When to Gamble — and When to Fold? Innovation Strategies for a New Economy

In the world of business innovation, it’s not always best to be first. Just ask trailblazing mobile communications giant Motorola, which in the 1980s and 1990s spent a whopping $7 billion to achieve the ambitious goal of a global, satellite-powered phone network — only to find the costly technology was outdated when it finally arrived.

According to Scott Snyder, a senior fellow at the Wharton School’s Mack Center for Technological Innovation, a Motorola engineer dreamed up the idea for the Iridium satellite project in 1985, when his wife was unable to make a cell phone call during a trip to the Bahamas.

After the engineer, Barry Bertiger, sold his bosses on the idea of a network of 77 low-orbit satellites offering subscribers virtually global coverage, it took more than ten years to make the ambitious idea a reality. During that period, the number of mobile phone subscribers and earth-based cell phone towers soared, while prices for digital phones plummeted. By the time the Iridium project came online in 1998, Snyder said, there was little demand for “a phone the size of a billy club” that cost $1,000, with conventional mobile coverage that was now almost ubiquitous. The $7 billion satellite network was sold for $35 million, which Snyder called “a lot of value destruction.”

“The lesson here is the set of assumptions we make a long term bet on … are very fragile,” Snyder noted at the recent conference, “Creating and Managing Innovation Portfolios: Improving the Allocation of Scarce Innovation Resources,” which was organized by the Mack Center.

Deciding when to gamble on a new and unproven technology — as Motorola did successfully with the very first cell phone in the early 1970s before failing spectacularly with its Iridium boondoggle — and when to adopt a more conservative research and development strategy that simply upgrades what is already on the marketplace is key to creating and managing a so-called “innovation portfolio.”

Companies that succeed in this area are not necessarily the ones who bring products to the market first. For example, Apple has a reputation for cutting-edge innovation, thanks to best-selling products such as the iPod music player and now the iPad tablet computer. But as Wharton entrepreneurship professor Karl Ulrich, pointed out, “We think of the iPod as being the first digital music player, but actually it was about 50th.” Apple also waited years — studying the pros and cons of its rivals’ models — before introducing the hugely popular iPhone, which thrived by improving upon applications offered through existing mobile phone technology. Simply put, Ulrich argued, introducing a brand-new technology is “hugely overrated.”

Just as the blunders by the large financial traders on Wall Street led to greater scrutiny and a call for better planning and more balance in traditional investment portfolios, the difficult economy has also cast a spotlight for inventive companies on the notion of innovation portfolios. Firms are re-evaluating not just how much to spend on research and development, but also how to strike a better balance between long-term, high-risk projects and more incremental efforts. In addition, businesses are trying to focus on initiatives that best leverage the company’s talents and niche in the marketplace, and developing new ways to track trends and come up with strategies for changing course if a particular effort isn’t panning out as expected.

Finding the Right Mix

According to Paul J. H. Schoemaker, research director of the Mack Center, the aftershocks of the financial crisis have caused many companies to look more closely at the concept of an innovation portfolio — that many firms had “a false sense of comfort” in their earlier strategies that has now been shaken up. Furthermore, the decrease in revenues at many businesses since the 2008 slowdown has led to fewer dollars being allocated for high-tech research, making strategic decisions even more critical.

Past research has shown that, overall, people tend to be fairly conservative with investment opportunities that don’t come with guaranteed rewards, Schoemaker noted. One such study showed that a majority chose a certain gain of $240 over an investment with just a 25% chance making $1,000, but a 75% chance of zero return. The same researchers found people were more accepting of risk; a larger number would accept a 75% chance of losing $1,000 (with a 25% chance of no loss) over an assured loss of $750. But Schoemaker pointed out that mathematically, people who make the opposite choice in those two scenarios make out slightly better.

“Why do the majority of people take a pairing that’s inferior?” Schoemaker asked. “The reason, I think, is because we don’t think in portfolio terms…. We look at decisions in isolation of other decisions. We look at this one as its own thing, and that one as its own thing, and we don’t adopt a portfolio view.”

In addition to a better understanding of the possible risks and rewards of research and development decisions, Schoemaker and other speakers stressed that sound management of a firm’s innovation portfolio also means simply developing an inventory of projects, eliminating duplicative efforts and understanding which ideas best match up with the firm’s core competencies, and which do not.

Ulrich divided innovation projects into three categories — short-term “Horizon 1” initiatives that might be a new application for an existing product; middle-term “Horizon 2” efforts that might feature an inventive new use for existing technology and Horizon 3, which is inventing a radical new product or process that did not exist before.

According to Ulrich, with the exception of Motorola’s introduction of the earliest cell phone, companies that bring a brand-new idea to market generally do not become leaders in that sector, which is why he believes companies should be cautious about investing too heavily in the Horizon 3 projects.

Instead, Ulrich suggested that successful companies can today either copy groundbreaking inventions from their rivals, or buy up innovative small companies, and thus reduce risk. He noted that despite Apple’s reputation as an innovation leader, the firm actually spends less than the industry average on research and development.

Planning for the Best — and Preparing for the Worst

Still, Ulrich added that strategies for building an innovation portfolio will vary dramatically across industry groups — an idea that was seconded by conference speaker Daniel Zweidler, who developed innovation strategies for Royal Dutch Shell for more than two decades before moving to pharmaceutical giant Merck, where he is senior vice president for global scientific strategy-portfolio management.

In switching from the oil and gas field to a leading pharmaceutical company, both Zweidler and his bosses initially focused on the similarities between the two industries. Over time, however, Zweidler began to see sharp differences in the strategies needed to succeed in each field. At Shell, a successful decision to explore a particular oil field typically led to a long and stable period of positive cash flow, assuming there were no major political upheavals. But at Merck, the launch of a new drug increasingly leads to only short bursts of market leadership because of intense competition.

“Exclusivity [to sell a particular drug] in the 1970s was about ten years, meaning it was ten years before the second entrant comes in,” he noted. “Right now, the second entrant usually comes in two and a half years later. So you have to do whatever you can from a scientific standpoint” to stay ahead of rival firms.

Zweidler also stressed that it is increasingly important for companies to think globally when developing an innovation portfolio, although that can mean different things in different businesses. In oil and gas, for example, it was vital to understand the political situation in each country, including those with a potential for nationalizing oil wells and thus destroying investment value. In the pharmaceutical business, however, a worldwide perspective means thinking of products for new markets such as China, where changing eating habits and increasing obesity is expected to cause a surge in diabetes cases, and where per capita spending on health care is also likely to rise dramatically in the coming years.

The Mack Center’s Snyder also focused heavily on global, political and social trends when he was asked by the U.S. Navy to develop a strategy for which energy projects it would invest in over the coming years. It is often overlooked, Snyder noted, that the U.S. military — in particular the Navy, which has large fleet of more than 285 active ships and more than 3,700 aircraft — is a massive user of fuel oil and other forms of energy.

The issue for the Navy in developing the proper innovation portfolio, Snyder found, was that planners must make judgments on what the world will look like a decade from now. He called such scenario planning the “missing link” that enables a large firm or entity to develop the right balance of technology investments.

For example, Snyder and his co-workers prepared four basic scenarios for the Navy. One highlighted a “green” future in which government and consumers accepted and encouraged more uses of alternative energy. But the others offered up worlds of political gridlock and dwindling supplies of fossil fuels, with steeply higher prices, as well as increased rivalries and warfare among nations, which would raise energy demand in an era of curtailed supplies. Once the array of possible decisions that flowed from each scenario was taken into consideration, Snyder’s team ultimately handed Navy officials 46 different options for innovation portfolios.

Whatever course that the Navy selects, Snyder added, it’s critical to monitor the ever-changing world, and to make adjustments mid-stream. Harkening back to Motorola’s satellite fiasco, Snyder noted, “They had assumed there would be large areas of the world where Iridium would have exclusive service and where people would pay $800 to $1,000 for a phone. If they had been monitoring that proliferation [of conventional mobile phones], at what point would they have said, ‘We’ve got to exit this investment, or change the shape of it, or bring in a partner to share the risk.'”

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