How to Create the Perfect Innovation Portfolio
When pursuing innovation initiatives, one of the most important considerations is the makeup of your “innovation portfolio.” Just as an improperly balanced portfolio can increase risk and minimize gains in investing, so too can the wrong makeup of innovation initiatives create unnecessary risk or reduce return on investment.
But what is the best approach when considering the makeup of an organization’s innovation portfolio? There are several approaches, but the framework we’ve found most useful is the Three Horizon’s of Innovation, pioneered by Steve Coley, Mehrdad Baghai and David White.
The idea is that to effectively innovate, and achieve consistent organizational growth, an organization needs to simultaneously think and invest at three levels.
Defend the Base
The first horizon is where mature businesses live. These are businesses that already have a proven, repeatable business model and have achieved scale. The objective at this horizon is to protect and defend the business line, improve profitability – basically execute on what’s already working.
This is the domain of incremental innovation. Incremental innovations aren’t seeking to transform a business, but rather to optimize its profitability, efficiency, or uncover new markets.
Incremental innovation can happen entirely internally, and usually represents the least risky type of innovation. As such internal team members at larger organizations are very comfortable at this horizon of focus.
Double Down on What’s Working
The second horizon is “rapidly growing businesses” – businesses that have identified a repeatable, proven business model but haven’t necessarily reached scale yet. These businesses usually have plenty of opportunity available to them, and their job is to double down on what’s working. Horizon two is where organizations will capture the most value and create the business of the next 10 years.
Internal team members and processes might have difficulty here, as a rapidly scaling organization is subject to different dynamics from a mature or stable organization. However, rapidly growing businesses likely have some alignment in terms of financial reporting, etc. They also represent much less risk for team members, since the model has effectively been proven, and plenty of people will want to ride on a rocket ship.
This stage of business is usually where the buy decision is made in terms of strategic acquisitions, as an external startup has removed considerable risk but not yet fully captured the value of the underlying business.
Make Lots of Little Bets on the Future
The third horizon is “emerging businesses”. This is where the brand new stuff lives, and this is what most people talk about when they talk about innovation.
It’s critical to understand that the rules of the game at this horizon are dramatically different. At this horizon you are trying to uncover new problems worth solving, and placing small bets (ideally several at a time) on potential solutions to those problems.
This horizon is where the least amount of alignment with the existing company lies. These types of opportunities usually need to be staffed with different team members who possess different competencies, and are measured and rewarded differently. They should be subject to “innovation accounting” which prizes the rate of learning above all else. They represent the most potential risk for most team members, since many of them end up failing and failure in big co is usually a bad thing.
To successfully execute at this horizon, the organization needs a very solid understanding at all levels of decision making about the goals of these innovations (identify problems worth solving and viable solutions, not a business generating tons of cash at scale.) This horizon is usually where external consultants can add the most value, as they can more effectively deal with the ambiguity and thrashing that can occur for potential businesses at this stage.
All Three Horizons Matter
Smart companies looking to innovate effectively need to consider all three horizons and devote appropriate resources to each. Incremental innovation work on horizon one should represent the lion’s share of the innovation output in an organization, but does not usually require the most resources.
Effective training of internal team members on how to identify and validate incremental innovations, coupled with some solid processes (and incentives) for moving those innovations through the organization are usually sufficient. A company looking to execute here should seriously consider making incremental innovation an essential part of goal setting and compensation processes.
Horizons two and three must have sufficient resources to be viable. If an organization already has successful innovations in horizon two, they should aggressively try to capture as much value as quickly as possible. Unfortunately, many organizations simply don’t have a business or innovation that accurately fit this description, and must look outside their walls.
Considerable effort should be spent on going outside the building and looking for disruptive businesses that have already found product/market fit, partnering or acquiring them and working hard to give the necessary access to capital, distribution and other resources that make big co desirable without bogging them down in the red tape of the larger organizational culture.
The third horizon of innovation should also receive considerable investment, building up its own portfolio within the larger portfolio. Rather than putting all of their eggs behind a single innovation opportunity, they should spread out their risk by identifying 10-20 potential innovations, give them a small amount of resources each, and use strict innovation accounting standards and stage-gate review processes to let the winners rise to the top.
This will require a heavy amount of buy in at the top to let these fledgling portfolio opportunities thrash—it will look to the untrained eye like a lot of failure and wasted money. But as the venture capital world has already learned, predicting which innovations are going to be successful at the outset is extremely difficult. Very often only one of the innovations will be a winner, but it’s victory will be able to provide more than enough return to justify the approach.
As a rule of thumb, we advocate for devoting 50% of resources on incremental horizon one innovation and 25% on each of horizons two and three. But ultimately it depends on the particulars of your business or industry. The primary goal of such a rule is to avoid the common mistake of investing entirely in the first horizon and little to none in the second or third.
It’s worth taking the time the do an audit of existing initiative at each horizon and determine the allocation to each in terms of talent and capital. The right innovation portfolio can ensure the company is protecting and expanding its existing business while also maximizing its likelihood of success years into the future.