Designing Your Innovation Portfolio

By: Langdon Morris

The process of designing and developing your own innovation portfolios occurs as a series of steps that are described in a sequence because the output of one step will help you to think about the subsequent ones. The process builds towards design conclusions and decisions about the choices you’ll have to make, and then the investments that will back them up. In this chapter excerpt, Langdon Morris walks us through the process.

Small businesses and large firms will often have different types of projects in their portfolios, and the big ones will be investing much more overall, but the actual process of portfolio design isn’t all that different – what’s most important is that it’s a thinking process and a managerial discipline, and that’s the same whether the firm is large or small.

For the purposes of this description we’re assuming that you will be preparing one overall portfolio that consists of three sub-portfolios. This reflects the three time frames that we discussed in relation to the cone of uncertainty: short term efforts (now to two years), medium term (two years to four years), and long term (five years and beyond).

Step 1: The Rate of Change

The process of designing the ideal innovation portfolio begins by thinking about how change is occurring in the external environment, and what the consequences of this are today, and are likely to be tomorrow for your enterprise.

We’ve already explored this in detail in a previous chapter. Very broadly it’s obvious that external change is defining what we might call “the strategic terrain,” the overall economic and market landscape in which your business competes.

Change will of course mean impact on your existing revenue and profit flows, which thus suggests that there is a rate at which current products and services are becoming obsolete, and therefore the rate at which future revenues can be expected to decline. This will impact not only the future marketability of your existing products and services, but will also affect the evolving competition in the marketplace and the plans and actions of your competitors. Understanding this rate will also enable you to forecast how much revenue has to be achieved or made up through the innovation process in order to maintain the current level of revenues and profits.

While you probably can’t predict this with great precision, you can certainly develop a sense of how fast change is occurring, and the impact this is likely to have. Again, as with the predictions we discussed above concerning the cone of uncertainty and the impact of the major forces of change, this thought exercise has a dual purpose, as the actual predictions are planning tools and you’ll probably make decisions based on what you predict, and the very act of making a prediction sets up a mental exercise through which you can compare your expectations with emerging realities, and thus gain invaluable insight into what’s appening. Is change faster or slower than you had anticipated? You can adjust your rate of investment and the sense of urgency accordingly. Is change happening in the ways you expected? If not, you can adjust your innovation development targets.

Regardless of the industry or industries that your company competes in, the rate of change is a factor that you must have a clear understanding of.

In some markets like cell phones the rate of change is very fast; devices are marketable for about 6 months, so a steady parade of new ones are constantly in the development pipeline. In other industries the rate of change is much slower, but regardless of the industry or industries that your company competes in, the rate of change is a factor that you must have a clear understanding of.

Without the predictions you’re only able to surf on the waves of change, whereas the fact of making a prediction creates a learning opportunity that enables you not only to surf, but to steer more purposefully.

Your action step is to write down a set of predictions if you have not already done so.

Step 2. Performance Goals

The next step in designing your ideal innovation portfolio is to identify the growth goals for your organization, both in terms of revenues and profits.

Adding together the impact of the rate of change as a process that may reduce your future revenues and the growth goals you’ve set tells you something of great importance, as it indicates how much growth the innovation process must achieve both in terms of overall revenues and profits going forward into the future.

In this way the overall mix of your portfolio is very much a topic of design, and cannot be taken as an assumption; it must be worked out as a consequence of the performance that you’ll need to achieve across your business, whether it’s one type of product or service, or many of them.

Your action step is to chart your goals so that you have a clear visual model of what you’re expecting your innovation investments to achieve in each of the three time increments.

Step 3: Design the Selection Process

A key goal of the innovation process is to gather new ideas, any of which may turn out to become vitally important new innovation projects. To select the right ones without letting your own biases exert too much influence, you need a systematic and orderly method of evaluating ideas and deciding which ones you’re going to invest in, and why.

Now that you’ve modeled the external environment and you know what your strategic goals are, you next develop a list of the specific evaluation criteria that you’re going to use to assess each of the innovation projects that are already under way, as well as all new ideas that are proposed.

The existing projects need to be evaluated because at the time that they were initiated and funds committed, the decision criteria may have been different than the criteria that are most appropriate today.

Developing the set of criteria you’ll use to evaluate all of the ideas gives you a systematic way to do this. Of course the criteria may be different for each of the three portfolios (short, medium, and long term) because the factors you need to use when evaluating incremental innovations that are relevant in one to two years are probably different from those you’ll use to evaluate potential long term breakthroughs.

The criteria are grouped into two lists, benefit or reward outcomes, and risks.

Among the benefits that you may want to include on your list are:

• Benefit to customers.
• Revenue potential.
• Competitive advantage.
• Fit with digitization.
• Enhances our brand value proposition.

Other criteria to consider may include “fit with existing products and services,” “fit with existing organizational capabilities,” addressing key customer pain points, accomplishes an important “job” for the customers, or helps the company adapt to accelerating change, etc.

Selection and Targeting: The Customer Value Proposition

Another way to think about the benefits of any particular idea is by exploring the options that customers have. When buying just about any product or service there are choices that may solve the problem at a variety of prices. If we’re talking about cars, then there’s basic transportation at one extreme, as simple and inexpensive as possible, and there’s complete luxury at the other end. If basic is your goal, you may choose to buy your friend’s twenty year old clunker since he’ll take $500 for it, and it runs. Or if things have been going really well, perhaps you’ll choose the high end Lexus, Telsa, or Mercedes.

At both ends of the spectrum you’ll be driving (as long as the clunker keeps running), but your two experiences would be quite different.

Everything you can buy comes with more or less the same options, so we can generalize and say that at one extreme you have a basic commodity, no frills, and at the other you have such a magnificent experience that you become a dedicated customer, loyal for life, and in fact a friend and advocate. You proudly wear the Tesla t-shirt, and you gladly take your friends for a ride and tell them how great the car is.

This of course relates closely to the business model matrix we discussed; as we move up on the matrix, towards more customization and luxury we experience differentiation, whereas when we move down towards the mass market we are purchasing commodities.

The figure shows this as a ladder, from a basic value as a customer at one end, to differentiated value as a loyal partner at the other. If we overlay this concept onto the business model map, we can see that the closer to the upper right corner we get, the more the experience is differentiated, and the more intimate and aligned the relationship is likely to be.

Risk

Innovation projects have another side to them of course, the side related to uncertainty and therefore to risk. Five potential risks to consider include these:

1. Financial risk, relating to the cost to develop the innovation.
2. Risk of not succeeding, i.e., that the idea simply doesn’t work out.
3. Technology risk, meaning that needed component technologies are not available, or not available at a price that fits the intended scope or market for the innovation.
4. Distribution risk, that your downstream distributors choose not to handle the product (if it is a product), or that your internal distribution system cannot readily cope with the specific requirements related to the innovation. This implies either a potential failure, or at least higher distribution costs that you may be accustomed to.
5. Market risk, meaning that customers simply may not want to buy.

Depending on the type of innovation and the specific internal and external context at the time you do the evaluation, the weighting can be adjusted. Significant external changes such as competitors’ initiatives, new technologies, or regulatory changes could alter the overall context and lead you to adjust the weighting, or even to change some or all of the criteria altogether.

Note, however, that when you change the criteria you may need to go back and reevaluate all of the existing innovation projects to see how well they core in the new environment. Some projects that used to look very attractive may have become entirely unnecessary, while others that were marginal or even rejected previously may now be essential. We refer to this as “pivoting the portfolio,” and it’s an important task to do when external conditions change.

As a detail, note that we recommend that weighting be done using a scale of 1, 2, 3, 5, 8. The purpose of this is to accentuate the more highly weighted criteria, bringing your best (and worst) options into clearer focus. Later, when you conduct evaluations we recommend that you use the same scale (technically, it’s called a Fibonacci scale, named after the Italian mathematician; each subsequent number is the sum of the previous 2).

Step 4: Build the Portfolio

Now I’ll describe the process we use to conduct the assessment of risk and reward. The assumption behind this description is that you’re engaged in a process of evaluating a set of ideas, perhaps 10 of them, to decide which ones are worth pursuing at this time.

You’re undertaking this evaluation with a group of people in a meeting that could last 2 – 4 hours, depending on the number of ideas that are being evaluated. It’s probably obvious to you why multiple people are involved – you’re looking for a variety of perspectives on these ideas and since each of us brings our own unique perspective and we each have our own blind spots, we want to engage in an open and creative conversation with a lot of viewpoints and possibilities so we don’t miss something important.

You may have a standing innovation committee as participants in the meeting, but perhaps you’ve also invited some additional people from your organization who are experts in topics that relate to the specific ideas that are going to be evaluated today.

We’ve done this with as few as a handful of ideas and four people, and as many as 100 ideas and 80 people at the same time, and we’ve found that the basic format is flexible enough to work well in a wide variety of settings.

To begin, the participants must of course learn about each idea, so each one is presented briefly, followed by discussion until everyone understands it thoroughly. Someone should lead the meeting and facilitate the discussion to assure that the conversation stays on track and the conversation is fruitful.

Next, each person does their own, individual scoring for each idea. Each uses a single form to evaluate each idea, so if there are 5 people and 10 ideas, they’ll be 50 pages of data, or 50 electronic forms created.

While this isn’t rocket science it is important that the process be followed with discipline, because if you don’t follow a process with rigor then it becomes likely that the process of selecting the ideas to invest in will become skewed by personal bias or preferences, forceful talkers, bullying, pet peeves, or personality differences, and that would lead to less than optimal results.

And while it may be tempting to determine the scores for each idea in a conversational setting, rather than having each individual participant determine the score for each idea on their own, we don’t recommend that. (In other words, don’t do it.) Doing the scoring in a conversational setting is likely to cause a lot of information to be lost, and the variety of individual perspectives is likely to be clouded under the social pressure that arises in any group when there is bias toward agreeable dialog that leads to a general consensus.

You’ll get much better results, and more genuine reflection of individual opinions, if each individual does their own thinking, and then you compile and discuss their individual scores as the next step.

So let’s say you have 10 ideas under consideration, and each person has completed the scoring for each idea. Now it’s useful to have a conversation to explore why people have scored various ideas differently on any particular criteria.

These are extremely valuable discussion because they expose differing assumptions. When there’s a difference of opinion, this presents an opportunity for both people to discover something new about their views, and perhaps change their evaluation based on new information they learn in the dialog itself. This is important learning not only as it pertains to the specific ideas under discussion, but also for each individual’s broader perspective on management and change, because of course the underlying context for the discussion is each one’s views on what new products and services will be most successful in the future marketplace. This conversation, then, becomes part of the ongoing dialog about change, and how change is occurring, and the impact it will have on your firm. What you’re discussing are the benchmarks and milestones that you’ve already established, and you’re calibrating the rate of change and assessing its emerging impact, enabling you to track how it is unfolding.

Here is where you will track the cone of uncertainty as the present catches up with the future, and you can see how accurate your predictions have been.

Hence, the innovation portfolio design process, and the dialogs that you’ll have in the process of designing and managing the portfolio, become the setting in which your efforts to track change become focused. Here’s where you engage in those critical conversations on a regular basis using a rigorous structure; here is where you will track the cone of uncertainty as the present catches up with the future, and you can see how accurate your predictions have been.

Total up the scores for each idea and you’ll most likely see a range of scores, with some clustering. In aggregate, the higher scoring ideas are, in the judgment of this group, the better ones, the ones in which you ought to be investing. But not necessarily.

It’s also quite possible that a low scoring idea is the most strategically important for some reason that is not reflected in the scores (it can and does happen), or conversely that a high scoring project isn’t really as attractive as its score may suggest. So while the scores should help enormously with the decision making, a high or low score in and of itself is not the deciding factor.

Once you’ve gotten the set of individual scores worked out and averaged, take the information you just created and plot all the ideas on a single matrix. Label the horizontal axis “risk,” and on the vertical axis “reward.”

Each idea is shown as a single point on the matrix at the intersection point of its specific risk and reward scores. High reward and low risk ideas are of course the most desirable, and conversely high risk and low reward are not attractive.

Note, however, that as with the scores, the matrix should be viewed as a useful input to the decision making process, but it is never a substitute for managerial judgment. The conclusions you’ve reach here are not definitive decisions about which projects to invest in, but a robust way to get sound input and guidance from a group of people who are qualified to have legitimate opinions, as of today, about the ideas themselves, the future market they would be sold into, and the best investment options for your organization.

By tomorrow things could change, and the assessment scores might be different, but you must make decisions each day based on the knowledge you have that day, so using this process enabled you to compare the relative merits of a set of ideas which could even be quite different from one another, and yet to do so in a rational way.

As a result of the evaluation process, you’re now looking a matrix that shows how the ten ideas compare to one another in terms of risk and reward. Are any of them so inspiring that you feel compelled to initiate any of the right now? Are there any that address immediate issues or concerns that you already have? How do these ideas compare with the ideas or projects you’ve already been working on?

Now your managerial judgment comes into play, as you need to select which, if any, you’re going to move forward with. The specific process we propose for doing that is the subject of the next chapter, Speed, so for this discussion the point is to know which you’re now prepared to invest in and which you’re not.

Portfolio Design Discussion Questions

As you work through the innovation portfolio process, here are some general discussion questions to consider bringing up that will help to broaden the conversation and maintain the strategic focus.

• What are the right innovation targets for our organization?
• How can we align our innovation portfolio with our organizational strategy?
• What we should be prepared for in the future that we are not prepared for now?
• How is the world is changing, how is the market changing, how technology is evolving, and what will the consequences of these changes be for our organization?
• What capabilities and techniques are our competitors developing that we also need to develop and implement?

Step 5: Success Factors for Ongoing Improvement

Managing the portfolio is an ongoing process, and now we’ll discuss some of the critical factors that will help assure its success. The first is to realize that in an innovation portfolio, just as in any other portfolio, some projects will be more successful than others. Some projects, in fact, may fail, and you may need to remind yourself, or others, that in the right context this is both inevitable and positive as long as it’s not a consequence of carelessness or neglect. Unlike most other parts of your business, where failure is considered entirely negative and stridently avoided, failing in order to learn is common in the innovation process.

Despite this awareness at the conceptual level, it’s still often difficult for managers, even innovation managers, to recognize that the logic of innovation portfolio management calls for the possibility of failure, and indeed the likelihood of failure, and that this can be very positive when it enables you to discover new opportunities, to identify opportunities that you hadn’t recognized before.

It’s important for leaders to be advocates for portfolio thinking, and to help the others understand the role that failure plays in the overall process of innovation development.

As a small business leader this will definitely have a different tone that it does in larger firms because your capital is so scarce, but even so, it’s important for leaders to be advocates for portfolio thinking, and to help the others understand the role that failure plays in the overall process of innovation development.

Another key factor to recognize is that investment in innovation almost always represents a short-term cost with benefits that (crisis management aside) are likely to be attained only in the longer term. This is directly opposite of how most profit and loss managers are incented, and consequently if you have operational managers, it’s important to separate innovation investment from their profit and loss performance assessments. They probably shouldn’t be expected to invest in innovation projects because it will be a detriment to their performance evaluations, but their input into the process of selecting the right projects to invest in, and helping to guide those projects, should be immensely helpful.

Lastly, remember that your innovation investments should be staged and aligned with project milestones. Assume that each innovation project will be funded in small chunks, and each as goal is met you’ll have the opportunity to make a renewed assessment of the quality of the work, and the overall relevance of the idea, before you decide to fund it further. This will also support your agility, and reflect that innovation is a learning process.

Taking Action

It should be obvious that you need to engage in a detailed exercise to design and build your innovation portfolio. This will perhaps involve a number of other people, including leaders, managers, and thoughtful people from throughout the organization, and from outside as well.

And remember that building and then managing your innovation portfolio is a process at which you’ll improve over time. The first efforts, no matter how unsure, will inevitably lead you in the right direction as your learn how to make the process work for your culture and the specific challenges that your organization faces. Give this time regularly, once each month or two, and allow the learning that will occur to bring its benefits.

By Langdon Morris

Photo: businessman presenting graphs from Shutterstock.com