Four Questions to Build Your Company's Capacity for Innovation (TPL Insights #234)

With paraphrased content from Rita Gunther McGrath’s October 13, 2021, article, "Four Questions to Build Your Company’s Capacity for Innovation"

With so much uncertainty about, well, everything, people are realizing that innovation?— the process by which new things create value?— is essential to thriving going forward. Many senior leaders recognize the need for innovation but don’t know where to start.

Asking yourself these four questions is a good place to begin. You can work your way through them, ideally with a little experienced guidance, in about 30 days. By then, you will know what projects are essential to succeed, how you will get projects into your portfolio (and which you might need to get out of it), where your innovation and growth unit will be located, and how you’ll start to work in earnest with a few small projects.

1. What is your growth gap?

While it’s quite common for executives to promise their investors both performance and growth, the reality is that they are seldom set up to deliver both. Typically, they are?paying a lot more attention to the day-to-day. A useful way to shake things up is to articulate your growth gap?— in other words, how much new growth do you expect and where will it come from?

Next, take?a look at your portfolio of opportunities?— the projects you are working on right now.?Essentially, this involves three things: assigning spending to what is necessary to keep today’s business going, deciding on what to invest in the next generation of your core, and figuring out how to explore options for the future that offer long odds on a huge return.

Ultimately, you’re examining whether you have projects that are capable of closing the growth gap, recognizing that your core business is likely to experience a decline over time. If you don’t, you are going to have to change direction, or you’ll miss your growth targets and will likely be penalized for it. One metric that can track this is the Imagination Premium, which is a measure of how willing investors are to pay a premium for a stock based on its potential for growth.

If your gap is large and your portfolio isn’t likely to fill it, that’s a solid signal that you must start doing things differently. At Honeywell, when David Cote took over as CEO, his first big challenge was getting the “today’s business” numbers in order. When he arrived, he found endlessly creative ways managers were meeting quarterly projections that were essentially cooking the books. Once those were cleaned up, he started identifying real opportunities for growth. Over time this freed up cash that the company could use to invest in projects with a 4- to 6-year future payoff.

Cote then reduced the number of initiatives and focused only on a few. He wanted to fund those with the potential to generate large gains. One breakthrough was HFO, a new kind of fluorine for industrial refrigeration that was 20% less environmentally damaging than carbon dioxide and 1,500 times less than the previous substance; today, this yields a business with?over $1 billion in revenue. Another big success was the Experion Orion Console, a monitoring system for oil refineries, run by Cote’s successor as CEO. At the same time, Cote relentlessly pruned the portfolio of projects that, even if successful, weren’t substantial enough to make a difference for an organization the size of Honeywell.??

This type of growth gap scoping can also be used as you structure your innovation process to set up “what must be true” checkpoints along the way to that strategic end state. This is a discipline derived from?discovery-driven planning. The idea is to identify what a successful end state would be and then work backward to determine what would need to occur for that end state to be met. For instance, if your desired level of growth is $10 million in profits in a certain year, and you operate at a 20% return on sales, that suggests that the amount of revenue required will be $50 million. If you price by the unit at $250,000 per unit, then you need to have a plan that will allow you to sell 200 units at that price that year.?This exercise will help assure your company that you are on track?— even though revenues and profits for your program might be months or even years away.

2. How will your innovation practices be governed?

The governance system in your organization is what gets projects into the portfolio, what stops them when necessary, and helps them transfer to a business unit in the parent organization if they meet their eventual objectives. The governance process also establishes the scope of innovations and defines what is in scope and out of scope. In an ideal scenario, a committee like a growth board meets frequently, has a set of agreed-upon metrics for what kinds of opportunities deserve further development and is also courageous about stopping or parking things that aren’t ideal to move forward.

There are?several different models?for governing innovation. In some organizations, senior leaders themselves are part of the growth board and are intimately involved in resource allocation decisions. In others, it’s driven by technical functions. In still others, innovation is widespread without specific “ownership,” at least at the early stages. At Amazon, for instance, employees up and down the organization experiment with early-stage projects without a great deal of central direction. It’s only when a project becomes substantial enough to require an irreversible strategic decision that its governance process kicks in.

Best practice, in McGrath’s experience, is for the funds the growth board manages to be separate from those that support the base business. Further, any losses incurred by a new business (even if it is transferred to a business unit) should be borne by this fund and not by the budget or incentives of the business unit leader. This allows the leader to get?all the benefits of any upsides and isn’t penalized for any downsides, of supporting new businesses.

Whatever your practice, though, know that simply having it is a plus. Evidence from Accenture finds that firms with deliberate innovation governance practices?had twice the revenue growth?from new products and services than firms without such practices over the period they studied.

3. How will you allocate resources for innovation?

It is quite astonishing how often innovations get started and even get to some considerable size before someone realizes that they aren’t a good fit with the firm’s strategy (see any telecom company trying to be a media and entertainment business). To address this, go through a process of translating the grand strategies of your firm into specific screening scorecards. While these scorecards are never perfect and precise, they can provide enormous value in immediately distinguishing between things that are potential big wins and things that are unlikely to be, even if they succeed.

Strategy, in a definition I like that was developed by researchers Don Hambrick and Jim Frederickson, is a central, integrated concept of how you are going to achieve your objectives. Good strategies imply choices. They pull you and your people into the future and ideally provide the grist for an alignment of interests throughout your organization. Unfortunately, this is seldom what happens in real life. What sounded so great at the all-hands town hall often deteriorates into meaningless confusion at the level at which people are making significant strategic choices.

Scorecards are the antidote to this. They let people see the logic behind your strategic choices throughout the organization and spell out what good looks like for your strategy (and conversely what doesn’t). The screening process implicit in the scorecard makes it crystal clear which opportunities are desirable and which aren’t and allows ideas to be mapped against the same set of criteria. The magic is not the scores — the magic is the thinking behind them.

4. How will you get started?

If you are at an early stage, do?not?start with a huge team, big ambitions, and a major budget. That’s a recipe for total disaster.

Instead, pick a couple of smallish projects in which success can be demonstrated in a small way, and use them to begin to train people on how to plan uncertain projects using a discovery-driven growth approach. This involves planning via checkpoints, rather than by hundred-cell Excel sheets. It involves people understanding the approach to testing and learning, and discovering which assumptions are valid and which are not. It involves experimentation and what innovation expert Alberto Savoia would call “prototyping.”

If you get through these four questions and the related activities, then is time to start bringing a rhythm and cadence to your innovation efforts. To do this, you will need practices that deliver on three outcomes: 1) ideation to generate potential ideas; 2) incubation to find product/idea/market fit and to test for customer enthusiasm; and 3) acceleration in which now-successful new ventures get to “grow up” and join the parent company in some meaningful way.

Innovation is a discipline that must be cultivated. A framework like the one described in this piece combined with attitudes and a mindset focused on growth are key. Give us a call and let’s have a conversation. We’d love to be your thought partner.

Warmest Regards,

Rob