Investing in Risk
- Business Model Innovation
- Design Thinking
- Validate & Experiment
How to overcome the biggest and least obvious barrier to your organization’s innovation program.
Innovation is inherently risky. There is no way around that. Innovation requires change and change literally means introducing variation to the way things are done. Variation is the classical definition of risk. The wider the spread of possible variations, the more risk there is, the more uncertain we will be about the results. If you want to safeguard your future success, you must change something.
Unfortunately, we tend to think of risk in the wrong way when it comes to business. We want to reduce uncertainty, we want to make plans, set targets, avoid unexpected costs. However, we are terrible at predicting the future. Our plans are made of guesses, and we tend to overemphasize our past success as a reliable enough indicator of future success.
So when we say we want to ‘de-risk’ something, often what we’re doing is making it more risky.
Why? Because as soon as you slow down the rate of change in your organization, you reduce your ability to learn and adapt to the changes happening around you (which, as the truism goes, are always increasing).
When it comes to risk in business, the most fundamental source is the business model of a business itself. The system of assumptions that inform how it goes about creating, delivering and ultimately capturing value from its operations.
Business Models are not just ‘how you make money’, they are themselves complex systems, operating within complex systems (the world, your market). When they change, the market changes. When the market changes, they change.
The only way to successfully scale a business or product these days is to invest in risk and change your mindset. Rather than reduce change and uncertainty, you want to increase it (in a controlled way). Rather than reducing risk, we should be focused on increasing investment readiness.
So what makes something ready for investment?
Well… you could answer this question by watching a few episodes of Shark Tank and trying to figure it out for yourself, the short answer is this; validation.
Can you prove to your investors (whether they are your senior project sponsors, or venture capitalists) that the assumptions you are building your idea around are accurate?
Validation is often overlooked when it comes to innovation programs. Too much time is spent on the ‘ideation’ and new idea creation, and comparatively, little time spent testing your understanding of the problems your prospective customer have, how your idea might (or might not) help them with that, and if you can actually deliver on the promise.
To manage these experiments, and track the progress of your innovation, we developed a new tool in partnership with one of worlds leading thinkers, founder of the Lean Startup Movement and author of acclaimed innovators handbook, ‘The Four Steps to The Epiphany’, Steve Blank.
The ‘Investment Readiness Level’ is an adaptation of the ‘Technology Readiness Level’ which was used by NASA and many other major investors in Research and Development to determine how ‘operationally ready’ a given innovation was. Steve’s insight, was that by applying these same filters to startups and new business model inventions we could overcome the subjective assessment of ‘ideas that blew us away’ and focus on the metrics that matter.
Using the Investment Readiness Level as your guide, you can begin to successfully reduce the risk in your innovation program. Let’s start at the bottom.
Level 1 – Ideas
Ideas are worthless. Your innovation program should encourage endless generation, variation, and evolution of new business model ideas. You can use the Business Model Canvas to help you articulate what your idea might be.
In a study published in late 2017 the Harvard Business Review by Dylan Minor, Paul Brook, and Josh Bernoff, they identified four key attributes were most predictive of future success in innovation programs.
- Scale – more participants. To succeed, an innovation program needs lots of participants. It’s the wisdom of the crowd: a large mass of participants will always out-ideate a small group of smart people.
- Frequency – more ideas. To succeed, a company needs to create frequent idea challenges for its employees. These challenges reinforce a culture of innovation and generate more ideas going into the pipeline
- Engagement – more people evaluating ideas. You need lots of other people figuring out whether those ideas are worth working on, or what it will take for them to become better.
- Diversity – more kinds of people contributing. A successful system needs contributions from all over the organization, especially staff who are close to the front lines.
Even if you have scale, frequency, engagement, and diversity in your ideation, you must remember that all of this effort is an investment in discovery. It is the new normal. Companies that stop thinking, eventually stop existing. Importantly, remember that is this BOTTOM level of investment readiness. You should not pay people for their ideas. If you are an investor, you will not be investing at this level. There is no proof. Pay people to execute, pay people to learn. That is how you will build a successful business.
Level 2 – Market Size and Competitive analysis.
You might have used some design thinking, customer observation or some other kind of ideation technique to help you generate your original ideas. Now we need to put the model under pressure. How big is the opportunity, really? At level two, you might invest enough only for the necessary opportunity analysis to be done, fill out the picture of the models in your innovation portfolio.
Level 3 – is achieved by validating something called ‘problem solution fit’.
Does your solution solve the problem that you designed it for? You will have moved off the page and back into the real world at this point, prototyping your solution and examining how / if it works with real customers.
Level 4 – As these experiments are conducted, you may find that the value proposition has enough promise to warrant investment in a more sophisticated prototype.
Building this Minimum Viable Product (MVP) opens up the next level of investment readiness. Perhaps the prototype is ready to ship, it just needs to unlock the right channels to market, or secure partners who can assist in building out its supply chain.
At level 5 – We begin to see that our business model is validating it ‘product-market fit’.
It has not only proved that the solution does the job well for customers, but it is regularly winning new customers and growing its market share. Here a venture might still not be making a lot of money, but is it building a market and securing some long-term contracts from customers.
To unlock level 6 – A venture must begin to validate that it can actually make money.
This might require a tweak to the revenue model, or changing the way customers pay. It could simply included putting prices up, as the quality of the product improves along with the quality of the business.
Level 7 – Investment readiness has built a high-fidelity product that is desirable and viable.
You may now be exploring opportunities to scale this business into new markets or develop complementary value propositions that can increase the value to the firm.
Level 8 – Is unlocked by a venture that can validate value delivery.
This means it can show to investors that it has the optimal mix of resourcing and activity to create value in a feasible and sustainable way. Getting here can often feel like a ‘business improvement’ process that might be more familiar to a large corporate than a startup or a new venture. It’s useful to remember that all businesses were once startups. In Australia, we often lose sight of that. In the United States, many of the most valuable companies in the country did not exist ten years ago. In Australia, most of our top 10 businesses are over 100 years old.
Level 9 – Investment readiness is as high as we go.
This is where we look to our entrepreneurs to validate the metrics that matter. Not the vanity metrics like ‘new or total users’, but the important metrics that tell us about the health of the company and its future opportunity. How long do customers stay? What is their total lifetime value, is that increasing or decreasing? Do customers ever come back? How much does it cost to acquire a new customer?
The take away.
All good businesses are learning organizations. They don’t have ‘innovation labs’, because everyone in the organisation who is ‘doing the work’ is empowered to run tests, gather evidence and update / adapt the way they work, to improve the way the business creates, delivers and captures value.
We need a revolution in risk. Are you ready to embrace uncertainty and burn your business plan?
Check out this video to learn more.
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