Managing Your Innovation Portfolio

c o n t r i b u t o r

Malgorzata GlinskaSenior Researcher, Batten Institute

glinskam@darden.virginia.edu

THE IMPORTANCE OF PORTFOLIO MANAGEMENT

Any company engaged in new-product development (NPD) faces a series of high-stakes decisions—which ideas to pursue, how many to keep in the pipeline, and how to allocate scarce innovation dollars.

Portfolio management, therefore, is critical to successful NPD. It is about resource allocation—how a company invests its capital and people. It is also about project selec-tion—choosing which projects to invest in and ensuring that there is a pipeline of big new-product winners. And, most significantly, portfolio management is about strategy.1

Executives find that innovation portfolio management is helping them to:

• Maximize their returns on R&D spending• Maintain their company’s competitive position• Allocate scarce resources • Create a link between project selection and business strategy• Achieve a stronger focus• Achieve the right mix of projects• Communicate project priorities both vertically and horizontally within the

organization• Provide greater objectivity in project selection2

BATTEN BRIEF INGIMPROVING THE WORLD THROUGH ENTREPRENEURSHIP AND INNOVATION SEP 2013

INNOVATORS’ ROUNDTABLE REPORT

INNOVATORS' ROUNDTABLE REPORT, SPRING 2013. CHARLOTTESVILLE, VIRGINIA.

1 Cooper, R.G., Edgett, S.J., and Kleinschmidt, E.J. 2000. “New Problems, New Solutions: Making Portfolio Management More Effective.” Research Technology Management.

2 Ibid.

2 BATTEN BRIEFING

BACKGROUND

To compete in today’s fast-changing global

environment, companies are under increas-

ing pressure to innovate—and to do it at

a breakneck speed. This challenge, with a

focus on managing an innovation portfolio,

was the main theme of the spring 2013

Innovators’ Roundtable, a periodic conver-

sation among senior leaders from some

of the world’s largest and most innovative

firms.

The fourth gathering of the Innovators’

Roundtable, hosted by the Batten Institute

for Entrepreneurship and Innovation on 2

May 2013 at the Robert H. Smith Center

at Montalto, in Charlottesville, Virginia,

brought together innovation executives

from Corning, CSC, DuPont, MeadWestvaco

and Siemens.

This Batten Briefing was prepared to

serve as background material for a candid

daylong discussion facilitated by Darden

faculty members Mike Lenox, Ed Hess and

Jeremy Hutchison-Krupat.

The management of NPD project portfolios is a critical but often frustrating chal-lenge for many companies. Poor planning, lack of discipline in project screening and inadequate attention to strategy are common problems.3

The issue is that all R&D, by definition, is uncertain. Managers must make deci-sions about projects that may not be technically or commercially feasible. Product engineers aren’t always sure about the technical and commercial attractiveness of various design options. And customers’ preferences, competitors’ responses and other external factors may be difficult to predict.4

The five sources of decision complexity outlined below highlight the difficulties as-sociated with NPD portfolio management.5

Strategic alignment. An NPD portfolio allows a company to operationalize and implement strategy over time. This implies that NPD portfolio management entails a large component of ambiguity and complexity, since the determinants of firm success and their interactions are rarely known. Moreover, successful NPD portfolio management depends on the ability to effectively communicate strategy down to the level of individual projects.6

Resource scarcity. Companies often pursue many projects in parallel in order to achieve broader product lines and higher market share. In such environments, deci-sions regarding the allocation of scarce resources are a critical factor for success.

Project interactions. Companies often develop multiple products and services in closely related market segments. Hence, the products may exhibit synergies or incompatibilities in their technical aspects. Similarly, on the market side, products may substitute or complement one another.

Outcome uncertainty. It’s impossible to know the outcome of an NPD project. Consequently, managers face risks related to the overall functionality of the product (technical risk) and to the adoption of the product by end customers (market risk).

Dynamic nature of the problem. Decision makers must allocate resources over time, and NPD programs evolve over time. Therefore, managers must take into ac-count future values and risks when allocating resources to a promising idea. How-ever, it is often difficult to quantify the potential of an idea or precisely measure the risks involved.7

The Challenges of Portfolio Management

3 Wheelwright, S.C. and Clark, K.B. 1992. Revolution-izing Product Development: Quantum Leaps in Speed, Efficiency, and Quality. Free Press: New York.

4 Pisano, G. and Gino, F. 2005. “Holding or Folding? R&D Portfolio Strategy under Different Information Regimes.” Harvard Business School Working Paper, No. 05-072.

5 Adapted from Kavadias, S. and Chao, R.O. 2007. “Re-source Allocation and New Product Development Portfolio Management,” in Loch, C.H. and Kavadias, S. Handbook of Product Development Management, 135-164, Elsevier/B-H, Oxford, UK.

6 Loch, C.H. and Tapper, S. 2002. “Implementing a Strategy-Driven Performance Measurement System for an Applied Research Group.” Journal of Product Innovation Management.

7 Kavadias, S. and Chao, R.O.

3

Some companies use a “bottom-up” approach to portfolio management. It starts with a broad range of ideas that bubble up from within the organization and are screened and evaluated. The best ones are funded.8

The problem is that techniques for evaluating and selecting projects are often weak or inadequate.

Project valuation is a typical approach. In it, projects are ranked on the basis of their expected financial results. The n best projects, according to their score, “make it” into the portfolio. Projects are typically ranked using discounted cash flow (DCF), net present value (NPV) and return on investment (ROI) metrics.

One of the most popular ways to evaluate an innovation project—in order to deter-mine its ranking—is to use DCF to calculate the project’s NPV.9 NPV calculations are always suspect in the early stages of new-product development. Managers who have “pet” projects know how to manipulate the numbers to make their projects look attractive. As one manager put it, “What number do you want to hear? The project team always delivers the right number to get their project approved!”10

The misguided use of various financial-analysis tools to evaluate and rank projects in an innovation portfolio is often cited as one of the reasons companies find it impos-sible to innovate successfully.11 In addition to DCF and NPV, other usual suspects are the use of sunk costs and the emphasis on earnings per share as the driver of share price.12 For example, the myopic focus on earnings per share diverts resources away from investments whose payoff lies beyond the immediate horizon.13 That atti-tude results in a very incremental portfolio that lacks potentially disruptive products and business models that could enhance the underlying value of the enterprise.14

Academic research demonstrates that generic criteria, such as scores based on risk or return, are not sufficient for effective NPD portfolio management. Rather, NPD activities must reflect an R&D strategy, which is linked to the company’s overall business strategy.15

The Bottom-Up Approach

8 Cooper, G.R. and Edgett, S.J. 2002. Portfolio Manage-ment for New Products. Basic Books.

9 Christensen, C.M., et al. 2008. “Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things.” Harvard Business Review.

10 Cooper, R.G., Edgett, S.J., and Kleinschmidt, E.J. 2000.

11 Christensen, C.M., et al.

12 Ibid.

13 Ibid.

14 Ibid.

15 Wheelwright, S.C. and Clark, K.B. 1992. “Creating Project Plans to Focus Product Development.” Harvard Business Review.

4 BATTEN BRIEFING

The best portfolio management practices are top-down rather than bottom-up. They start with the organization’s vision and strategy, and new-product initiatives and re-source allocation flow from there. In other words, companies that innovate success-fully start at a high level by developing their business and technology strategy: Who is our customer? What is the product or service we want to offer? How should we do this in a cost-efficient way?16 Then they make sure that their innovation portfolios reflect those strategies.

One example of a top-down approach is the “strategic buckets” model. It starts by considering the organization’s vision, goals and strategy and then asks,

• How should we be spending our development funds?

• What areas do I need to be in?

• Which markets, technologies and customer segments should I invest in?

The answers to those questions result in the setting aside of funds—buckets of money—across various dimensions, such as product line, type of market, technology area, project type or geography.17

Once the buckets are defined, each with its allocated resources, various development projects are sorted into them.18 Projects are then ranked within each bucket and funded in rank order until that bucket runs out of resources. Ranking is often done using a financial index, the expected commercial value (ECV) or a scoring model (projects are rated or scored on a number of questions or criteria). However, many businesses have no formal ranking method.19

The major strength of the “strategic buckets” approach is that development projects and spending are aligned with the company’s strategy.20 It also helps senior manage-ment achieve the right balance and mix of projects. Earmarking specific amounts to each bucket ensures that projects in one bucket—for example, “new products”—do not compete for funding against projects in another bucket—for example, “improve-ments and modifications.”21

Top-Down Approaches

16 Markides, C. 1999. “Six Principles of Breakthrough Strategy.” Business Strategy Review. The “Who-What-How” framework was originally developed by Derek Abell in Defining the Business: The Starting Point of Strategic Planning. Prentice Hall, 1980.

17 Cooper, R., Edgett, S.J., and Kleinschmidt, E. 2001. “Portfolio Management for New Product Development. R&D Management.

18 Cooper, R.G. and Edgett, S.J. 2010. “Developing a Product Innovation and Technology Strategy for Your Business.” Research Technology Management.

19 Cooper, R.G. and Edgett, S.J. 1997. “Portfolio Manage-ment in New Product Development: Lessons from the Leaders.” Research Technology Management.

20 Ibid.

21 Cooper, R.G. and Edgett, S.J. 2010.

5

Managers making resource allocation and NPD portfolio decisions face a difficult choice: allocate resources to the development of fundamentally new technologies, products and markets, which are inherently risky, or improve existing technologies, extend product lines and entrench existing market positions without taking exces-sive risk. The former investments have the lure of potentially high payoffs, while the latter often result in smaller returns.22

70-20-10—The Winning Ratio? A recent study of companies in the industrial, technology and consumer goods sectors demonstrated that the high-performing ones directed about 70% of their innovation resources to “safe” core initiatives (enhancements to their core offerings—optimizing existing products for existing customers), 20% to adjacent initiatives (expanding from existing business into busi-ness that’s new to the firm) and 10% to transformational opportunities (developing breakthroughs for markets that do not yet exist). The companies that maintained the 70-20-10 balance outperformed their peers, typically realizing a P/E premium of 10% to 20%.23

One of the reasons many organizations fail to generate the growth they seek is that they don’t strike the right balance between risk and reward. They focus too much on safe, incremental innovations in familiar markets. These may be necessary for continuous improvement, but they fail to give these companies a competitive edge or significantly contribute to their profitability. The kind of projects they need are those that are often shunned: big innovations that have potentially huge payoffs, perhaps far in the future.

THE INNOVATORS’ ROUNDTABLE

The Innovators’ Roundtable is a mem-

bership network of senior innovation

executives from some of the world’s most

innovative companies. The purpose of the

network is to share best practices, discuss

common challenges and push the state of

the art in corporate innovation in a highly

interactive and candid forum. To encour-

age frank discussion and to motivate

interdisciplinary learning, members are

selected from among non-competing firms

and diverse industrial sectors. The Batten

Institute, a leading center for research in

entrepreneurship and innovation at the

University of Virginia’s Darden School of

Business, convenes the Roundtable execu-

tives once or twice a year for conversa-

tions facilitated by the world’s top scholars

in innovation. Participating members have

included Accenture, Alcoa, Corning, CSC,

Bank of America, MeadWestvaco, Northrop

Grumman, Salesforce.com and Siemens.

For further information about opportunities

for membership, please contact:

batten@darden.virginia.edu.

Risk and Reward in Your Innovation Portfolio

22 Tushman, M. and O’Reilly, C. 1996. “Ambidextrous Organizations Managing Evolutionary and Revolutionary Change.” California Management Review.

23 Nagji, B. and Tuff, G. 2012. “Managing Your Innovation Portfolio.” Harvard Business Review.

6 BATTEN BRIEFING

THE RISK AND REVENUE MATRIX

This matrix represents an innovation

portfolio of an imaginary company. Each

dot represents one innovation, with the

size reflecting that innovation’s estimated

revenue. Each innovation is positioned

on the matrix by determining its score

on two dimensions—how familiar to the

company the intended market is (X axis)

and how familiar the product or technolo-

gy is (Y axis). Familiar products aimed at

the company’s current markets fall in the

bottom left of the matrix, indicating a low

probability of failure. New products aimed

at unfamiliar markets are located in the

upper right, indicating a high probability

of failure. This portfolio, dominated by

relatively low-risk, low-reward projects, is

typical in its distribution of risk.

Source: George S. Day

PROBABILITY OF FAILURE

So, how can companies take the big—yet smart—innovation risks they need in order to succeed today? The solution lies in a disciplined process that distributes projects in a company’s innovation portfolio more evenly across the spectrum of risk. Two tools can help: the Risk Matrix and the R-W-W screen.24

The Risk Matrix is a visual representation of the company’s mix of projects and their fit with its overall strategy and risk tolerance. It reveals the distribution of risk across a company’s ensemble of innovations, showing each project’s probability of suc-cess or failure based on how big a stretch it is for the company. The less familiar the intended market and the product or technology, the higher the risk.25

The R-W-W (“real, win, worth it”) screen is a powerful tool that can help compa-nies look at each product concept’s prospects in the market. It helps to evaluate the risks and potential of individual projects by answering questions in three broad topic areas.

“IS IT REAL?” explores the nature of the potential market and the feasibility of building the product by asking a development team to ponder questions such as: Is the market real? Is there a need for the product? Will anyone buy it? Is the product real? Can it be made? Will the final product satisfy the market?

“CAN WE WIN?” considers whether the innovation and the company can be competitive by digging deeper and asking the following questions: Can the product be competitive? Can the product’s competitive advantage be sustained? Can our company be competitive? Do we have superior resources? Can we understand and respond to the market?

“IS IT WORTH DOING?” examines the profit potential and whether developing the innovation makes strategic sense by asking the following questions: Will the prod-uct be profitable at an acceptable risk? Does launching the product make strategic sense? Will top management support it?26

Risk Matrix and R-W-W (REAL-WIN-WORTH IT)

c o p y r i g h t

BATTEN BRIEFINGS, September 2013. Special Edition,

published by the Batten Institute at the Darden School

of Business, 100 Darden Boulevard, Charlottesville,

Virginia 22903.

batten@darden.virginia.edu | www.batteninstitute.org

©2013 The Darden School Foundation. All rights

reserved.

24 Day, G.S. 2007. “Is It Real? Can We Win? Is It Worth Doing? Managing Risk and Reward in an Innovation Portfo-lio.” Harvard Business Review

25 Ibid.

26 Ibid.

7

When most people think about innovation, the first thing that comes to mind is product innovation. However, by definition, innovation is any novel creation—any project, not just a product or service—that produces value.27

The Doblin Group, a Chicago-based innovation consultancy, identified ten types of innovation: business model, networks and alliances, enabling process, core processes, product performance, product system, service, channel, brand and customer experi-ence.28

Target, for example, is particularly adept at networks and alliances innovation, work-ing across its entire value chain without side parties to bring products to its stores. Zappos is one of the greatest examples of service innovation.

Doblin Group also found that instead of focusing purely on product performance, the best way for an organization to become more innovative is to start with its business model or customer experience. When you set out to change your business model or customer experience, you automatically spark multiple types of innovation along the way.

Business model innovation almost always requires the sophisticated integration of multiple innovation types—at least six or more—to succeed. When you start with business model innovation, you are forced to think about your core process, product performance, product system, channel and brand. As a result, you may come up with a breakthrough business model that involves six different types of innovation. In its research on thousands of innovations from hundreds of companies, Doblin found that the most successful innovators are companies that combined at least five or more types of innovation.29

What implications do Doblin Group’s findings have for managing an innovation portfolio? It is important to remember that most value is generated around the business model, not around the new product. Therefore, focusing solely on products in the innovation portfolio is unlikely to yield the kind of breakthrough innovation most companies seek.

DOBLIN GROUP’S TEN TYPES OF INNOVATION® FRAMEWORK

Source: The Doblin Group

innovation type + description

Business Model How you make money

Networks and alliances How you join forces with other companies for mutual benefit

Enabling process How you support the company’s core processes and workers

Core processes How you create and add value to your offerings

Product performance How you design your core offering

Product system How you link and/or provide a plat-form for multiple products

Service How you provide value to customers and consumers beyond and around your products

Channel How you get your offerings to market

Brand How you communicate your offerings

Customer experience How your customers feel when they interact with your company and its offerings

FINANCE

PROCESS

OFFE

RING

DELIV

ERY

1

2

3

4

5

6

7

8

9

10

The Many Ways to Innovate

27 Nagji, B. and Tuff, G.

28 Tuff, G. “The Ten Types of Innovation.” http://www.youtube.com/watch?v=2DMJ8cHwD0I (Accessed on 20 April 2013.) Similarly, authors of the following article identified 12 different ways companies innovate: Sawhney, M., Wolcott, R.C., and Arroniz, I. 2006. “The 12 Different Ways for Companies to Innovate.” MIT Sloan Management Review.

29 Ibid.

8 BATTEN BRIEFING

Essential ReadingARTICLES

“Best Practices in the Idea-to-Launch Process and Its Governance.” Robert G. Cooper and Scott J. Edgett. 2012. Research Tech-nology Management. 55 (2): 43-54.

“Creating Bold Innovation in Mature Markets.” Robert G. Cooper. 2012. IESE Insight. (14): 28-35.

“Creating Project Plans to Focus Product Development.” Steven C. Wheelwright and Kim B. Clark. 1992. Harvard Business Re-view. 70 (2): 70-82.

“Developing a Product Innovation and Technology Strategy for Your Business.” Robert G. Cooper and Scott J. Edgett. 2010. Re-search Technology Management. 53 (3): 33-40.

“Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things.” Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih. 2008. Harvard Business Review. 86 (4):129-130.

“Is It Real? Can We Win? Is It Worth Doing? Managing Risk and Reward in an Innovation Portfolio.” George S. Day. 2007. Har-vard Business Review. 85 (12): 110-120.

“Managing Your Innovation Portfolio.” Bansi Nagji and Geoff Tuff. 2012. Harvard Business Review. 90 (5): 66-74.

“New Problems, New Solutions: Making Portfolio Management More Effective.” Robert G. Cooper, Scott J. Edgett and Elko J. Kleinschmidt. 2000. Research Technology Management. 43 (2): 18-33.

“Responses to Disruptive Strategic Innovation.” Constantinos D. Charitou and Constantinos C. Markides. 2003. MIT Sloan Management Review. 44 (2): 55-63.

“Strategic Innovation.” Constantinos C. Markides. 1997. Sloan Management Review. 38 (3): 9-23.

BOOKS

Handbook of New Product Development Management. Christoph Loch and Stylianos Kavadias, eds. 2007. Elsevier/B-H: Ox-ford, U.K.

Portfolio Management for New Products. Robert G. Cooper, Scott J. Edgett and Elko J. Kleinschmidt. 2001. Perseus Books: Cambridge, MA.

Revolutionizing Product Development: Quantum Leaps in Speed, Efficiency, and Quality. Steven C. Wheelwright and Kim B. Clark. 1992. Free Press: New York, NY.

Strategic Management of Technology and Innovation. Robert A. Burgelman, Clayton M. Christensen and Steven C. Wheel-wright. 2008. McGraw-Hill/Irwin: New York, NY.

TECHNICAL NOTES

“Creating a Growth Portfolio.” Edward D. Hess. 2011. (UVA-S-0199)

“Learning Launches: Growth Results from Experimental Learning.” Edward D. Hess. 2011. (UVA-S-0198)