Long before Jack Dorsey and Steve Jobs reflected on the keys to innovation, Mervin Kelly, one of the early architects of Bell Labs, weighed in on the subject. I learned this from Jon Gertner's "The Idea Factory", a fascinating account of Bell Labs' age of innovation. In particular, Chapter 9, "The Formula" describes a speech that Kelly gave to the Royal Society in London in 1950, shortly after the invention of the transistor at Bell Labs, which highlighted his thoughts on innovation. At this time Bell Labs was widely considered to be the most innovative industrial research lab in the world. After years as a physicist and then director of research, Kelly was by then an executive vice president at Bell Labs.
Interestingly, the formula for innovation does not seem to have changed much over the years. Kelly considered these three ingredients essential to innovation:
Bring together a multi-disciplinary team of smart people. Kelly encouraged the constant exchange of ideas between researchers, engineers, and technicians. These exchanges could be formal or informal; they could take place in the hallway, over lunch, or within assigned multi-disciplinary project teams. And, ideally, these exchanges were in person; the Murray Hill building was even designed with this in mind, featuring long hallways that increased the chance of serendipitous encounters.
Give them real-world, challenging problems to solve. At Bell Labs, there was no shortage of problems related to supporting AT&T's communications business: from inventing ways to save money - by replacing fragile vacuum tubes with transistors, for example, to coming up with better products and services. In addition, during WWII, Bell Labs applied its expertise in technologies, such as radar, to military applications.
Give them the best technological tools and a stable source of funding. Last but not least, innovation at Bell Labs relied on a stable source of funding coming from the phone companies that it supported.
Further reading. Jon Gertner's New York Times' op-ed provides more details from his book. The Wikipedia entry for Bell Labs lists its long history of innovation.