- Apr 18, 2011
Balancing a Portfolio
The answer isn't all that complicated as an oversimplistic metaphor can demonstrate. A billboard recently seen in Nevada, where gambling is legal, advertised prime rib dinners with the price of $7.77, showing as three winning numbers on a slot machine. Yet think about slot machines and the casino business. You never know each time you pull the handle or press the button of a slot machine whether you are a winner or a loser. Yet, in spite of the unpredictability of any given play or even any given machine, few casino owners worry about losing money across the casino. The methods for managing systems of probabilities and unpredictable processes have been around for a long time; however, they need to be applied with greater rigor to the innovation processes, on which we survive.
Now, of course, you can fully appreciate that the notion of managing innovation as a portfolio of opportunities is hardly novel. But we can and should explore more deeply the relationship between innovation portfolio management and the historical growth of "open innovation," which is the use of invention sources independent of the organization charged with delivering the innovation to the marketplace. This phenomenon was defined, and its substantial business impact analyzed in the seminal work Open Innovation 1 by Professor Henry Chesbrough and to which we refer the reader for a deeper grounding. What are the strategic opportunities created by a more deliberate integration of the role of "open innovation" into the overall portfolio? When you use the term portfolio, you must, of necessity, mean a balanced portfolio. And actually, since a portfolio would be nothing more than a collection in the absence of that adjective, "balanced" is always implied. And so what is it that "unbalances" your portfolio? In later chapters, we spend far more time on the topic of diversity, so all those arguments aren't replicated here. But internally generated projects are bound to possess a certain sameness. Thus, balancing is likely to demand an openness to external ideas, external projects, and external products—namely, ones that originate outside the organization.
Sourcing of more projects from outside the organization is not just a numbers game. Do not trivialize these arguments as merely the admonition to "take more shots on goal." Plenty of analyses from the sports world suggests that the higher scoring team makes a higher percentage of attempted shots as well. The processes used to manage a portfolio of innovative ideas must be well designed and rigorously applied, but the tools and specifics—that is, pareto diagrams, decision-trees, and option theories—deliberately remain beyond the scope of this book. The focus of this book is not "how" to manage a portfolio. It is rather to show that new innovation channels offer a portfolio balancing capability, and therefore a desirable outcome, unavailable with internal projects alone. This notion that a diverse portfolio of assets predictably outperforms a more correlated one is an important concept and one which is approached from multiple angles.
Beyond the factor of diversity, a second factor linking open innovation and innovation portfolio management is risk. There are many complex and valuable ways you can address the topic of risk and far more is said and written about risk than is done to contain it. When advancing an innovation portfolio, you need to worry about three kinds of risk: financial, technical, and execution. Closed innovation systems, where all the invention and creation takes place within the walls of a single institution, compel the innovator to load all this risk into one organizational basket. And that cumulative risk too often results in a "bet the farm" scenario. This risky strategy has resulted in the disappearance of many fine companies across numerous sectors. The pharmaceutical sector stands as a notable example. Think of the various medicines you and your family have taken. Many of the original producers, of well-known products like Motrin, no longer exist as individual entities, including SmithKline, Beecham, Ciba-Geigy, Roussel, Hoechst, Marion, and Merrel. What happened to Parke-Davis, Upjohn, Burroughs, and a host of others? These brands no longer exist. The executive teams no longer exist. The stock in those companies no longer exists. And although the answer is complex and has many elements idiosyncratic to those specific institutions, it is also a generally true statement that their demise could be traced to an over-accumulation of risk within their business entity.
The simple point to be drawn is that open innovation provides an invaluable means to balance an innovation portfolio and share risks. The consequences are so significant that all business leaders should be actively charged to attend to the innovation process and its strategic role.
Now recognize that the implementation of an actively managed innovation strategy won't be without obstacles. Scientists generally prefer to be ignored by process-mongers, portfolio managers, and others who might not be there with an agenda that is fully aligned with theirs, which is, first and foremost, peeling away nature's layers of obscurity. Similar comments could be made about the resistance of technologists or artists. Although there might be plenty of opportunity to talk about the underlying reasons that these creative types, as a whole, have a tenuous relationship with authority, we would rather focus on how the overall systems tend to be biased toward flawed portfolio management. We will look next at how corporate culture and organizational myths distort attempts to effectively manage a portfolio of innovative projects with uncertain outcomes and a frequently low probability of success.