The Optimal Innovation Strategy

An innovation strategy outlines the key areas a firm invests in because it believes these areas will help it fulfill its ambition. Finding the right level and areas of investment can be challenging due to the various options and uncertainties surrounding everything new. This article explains how a firm’s ambition, biography, and industry clock speed define the formulation of an optimal innovation strategy.

More than 50% of innovation investment is wasted, says Geoffrey Moore - the originator of the chasm theory in the diffusion of innovation. The cause is not primarily inefficient operations, delayed execution, or sunk unsuccessful investments, but rather investing resources into too many places, projects, and incremental improvements. Investments are wasted because of unclear innovation strategies.

A strategy requires a commitment to a set of coherent, mutually reinforcing activities that achieve a specific competitive goal. Good strategies have an interwoven connection between each investment choice and how it relates to the company goal. Without a clear innovation strategy, a company’s innovation performance will suffer from a scattered collection of popular best practices. These may involve creating decentralized R&D teams, fostering accelerators and incubators, establishing corporate venture capital funds, forming external partnerships, utilizing open innovation and crowdsourcing, collaborating with customers, and adopting rapid prototyping. While these practices are inherently beneficial, good innovation strategies employ those engines purposefully with a clear understanding of their unique contribution to the company’s goals.

I think it's critical to be aligned with the strategy. You cannot try and drive innovation without knowing what your strategy is. Everyone, every core business, every business which we run into, there is innovation happening. But there are different ways of thinking. We look at it from a degree of separation to our existing businesses to ensure that we are incubating into projects that can become the next growth areas for the company.

- Sanjeev Mervana, Cisco

There is not one innovation strategy that will work equally well for all organizations and circumstances. That is why it is important to understand the antecedents of formulating a sound innovation strategy and preparing the ground for realistic execution. In a nutshell, finding the right investment balance follows from the company’s biography, its ambition, and its industry dynamics. These factors combined help you craft your optimal innovation strategy.

Investment decisions following the Three Horizons Model

Innovation strategies are investment decisions—at least if taken seriously. These investment decisions are made today because the firm believes these investments will lead to future returns. The essential question is thus: What is the optimal investment portfolio that maximizes the firm’s future profit and aligns with its interests? In other words, what is the optimal innovation strategy?

The answer to this question first hinges on the company’s ambition and revenue goal over the next years. If we take the example of a company that makes €2 billion in revenue today and aims to achieve €6.5 billion in revenue in 3 years, a gap of €4.5 billion needs to be earned over the next years. The firm thus needs to ask how and where to invest to best close the gap. From the company’s perspective, it might be best to close the gap by continuing to invest in the current core business model. Since the firm has built expertise, it does not want to unnecessarily engage in uncertainty and new business fields. In such a case, they could invest 100% of their budget into Innovation Horizon 1 activities to improve the core.

However, this strategy has strong prerequisites in terms of the firm’s capability and industry dynamics. Achieving such a return on investment (CAGR: 48%) is unrealistic; not even the best-performing business models in the world generate such margins. This innovation strategy is only seen at start-ups, who are investing solely in getting product-market fit. What this means for our example company is that their ambition is either unrealistic or they need to make more risky investments in uncertain terrains.

The optimal innovation strategy follows a gap analysis between the company's future ambition, what is expected from following today's trajectories, and what innovation contribution is missing to reach the ambition:

For most established firms, this 100% core innovation strategy is illusory because they operate in slow-growing or saturated markets. In theoretical terms, their core business is already at a point on the industry’s production curve with diminishing marginal utility—every extra dollar spent leads to less marginal improvement. However, this also explains why companies invest most of their budget into Horizon 1 innovation. They need to invest, otherwise, customers would leave, leading to significant losses.

To close the innovation gap, firms should thus determine the minimal investment in core required to retain customers. In addition, they might make a slight contribution to closing the innovation gap. As a rule of thumb, investments in innovation Horizon 1 lead to a 1.1 return on investment with high certainty. When firms know how much they need to invest to secure their core, they can calculate the contribution to the innovation gap.

Once firms have clarity on how much investment is needed to keep the core alive and how much to contribute to the innovation gap, they can calculate how much contribution needs to come from the other two innovation horizons. Innovation Horizon 2 is still related to the core business and helps companies to expand it, for instance, by addressing new customer groups or adding new solutions that provide new value to existing customers. There might be a bit more uncertainty related to it than Horizon 1, but it might still not be that risky. That is also why firms can typically expect a return on investment of around 1.2. However, this return depends on the industry dynamics and the value of the business model expansion. Finally, firms can calculate the expected contribution from moving beyond the core business model. This might be the riskiest endeavor, but it also promises the largest return ratio of about 1.7.

Typically, this leads to the conclusion that companies should invest 70% of their budget into improving the core (Horizon 1), 20% into Horizon 2, and 10% into Horizon 3. But, this split needs to be adjusted to the company’s ambition and the industry’s dynamics. If companies want to grow progressively, they will need to invest more in Horizon 2 or Horizon 3.  

One is transparency about the strategy. For example, I can know upfront that if I were to come up with a new manufacturing process for making paper towels and go and try to champion that, I'm wasting my time. That's not our business, right? We can know things that we do and don't do. We don't manufacture semiconductors. As an innovator, it makes sense to try to align to a previously communicated strategic direction.

- Cordell Hardy, 3M

The teams and leads in the firm that own the respective innovation horizons are responsible for exploring the opportunities that could achieve the expected return. Ideally, these opportunities and projects are governed by an innovation portfolio and in a recurrent forum (read more about innovation growth boards) where the teams meet with leadership and plan to close the innovation gap.

Typical Innovation Horizon Splits of Industries

To execute an optimal strategy correctly, it is worth emphasizing that each team that owns an innovation horizon needs to own the budget control and decide what opportunities to explore and test. Not having a dedicated innovation budget is one of the most common pitfalls leading to failed innovation strategies.

When innovation strategies fail and when they succeed

Besides employing a weak innovation strategy, companies might also have no innovation strategy in place at all. Returns from the core business may be promising enough not to invest money unnecessarily in more risky, unknown terrain. In the long run, however, every company needs to move beyond its core business, as the Innovator’s Dilemma explains. Consequently, having no innovation strategy at all is the biggest failure. Yet, even with an innovation strategy in place, there are common pitfalls, which means there is room for improving a company’s innovation performance:

• Unclear innovation expectation: Without clear expectations for every horizon, no benchmark is given to check achievements. This most often stems from an unclear company ambition and, as a consequence, a missing calculation of the innovation gap, i.e., the required innovation portfolio contribution.
• Missing ownership or redundant ownership: Companies have various options to innovate (e.g., idea campaigns, start-up collaboration, crowdsourcing). With missing clarity, organizations tend to employ too many innovation engines, working in parallel on the same topics or not performing well because the engine does not fit the company's ambitions.
• Underfunding: Companies tend to apply the concept of sponsoring, where innovative ideas need to find sponsors in core business lines. The ideal is that each innovation horizon and each team has a budget to spend.
• Underestimating industry dynamics: Firms can significantly profit from first-mover advantages. To appropriate the innovation rent, firms must understand how quickly their direct competitors move as well as other companies in the industry.
• Splitting exploration and execution: To activate the best expertise, companies tend to split between opportunity discovery and enactment. Such a split requires a lot more work to convince others. This can lead to less motivation and ownership, as well as delays in executing the innovation strategy.
• Bucket investment without increased confidence: The act of innovating is inherently uncertain. That is why the innovation process typically involves stages, where each stage is used to collect more evidence and increase confidence. If no new confidence is gained, innovation projects should be killed. However, companies tend to fund the complete project from the start rather than using metered funding as an alternative. If this happens too often, the strategy execution will fail.
• No central control boards: Without the necessary understanding of innovation as a business priority, firms tend to leave decisions to single innovation teams. However, since today’s earnings sponsor every future endeavor, it is necessary to have one central committee with an overview of all innovation initiatives and all horizons.

Avoiding these pitfalls will help you formulate and execute the innovation strategy.To have a good innovation strategy, firms must clearly communicate their ambition and calculate their innovation gap. Then, give teams clear ownership and budgets, as well as expectations in terms of revenue and deadlines. To assess the execution of the strategy, organizations must continually monitor and control the innovation portfolio to ensure it reaches the ambition on time.  

The optimal innovation strategy is a matter of your company's biography, ambition, and the industry's clock speed:

The matter of company biography: Where are you now?

To find the optimal innovation strategy, a firm needs first to recognize its capabilities formed by its history, assets owned, and culture.  In other words, its biography. Every company has a story—a unique journey through its past—that shapes its present decisions and future. A company that has experienced significant success with bold innovations in the past is likely emboldened, fostering a culture that is unafraid to take risks. At the same time, their internal strength might limit their willingness to accept external solutions, crowdsourcing, and collaboration with start-ups. Or, a history peppered with failed ventures might make a company more cautious, shaping a more conservative approach to innovation. While these factors might have a less obvious impact, they are worth considering when changing strategic direction and require convincing communication of the innovation strategy.

The impact of resources and capabilities—allocated over time—is more obvious. These are the lifeblood of innovation. Often, past earnings provide  finance for innovation investment. Companies that can allocate substantial resources to their innovation efforts are able to pursue more ambitious projects and innovation activities.

For companies with fewer resources, innovation must be more strategic and focused. Ultimately, it needs to be clear how much resources you are willing and able to invest. You can split this number across the teams, owning the different innovation horizons.

The matter of industry clock speed: Stormy sea or calm waters

Besides a firm’s history, industry clock speed—the rate of change within an industry—is the second factor influencing the effectiveness of innovation strategies. Industry clockspeed is important because it tells you how long the window of opportunity is open and, therefore, dictates the necessary speed and volume of innovation responses (learn more about the tactics to slash time to market here).

The clock speed of different industries as a measure of expected changes and growth expectations

(inspired by Accenture Research Disruptability and AlixPartners Disruption Index)

To fully capitalize on the investments, it is not enough to just explore the right innovation opportunities, you must exploit them fast enough. An industry’s clock speed determines the time that innovators have. If they move faster than the competition, they have a chance to profit from the first-mover advantage. If they move too slowly, competitors may have already gained a dominant position.

Plus, industry dynamics also impact the innovation strategy and the need to invest in Horizon 2 or Horizon 3. If the industry expects many changes to happen—like a transformation to a new dominant design—it is clear that organizations need to focus much more on these horizons to develop a new business model.

The matter of ambition: Accelerated growth or defending the core

As a third factor, organizations searching for an innovation strategy need to consider their ambition. As outlined in innovation strategies as investment decisions, a firm’s ambition crucially defines the split between the innovation horizons. If a firm aims to grow stronger than the market, it needs to make more risky investments. Higher risk will crowd out competitors and, thus, promise higher returns. However, this also requires the firm to accept failures and cutbacks on the core business.

If the firm does not have ambitious growth goals—and if the industry clock speed is slower—it is a viable innovation strategy to focus on incremental, core business innovations. The goal is to sustain the current position and squeeze more out of the company’s existing market and technology without fundamentally altering the underlying business dynamics, risk, and security of future returns. Typically, these firms prioritize investing in technologies and processes that improve quality and customer service, reduce costs, and comply with regulatory standards. In such cases, the core product lines govern the innovation activities.

If the ambition is higher, firms need to invest in more adjacent and transformative business areas. This needs to be seen as complementary to the current core business model. Most of the investment capabilities in this strategy have been earned in the core business. Yet, it needs dedicated teams with resources to explore and test new business opportunities.  

Formulate your innovation strategy on a canvas

Organizations that want to formulate the optimal innovation strategy should be clear on their biography (the assets they own), their ambition (the growth they aim for), and industry clock speed (the change expected). A clear picture of these factors will result in the right commitment. Some rules of thumb can be applied to formulate the optimal innovation strategy:

• The more ambitious a company is, the more it needs to move investments from Horizon 1 to Horizons 2 and 3
• The more disruption expected, the more the company must move investments from Horizon 1 to the other Horizons
• The faster the change, the faster the company needs to move from opportunity exploration to go to market
• Each team needs to own opportunity exploration and execution, thus requiring their own resources to explore and test
• The more mature (and saturated) an industry is, the less growth can be expected from only investing in the core
• Every industry has a lifecycle and will reach saturation. At some point, it will, therefore, be important for any company to move beyond its core business.
• To explore new opportunities (in Horizon 3), collaborating with start-ups and universities is a less cost-intense alternative to the company’s own research and development.
• Every innovation engine you employ needs to have a direct connection and positive contribution to your corporate ambition. 

To pursue a moderate ambition, a 70-20-10 split is seen as the best investment split across different contexts.

Supporting the execution of the innovation strategy

Once you have defined your innovation strategy, the ITONICS Innovation OS is the perfect fit for ensuring its execution. The ITONICS Innovation OS is the end-to-end innovation management solution that connects all your teams, working towards your ambition.

The software comes with unique features to give you a complete overview of your opportunities and committed projects, thus giving you full oversight of your budget. It enables your teams to get their work done and collaborate effectively. Create the transparency your teams need to avoid double work and foster synergies.