Complexity, Risk and the Fuzzy Front-End of Innovation – Part 1

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This post is PART 1/2 of a paper entitled “The AVID Methodology.” Summary—A new contemporary approach is discussed that systematically resolves the risks associated with the fuzzy front-end of innovation. Startups and companies can create NEW products/services in less time with less risk and at a significantly lower cost than conventional product development methods.

Business today is complex! Yet this did not happen overnight. Rather, complexity has been steadily increasing over the years driven by globalization, the Internet, faster development of technologies, more competitors entering the market, more diversity in what customers want, multiple stakeholder demands, and other factors. What is not obvious, however, is the effect that complexity has had on innovation risk.

The relationship between complexity and innovation risk is an indirect one. Complexity affects the business environment in two significant ways. First, complexity drives business uncertainty — the extent to which business conditions and outcomes range from predictable to unpredictable. Second, complexity drives industry clockspeed, a concept introduced by Charles Fine in 1998, which he described as the evolution rate of an industry.

This evolution can be defined across two dimensions — 1) how quickly products/services mature and 2) how often business models change. Industry clockspeed determines the extent that business conditions are stable or dynamic. In sum, complexity affects innovation risk via the impact it has on business uncertainty and industry clockspeed (see figure below).

Back in the day, the business environment was relatively stable and predictable. Industry boundaries were well compartmentalized, and most industry clockspeeds were slow and steady. Business uncertainty was relatively low because most followed similar business rules, practices, and strategies. Companies knew who their competitors were and where they stood in the pack. Back then, companies determined what products/services customers would get and when they would get them — a supply side economy.

Companies had the luxury of efficiently planning and executing profitable growth. However, a dramatic increase in complexity has changed all of this. The business environment is now dynamic and unpredictable (see figure below). Companies live in a world today where competitive response to new products/services is faster, disruptive business models appear with little notice, and customer priorities can change on a dime.

The upside of increased complexity is that there are more ways to create and deliver value. Ironically, this also makes it is more difficult to identify value creation opportunities and how best to exploit these opportunities. Thus, increased complexity, coupled with the fact that industry clockspeeds are much faster, means that there are more growth opportunities. The bad news is that complexity obscures these growth opportunities, making them difficult to identify and riskier to implement. I call this the innovation paradox.

Back in the day, the primary growth strategy for most companies was to incrementally extend the value of existing products/services for as long as it remained profitable to do so. They had plenty of time to exploit their core products/services because the business environment was relatively stable and predictable. In today’s business environment, however, incremental value enhancement does not have the horsepower to propel growth like it used to. The window for exploiting existing products/service is much shorter because product/service maturity happens faster — commoditization sets in much sooner.

The bottom line is that the life expectancy of core products and services is getting shorter in most industries, and the only way to compensate for this is to build more growth engines—that is, new products/services that customers want. Companies that are not able to consistently build such new growth engines will see their earnings steadily decline.

The most profitable and enduring growth engines attract customers with new value propositions and establish new markets. To build these kinds of super growth engines, companies must engage in product/service innovation. The catch-22 is that innovation risk is high today. Because of this, only one in five new product/service innovations succeed.

A successful innovation is one that generates an amount of profitable revenue sufficient to carry its pro rata share of a company’s growth target relative to the time and resources invested into the effort. Thus, an innovation may produce marginal profits and still be considered a disappointment by this definition.

It cannot be said that risk is the ultimate cause of innovation failure. That would be too bold a statement. Although innovation risk kills many new product/service projects, the real reason for these failures is that companies are not effectively resolving innovation risks prior to execution. The key to successful innovation is to first recognize risk factors, and then proactively eliminate and/or manage them so that success is in your favor, not the other way around.

What are these risk factors? In short, a risk factor is anything that gets in the way of:

  • Creating a product/service that will be valued by customers;
  • Converting this value into sufficient customer demand to generate revenue;
  • Developing a business model capable of converting the revenue into enough net profit to drive growth

Given these objectives, you can image the incredible number of innovation risk factors working against success — selecting a poor innovation opportunity, not understanding what customers value, developing a new solution that can easily be imitated by competitors, unexpected costs that decrease the profitability of a new solution, poor operational execution, conflicts and snags with partners in the ecosystem — and the list goes on.

All risk factors fall into one of two categories—

  • Risk factors that are ignored or unrecognized;
  • Decisions, designs, strategies and/or activities that are informed by flawed assumptions

Value Innovation Versus Value Enhancement

Let’s dig even deeper. Why do companies have a hard time recognizing and then effectively resolving these risk factors during the innovation process? To answer this question, we must first make the distinction between two very different types of product/service development projects.

Companies tend to view new product/service projects as if they were all the same. Yet, they are not all the same. At this point, I clarify the difference between value enhancement and value innovation. Improving and/or extending an existing value proposition, a product/service design, and/or business model is value enhancement. Value enhancement seeks to increase the perceived value of an existing product/service. Value enhancements are relatively low risk projects because the path forward is well illuminated.

There is relatively little ambiguity as to what is needed, who it will be sold to, how it will work, how it will be sold, and how it fits in with the current business model. The success of an existing value platform validates these assumptions. Value enhancement is about exploiting existing products/services by incrementally moving the value proposition up a sustaining value trajectory. Because industry clockspeeds are getting faster, the window for exploiting core products/services is much shorter today. This is due to the effects of complexity.

A value innovation, on the other hand, is a product/service that creates a new value proposition. Specifically, the new product/service involves helping customers get an important “job” done in a new way. A new value platform is created that can be exploited over time by moving the value proposition up a sustaining value trajectory.

You know you are dealing with a value innovation if the value proposition— 1) requires a fundamental change in the current business model or requires a completely separate business model, 2) involves a new market, 3) sells to new customers, and 4) involves changes to the company’s business ecosystem.

Unlike value enhancement, value innovation is high risk because the path forward is ambiguous — there is no existing value platform to inform decisions about what customers value, the business model, and product/service design. It is seldom the case that a good value innovation opportunity falls at the front door of a company. To find these opportunities, companies must engage with customers, suppliers, partners, and others in different ways to discover new ways to create, deliver, and capture value.

Value innovation opportunities and risk factors elude conventional business analysis techniques. For instance, companies often use the SWOT framework to access opportunities and risks. They use traditional “voice of the customer” methods to capture customer requirements; they develop a business case that argues for a growth opportunity; they quantify the profit-generating potential of a new product/service; and they assess the risk factors. If the business case passes the ROI test, management approves the project, and off it goes to planning and execution.

The problem is that the entire business case is premised on the notion that innovation opportunities and risk factors are already “out there” and therefore can be captured and analyzed. The business case is assumed to be complete and accurate when, in fact, it is replete with omissions and flawed assumptions. Even though the business case may look reasonable on paper, the failure of the project is already guaranteed, because the opportunity is at best marginal and at worst fictional. The innovation risk factors cannot be resolved because they are not known. This is the strange case where the company doesn’t know what it doesn’t know.

Now we can better answer the question posed above — why do companies have a hard time recognizing and then effectively resolving risk factors during the innovation process? The answer is that they are using conventional product/service development tools and methodologies designed for low-risk value enhancement projects to drive high-risk value innovation projects. They fail to recognize that value innovation projects require a radically different approach to identifying growth opportunities and resolving innovation risks.

From a project management perspective, a key difference between a value enhancement project and a value innovation project is in the discovery phase (also referred to as the front-end of innovation and the pre-development phase). Before a value innovation project can move out of the discovery phase and into the development phase, three critical outputs are necessary for innovation success—

  • A compelling value proposition for a customer segment.
  • A product/service design that can fulfill the customer value proposition better than competing solutions.
  • A business model that can create and deliver the product/service to customers while generating the required net profit for the company.

All assumptions associated with these critical outputs must be valid or the project is doomed to fail.

The Discovery Phase and Critical Outputs

The discovery phase of an innovation project is often called the “fuzzy front end” because of the ambiguous nature of innovation under conditions of high uncertainty (that is, the critical outputs are not clear). Innovation risk increases to the extent that the assumptions underlying critical outputs are flawed. The ambiguity surrounding value innovation makes it easy to generate fictional or weak critical outputs. Further, activities in the discovery phase for a value innovation project are viewed as seemingly chaotic, unpredictable, and unstructured.

By contrast, the discovery phase of a value enhancement project is relatively straightforward (more pre-development than discovery). Because the critical outputs in a value enhancement project are in line of sight, activities are structured, predictable, and formal. The purpose of a value enhancement project is to move an existing value proposition up a sustaining value trajectory.

As such, the path forward is relatively clear because the value platform that is being extended already exists. That is, the existing value platform provides a baseline from which to identify/define critical outputs and to validate the accuracy of these outputs before moving to the development phase.

Because the critical outputs are known up front, the risk factors for a value enhancement project are conspicuous and can therefore be readily identified and described in the business case. Uncertainty for a value enhancement project is relatively low. Most of the risk associated with a value enhancement project has to do with execution variances, which are managed during the development phase. A value innovation project, on the other hand, does not have an existing value platform which can be used as a baseline to identify/define critical outputs.

Uncertainty obscures the critical outputs, which drives up innovation risk. Unlike execution risk, which can be managed in the development phase, innovation risk must be resolved in the discovery phase before execution. Because of the extreme difference in the level of uncertainty, the dynamics of the discovery phase for a value innovation project are much different from the dynamics of the discovery phase for a value enhancement project.

The high level of uncertainty in the discovery phase partially explains why the success rate for value enhancement projects is generally much higher than that of value innovation projects. Conventional methods/tools effectively handle the discovery phase for value enhancement projects because the critical outputs are in line of sight with an existing value platform. Due to higher uncertainty, however, these same methods/tools are less effective at handling the discovery phase for value innovation projects.

Companies that use conventional methods/tools for the discovery phase when uncertainty is high, often end up with fictional or marginal critical outputs based on omissions and flawed assumptions. In such cases, value innovation projects are literally designed to fail, regardless of how well the project is executed because innovation risks have not been resolved.

To increase the success rate of value innovation projects, companies need to adopt an approach for the discovery phase that involves a different mindset, different methods, and different tools than those conventionally used for value enhancement projects.

The discovery approach is premised on the idea that critical outputs are “discovered” through exploratory activities that engage customers, employees, managers, partners, and other stakeholders in the search for new ways to create, deliver, and capture value. These exploratory activities involve—

1) Re-conceptualizing the market and the value that a company is capable of creating;

2) Interacting with customers and non-customers in different contexts to gain insights into the important “jobs” that they need to get done;

3) Designing profitable business models that offer customers compelling new value propositions;

4) Designing new product/services based on how customers perceive value rather than how the company defines value;

5) Finding new ways to work with business suppliers and partners to create value for customers and the business ecosystem

In short, the discovery process is about collaborative learning. Discovery is not about executing a plan or applying conventional analytical methods/tools coming from the mindset that critical outputs and risks can readily be identified because they are already “out there.” The outputs of the discovery phase must be validated through empirical procedures effectively resolving the innovation risks. Only with correct critical outputs can a company move a value innovation project to the development phase with a reasonable expectation that it will succeed.

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