Thoughts on Risk Diversification in Innovation

The biggest challenge to innovation is not "having a good idea." It's the way people in an organization understand, and respond to, the risk of innovation failing. This is commonly called culture: the organizational precedents and attitudes that have been established related to taking creative chances. I've been intrigued with the culture of risk since observing good ideas shelved during quarterly reorgs. There's a pattern to the death of good ideas, and it looks something like this.

A new product, system, or service is in development. It may or may not be on time or on budget, but it's aligned, at least superficially, with the larger strategy put forth by senior management.

Mid-way through the development process, these things seem to happen.

The management team has rallied around a new series of four or five year "imperatives", and this has forced a reconsideration (and reorganization) of people, business units, and roles.

Earnings are reported, and they aren't where they need to be. A message is passed down to various directors: find ways to cut the fat by eliminating unnecessarily risky projects. Risk, in this context, usually means something that will have an unknown market effect.

The head of each business unit evaluates the projects under their control, based on the new priorities, and eliminates several of them based on how far along they are, how much money has been spent, how risky the project is, and how aligned it is (or isn't) to the new priorities.

Projects are killed, and team members reassigned to accommodate new projects, or laid-off entirely.

By way of example, one of the projects I worked on was for a major consumer electronics manufacturer. Like everyone else, they wanted to "own the home", and figured that a router and device-management software would help them establish a walled garden around the various electronics a family had, providing more seamless connectivity between devices and locking the family into a particular brand. The software would give the company the ability for all devices to speak to one another elegantly, acting as a less awful version of iTunes. Analytics software on the device could phone-home to the company to indicate usage patterns, providing lots of back-haul, big data opportunities. The company had begun tooling for the physical production of the device, had organized the supply and distribution channels and plans, and the software was halfway done. In retrospect, it would have been a great way for the company to position themselves against Apple's domination. And then, they killed the project, through a process as described above. A strategic re-alignment, based on poor earnings, sent the various teams scrambling to identify which of their projects were the most risky, and those were the ones that were eliminated.

But to examine the "risk" of a project means more than considering the discrete nature of the market effect for that one project. Risk should be evaluated in the context of a broad strategic importance to the company. This is based on a holistic understanding of how all projects work together to best support a strategy, and requires tempering risk decisions based on, as economist Daniel Kahneman describes, a broad policy-based frame and a lack of individual-project regret. Of course, this means that the individual in charge of making any decisions needs to have visibility of the various other changes being considered, so as to way risk across all projects. Kahneman relates an anecdote of a decision made by the top managers of 25 divisions of a large company. Each was asked to make an extremely risky decision, and each elected not to. And then, the CEO of the same company was asked his opinion, and he said "'I would like all of them to accept their risks.' In the context of that conversation, it was natural for the CEO to adopt a broad frame that encompassed all 25 bets."

In my personal example above, an executive decision to cut spending rolled downhill, and at a middle management level, a decision was made most likely without the benefit of a broad frame of reference. I wonder what the CEO would have thought of the decision to kill the router project, if he approached it from the perspective of an innovation portfolio of risk, rather than from a purely economic standpoint. I suppose if there's a lesson here, it's to avoid making go/no-go decisions based on a limited purview, and a decision maker should always attempt to gain the benefit of a broader frame of reference. Talking to people is likely the most immediate way to gain that broader frame.

The broad frame approach manifests in a strange way for startups, at least for those who have taken investment capital. A good VC, taking a broad frame approach, will broadly guide their entire portfolio to make riskier decisions. But the founders in any of the individual portfolio companies will likely steer the ship towards a sure thing. Having never been in the VC position, I can't imagine how that plays out, but I would guess that it's conflicting and stressful for everyone involved.

I wonder what the parallel is for startups focused on social entrepreneurship. Organizations in the social sector are far from removed from misguided risk assessment, although they are less likely to be engaged in innovative development work in the first place. Traditional non-profits are extremely conservative, and seem to be in a perpetual state of realignment around a mission statement. In a startup context, there's a "risk" to doing anything, and that sometimes causes people to become paralyzed: what if I make the wrong choice? It seems like one approach to utilizing the implicit lesson of the 25-bet broad frame would be to do more things, spreading risk across the various actions and activities. This can be challenging, because most people at a startup already feel like they are running as fast as they can. I also wonder if the broad frame approach plays well with the idea of doing just one thing in an agile and learn way, in order to learn quickly and adapt.

If innovation is desired, and innovation requires risk, and risk is best managed by a broad-frame approach, it would appear that we should all be a) attempting to elevate our perspective by constantly looking for a broader frame, and b) taking more individual little chances, knowing that most will fail in order for a few to succeed.

Originally posted on Sat, 28 Apr 2012