Innovation: Can You Improve the Odds of Success? CFO Insights: A newsletter from Deloitte’s CFO Program DOWNLOAD

As we head into 2012, many finance executives are committed to growth despite the continued global economic malaise -- and making the necessary investments to fuel that growth. In fact, according to Deloitte’s Q3 2011 CFO Signals survey, finance chiefs say their companies’ strategic focus is still 50% on revenue growth/preservation, and they foresee an almost 8% uptick in year-over-year capital investments and roughly 4% in R&D spending.

Still, picking the right projects and initiatives that lead to true innovation – and transformational growth – has rarely been easy. Part of the reason is that the traditional models for evaluating investments have created a bias toward that which can be measured, such as operational improvements. The other issue is that innovation management processes are often designed to keep costs down – and reduce the cost of failure.

But what if the results of new ventures could be predicted with a higher degree of certainty? Would it change investment portfolios – and the chances of uncovering true game-changing innovation? In this issue of CFO Insights, we examine the predictability of successful innovation and ask what the impact would be for finance if the odds were increased.

Full article is also available for download, in PDF, at top of page. 

Making innovation more predictable

In his recent book, The Innovator’s Manifesto: Deliberate Disruption for Transformational Growth (Crown Business, August 2011), Michael E. Raynor argues that there is indeed an empirical way to make innovation more predictable. In fact, he makes the case that Disruption theory -- the theory, discovered in 1992 by Clayton M. Christensen, that explains how particular types of new products and services come to achieve success or even dominance, often at the expense of once-powerful incumbents – is virtually the only theory statistically demonstrated to have predictive power.

Disruption happens when new solutions to customer needs topple old ones by building from a foothold in very different, and typically much less attractive, market segments. Those innovations, Raynor points out, also have certain fundamental properties: a business model that allows them to draw an entirely new curve on the frontier of industry; a position in the cost/performance space that existing competitors cannot imitate; and an enabling technology that allows them to move from its initial niche market into the mainstream without fundamentally changing its way of doing business. And to illustrate, he draws on an array of examples in the book that includes Southwest Airlines and Holiday Inn.

The backbone of his case for the predictive qualities of Disruption theory, however, comes from a particular collaboration with the New Business Initiatives (NBI) group at Intel Corporation. NBI made available the business plans for 48 early-stage ventures that had already been vetted and funded with a success rate of about 10%. By applying Disruption theory to the portfolio in controlled experiments (without knowing the outcomes), however, the rate of predicting success increased by almost 40%. Then when the experiment was replicated with more than 300 MBA students at Harvard, MIT, and the Ivy Business School in London, Canada, the hit rate rose even higher – showing that the process could actually be taught and applied.

In those experiments, the students initially analyzed six randomly selected cases and made predictions using their own intuition. The survival rate of their portfolios, however, was no different from the one that Intel had originally approved. But after being exposed to Disruption theory, the students reevaluated the ventures using a 2x2 matrix that labeled them either “entrant,” “incumbent,” “sustaining,” or “disruptive,” and improved their success in picking winners by as much as 50%. Overall, in fact, the survival rate of the portfolio went from about 10% to about 15%.

How CFOs can organize for innovation

Obviously, an improvement from 10% to 15% is still a long way from 100% accuracy. But Raynor argues that it is a material and significant improvement that can be used to better manage innovation processes. And, for CFOs, it may be the difference between having the confidence to support and fund Disruptive innovation and missing an opportunity.

Those odds for improvement may increase even more if finance can also help foster an environment for innovation based on the following principles:

1. Focus: The first step is to identify those opportunity areas that will define the future of your industry, using, for example, scenario-based planning exercises. Since Disruptive innovations are systematically more successful than those that aren’t, you can then focus your efforts on those markets and technologies that target unserved or overserved segments and which intersect with your company’s capabilities.
2. Shape: Instead of seeking to reduce the cost of failure, you can shape innovative ideas that conform to meaningful patterns of success. Specifically, by serving markets that incumbents deem inconsequential, new businesses can create a valuable foothold. Then, by building businesses around “enabling technologies,” entrants can parlay that foothold into mainstream success.
3. Persist: Disruption may improve predictive accuracy, but doesn’t guarantee it. What this means is that although we can more confidently commit to specific markets, technologies, and strategies, there is still a lot to learn – as long as you are willing to persist despite early setbacks. Armed with the empirical evidence, however, you can use those setbacks to inform the business model early in the development and commercialization process. In other words, don’t fail fast, learn fast.

For CFOs, the main takeaway is that the current models of innovation may not be adequate for these competitive times or deserving of precious resources. Rather than seeking to find as many different ideas from as many different places as possible, companies should instead focus their efforts on areas where Disruption is possible. Rather than trying to fail fast in order to reduce the cost of failure, companies should shape ideas in ways that leverage the possibility of success in the long run. And, rather than simply doing whatever the market says to do in the short run, companies should persist with their innovative ideas. Armed with the empirical evidence, companies can stick with the ideas they have reason to believe will succeed even if there are material speed bumps along the way. 

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