promote effective innovation within an organization Enabling Innovation : Innovation Framework Strategy Business Strategy • Overall objectives of the business as defined by corporate vision, mission etc. Innovation Agenda Innovation Agenda • Overall direction, life-stage, mix, characteristics and value proposition around innovation Innovation Agenda • Overall direction, life-stage, mix, characteristics and value proposition around innovation Innovation Management & Governance Innovation Management & Governance • Structures, processes, policies, frameworks and tools used to manage innovation Innovation Management & Governance • Structures, processes, policies, frameworks and tools used to manage innovation Innovation Enablers Innovation Enablers • Elements that enable execution of the overall innovation process Innovation Enablers • Elements that enable execution of the overall innovation process

24. Enabling Innovation : Innovation Framework Innovation Agenda sets the overall direction for innovation and maintains alignment with business strategy Business Strategy Innovation Strategy InnovationAgenda Vision Innovation Strategy Vision Innovation Mix Innovation Mix Innovation Model Definition Value Proposition Innovation Model Definition Innovation Management & Governance Portfolio Management Innovation Organization Management Risk/Benefit Evaluation Project Management Value Proposition Knowledge Management Business Value Analysis Incentives and Rewards Communi-cations Innovation Enablers Talent Culture Internal Collaboration External Collaboration Tools & Frameworks Infrastructure

25. Enabling Innovation : Innovation Framework Innovation Management and Governance aligns the structure, process, framework and tool to manage innovation Business Strategy Portfolio Management Innovation Organization Management InnovationAgenda Innovation Strategy Vision Risk/Benefit Evaluation Innovation Mix Innovation Model Definition Value Proposition Project Management Innovation Management & Governance Knowledge Management Portfolio Management Innovation Organization Management Risk/Benefit Evaluation Project Management Business Value Analysis Knowledge Management Business Value Analysis Incentives and Rewards Communi-cations Incentives and Rewards Innovation Enablers Communi-cations Talent Culture Internal Collaboration External Collaboration Tools & Frameworks Infrastructure

26. Enabling Innovation : Innovation Framework Innovation Enablers provide the necessary support for execution of the overall innovation process Talent Business Strategy Culture InnovationAgenda Innovation Strategy Vision Internal Collaboration Innovation Mix Innovation Model Definition Value Proposition External Collaboration Innovation Management & Governance Portfolio Management Innovation Organization Management Risk/Benefit Evaluation Project Management Tools & Frameworks Knowledge Management Business Value Analysis Incentives and Rewards Communi-cations Infrastructure Innovation Enablers Talent Culture Internal Collaboration External Collaboration Tools & Frameworks Infrastructure

27. Enabling Innovation : Innovation Cycle This Innovation Framework is supported by the Innovation Cycle which is a formal approach to developing innovation initiatives INNOVATION CYCLE Assessment of experience Identify and assess innovation capabilities, structures, processes, assets, tools, methods and innovation archetype (less comprehensive after first completed) 2 Sensing and Envisioning Obtain inputs into, and scope the innovation effort through activities which may include trends analysis, scenario envisioning, area identification and selection 1 Assessment of the organization and innovation experience Sensing & Envisioning of inputs into the innovation process Realization Execute, release or implement the idea 3 Ideation Leverage various techniques and tools to conceive ideas around the innovation areas 6 Realization of ideas through execution Ideation around identified areas Development of selected ideas Evaluation of ideas identified Development Refine selected ideas through additional research, compliance assessment, clear business model articulation, full business case development, etc. 4 Evaluation Prioritize and select a set of high value ideas for each defined innovation area for future investment and development 5 TheInnovation Cycle is a formal timeline and engine to drive and capture innovative ideas and initiatives IBM’s Innovation framework coupled with the Innovation Cycle creates a strong tool to embed innovation

28. Appendix : Innovation Archetype Examples The marketplace of ideas: case studies • Follows three horizons approach (i.e. 70/20/10) for managing innovation portfolio (70% of time for regular job, 20% of time for job related innovation, 10% of time is open for any ideas) • Employees’ contribution to innovation is linked to their performance results • Formal communication platforms are in place to enable internal collaboration (e.g. Google Projects, Google Ideas, Google Caribou, Moma inside Google) • Product requirements are kept as simple as possible so that features may evolve as users provide feedback • 15% of employee’s time is devoted to generation or development of new ideas • Promotes a culture of ‘small company within a big company" by creating small autonomous business units and product divisions • Internal venture capital is available to support new ideas • ‘Innovator’ (a collaborative tool) supports communication between internal and external teams, and tracking of ideas • Everyone from vice presidents to clerks are encouraged to come up with new ideas. All ideas are taken seriously, considered and often acted upon • Enables people to make their own decisions about store operations, including product mix and in-store displays • Corporate office sets execution guidelines around ‘what to do’. Employees makes decisions around ‘how to do’ • Employees are given autonomy, including the ability to allow customers to taste products

29. Appendix : Innovation Archetype Examples Visionary leader: case studies • CEO formally defines the innovation vision to drive innovation across organization • Every new product launch is driven by strategic decisions made by centralized team. Strategic decisions carve a new path for new product launch • Formal teams are in place for development and execution, but these teams are scattered and not aware of end to end development and execution activities • Follows a formal process to drive innovation during idea development and execution phases • Fung Hon-chu, who led Hong Kong’s Li & Fung Company, developed the “global sourcing solutions” business model whereby his company coordinated the design and production process for orders placed by American and European companies • Li & Fung relies on its partners to help solve problems, not just fulfill orders • Business units are given substantial autonomy in operating their divisions • Group’s leadership nurtures entrepreneurial behavior in the divisions so that division staff can be creative in meeting customer needs • It is CEO’s goal to first give direction, and then let sr. management team take control of the situation there after. • Managers are free to make decisions independently for growth and feel the same degree of ownership and values that any other manager in the Virgin group would feel • Radical innovation is governed through VML. BU’s are expected to execute the CEO’s vision and has autonomy in execution • Sr. leadership collective innovative thoughts and ideas are applied directly into business

30. Appendix : Innovation Archetype Examples Innovation through rigor: case studies • The firm succeeds through a mix of senior executive prioritization and team processes • The company invests about 10 percent of its revenues in R&D – a very high figure for the industry – and it devotes 15 percent of its R&D team to looking at needs and lifestyles more than 10 years from now • Output is rapidly prototyped and tested for usability • The teams strive to break down stale cultural norms, and encourage junior members to challenge senior staff • Over 50% of its employees are engaged in research and development • Decisions are made with input from several sources in the company • Formal product R&D function is to deliver timely solutions for anticipated and actual customer needs by developing innovations in technologies, products, solutions and services • It has set up over 20 joint innovation centers with top operators to transform leading technologies into a competitive edge for customers and achieve business success • Chief Technology Office brings together the strongest forces within the company • Innovation strategy incorporates elements such as technology strategy, resource optimization for research and development, shaping the innovation process, and patent and standardization strategy, whereby consistent and rigorous application holds the key to success • Like technology planning, active patent management is also conducted in a strategic manner at Siemens • Structured consolidation of the innovative ability of numerous Siemens employees from diverse disciplines and regions to be achieved through so-called Innovation Jams

31. Appendix : Innovation Archetype Examples Innovation through collaboration: case studies • More than 50 percent of product initiatives at Procter & Gamble involve significant collaboration with outside innovators • P&G's Connect+Develop open innovation strategy has established more than 1000 active agreements with innovation partners • The current structure is a network model that has P&G globally linked to external innovation assets to accelerate innovation through identifying ready to go ideas and effectively leveraging people outside of P&G’s base • Collaboration with stores for innovation - Zara is in tune with its customers, who help it give shape to the ideas, trends and tastes developing in the world • A non-stop flow of information from stores conveys shoppers’ desires and demands, inspiring its 200-person strong creative team • Recipe of centralization and integration - vertically integrated business model that spans design, just-in-time production, marketing and sales, giving it more flexibility than its rivals to respond to changeable fashion trends • Technology-based local supply chain enables store managers to restock quickly and in smaller batches • Bharti created a highly specialized Telco business model by focusing only on its key differentiators – marketing, sales and distribution and partnering for everything else • The company deployed the technology and operates state-of-the art networks using the services of its partners like Ericsson, Nokia and Siemens • Bharti entered into a 10-year agreement with IBM to transform its processes and take on the management of its IT Infrastructure. The agreement construct makes innovation all pervasive in the entire Bharti organization