In today's fast-moving marketplace, companies typically compete by improving their products in small ways. They make them visually more attractive, or more reliable, or less costly. Maybe they tinker with the marketing. The result is predictable: Competitors make a countermove -- and in the end, market share moves slightly, if at all. In thinking small, though, companies miss out on the chance to win big. Instead of trying to influence what brand people buy, they should be focusing on what people buy. Real innovation involves creating categories or subcategories with distinctly new value propositions. They change the competences and strategies required to compete and, at their most powerful, transform markets by making competing products irrelevant. The Prius hybrid, for example, developed with new technology from Japan's Toyota Motor Corp., has made other cars irrelevant for some buyers, and has helped Toyota establish itself as a leader in industry efforts to make more environmentally friendly cars. Often, important innovations come from smaller companies, whose success with a new idea can catch much bigger competitors flat-footed. Today's beverage arena, for example, has undergone dramatic change in recent years, thanks largely to innovations by smaller players in the sector. Indeed, PepsiCo Inc. and Coca-Cola Co. missed out on much of the high growth in sports and health drinks through the 1980s and '90s, focusing instead on their long-established dueling colas for much of that time. Among the big winners that Coke and Pepsi eventually were forced to acquire were Gatorade, bought by Pepsi as part of its acquisition of Quaker Oats Co. in 2001; the Odwalla line of juices and other health drinks, which Coca-Cola acquired in 2001; and SoBe, formerly the South Beach Beverage Co., a maker of juice blends and teas purchased by Pepsi in 2000. While creating new product categories and subcategories is not always possible -- and can be risky -- research has shown it produces far greater rewards than sticking with the tried and true. In 2004, two professors at the French business school Insead made a study of 108 business launches over a recent five-year period, some 14% of which represented innovations that went beyond incremental improvements in an existing market space. The study, by W. Chan Kim and Renee Mauborgne, found that those 14% produced 38% of the revenue and 61% of the profits for the entire group. Innovating 101:So how does a firm identify, or better yet, drive, these real innovations, without depending on technological breakthroughs? Here are some ways: • Augment the offering with a feature or service that consumers will regard as essential. Westin Hotels, a property of Starwood Hotels & Resorts Worldwide Inc., created a subcategory of hotels that offer a premium bedroom experience with its Heavenly Bed, a pillow-like mattress filled with down, and, later, the Heavenly Shower, extra roomy and with dual shower heads. General Motors Corp.'s OnStar service, which allows motorists to get help or get directions, has changed automobile buying criteria for some. • Provide faster access to new products. Two successful clothing retail chains, Zara, part of Spain's Inditex SA, and American Apparel Inc., have innovated in fashion by keeping design and manufacturing primarily in their home markets, Spain and the U.S., respectively. This helps the companies deliver new fashions into their stores much faster than some of their competitors. • Find an underserved segment. That's what Clif Bar Inc. did with the Luna energy bar for women, introduced in 1999. Clif Bar still markets the Luna as the first nutritional bar with a taste, texture and nutritional ingredients chosen to appeal to women. • Expand the offering from components to systems. This is what software companies do when they go from selling isolated applications to offering a system to handle all of the customer's related needs. Microsoft Corp.'s Office suite, for one, bundles features such as word processing, spreadsheets, calendars and email. • Market a new and distinct use or application. Bayer Corp. helped create a new market for itself by offering the regular use of Bayer Low Dose aspirin as a way to ward off heart attacks. The innovation brought new users into the market. • Create a new product form or delivery method. Packaging yogurt in Go-Gurt's colorful nine-inch tube helped Yoplait, a subsidiary of General Mills Inc., forge ahead of Danone SA's Dannon, a brand that Yoplait had trailed for decades. Go-Gurt's tube changed what parents were buying, making yogurt easier and more fun for kids to eat. Similarly, the invention of cereal bars, in response to a society on the run, succeeded in changing where and how consumers bought and ate cereal. • Capture a market need, whether latent or visible. There was no general outcry for upscale coffeehouses when Starbucks Corp. started building its chain of stores that delivered consistent high-quality coffee in a social and aesthetically pleasing environment. Driving Forces: For a different look at how powerful real innovations can be, consider a brief history of the U.S. auto market, in which a dozen or so innovations each changed the way consumers bought and thought of cars: Henry Ford's Model T, which in 1913 rolled off the first moving assembly line, revolutionizing mass production; the enclosed car, an early winner being the affordable Hudson Essex in 1921; GM's marketing strategy of combining multiple brands in one large corporation; the ability to buy cars in installments, making them more affordable; automatic transmissions, which made cars easier to drive; rental cars, creating a market for short-term use; Ford's 1955 introduction of the Thunderbird, an affordable two-seat personal luxury car; the Volkswagen Beetle, a 1960s icon, of which more than 21 million were sold; inexpensive and reliable Japanese cars of the 1970s; and finally, the vehicles at the heart of three key market shifts since the 1980s -- the minivan, for its convenience: SUVs, for power; and hybrids, for their better mileage and lower emissions. The innovators behind each of these developments achieved above-average profits that sometimes extended for years. In particular, the Chrysler minivan, which was introduced in late 1983, sold more than 200,000 cars in its first year, maintained leadership in the subcategory it invented for at least a decade, and was a critical contributor to the company's survival. Other innovations that have supported high returns for companies that were early market leaders: Charles Schwab Corp.'s OneSource, a mutual-funds supermarket with no transaction fees; Cirque du Soleil, the acrobatic group whose dramatics breathed new life into the circus business; Southwest Airlines Co., which specializes in point-to-point, no-frills service; Home Depot Inc., which sells advice and home-improvement products for the do-it-yourselfer; Cable News Network, which put 24/7 news on television; and Apple Inc.'s iPod and iTunes, the music player and online music store that have helped rewrite the rules for marketing music. Advantage, Innovator: The high returns that innovations produce are sometimes the result of advantages the innovator already holds: entry barriers based on technology, assets and expertise, the loyalty of a customer base, and an image as the originator of the innovation. Other times innovators extend their profits because their rivals are held back by the curses of success and size. Competitors in an established market, for example, may believe that participating in a new subcategory will cannibalize their existing business. When Chrysler invented the minivan, for example, its peers decided to protect their station-wagon businesses rather than invest in a new line of vehicles. Chrysler, on the other hand, with a weak position in station wagons, had little to lose. Alternatively, big companies may believe that an emerging subcategory will be too small to materially affect their business. Such thinking held Coca-Cola and PepsiCo back while the new health- and sport-drink categories were blossoming. Innovators need to be aware that their challenge is not only to create an offering and brand, but to create, manage and protect the perception of the new subcategory. The ideal way is to make the brand synonymous with the subcategory. The assumption should be that competitors are irrelevant because they lack visibility, credibility and authenticity. The inevitable result will be that the innovator is also considered the most relevant brand -- perhaps the only relevant brand -- for the subcategory. --Dr. Aaker is professor emeritus of marketing strategy at the Haas School of Business, the University of California at Berkeley.