Pearson on Excellence: Innovation and Risk Management—Surprisingly symbiotic

Some large companies believe that their commitments to risk management stifle innovation. Many are also convinced that blue sky innovation involves too much risk, too much capital, and too little structure—that it’s not possible to mimic small or startup businesses, whose efforts are buoyed by highly flexible operations.

The net effect is that when it comes to innovation, big companies often settle for conservative approaches such as those enabled by stage-gates. Unfortunately, stage-gate processes are classic innovation killers. Designed to reduce uncertainty as exposure to risk grows, stage-gate processes mostly ensure that only weak, incremental ideas emerge from the funnel.

Stage gating aside, the real issue is that innovation and risk sensitivity really aren’t incompatible. Accenture recently studied the 60 U.S. publicly traded businesses that are included on the Forbes list of most innovative companies. The key benchmark was a company’s beta value: the measure of its share price volatility relative to the market’s overall volatility. A beta of 1 indicates that a company’s share price moves in line with market fluctuations.

Accenture found that the beta of Forbes’ most innovative companies averaged only 1.1—hardly riskier than their less innovative peers. We also found no correlation between a company’s beta and its position on the list. In other words, a higher innovation ranking doesn’t translate into higher risk.

The study’s clear implication is that innovation is less risky than many companies believe. So why are so many businesses unwilling to “risk” developing truly new products and services? Several clues can be gleaned from the venture capital business—arguably the sector that is most adept at driving innovation and managing risk.

Imagine a VC firm that uses proposals and meetings to winnow down 20 ideas to only one or two, and then places all its bets on the two survivors—highly unlikely. Instead, most venture capital firms create a portfolio of investments and manage them through the insights gleaned from the results of each. They know that a lot of those experiments will fail, but they leverage the knowledge gained from successes and failures to make the overall business profitable.

The point here is that failures can be essential building blocks and that fault tolerant cultures often drive innovation. Unfortunately, most companies only celebrate success. Rarely do people in large enterprises rise in the ranks with a failed experiment on their résumés—even if the failures provided insights about future opportunities or kept an organization from moving in a dangerous direction.

Grey Group, recently named one of the “50 Most Innovative Companies” by Fast Company magazine, thinks differently. The 10,000-employee agency offers a “Heroic Failure” award, which it grants to clever ideas that nonetheless didn’t work. Surepayroll.com, the number one online payroll company, takes a similar tack. It offers a “Best New Mistake” award to smart, well-intended employees who are trying to do a good job, but nonetheless made a mistake and learned from it.

In addition to fault tolerant cultures, a second innovation cornerstone is flexibility—the willingness to become something different. In the 1970s, Monsanto (#16 on the Forbes innovation list) realized that genetic modifications could become very important to its seed business. However, these modifications carried a range of risks, which Monsanto helped mitigate by creating a portfolio of experiments beginning with careful investments in biotechnology companies.

With the traction, knowledge and experience gained from those experiences, Monsanto then opened its Life Science Research Center. By the 1990s, Monsanto was busily acquiring biotech delivery vehicles and enabling technologies. Today, biotech anchors the company’s highly successful seed business.

Speed is the third cornerstone. Companies that excel at rapid experimentation and agile development increase their chances of building innovation portfolios without increasing risk. The idea is to shorten learning cycles, recognize failures early and make timely course corrections.

When Salesforce.com (#1 on the Forbes innovation list) was launched in 1999, it had only a few people in its R&D department, but was issuing four major software releases each year. Five years later, the R&D staff had grown to 200, but the number of releases had slowed to one per year.

In 2006 Salesforce.com replaced its stage-gate process with a faster, more agile approach: using cross-functional teams that work iteratively with the market through frequent tests. The company’s innovation prowess quickly returned to the high-octane levels of its early years.

Smart risk management isn’t the innovation inhibitor most companies believe it to be. More often than not, the barriers to innovation are inflexible, over-conservative processes and cultures.