Innovation thesis and innovation portfolio- lessons from VC and Mckinsey

In the article “The raise of ambidextrous organizations as a corporate strategy to cope with disruption”, we discussed the introduction of a dual innovation system to improve the ability corporates in coping with disruption.

By
Andrea Giordano
on
July 24, 2020
Category:
Business Plan

In the article “The raise of ambidextrous organizations as a corporate strategy to cope with disruption”, we discussed the introduction of a dual innovation system to improve the ability corporates in coping with disruption.

The beauty of the system is its ability to serve as a plug-in with the current business structure by introducing an exploratory unit at the support of the exploitation unit.

The exploitation unit stands for the core company, which is responsible for optimizing the business and innovating it by applying incremental innovation.

The exploratory unit stands for the people looking to challenge the core products and business model of the company, with the goal of recognizing opportunities, test them, and convert them into new products and alliances. A different management process must be applied for testing opportunities and allocate capital.  

The exploitation and exploratory units are independent, and both refer to the board.

How can the board align its objective and split tasks and resources to the two units?

The exploitation unit of a corporation with billions of revenue rarely has a strategic interest in emerging trends. Emerging trends cannot solve the growth needs of large corporates simply because they don’t have enough revenue potential yet. Nevertheless, they might become important after 3-5 years down the road.

The exploratory unit steps in with the responsibility of testing the market opportunities and build new products in emerging trends. In case of success, the products are integrated back to the core unit when the market is mature enough. The proposed approach solves the problem of being suddenly disrupted by new startups because of the negligence of emerging techs.

In order to have the two units work smoothly, the boarding has to define the objectives for the exploratory unit. For this task, it comes handy the innovation thesis usually used by venture capitalists, which is their point of view of how the world is going to change in the next 5-10 years. This statement is supported by hypotheses about how startups can take advantage of new trends.  

Innovation thesis is compelling because it allows innovation managers to prioritize which trends to look at, which innovation concept to experiment, and which ones to neglect.

A balanced innovation portfolio

Because we cannot predict the future, the innovation thesis must be developed and viewed as a hypothesis that will evolve over time. The investments in various ideas will be the experiments for testing and update the thesis. On a quarterly or biannual basis, leaders can gather together to review the progress and refine the innovation thesis.

There are numerous frameworks used to develop an innovation portfolio of products. My favorite one is the framework developed by Mckinsey and featured in the book Alchemy of growth. This framework supports companies in managing their future growth without hurting current profitability.

The Mckinsey framework states that for a company to achieve consistent levels of growth, they must invest in its core products as well the products with the potential to become the next cash-cows.

graph-mckinsey-D100

Horizon one (H1) is associated with the core business of the company. In H1, the company is focused on improving performance and maximizing financial metrics.

Horizon two (H2) represents emerging technologies and trends which are likely to generate sustainable profit in 3-5 years.

Horizon three ( H3) represents ground-breaking innovation. These are bets on the future, which have the potential to transform the company and its industry, and they have a high intrinsic risk of failure.

A Harvard study made by Nagji and Tuff, concluded that firms that allocated in average 70% of their innovation funds to incremental innovations (H1), 20% to emerging trends (H2), and 10% to breakthrough high-risk initiatives outperformed their peers. In fact, they have realized a P/E premium of 10% to 20%.

Case in point: Google’s co-founder Larry Page told Fortune magazine that the company strives for a 70-20-10 balance, and he credited the 10% of resources that are dedicated to breakthrough efforts with all the company’s truly new offerings

The 70-20-10 is an attractive rule, but it needs changes based on the analyzed industry. Nagji and Tuff proposed an 80-18-2 ration for Consumer goods companies (low tech), whereas mid-stage tech firms should have ratio closed to 45-40-15.

As proven by Harvard professors Nagji and Tuff, a balanced portfolio is necessary to move towards competitive advantage over time.

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