5 Questions to Build Your Company’s Capacity for Innovation

With so much uncertainty about, well, everything, people are realizing that innovation — the process by which new things create value — is essential to thriving going forward. In my work advising senior teams on strategy and innovation topics, I’m getting a lot of inquiries along the lines of, “We need to create an innovation capability, but we don’t know where to start.”

Asking yourself these five questions is a good place to begin. In my experience, you can work your way through them, ideally with a little experienced guidance, in about 30 days. By then, you will know what projects are essential to succeed, how you will get projects into your portfolio (and which you might need to get out of it), where your innovation and growth unit will be located, and how you’ll start to work in earnest with a few small projects.

1. What is your growth gap?

While it’s quite common for executives to promise their investors both performance and growth, the reality is that they are seldom set up to deliver both. Typically, they are paying a lot more attention to day to day performance, as Oyster International’s Don Laurie and Harvard Business School’s Bruce Harreld describe.

A useful way to shake up the status quo a bit is to ask your organization to articulate their growth gap — in other words, at some point in the future, how much new growth do you expect to get and where will it be coming from? The first thing is to figure out what that aspirational growth number is; this fun video explainer from Innosight explains how.

A terrific example of an organization that used this way of thinking to pursue both performance today and innovation for tomorrow is Honeywell, under the leadership of former CEO David Cote. He joined the firm in 2002 with the goal of doubling sales while keeping costs in check. As explained in his book, Winning Now, Winning Later, and in an interview with Fortune, he clearly articulated this growth gap and insisted that the four big overhead functions — finance, human resources, legal and IT — hold their annual dollar outlays at 2003 levels “forever.”

Next, you need to have a look at your portfolio of opportunities — the projects and programs that you are working on right now. Essentially, this involves three things: assigning spending to what is necessary to keep today’s business going, deciding on what to invest in the next generation of your core, and figuring out how to explore options for the future that offer long odds on a huge return.

Ultimately, you’re examining whether you have projects that are potentially capable of closing the growth gap, recognizing that your existing core business is likely to experience a decline over time. If you don’t, you are going to have to change direction or you’ll miss your growth targets and will likely be penalized for it. One metric that can track this is the Imagination Premium, which is a measure of how willing investors are to pay a premium for a stock based on its potential for growth.

If your gap is large and your portfolio doesn’t look likely to fill it, that’s a very strong signal that you have to start doing things differently. At Honeywell, Cote’s first big challenge was getting the “today’s business” numbers in order. When he arrived at the company, he found an endless number of creative ways managers were meeting quarterly projections that did not reflect reality of the business. Aggressive accounting, capitalizing R&D, distribution loading, and “make the numbers” meetings with finance were all contributing to an unhealthy system that would be doomed in the long run. After that was cleaned up, he moved on to adopt more progressive management techniques very like the Toyota Production system, called the Honeywell Operating System (or HOS). Over time this freed up cash that the company could use to invest in projects with a 4- to 6-year future payoff.

Then, Cote focused on fewer, higher-impact projects than the firm traditionally pursued. He wanted to fund those with the potential to generate large gains if they were successful. One breakthrough was HFO, a new kind of fluorine for industrial refrigeration that was 20% less environmentally damaging than Carbon Dioxide and 1,500 times less than the previous substance; today, this yields a business with over $1 billion in revenue. Another big success was the Experion Orion Console, a monitoring system for oil refineries, run by Cote’s successor as CEO. At the same time, Cote relentlessly pruned the portfolio of projects that, even if successful, weren’t substantial enough to make a difference for an organization the size of Honeywell.  

This type of growth gap scoping can also be used as you structure your innovation process to set up “what must be true” checkpoints along the way to that strategic end state. This is a discipline derived from discovery-driven planning. The idea is to identify what a successful end state would be and then work backward to determine what would need to occur for that end state to be met. For instance, if your desired level of growth is $10 million in profits in a certain year, and you operate at a 20% return on sales, that suggests that the amount of revenue required will be $50 million. If you price by the unit at $250,000 per unit, then you need to have a plan that will allow you to sell 200 units at that price that year. This exercise will help assure your company that you are on track — even though revenues and profits for your program might be months or even years away.

2. How will your innovation practices be governed?

The governance system in your organization is what gets projects into the portfolio, what stops them when necessary, and helps them transfer to a business unit in the parent organization if they meet their eventual objectives. The governance process also establishes the scope of innovations and defines what is in scope and out of scope. In an ideal scenario, a committee like a growth board meets frequently, has a set of agreed-upon metrics for what kinds of opportunities deserve further development, and is also courageous about stopping or parking things that aren’t ideal to move forward.

There are a number of different models for governing innovation. In some organizations, senior leaders themselves are part of the growth board and are intimately involved in resource allocation decisions. In others, it’s driven by technical functions. In still others, innovation is widespread without specific “ownership,” at least at the early stages. At Amazon, for instance, employees up and down the organization experiment with early-stage projects without a great deal of central direction. It’s only when a project becomes substantial enough to require an irreversible strategic decision that its governance process kicks in.

Best practice, in my experience, is for the funds the growth board is managing to be separate from those that support the base business. Further, any losses incurred by a new business (even if it is transferred to a business unit) should be borne by this fund and not by the budget or incentives of the business unit leader. This allows the leader to get all of the benefit of any upsides, and isn’t penalized for any downsides, of supporting new businesses.

Whatever your practice, though, know that simply having it is a plus. Evidence from Accenture finds that firms with deliberate innovation governance practices had twice the revenue growth from new products and services than firms without such practices over the period they studied.

3. How will you allocate resources for innovation?

It is quite astonishing how often innovations get started, and even get to some considerable size, before someone realizes that they aren’t a good fit with the firm’s strategy (see any telecom company trying to be a media and entertainment business). To address this, go through a process of translating the grand strategies of your firm into specific screening scorecards. While these scorecards are never perfect and precise, they can provide enormous value in immediately distinguishing among things that are potential big wins and things that are unlikely to be, even if they succeed.

Strategy, in a definition I really like that was developed by researchers Don Hambrick and Jim Frederickson, is a central, integrated concept of how you are going to achieve your objectives. Good strategies imply choices. They pull you and your people into the future and ideally provide the grist for an alignment of interests throughout your organization. Unfortunately, this is seldom what happens in real life. What sounded so great at the all-hands town hall often deteriorates into meaningless confusion at the level at which people are making significant strategic choices.

Scorecards are the antidote to this. They let people see the logic behind your strategic choices throughout the organization and spell out what good looks like for your strategy (and conversely what doesn’t). The screening process implicit in the scorecard make it crystal clear which opportunities are desirable and which aren’t, and allow ideas to be mapped against the same set of criteria. The magic is not the scores — the magic is the thinking behind them.

Here’s a process I often use with clients. First, find a time when everyone can be together — virtually these days. Next, have everyone identify two initiatives or ideas they were involved with developing recently, one which was a good strategic fit and which they were happy with, and the other which, in the wisdom of hindsight, they’d have preferred not to be involved with. Then identify up to five factors that made the difference between the two. Call the positive ones “rockets” and the negative ones “anchors” (building on the terminology built by SolveNext). Then go around the room, collect all the rockets, and document them. Do the same with the anchors.

Next, identify the common themes that emerge. These are candidates for the “dimension” portion of your scorecard. For instance, with a major Jamaican insurance company I worked with, a big theme was developing trust from aspirational customers. A resulting dimension had to do with the concept of trust (high scores for trust-building, low ones for trust-risking) and the nature of the customer (high scores if the idea could help them achieve their goals, low scores if it didn’t). You also might consider adding in assumptions about potential future dimensions that may be important.

The next step is the most fun: working as a team to score a few actual projects that the organization is working on. You’ll probably find that the scorecard needs to be adjusted during this process, which is fine.

At the end of the exercise, you’ll have is a set of statements that take your grand strategy statements and make it absolutely clear what good (and bad) looks like. That clarity can be incredibly energizing.

Some years back, I did a strategy exercise with the global elevator company Kone. One of their broad strategic pillars was to “improve the lifetime value of a building to its owners.” We translated that concept into the following scorecard:

4. Where does your innovation group belong?

Now we come to the question of where to put the people who are actually working on innovation projects (as opposed to the governance committee that allocates resources to it). There are at least 7 archetypes for how to locate an innovation group within the firm. All of them have advantages and drawbacks.

1. Put the innovation group inside an existing business unit. While this is organizationally easy, it will be hard for the team to keep its focus and budget when the existing business is reacting to the pressures of the day to day.
2. Create a division within an existing unit specifically for innovations. This is often better than option one, and can work if the business unit head is prepared to focus on the venture.
3. Throw it into R&D. As much as I love R&D, one of the problems is that it is easy to become deaf to the voice of the customer in its hallowed halls. But it does eliminate a lot of the day-to-day friction of being part of the existing business.
4. Have innovation report to a dedicated, senior staff function with direct responsibility and a line of sight to the top leadership. This is an approach taken by many innovative firms such as IBM under Lou Gerstner.
5. Create a whole new ventures division. In this structure, all the things that are radically different than what the company does today are segregated from the existing business and allowed to operate independently until they are mature enough to stand on their own. This can work well with the right structures in place.
6. Have the innovation group report directly to the CEO. While this usually eliminates problems of getting resources and people’s attention, it creates the potential for political frictions and resentment. And don’t forget, CEO’s have a lot of other stuff to do, so it’s a drag on their ability to manage the rest of the firm.
7. Adopt “permissionless” structures. In this model, innovation is practiced by what are called “two pizza teams.” This works at places like Amazon, where everyone is involved with some aspect and innovation happens organically throughout.

Note that adopting one of the last three archetypes involves a fairly heavy-duty organizational change effort. So, if you are just getting started, using one the first four probably makes the most sense.

5. How will you get started?

If you are at an early stage, do not start with a huge team, big ambitions, and a major budget. That’s a recipe for total disaster.

Instead, pick a couple of smallish projects in which success can be demonstrated in a small way, and use them to begin to train people on how to plan uncertain projects using a discovery-driven growth approach. This involves planning via checkpoints, rather than by hundred-cell Excel sheets. It involves people learning the approach to testing and learning, discovering which assumptions are valid and which are not. It involves experimentation and what innovation expert Alberto Savoia would call “pretotyping.”

Bear in mind that the progress metrics you will be using for innovation are different than those you would use in the established business. Instead, you’ll want to track how you are doing in learning about customers’ problems and solving them. Appropriate metrics might include progress through checkpoints, the speed of experimentation, the number of interactions with customers, success in creating prototypes, and even the number of ideas rejected in favor of better ones.

If you get through these five questions and the related activities, then is the time to start bringing a rhythm and cadence to your innovation efforts. To do this, you will need practices that deliver on three outcomes: 1) ideation to generate potential ideas; 2) incubation to find product/idea/market fit and to test for customer enthusiasm; and 3) acceleration in which now-successful new ventures get to “grow up” and join the parent company in some meaningful way.

In terms of timeframe, you can easily work through the five questions and make decisions in a 30-day period, assuming that others you need brought onboard are available. If you’ve never done anything like this before, it’s definitely worth getting help from someone who is experienced in the innovation process. For most other organizational challenges, such as implementing a quality management system, it’s obvious that one would need trained experts in that system to set it up. But somehow, when it comes to innovation, we often let people sink or swim without realizing there is already a large body of knowledge out there about how to do it right.

And throughout, remember: Innovation can be a repeatable, reliable process. But you don’t get to it by using the same practices that you use in the core business.