Your organization, like any other, has to innovate just to stay relevant. In a business environment that is disturbingly in motion, innovation management does not mean an endless chase for the next blockbuster design, product or business model idea.
Even if you hit the innovation jackpot, there will always be the next big thing. Business history documents countless organizations that eventually failed despite having blockbuster innovations once.
Consider Polaroid, which enjoyed a monopoly position in instant photography market with a jaw dropping 70 percent profit margins. We all know the story: analog photography got disrupted by digital imaging. What is less known however is that Polaroid had one of the earliest digital camera prototypes, but delayed its launch as it kept trying to mount a printer onto the camera and insisted using its existing business model only to realize later that consumers did not want a printer on their digital cameras.
Consider Motorola—once a market leader in mobile telephony. Motorola bet 8 years and around $6 billion to place 66 satellites in the Earth’s lower orbit for its Iridium phone’s network. It had to file bankruptcy in less than a year after realizing that no one wanted an expensive and bulky satellite phone. To reiterate, innovation is not about a quest for the holy grail of products or services. Innovation is about developing the right strategy, structures and processes for innovating continuously. Once an organization has this magic blend, no competitor can dethrone it.
Different models and assessment metrics
Regarding the right innovation process, a recent and popular one is the lean startup model. By shifting the waterfall (also known as the stage-gate model) paradigm, the lean startup model has taken business practice by storm. The waterfall model is more common and entails a linear process of conceptualizing an innovation, designing, developing and testing it in the market sequentially. Market information is included only at the concept and test phases. Each phase is separated by gates, where decision makers assess the progress and make go/no-go decisions.
Conversely, the lean startup model entails an iterative process where a minimum viable product in each phase is developed and tested in the market. The goal is not to develop a full-fledged innovation, but to build simpler versions enough to measure and test hypotheses regarding whether the innovation satisfies what market needs (known also as value hypothesis) and wants (e.g. growth hypothesis).
Because of the lean startup model’s iterative and non-linear nature, the traditional assessment metrics, such as Return on Investment (ROI) and Net Present Value (NPV) calculations, might be ineffective. These calculations are often assigned to project managers or controllers to assess the value of an innovation project. However, the inputs to make these calculations (e.g. projected revenues and probability of good or bad outcomes occurring) happen to be not more than a guesswork. This is because no one knows how the future will unfold. And innovations projects are not similar to rolling a dice, which can reveal its probability of having tails or tails if tossed hundred times or if the universe of all possible outcomes is observed.
Each innovation project is different, and no firm can afford launching the same project several times just to calculate the probability of certain scenarios occurring. How can then project managers and controllers assess the value of an innovation project? This is a very important task since it is the controllers’ assessment that can kill or save a project.
Investing in uncertainty
There is a very useful but seldom used solution: To reduce uncertainty facing innovation projects through rapid prototyping and market testing, project managers and controllers should abandon traditional assessment metrics in favor of ‘real options’ methodology. Real options methodology is borrowed from option pricing in finance, which brought a Nobel Prize to two of its inventors, Robert C. Merton and Myron S. Scholes. While real options calculations come with more complex mathematical formulae than simple Net Present Value calculations and have its own set of assumptions, its logic is both intuitive and useful.
Real options methodology advocates investing only small sums of funds initially, making investment decision sequentially, and reallocating funds from failing projects to the ones with more promising prospects. Because innovation projects are uncertain, by investing a small amount, the organization buys the right but not the obligation to make further investments. If minimum viable products show promise in the market, the organization may make further investments. If not, it abandons the project and avoids sinking further investments to a project that is deemed to fail. And of course, the organization should strive for a balanced portfolio of innovation projects.
For example, if Motorola’s Iridium project had used real options methodology they could have saved eight years of sweat and tears alongside of $6 billion, and avoid bankruptcy. If Polaroid had used this methodology, they might have soon realized the redundancy of a printer on a digital camera. This should be no surprise for you then that venture capitalists use real options in valuing the startups in their portfolio.
Waterfall or lean approach?
I should note that while the lean startup model involves customer learning early on and is faster, it might not be the panacea for every organization. The choice between the waterfall and lean approaches depend on several factors. And in many occasions the organizations may need to tailor a hybrid process falling in between the lean startup and waterfall methodologies.
For example, if health, safety or environmental compliance is an issue, the organization cannot and should not try to fail fast and learn. In addition, the lean start up model requires an open company culture where experimentation and mistakes are embraced, not punished. If your organization is not there yet, a waterfall approach might be more suitable before you carry out a cultural shift.
The auteur: Murat Tarakci
Murat is Associate Professor of Innovation Management & Academic Director of MSc Management of Innovation
Hij geeft op 19 april 2018 tijdens de PCO Kennisavond een lezing over ‘Lean management technique – changing traditional projectmanagement and control techniques’ (Engelstalig).