by Martin Kupp & Tristan Kromer
Martin Kupp is an associate professor for entrepreneurship at ESCP Europe in Paris and a visiting professor at the ESMT European School of Management and Technology in Berlin. His work has appeared in California Management Review, MIT Sloan Management Review, Business Strategy Review, Info Journal, Financial Times, the Economist, the Economic Times of India and the Wall Street Journal.
Tristan Kromer works with innovation teams and leaders to create amazing products and build startup ecosystems. He has worked with companies from early stage startups with zero revenue to enterprise companies with >$1B USD revenue (Unilever, Swisscom, Salesforce, Fujitsu, LinkedIn).
Newly appointed VPs of Innovation have been popping up in every company these days. While they are often given vague tasks such as “install the entrepreneurial mindset in the core business” and “look to the future,” managing the innovation portfolio is one of their most important responsibilities. To manage your innovation portfolio, you need to know what to optimize for.
WHAT IS INNOVATION PORTFOLIO MANAGEMENT?
Innovation Portfolio Management is the process of allocating finite resources into potentially infinite opportunity arenas and then into specific projects to capture a strategic objective. Decisions are not based on individual projects, but on an ideal mix of investments over arenas due to the uncertainty of innovation projects.
WHY BOTHER? ISN’T INNOVATION UNPREDICTABLE?
While it is virtually impossible to predict the financial output of a highly transformational innovation at the very early stages, some projects are substantially less risky. There is a big difference between the transformational approach of moving financial transactions to blockchain and a core innovation of simply providing SMS updates on the status of the same financial transaction.
No innovation is certain — they all represent different risk profiles.
Just as a good retirement fund will spread its investment into high-, medium-, and low-risk categories, companies must decide where and how to allocate their resources in an ever-changing environment. By diversifying investments into many different bets instead of one big transformation project, managing our innovation portfolio can make the overall output more predictable.
The primary goal of building innovation portfolios is to make the unpredictable more predictable.
IT’S NOT ABOUT THE TOOLS
From the McKinsey Three Horizons model, to the Innovation Ambition approach used by Google, to the Strategyzer Innovation Portfolio, academics and consultancies alike are putting ever more tools on the market, each promising to solve the difficult task of managing innovation.
Even the word tool is confusing. What used to be a piece of paper presenting a framework or template is now called a tool by many companies and consultants. The innovation portfolio management software used to visualize all this information is now called a platform. The number of frameworks, tools, and platforms to manage innovation is growing almost as fast as the number of salespeople pitching them.
Before measuring the pros and cons of one tool versus another, an innovation manager needs to understand why they are building an innovation portfolio, and more importantly, what interdependencies need to be identified, monitored, and visualized. The right tool should not only provide a broad overview of the portfolio, but should also help the manager allocate resources, set priorities, and develop options for the future.
In helping innovation managers visualize the portfolio, the right tool will force them to make decisions by making the need for decisions obvious. Ultimately it is up to the manager to say no to projects that would only distract the team and suck up resources. This requires strategy.
PREREQUISITES FOR INNOVATION PORTFOLIO TOOLS
Before choosing their tools, a surgeon knows exactly what they have to do and what they want to achieve. No one wants a surgeon just cutting away without a clear objective. The same is true for innovation managers and CEOs.
The first prerequisite of any innovation portfolio is that there is an actual innovation strategy. What is promoted inside the company as a strategy is often no more than an empty slogan like “Be the most innovative.” A viable strategy will tell you which projects belong in the portfolio and which do not.
Similarly, slogans such as “Unlock the innovation potential of digital transformation” are equally useless. This simply tells the company that anything with a mobile app will get approval while worthwhile cost-cutting measures and routine operations are out of favor.
The strategy must clearly state what trends are impacting the business environment, where the tipping points are, and where the company wishes to position itself in the future.
Are there technological, social, economic, or other trends? Are they predictable linear trends, or do they represent exponential changes that will appear very slowly, but will quickly reach a tipping point? Where does the company need to be positioned when the tipping point happens to make use of the opportunity?
Does the company have a high tolerance for risk, and does it seek to transform the way all businesses in the industry operate? Does it have a low tolerance for risk, or does it operate in a very slow-to-change environment?
Companies must understand their own vision for the future and their tolerance for risk, and use them to define the scope of their innovation ambition. Many companies state lofty ambitions but focus their entire rewards and performance reviews system on quarterly goals. This leads to focus only on core innovation.
But what is core innovation other than the acceptance of the status quo? Without clear alignment, any attempt at strategic innovation portfolio management is useless.
STRATEGIC ALIGNMENT & COMMUNICATION
Developing and aligning the strategy with action requires good communication between innovation managers and senior management. Senior managers should be actively involved in the development of the innovation-portfolio approach to help innovation departments not only fund projects to some level of success, but to prevent them from being orphaned when no one from the C-suite is interested in adopting the project into the core business.
The process of developing a portfolio approach is more important than the final portfolio itself — a company may start with a clear portfolio strategy and only discover during execution a better, emergent strategy that requires a pivot. It is during this iterative portfolio management process that innovation managers and executives discover the insight needed to continuously improve their company’s innovation potential.
PORTFOLIOS ARE ABOUT INTERDEPENDENCIES
The underlying premise of developing and using an innovation portfolio lies in balancing key aspects of the business: resources, time, risk, options, and last (but not least) profitability. Each of these elements can serve as the main perspective of a dedicated portfolio approach, or implicitly integrated into an alternate approach.
In the early days of innovation portfolios, one of the central concerns was whether the company or business unit would have enough resources to support all of the innovation efforts, and a number of innovation portfolios were developed that tried to better understand or predict the resources involved in new product development.
In 1992, Wheelwright and Clark developed a tool for mapping five types of development projects: derivative, breakthrough, platform, R&D, and alliances and partnerships. Their initial observation was that many companies initiate too many projects and ultimately lack the resources to follow through, leading to high failure rates. Companies would have to understand the nature of their projects to be able to balance the necessary resources for different types of innovation.
One of the weaknesses of this approach is centered around the “going concern” principle. In other words, infrastructure is maintained, even if it might soon be obsolete — so investments in some platforms, alliances, and R&D capacity may also become obsolete.
Accepting that some projects or capabilities will eventually be stopped makes it necessary to “overbook” the innovation pipeline, much like an airline overbooks seats. Some people are bound to cancel, so the seats are kept full. But what is the right amount of overbooking? This is where timing and throughput become critical.Only four years later, in 1996, McKinsey consultants Baghai, Coley, and White published their “Three Horizons of Growth” model, which distinguishes between the current core business, emerging growth businesses, and options for future staircases.
While the main focus here is on the timeline, there is also a link to risk in the sense that Horizon 1 is close to the existing core business and therefore less risky, while Horizons 2 and 3 lie farther away from the core business, and are therefore inherently more risky. And given that disruption is happening faster than ever, hoping that disruption is always 5-10 years away seems itself a risky proposition.
In 2012, Bansi Nagji and Geoff Tuff wrote about the Innovation Ambition Matrix to facilitate conversations about portfolio management based on risk and scale of ambition. The matrix is based on mathematician H. Igor Ansoff’s classic diagram to help companies allocate funds among growth initiatives, but it replaces Ansoff’s binary choices of product and market (old versus new) with a range of values. In addition to providing an overview of all innovation initiatives (which all portfolio approaches aim to do), this matrix focuses on the overall ambition for the company’s innovation portfolio and thus its appetite for risk. Although time might be an implicit consideration — transformational initiatives are most likely more long-term — this approach has a clear focus on risk. Companies typically use such a risk matrix to allocate resources based on their ambition and risk tolerance.
A more recent approach, the 2017 Business Model Portfolio Map by Osterwalder and Pigneur, combines elements of the Innovation Ambition Matrix with a clear focus on business models. The Explore section on the left represents transformational projects that give way to more adjacent projects in the middle, while the Exploit section on the right represents the core or adjacencies that are ready for execution.
This model allows for adjacent projects to be compared to more transformational projects in terms of expected returns and “innovation risk,” which is another way of identifying the amount of validation a business model currently has. (An adjacent business model that only changes one element of the core business already has a high degree of validation.)
Innovation is fundamentally about creating options for future growth, so it’s not surprising that scholars like Rita McGrath focus on Arenas of opportunity. For McGrath, an arena is “a combination of a customer segment, an offer, and a place in which that offer is delivered.” Others may use different terms and talk about emerging trends or micro-battles, but McGrath’s main point is that these opportunities are transient and must be captured and exploited immediately. There is no sustainable, long-term advantage. As the consumer landscape shifts, companies can look for growing markets and invest more where the growth exists.
McGrath developed a prescriptive portfolio approach based on understanding what type of options need to be developed in any given arena. For example, if a company is not well organized to address an arena and the market is unclear but the technology seems to already exist, then generating options by scouting existing companies is a viable path.
BE CREATIVE, CREATE YOUR OWN!
The portfolio tool an innovation manager chooses serves as a lens through which they see the company’s innovation efforts, and will ultimately influence the decisions being made. So choosing the appropriate portfolio tool is a key part of the innovation manager’s job.
This simple task can become increasingly complex as each executive demands that their viewpoint be included in the portfolio map. Some want to focus on a mix of projects leading to healthy returns in a certain timeframe, while others see disruption as more urgent and want to balance risk. New frameworks often attempt to combine one or more of these attributes.
The 4:3 Corporate Startup Portfolio framework by Dan Toma is exactly such a tool, combining the Three Horizons Model with the Innovation Ambition Matrix. Here, they have mapped out Alphabet’s innovation portfolio as an example.
Radar charts are another approach to combine several attributes, as they can compare different projects across multiple axes. Despite this flexibility, they tend to be difficult to use for a portfolio of more than a few dozen projects. They also don’t effectively show overall investment levels in any given area (although a cumulative radar chart can be used to this effect).
A divided pie chart can roughly combine different Arenas of opportunity with either the Three Horizons Model or the Innovation Ambition Matrix. For example, the core business (Horizon 1) is the center of the pie chart while transformational (Horizon 3) is the outermost portion. The Arenas are represented by slices. This visually represents that there is more surface area in the outermost portion and thus more opportunity in transformational or Horizon Three projects. That’s simply due to the fact that there is more uncertainty and thus more possibilities. Those possibilities may collapse at some point, but the future generally has more options.
There are additional options to represent investment by the size of the dot or the level of business model validation by color. But trying to make a visually impressive slideshow that represents everything at once can turn into a useless decision-making tool.
Perhaps by now you’ve noticed that there is no right or wrong in portfolio management. You can and should create your own portfolio approach that takes your specific situation into account (or mix and match existing tools). You can choose what you want to focus on (resources, time, risk, options) and how you might integrate additional points of view. Innovation is not a copy/paste exercise — it needs to be specific to industry and vision. You can’t manage by template.
Ultimately, innovation managers need to build frameworks that are useful for making decisions. They cannot be so complex that no one understands them, but they cannot be so simple as to remove rigorous thinking from the process.
A good framework for building innovation portfolios should uncover where companies are overinvesting and where they are not investing. This transparency will allow executives to make coherent decisions on how to reallocate resources. Having multiple frameworks and dimensions to measure the portfolio is an absolute must.
Managers should understand constraints and requirements in terms of resources, time frame, risk, and optionality, and how they fit into the overall strategy. Without that basis in strategy, any portfolio map is an academic waste of time at best, and innovation theatre at worst.
- A portfolio framework without strategy is a performance, not a usable tool.
- Know what you are optimizing for (resources, timing, risk, options).
- Be creative: use existing tools, mix and match, and develop your own toolkit.
Special thanks to those who contributed early feedback to this post: Rob Aalders, Dan Toma, Franck Debane, Jorge Castellote, Esther Gons, Josh Berry, Chris Cannon, Megan Kennedy, Alexia van Schaardenburg.