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It’s hard to imagine a company discussing innovation and suddenly turning to risk management as the catalyst that will unleash it.
Risk management is often viewed as the enemy of the innovation ideal: the start-up with its highly empowered teams, agile development, minimal controls, and executives staring down risk with steely courage.
Applying the startup ideal in large organizations has often been an outsized challenge. Many global enterprises are complex and a battery of controls often holds them together. But the side effects can be toxic to innovation—they can create a decidedly risk-averse culture.
Some experts even argue that controls will always stymie innovation. Driving it often requires parallel systems of empowered teams with their own funds and decision-making authority. We argue differently. Through our experience with both innovation and risk management, Accenture has come to see them not as adversaries, but as a potentially powerful union if married properly. In our view, the marriage is about much more than the controls that mitigate downside risks. The fusion of innovation and risk management can play a major role in successfully pursuing upside opportunities that a risk-averse culture may be leaving on the cutting room floor—it can drive a company’s innovation agenda by revealing blind spots and areas of underinvestment that threaten a company’s future.
In many companies however, the union of innovation and risk management is formed around an innovation-choking funnel process—a series of stage gates designed to reduce uncertainty as exposure to risk grows. For many companies, the funnels end up producing only weak, incremental ideas that often come to market slowly and miss cost targets. Despite such dismal results, many companies avoid unleashing innovation, fearing that capital requirements and business risks will soar.
What industry is better skilled at managing risk and driving innovation than venture capital (VC)? Imagine a VC firm that used proposals and meetings to winnow down 20 ideas to only one or two, and then placed all their bets on those. Highly unlikely. Venture capital firms typically create a portfolio of investments and manage them through the insights gleaned from the results of each. These firms often know in advance that most experiments will fail. They are often able to use their growing knowledge to double down on promising avenues and leverage the “skill to kill” to move away from investments that are not panning out.
To achieve the highest return on their portfolios, many VC firms apply three principles to their work:
Flexibility. Similar to the way an investor uses put and call options to build a flexible portfolio before knowing which investments will pan out, companies may want to consider building a portfolio of early innovation investments that act as options.
Speed. Companies can use rapid experimentation and agile development to increase their chances of filling their innovation portfolios with new products and extensions—with the risks well managed.
Control. VC firms use controls. But these controls are often designed to achieve the opposite effect than they do in most enterprises. They are often designed to increase risk tolerance by creating a culture that embraces the logic of intelligent mistakes and bridges two organizational mind-sets that are often at odds: finance and operating units.
A primary goal of the funnel is to ferret out the best innovations by winnowing them through a series of stage gates that reduce risk. The reality is often very different. Driven by risk aversion and poor risk management capabilities, the process often weeds out big ideas in favor of small ones. Decision-making bodies often send back proposals for additional research and work, creating time consuming, creativity-numbing rework loops. Anything but agile and iterative, the process can be a slow, linear march that rarely moves the growth needle. The tools used to support the funnel process can bog it down. They are often one-dimensional, inadequate measures of an initiative’s value based on backward looking analytics.
Net Present Value (NPV) models for example, are designed to leverage market projections, but often through the lens of recent trends. As a result, innovation decisions can skew toward optimizing the company’s existing product lines through extensions and incremental improvements. Although these are important considerations, they can define opportunities very narrowly and miss market discontinuities and new opportunities. Ironically, a corporate culture that celebrates success can be the final nail in the coffin. Only infrequently does someone in a large enterprise rise in the ranks with a failed experiment on his or her resume—even if the failure provided insights about future opportunities or was an extremely cost-effective means of eliminating dangerously wrong directions. Our view is that perhaps managers should be rewarded for a portfolio that includes strategically intelligent mistakes.
Executives globally are focused on growth strategies, their associated risks and risk management capabilities. Programs to accelerate innovation are becoming more common, in part, because successful innovation is the cure for many risks companies face. Many organizations must leverage their investments in risk management structure and techniques to support innovation. Risk management can add a level of discipline and transparency, while supporting the desired risk culture and appetite. To fuse innovation and risk management processes in a way that unleashes innovation in a disciplined way, we recommend considering these principles:
Culture. Recognize that small failures are acceptable as long as they occur within the business’ defined risk tolerances.
Oversight. Provide lean risk and innovation governance and processes in an effort to support investment decisions and speed.
Business Model. Map how company strategies, upside and downside uncertainties, risks and innovation activities are related.
Analytics. Use risk measurement and scenario analysis techniques to better understand individual risks, combinations of events, and untended consequences—including the risks of underinvesting.
Innovation Portfolio. Align your innovation portfolio with company strategies and top risks with a goal of maximizing the potential benefits from investments.
Innovation Processes. Focus your innovation process on speed in an effort to shorten learning cycles, recognize failures early, and make timely course corrections.
December 10, 2012
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