February 5, 2021

Actively Manage Key Building Blocks To Unlock Upside

6 minute read

When turning a novel idea or technology into a new business, most companies do a good job understanding and managing risk, but few companies use the learnings that drive their understanding of risk to help them actively manage to the upside. There’s a great Harvard Business Review article that provides an analogy to help bring this point to life called Strategy as a Portfolio of Real Options. The gist of the analogy is that innovations are like tomatoes growing in a garden: the ripe and rotten ones are easy decisions, but the ones in between are difficult because it’s harder to judge their value given the level of uncertainty that remains.

We’d push this analogy further by stretching it across categories, which would further highlight the difficulty as you’d be comparing a one-inch green tomato with a one-inch pepper with a one-inch squash and deciding if all deserve the same treatment. At the beginning of the season or the end of the season, the decisions are easy – at the early stage, not enough info exists to differentiate and at the end, not much will change. The interesting question is what can/should be done in between, given all the uncertainty that exists and the level of influence you can have on the outcome (e.g. you can’t control the rain, but you can control the water a plant receives but that takes more work/resources).

While not a perfect analogy for all innovations or innovation pipelines, the analogy holds a number of good learnings:

Extremes are easy decisions: Like ripe or rotten tomatoes, ideas that have gone through “the process” and are clear winners or losers are easy decisions as there is not a lot of risk and the upside is limited because there isn’t a lot of uncertainty left – you have a clear understanding of the business potential so your decision is easy.
Uncertainty makes “not yet ready” ideas difficult: Like comparing small green tomatoes to each other and to other immature vegetables is hard because it’s hard to know the potential, comparing ideas at different stages in your pipeline is difficult because the potential is uncertain.
With uncertainty, focus is normally on risk: All gardeners know that food and water are building blocks of productive plants and they have a plan (e.g. fertilize early and water daily) and risk management plan (e.g. hire neighbor to water plants when you are on vacation). If a plant doesn’t look like it’s going to make it, they stop investing resources (time and money) in it and turn focus to the others. Reasonable enough. In our experience, this is the way most companies think about their innovations – money from the core business is at risk, so minimize the chances of losing that money, first and foremost.
However, uncertainty also means there’s upside potential: Master gardeners, however, know that, while issues with the food and water building blocks have the potential to kill the plant (wasting a lot of time and money), getting the food and water levels just right can deliver outsize returns. Because of that, they have both a plan to mitigate risk and also a plan to unlock the upside. To unlock the upside, they use tools most gardeners do not use to manage the building blocks, like using tools to optimize the soil’s organic content and nitrogen levels, thereby improving root growth without causing tomatoes to “burn.” Both of these help manage downside risk AND produce better yields. This focus on optimizing the key drivers of growth is the core of the idea behind “active management.”
Active Management helps unlock the upside potential: Like the master gardeners above, companies can both manage risk and manage for the upside, but it requires an evolution in mindset. Specifically, companies need to shift from being satisfied with simply eliminating the downside of uncertainty (risk) and transition to driving for a deeper understanding of the uncertainty, in total around each of the building blocks, to understand how to both reduce the downside AND find the upside. For example, a potential customer of ours was using a standard stage & gate approach with Concept & Use hurdles they needed to reach to proceed. The unintended consequence of this approach is the team was focused ONLY on delivering a BASES volume forecast (grounded in how others performed) and spent no time trying to understand the potential upside that was being left on the table by optimizing each of the building blocks, so they had no way of knowing if they should be spending resources on the upside or not. Putting this back into the garden analogy, they had a tomato that they were deciding what to do with based upon a comparison to others they’d seen instead of making a decision based upon how much growth potential it had left. Picking a tomato too soon can be just as bad of a decision as picking a tomato too late.

So, what do companies need to do to enable better “Active Management” of the ideas in their pipeline? First, as stated above, companies need to decide to understand the totality of uncertainty, both the downside risk and the upside potential. Second, companies need to understand the totality of the uncertainty that the Finance Department is using to understand the risk side of uncertainty. Finally, if the current tools aren’t delivering enough understanding of uncertainty, then companies need to incorporate new tools to help them understand the totality of uncertainty at the building block level (e.g. the business prototype).

Key Points

Most companies do a good job understanding and managing risk, but few companies use the learnings that drive their understanding of risk to help them actively manage to the upside.
To use the learnings to actively manage to the upside, you first need to understand the underlying building blocks that lead to the understanding of risk as it will also contain information on the upside.
For each underlying building block, determining the driver of the uncertainty and what can be influenced and what is outside of your control is critical to focusing your efforts.
Once you know what you can influence, you need to understand those that drive the most value and then prioritize and focus on “actively managing” the Key Value Drivers to unlock your innovation’s upside potential (or your portfolio’s upside potential).
The business prototype is a tool to embrace uncertainty and unlock potential by understanding what matters most and actively managing those building blocks.