Apr 12, 2017
Is it even possible to innovate in the enterprise? Corporate history is littered with botched innovation. The Xerox of the 1970s is a popular example. At their Palo Alto Research Center, they effectively invented the laser printer, ethernet, and the personal computer. However, the company was so poor at capitalizing on its own innovations that it was the subject of a book entitled Fumbling the Future. Despite having the jump on several multibillion-dollar industries, Xerox is still a copier company.
Did you know that Kodak invented the digital camera? Though the company patented the technology, executives at the time decided to shelve the project. As Steven Sasson (the inventor) recounts, “they were convinced that no one would ever want to look at their pictures on a television set.” It’s easy to see why Kodak, which made their money selling consumable film, would not want to threaten their own cash cow by introducing a camera that didn’t use film. They successfully defended their brand as the leader in film, but the short-sightedness caused their market cap to fall from nearly $30B in 1997 to a low of $145M in 2012.
We don’t need to pick on these companies specifically. According to a trend analysis performed by Richard Foster in association with the Yale School of Management, 75% of the S&P 500 will be replaced by 2027. The data clearly show that the lifespan of large enterprises on this distinguished list is getting shorter and shorter. It isn’t just academic research that has noticed this trend — it’s something felt intuitively by today’s top leaders. According to the McKinsey Global Innovation Survey, 80% of executives acknowledged that their business models are at-risk, but only 6% were satisfied with their company’s innovation performance. When John Chambers stepped down from his role as CEO at Cisco, he remarked that “40% of businesses… will not exist in a meaningful way in 10 years.” On April 3, 2017, Starbucks CEO Howard Schultz stepped down in order to focus full-time on the company’s innovation initiatives and premium Starbucks Reserve products. As someone who began his career at Xerox in the late 1970s, perhaps he sees that without leadership commitment to innovation, Starbucks too may be dethroned by a disruptive competitor.
Why has the tenure of S&P 500 companies dropped from 61 years in 1958 to only 18 years now? While technology has always had the capacity for disrupting the status quo, today’s breakneck pace of change can broadly be attributed to digitization. Software, and particularly web-based software, has lowered the barriers for startups to bring competitive solutions to market and has also lowered the barriers to consumer adoption of new products.
None of this is probably news to you. Virtually all companies of a certain size have seen the writing on the wall and invested heavily into “digital transformation.” This undertaking is massive and multi-pronged. There is the business side, understanding and adopting digital business models. There is the operations side, expanding the role of IT from a cost center to a critical driver of revenue. There is the infrastructure side, moving away from on-premise to the cloud, and all of the security and compliance concerns that go along with that. And of course the technology delivery side, moving from the traditional waterfall methods to agile methods.
All of these changes are necessary to compete in today’s fast-paced business environment. However, they are not sufficient for innovation. Xerox unveiled the Alto PC in 1973, a decade before GUI computers hit the mass market. Kodak invented the digital camera in 1975, a full 20 years before that technology was ready for wide consumer adoption. In these cases, improving their delivery or infrastructure wouldn’t have helped. These failures happened because the companies didn’t develop them into viable strategic options.
In the 1999 book The Alchemy of Growth, the authors put forth a simple framework called the Three Horizons framework. The framework was developed by researching and synthesizing the practices of 36 companies worldwide that exhibited sustained growth over time. What they found was that these organizations were able to manage their portfolio of businesses on three different time horizons simultaneously:
The first horizon represents existing businesses. These are proven and generally profitable business models that are maturing. Within this timescale, the mode of operation is to defend and scale the existing business. Typically these businesses are subject to a lot of competition and not a lot of differentiation, so the firms that win are those with superior execution.
The second horizon is about building emerging businesses. For designers in the enterprise, these are often the most exciting and high-profile projects to be involved with. Typically they are complex and have multi-year timelines and roadmaps. The reason that this complexity exists is because the company has vetted the idea, understands the market, and aims to control the risk factors in its investment. Although the markets already exist to some degree, these projects are often secretive because their goal is to create a temporary positional advantage for the company.
The third horizon is very different from the execution and building actions of the nearer-term horizons. Instead, the objective for the third horizon is to boldly explore the unknown to identify viable future options for the company. We might think of this as divergent thinking for corporate strategy. When practiced well, it increases the agility of an organization by providing foresight into various possible paths it may take in the future.
The third horizon is typically full of ambiguity and devoid of quantitative data. This may sound appealing to a UX researcher and/or designer, but it is a scary place for executives to invest their time and money. Generally speaking, the third horizon is not well managed, and it’s no surprise why. There are a lot of ugly truths to third horizon businesses:
1. At present, they are inferior to Horizon 1 and Horizon 2 businesses
As a rule, H3 businesses always look inferior. They require more investment, more time, and have far more risk than shorter-term investments. They have unknown or completely imperceptible markets. And there isn’t a lot of competitive data. In the short-run, H1 businesses appear highly profitable but with slowing or negative revenue growth; H2 businesses may be profitable or unprofitable but have high growth; but H3 businesses appear to hemorrhage capital and have no clear path to ROI. Accordingly, a watchful executive would generally be inclined to limit their H3 investments.
2. They are subject to infanticide
Successful companies got that way because they beat competition. Unfortunately, when we talk about innovation on Horizon 3, we are talking about businesses that may disrupt the incumbent H1 businesses, which are a company’s cash cows. Since the modus operandi of H1 businesses is to defend and scale, the default response of the H1 immune system is to neutralize the H3 antigen. This self-preservation bias prevents good ideas from gaining traction.
3. No one in the organization is incentivized to care
Executives are responsible for creating shareholder value, and receive much of their compensation in the form of stock to ensure this alignment. However, the market evaluates value growth quarter over quarter, forcing execs to focus primarily on short-term gains. Moreover, the median tenure for a Fortune 500 CEO is only 6.9 years, making it difficult for them to manage disruptive innovation projects that may take 5–10 years to take hold.
4. Virtually all will fail
Most estimates place the new venture failure rate between 80% and 90%. Some place it as high as 98%. The simple fact is, innovation is hard and pursuing it is risky. Successful companies operate in a way that reduces risk, which is yet another reason why potentially innovative ideas never get to see the light of day.
5. They require different tools, management, and mindsets to nurture.
According to Steve Coley, Director Emeritus at McKinsey & Company and one of the authors that developed the Three Horizons framework, “the performance metrics and organizational style for Horizon 1 businesses are not the same that are appropriate for Horizon 2 or Horizon 3… It is important to differentiate the way you manage initiatives in each one of these horizons.”
Even if a company can accept the first four truths about the third horizon, this fifth point is nearly insurmountable. Corporations are organisms that have evolved to reduce risk and create consistent returns for shareholders. Unfortunately, the culture and systems inside such an organization can amount to an environment that is hostile to true innovation. This is why UX leaders who have a mandate to innovate can find themselves in a frustrating catch-22.
We believe that new solutions can’t be developed through the same mindsets and methods as the old ones. To make different things, companies must make things differently. The enterprise admiration and fear of high-performing startups is valid. When a small team that can ship faster than you is first to a new market or leapfrogs your value proposition in an existing one, it may spell disaster.
But we also believe that an enterprise, by definition, cannot be a startup. Companies sustain businesses, whereas startups search for them. The mindsets and methods are fundamentally different.
So how are organizations dealing with the catch-22?
Everyone has an innovation lab or skunkworks program, but I’m bearish on them. The intention is good, but when innovation is treated like a separate function in the enterprise its projects can quickly get misaligned with corporate strategy. Without executive feedback and sponsorship, you end up with Xerox PARC.
In contrast, Xerox also had an internal venture capital fund called Xerox Technology Ventures. XTV started with $30M and the mission to invest in businesses that could leverage Xerox technology. Within seven years, the value of XTV’s portfolio had reached $200M. Why were XTV companies so successful in bringing Xerox technologies to market? Experts such as Trevor Owens, author of The Lean Enterprise, would attribute it to two things: 1) the entrepreneurs were sufficiently motivated with equity, and 2) the startup was unencumbered of the corporate culture. But the corporate venture model isn’t perfect either. Despite its success, XTV was shut down in 1996. According to Steve Blank, the fund’s success was actually resented by employees and leaders on the Xerox mothership.
In the last five years, more and more companies have started a corporate accelerator model. They all work differently, but most focus on bringing startups that could be strategically aligned under their roof. The success of these programs seems to vary widely; many have shut down, whereas others (such as Disney’s accelerator) have succeeded in creating brilliant corporate-startup partnerships. From the perspective of design leaders, however, both the accelerator and venture approaches may feel too external, long-term, and scattershot.
Many of our clients have found success with a new type of model: partnering with a rapid innovation firm such as Philosophie. They bring their most promising ideas and domain expertise, and we apply the startup mentality and toolset to prototype and try to validate them within a few short weeks. This approach isn’t for everyone; it takes brave entrepreneurial leaders to set the vision, protection from an executive sponsor, and a willingness to move uncomfortably fast. But for those who have a strong idea pipeline and internal entrepreneurs, we’ve found it to be a powerful option in the innovation toolbox.
What is the right answer? Probably a mix of all of them! Large organizations should use a blend of venture, accelerator, and rapid business validation to manage their third horizon business portfolio. The venture model allows them to make a lot of small bets on externally-run businesses that may provide a financial return. The accelerator model lets them make fewer bets, but affords the opportunity to collaborate closely with startups to co-create value. And finally, working with a rapid innovation partner gives them the option to empower their internal entrepreneurs to begin to realize third horizon businesses on a much shorter timeframe.
What is the role that design and innovation leaders can play?
Design leaders inside of the enterprise may find themselves balancing “what if?” with “what now?” Possibilities vs. pragmatism. Sometimes this ambiguity management is explicit and other times tacit. In either case, I see ambiguity triage being the juncture between Horizon 2 opportunities and Horizon 3 possibilities. Internally, most of the effort needs to be devoted to building for Horizon 2, but here are some concrete ways that design leaders can keep an eye on Horizon 3: