The Innovation Factor

It was a humble scrap of foam, but Scott Augustine found it compelling. Something about its texture and the tender way it submitted to the pressure of his fingers told the CEO that this vendor sample might prove to be one of his many grails: material for sealing a patient's airways during surgery. Excitement stirring beneath his midwestern composure, Augustine rushed the sample to R&D and placed it in the care of Randy Arnold, a former theatrical-prop builder whose job as senior design engineer is to make Augustine's visions flesh. Arnold shaped the foam with a band saw, hand-carved a plastic frame, inserted a bit of tubing, and a few hours later presented himself in Augustine's office with a rough prototype of an airway seal. Pausing only to spray his throat with a topical anesthetic, Augustine plunged the device down his own throat. Later that day he announced to his staff that they would be selling the airway product in three months.

Abstract ideas don't stay abstract for long at Augustine Medical, a 15-year-old, $64-million maker of medical devices based in Eden Prairie, Minn. The company, which has been profitable since its third year, has 108 U.S. patents, three product lines and two more under development, and a business plan that calls for the creation of one new "paradigm shifting" product a year beginning in 2005. With his eye on the public markets, Augustine wants to create a kind of innovation mill, where invention is detached from that unreliable progenitor called inspiration and becomes instead the stuff of routine. To do that he is building something that is unusual even among highly creative companies: a continuously experimenting organization, one that is capable of churning out profitable products one after another.

Augustine is barking up the right tree, business experts would agree. Peter Drucker proclaimed innovation's primacy to business at least 50 years ago; today it is more important than ever, thanks to the breathless competition spawned by globalization and easy access to information. Innovation is also "enormously profitable," says intellectual-capital consultant Frances Horibe. In her book Creating the Innovation Culture, Horibe cites a study showing an average rate of return of 56% for 17 products considered innovative by their industries. That compares with an average return of 16% for all American business over a 30-year period. Looking beyond products to companies, researchers at MIT's Sloan School of Management have calculated that each 1% increase in spending on research and development produces a 4.3% increase in a company's market-to-book-value ratio. CHI Research, in Haddon Heights, N.J., has even patented a stock-analysis method that ties companies' innovativeness (as measured by the quality and quantity of their patents) to market performance.

But if the "why" of innovation is beyond dispute, the "how" is often far from clear. Does innovation mean spending huge amounts on R&D? If so, that leaves out most small companies. Or does it require some sort of creative alchemy -- an occurrence as rare as it is mysterious? To Drucker, the answer to both questions is no. Innovation, he writes, is simply "organized, systematic, rational work" that can be pursued by companies of any size. And it goes well beyond R&D to include nearly every facet of a company's operation.

STAGE CRAFT: Randy Arnold used to build theater props. Now he builds medical devices. The two jobs are pretty much the same: dream something up, build it, then break it down.

Drucker wouldn't get an argument from Scott Augustine, whose company pursues innovation in some very innovative ways. Augustine's R&D group, for example, employs not just engineers but also a healthy complement of prop builders recruited from regional theater and opera companies. It is a kingdom of tinkerers, where no one needs permission to build whatever pops into his or her mind, and where home-workshop tools are favored over sophisticated computer-aided design. But innovation doesn't stop at the lab door. Augustine requires every department, from marketing to information technology, to be just as experimental as his new-products team. "One thing that will get a senior manager in trouble fast is if I detect there's nothing new going on in their department," says Augustine. "I ask people constantly, 'What experiments have you done lately?' It might be how to shuffle paper faster or how to eliminate a step in manufacturing -- I'm not fussy. But if you can't tell me two or three things you've tried, that's a good way to get on my bad side."

The spoils of Augustine's war against stasis can be seen in operating rooms around the world. The company's first product, the Bair Hugger surgical warming blanket, owns 85% of the market it invented. And Warm-Up -- a heated, pup-tent-like unit that's a novel treatment for chronic wounds (like pressure ulcers) -- is rapidly gaining traction. "It's only once in a great while that products come out that take patient care into another dimension," says Jonathan Benumof, a professor of anesthesiology at the University of California, San Diego, School of Medicine. "Bair Hugger and Warm-Up are at that level."

Augustine has convinced customers that he makes innovative products. More important for the company's future, he has also infected his staff with his obsession. The patent awards that sweep across one lobby wall are engraved with names of inventors from marketing as well as from R&D; a sales rep recently dreamed up a design innovation while lounging on the beach in Hawaii and faxed it in from a napkin. Employees treat their boss like an ambulatory suggestion box, constantly waylaying him in the hall with ideas large and small. "There's a genuine excitement when Scott makes his rounds; everyone wants to have something new to show him," says John Rock, the company's director of intellectual property.

Having made new products his uncontested priority ("Think it, build it, test it" is the founder's mantra), Augustine has built innovation into the very structure of the organization. Its geography fosters new ideas. Its R&D lab renders them in tangible form -- fast. And its intellectual-property expert not only protects the company's ideas but also mines the ideas of others for new opportunities. "Innovating is the best way to grow a business. It's certainly the most fun," says Augustine. "What we have created here is a platform for doing that."


Augustine can trace to childhood his enthusiasm for building things -- in some cases over and over again. (The airway device that was supposed to go on the market in three months actually took four years to develop and passed through some 300 iterations in the process.) The son of missionaries, the CEO spent his youth in the Tanzanian bush, more than 200 miles from any city large enough to deserve the name. "If we needed a water heater, it was a barrel sitting outside over a wood fire with a pipe," recalls Augustine, who at 48 is tall and fit, with close-cropped gray hair. "For power we had a diesel engine hooked to a generator, and every year we had to tear it down and overhaul it. I made my own toys. Living that way, you get confident that you can build stuff. Trying something new isn't scary."

After a stint in the navy, Augustine -- armed with a medical degree -- settled in Kansas City, where he worked as an anesthesiologist. But he soon became frustrated with the shortcomings of the operating room. What bothered him most was the inability to control patients' temperatures during surgery. "I was wheeling them into the recovery room cold, and I said, 'Why?" he explains. Techniques such as warming either intravenous fluids or the air patients breathe worked poorly. Warming the room itself, the medical literature suggested, was the only effective remedy, but "the surgeons won't let you do that," says Augustine. "So I thought, 'What if we created a cocoon of moving warm air around the patient -- a kind of personal little room?" That cocoon took shape on Augustine's workbench as an inflatable blanket riddled with holes that allow warm air to pass across a patient's body. In 1987, with the help of his father, he launched Augustine Medical in his garage.

"The Garage Startup," reads a plaque outside Augustine's office, and the historic photos beneath it -- a younger, mustachioed Augustine grinning in front of the manufacturing machine he built from scratch, the entrepreneur and his father dragging the machine onto a trailer -- attest to his enduring fascination with the archetypal birthplace of American ingenuity. "I'm a huge believer in garages," says Augustine. And in some ways Augustine Medical, housed in a featureless industrial park outside of Minneapolis, resembles a mammoth garage business, where most of the machinery is designed and built in-house, and where an engineer might be working on a new kind of chemical warming pack with the help of muffin tins and a $20 coffee grinder. New-product teams, which Augustine likens to start-ups, are often sequestered in separate buildings, isolated from the company's daily affairs. "In a garage, it's two or three people working in a 30-by-30 room, and you don't send memos and you don't schedule meetings -- you just talk," says Augustine. "All the bullshit that exists when a company gets bigger doesn't exist. It's a very efficient way to start a business."

"If you can't tell me two or three things you've tried, that's a good way to get on my bad side."

--Scott Augustine

Even in the main offices, Augustine has achieved a garage-like effect by creating plenty of places for intellectual interaction. Augustine Medical has 15 conference rooms scattered about, each with several whiteboards, so that whenever a hallway conversation threatens to turn productive, it can instantly find a home. (The conference rooms are named after scientists and inventors such as Einstein, da Vinci, and Ford. There's even one called Naismith, after the father of basketball. "He's a very important person," explains Augustine.) "An idea will go up on a whiteboard, and you'll see a parade of people from every part of the company going into that conference room for half an hour each and giving Scott their perspective on it," says Rock. "It goes on all the time."

A separate space, unofficially dubbed the Creative Room, is meant to facilitate the sort of thinking that is generally characterized by its incompatibility with boxes. The room is painted purple and gold and has variable mood lighting; a garish rabbit lamp adorns one wall; toys such as Slinkys, modeling clay, building blocks, and gyroscopes lie in a jumble on the conference table. "The Creative Room is still a work in process," says director of marketing Teryl Woodwick Sides, whose idea it was. "Originally, we were going to give it an underwater theme, and then we thought about making it into a giant toy box -- silly things like that. It's taking what ad agencies do to stimulate creativity and bringing it to a small medical-device company."

Augustine calls the Creative Room "fun" and "comfortable" but is skeptical that it contributes much to innovation. "I think our best problem-solving happens when three or four smart people get together and bang away at it, and we make that as easy as possible," he says. Nor is he convinced that innovation naturally occurs in an office between the hours of 9 and 5. Rather, people innovate whenever and wherever they think best, parameters far too vague and various to be incorporated into even the most flexible office design. Consequently, Augustine allows employees -- with the exception of customer-service reps, production workers, and a few others -- to dictate their hours, assuming that while they are away from work, work won't be wholly away from them.

Augustine does his own best thinking on the running path. He "religiously carves out the first two hours of my day for thinking and problem solving," which he accomplishes at the same time he's getting his exercise. "I'm out there consciously trying to solve problems; I keep track of them in my head," he says. "If my mind starts to stray to something unrelated, I'll tell myself firmly, 'No, I'm here to work." Randy Arnold, by contrast, feels most creative standing in a stream in the open air. So he doesn't consider it time off when, during the summer, he devotes one day a week to fly-fishing. "This company gives you the freedom to go where you're most productive in your thinking," says Arnold. "When I'm fishing, I'm still thinking about my projects. I'm not leaving my work behind."


You can take the prop designer out of the theater, but Augustine wouldn't dream of taking the theater out of Randy Arnold. Clinging to his uniform of shorts and a T-shirt well into the Minnesota winter, the design engineer sports shoulder-length locks, an earring, and an ever-present beret. He and Augustine don't look as though they have enough in common to sustain a conversation at a bus stop. But in addition to their mutual love of invention, the two share a history: they met in seventh grade and cemented their friendship working side by side at a small pontoon- boat company. "Everything we did -- welding, grinding, assembling -- Randy did it faster and better," says Augustine. "We were always racing, and I was always losing. I said to myself, 'If I ever start a company, I'm going to get him."

After four years of college (he didn't graduate), Arnold landed at the renowned Guthrie Theater, in Minneapolis, where for 11 years he built props and scenery. Augustine's invitation to join a start-up, when it came, sounded like a career non sequitur. "I knew nothing about medicine, so how would I fit in?" Arnold recalls thinking. But he soon found that the problems posed by the medical-device industry resembled those he'd encountered in the theater. "It's all mechanical," says Arnold. "You're trying to get something to work a certain way, and you noodle on it in your mind until you find a novel way to get it done."

Arnold's experience also meshed well with Augustine's emphasis on building lots of rough prototypes quickly and cheaply. "One mistake engineers make is that they overly complicate things by trying to add too much detail or features," says Arnold. "I gravitate toward the most basic elements needed to make something work. In the theater the build period for a show is four to six weeks, and things have to be done by opening night, and they have to work reliably. The way to achieve that is to keep things simple." Also, when a show closes, sets and props are broken down and thrown away, so their builders don't get too invested in any one creation. Perpetual experimentation requires that failures -- even promising ones -- are similarly abandoned. That's not a problem for Arnold.

TO SERVE AND PROTECT: John Rock is building a fortress of patents.

The prop master's approach sat so well with Augustine that over the years he hired half a dozen more crew members from the Guthrie and other local performance organizations. (A few also came with experience building interactive exhibits for the Science Museum of Minnesota.) Today the R&D staff is more or less equally divided between former prop builders and engineers, both mechanical and biomedical. "Someone has a flash of inspiration about something they can do that's different," says Augustine, "but then a lot of the real innovation happens during prototyping, as the builder plays around with the specifics. We want people who can just start building whatever they can think of. A lot of engineers can't go into a workshop and not cut their fingers off."

Computer modeling and other sophisticated technologies are brought in later in the development process, after a viable prototype has emerged. The most expensive tool in Augustine's R&D shop is a $35,000 mill that uses digital data to forge parts. But Arnold much prefers the 25-year-old Bridgeport mill he bought for $2,000 at a secondhand machinery shop. The Bridgeport must be operated by hand but is fast and easy to use. And although the parts it produces are rough, rough is fine, Arnold says. "As long as it works the way it's going to work in the real world, you don't need all the spit and shine," he adds.

"We're not against computers here," explains Augustine. "We understand computers. We use computers. We're just not convinced that computers work better, faster, or cheaper."

Better, cheaper, and especially faster assumed greater importance for the company eight years ago, when Augustine decided to diversify. Up until 1994 the company had focused exclusively on the warming blanket, furiously devising new features and fortifying its wall of patents. But Augustine assumed that a public offering was in his future, and "the risks are too high for a single-product company," he says. So he began to make changes. On a marketing level, he repositioned the company around the idea of innovation, jettisoning the old logo (the letter A surrounded by two parabolas that resemble lungs) and substituting a graphically slick lightbulb. He also promoted the name Augustine Medical over the product brand Bair Hugger, which was far better known in hospital procurement departments.

More substantively, the company began developing new products, including Warm-Up, the heated, tent-like wound therapy; the airway device; blood- and fluid-warming instruments that don't rely on a hot- water bath (the industry norm); and others that are still under wraps. Since the culture of experimentation was already well established, the CEO made no major changes in staffing or organization. "We're just doing what we've been doing, only more of it," says Augustine.

But there was one area that Augustine felt needed bolstering: intellectual-property management. In the eight years before 1995, Augustine Medical filed 27 U.S. patent applications; in the seven years from 1995 through 2001, the number of applications increased to 129. The new product lines made the company's patent portfolio substantially more complex and meant that more research was required every time it set out to prove it was doing something new. For Augustine Medical, patent management was becoming a core competency. Fortunately, Augustine had someone more than competent to handle it.


Inside John Rock's office, it looks as if a Kinko's exploded. More than a dozen piles of paper, some a foot high, cascade into one another, obscuring his expansive desktop. There are more papers on the floor, loose and in folders, as well as piles of books and magazines. Two patent-award plaques -- still in their plastic sheaths -- lean against one wall. The bookcases are packed with fusty-sounding journals: Intellectual Property Today, Law Technology News, the British Journal of Anaesthesia. "There's rhyme and reason to it all," insists Rock, who arrived at Augustine not from a law firm but from Juilliard, the Spoleto Festival, and the Minnesota Opera. "It's a library of information. I love my office."

Originally hired to do R&D, Rock had his first exposure to intellectual-property law in the mid 1990s, when Augustine Medical sued competitors for infringing its patents on Bair Hugger. Augustine had been a firm believer in patents from day one ("If you can't protect it, you shouldn't make it," he says) and had written most of the company's early claims himself, with help from an outside lawyer. Unfortunately, those first filings were flawed; the company won its case in federal district court but lost on appeal a year later. Despite that outcome, Rock, who attended the entire trial, was hooked. "It was like cramming three years of law school into two weeks," he says. "I was fascinated by the strategy behind it -- the way you have to write a patent now on a technology that's not fully developed that you're going to have to defend 10 years down the road. It's like three-dimensional chess."

Rock followed his curiosity to the Minneapolis Public Library, where he took a course on searching patents and then studied the subject on his own. The more he understood, the more he worried that Augustine Medical's portfolio was becoming too unwieldy. The company risked filing duplicate claims or repeating terminology that created vulnerability in a line of patents. If a claim term were construed narrowly, all inventions described using that term might suffer, as happened with some of the Bair Hugger patents. So Rock put aside his drills and hammers, sat down at a computer, and graphically mapped the company's patents and patent applications. The resulting family tree -- which over the years has become a small orchard of family trees -- in combination with a patent database, meticulously lays out every iteration of every technological innovation Augustine has ever patented, as well as its antecedents and descendants. "If an R&D person comes to me and says, 'Here's an idea. I have to know whether we've already [disclosed this in a patent application] and how it relates to what we're doing now,' I can show them in the model where it would fit," says Rock. "It's also helpful as we start to think about licensing, so companies interested in a technology can easily see all the patents we have related to it."

Consumed by the growing demands of the business, Augustine gratefully ceded patent-wrangling duties to Rock, naming him director of intellectual property in 1998. Rock is now the go-to guy for staffers who think they may be onto something and need to know if someone else was onto it first. Engineers are adept at explaining their ideas and often show up in Rock's office armed with charts and test results. But others -- particularly those in sales and marketing, whom Augustine has urged to think like inventors -- may have trouble describing just what they have in mind.

In those cases Rock plays innovation midwife, helping tyros flesh out their ideas enough so that he can either research and file patents on them or point their creative thinking in a more fruitful direction. "Someone says they have an idea for a better connection on our blower [used to inflate the surgical blankets]," says Rock. "And I'll get them to step back by asking 'What made you start thinking about this?' And they'll say, 'I heard one of the clinicians complaining about the noise.' So it turns out it's really a noise problem they're trying to solve. And then I ask them, 'Are there alternatives? If you didn't use this metal foil, what else could you use?' So their idea starts to blossom into a more well-rounded picture."

Rock also plays a competitive-intelligence role. He tracks competitors and potential partners by scanning the titles of as many as 400 U.S. and 350 international patents every week and reading the full text of a dozen or so. Those documents alert Rock to technologies to steer clear of, technologies that might be worth licensing, and technologies whose mere existence makes possible a new set of innovations for Augustine Medical. In addition, he'll come to the aid of his former R&D colleagues by searching patents from unrelated industries for nonobvious solutions to knotty problems. Recently, for example, a company scientist was talking to Rock about ways to get heat into deep tissues. Rock looked up patents relating to microscopes because "optical products and microscopes manipulate waves, and heat is a waveform like light," he explains. "Patents are an amazing teaching tool."

"John makes sure our patents are covering the waterfront the way we'd like them to," says Augustine. "It's a very complicated game to play. You can use outside patent attorneys and experts, but for us it's too important."


Such sophisticated husbanding of intellectual property, Augustine hopes, will reflect well on his own leadership if the company goes public, as he expects it will in 12 to 24 months. He is aware that scientist and physician founders often get the hook if their management skills don't equal their research feats. But Augustine has studied business diligently on his own -- he has read more than 100 books on the subject -- and over 15 years has parlayed $5 million that he received from a group of disparate investors into a $64-million company. "After the IPO, I'll stay on as chairman, and not a wallflower chairman," he says. "I don't want to spend my days doing investor relations. If I give up the CEO job, I'll become chief technology officer. The innovation piece is what I enjoy."

It's also where he's most needed. One potential problem for Augustine Medical is its lack of an intellectual-succession plan. Augustine is the only one on staff with both a medical background and experience in R&D: the company's big ideas, to date, tackle bugbears from his years behind the mask. "You do need ideas, and in this case the ideas come from Scott," says Arthur Kydd, president of St. Croix Management Group, in Minneapolis, and one of Augustine Medical's earliest investors. "One of the criticisms I've pushed on him over the years is the Not Invented Here syndrome, and he has started to look elsewhere for ideas and bring them in. But you're not going to find many people out there who are as innovative as Scott is."

Augustine is trying to follow Kydd's advice. "We're working on institutionalizing this so if I get hit by a bus, the company can keep on innovating," Augustine explains. The current plan is to enlist teams of three to five outside doctors, give them equity, and spirit them to Eden Prairie several times a year to work on various projects. "We don't want the experts in a given area because they would have too much of a vested interest in their way of doing things," says Augustine. "We want bright people who can think outside the box."

The doctors would be presented with a problem -- or asked to identify a problem they want a crack at solving -- and then would spend several days "brainstorming, game playing, and role-playing around it," says Augustine. A handful of rapid prototypers would observe the festivities. Every time the physicians came up with an idea, the design folks would sprint back to R&D to build it.

"Someone else can provide the flash that tells us generally the way to do things," says Augustine. "Most of the innovation happens after that. Think, build, test. Think, build, test."

Leigh Buchanan is a senior editor at Inc.

The Economics of Innovation

Expect to spend a lot of money if you want to develop innovative products. Just don't expect to spend it on product development.

Producing innovations is an expensive game, allows Scott Augustine, particularly in a market like health care that requires extensive experimentation, testing, and plowing of regulatory ground. By itself, research and development costs Augustine Medical about 8% of annual revenues, which is about average for the medical-device industry. The figure climbs to 11% when clinical research, regulatory work, and intellectual-property management are figured in. That kind of investment "presents a real challenge to would-be small- company innovators," acknowledges Augustine, the company's CEO and founder.

But prelaunch development is a bargain compared with the cost of selling an innovation. "Missionary selling" -- imposing an unprecedented product on uneducated customers -- is significantly more expensive than touting incremental improvements to something familiar, says Augustine. How much more expensive is selling innovation than innovating? The costs include a highly trained -- and highly compensated -- sales force, aggressive marketing, trade-show launches, educational sales calls, customer training, and product trials and samples. Consider Warm-Up, Augustine Medical's treatment for chronic wounds. The product cost $10 million to develop. By contrast, costs over three years for sales, marketing, clinical support, and Medicare-reimbursement approval have totaled nearly $40 million. "And the product is still not cash-flowing itself," says Augustine.

Oh, but it's worth it -- at least if your products, like Augustine Medical's, have long life cycles. "If your products are paradigm shifting, they create 'new shelves,' which presumably you will own," says the CEO. "You will reap the benefits for a very long time, typically at higher-than-average margins." For example, he explains, a company that devises surgical suture that dissolves more readily than existing materials might win market share. But the advantage wouldn't last -- there are simply too many similar materials out there that can do the job. However, Augustine muses, what if you created a substance from blood proteins that could actually be used to glue wounds shut? A company that successfully patents that innovation "may control the market for years to come," says Augustine, suddenly sounding like a guy in a garage. "The greater up-front cost will be richly rewarded."

The Innovation Factor

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