With the rather negative exceptions of Enron, Bernie Madoff, and WorldCom, finance is not the first place we think of when we hear the word "innovation."
Still, asset allocation—a staple of financial planning—can be applied to your "innovation portfolio" with terrific results. We'll explain.
When it comes to how you divvy up your personal investments, you have always been told that they should be spread among asset classes (stocks, bonds, and cash) and then diversified further within the classes themselves. For example, you might hold stocks in both foreign companies and domestic ones, enterprises with large and small market capitalization, retailers, and high-tech companies.
The idea is to capture all the potential gains out there—the more bets you place, the greater the chances you have of being right—while minimizing risk. For example, if you're investing in the small-cap growth stocks sector and it tanks, your bond holdings might mitigate the loss.
You can use exactly the same approach when it comes to innovation. In determining whether or not to invest in research and development, product tweaks, line extensions, or new offerings, it is helpful to think of your budget dollars and people time as assets, then diversify them as well.
Why? Clearly, these activities present different levels of risk and reward trade-offs. Like stocks, bonds, and cash, they are not necessarily correlated to one another; the success of one is not contingent on another. As with financial planning, the idea of hedging your bets—while making sure you are represented in whatever sectors are hot—just seems to make sense.
the Four classes of innovation
If you want to go down this road (and we think you should), how would you divvy up your innovation portfolio? Before you can answer that question, you need to determine the classes into which your innovation efforts fall. There are four:
1. Evolutionary Innovation. (Technically easy and a clear customer benefit.)
This is the effort you extend to keep current cash cows fresh and to grow brands in the market. This is a hedge against becoming stale in the current markets and categories. It is generally the largest portion of any company's development budget, and it's sometimes over-weighted in companies that tend to "follow." Examples would include combining DVR functions into a cable box and launching a new flavor variety in an existing product.
2. Differentiation. (Technically difficult and a clear customer benefit.)
This portion of your innovation budget is used for making a distinction between your products and those of your competitors. Multitouch interfaces were studied for years; Apple (AAPL) took on the technical challenge to put it into a phone.
3. Revolutionary Innovation. (Technically difficult and there's no way of knowing ahead of time if the customer will accept it.)
This is the place where you search to find groundbreaking ideas for products, services, and business models. PayPal, iRobot's (IRBT) Roomba, and Fuji's (FUJI) environmentally safe batteries would be examples. This is a bet that the market will move toward your idea and your company will have a first-mover advantage.
4. Fast-Fail Innovation. (Technically easy but no way of knowing if the customer will accept it.)
This is the activity where you go to market and do your testing and learning there. It is the opportunistic segment of your development activity (i.e., it's well within your wheelhouse of capabilities and core competencies but far more experimental than usual). Here you expect to fail quickly before succeeding with an offering that may literally be refined by your customers' feedback in market. It is fairly low risk—you don't spend much before you send the product out into the marketplace—and has an extremely high potential reward as customers express exactly how they want you to alter it. Google (GOOG) runs multiple tests on ads and then goes worldwide with the ones that work best; companies are using Twitter as a potential customer-relations and resolution channel. Is it possible that Apple is planning to learn more about the growing tablet market by introducing the iPad?
In more aggressive industries—that is, industries such as consumer electronics that live and die on new products—your innovation portfolio development model might see a higher balance of effort in the upper right side of the diagram and less on the left. In more conservative industries, it's vice-versa.
One last point: To take the financial planning metaphor one step further, automatic "rebalancing" is important, too. Once an idea develops in the revolutionary or fast-fail boxes, it may move to the maintenance box after it grows and matures. The budget should be shifted accordingly.
The nice thing about approaching innovation this way is it reduces the subjective "whichever way the wind blows" process of deciding where to invest to the actionable and strategic no-brainer. You have your innovation asset allocation model and you divide the money up accordingly. It reduces the stress at budget time by getting everyone thinking concurrently about how to set priorities. It allows your teams to stay focused on generating the right ideas and then implementing them, vs. the hamster-wheel scenario of repeatedly guessing at the "how much should we spend?" question.
It's a very handy idea.