When pursuing innovation initiatives, one of the most important considerations is the makeup of your “innovation portfolio.” Just as an improperly balanced portfolio can increase risk and minimize gains in investing, so too can the wrong makeup of innovation initiatives create unnecessary risk or reduce return on investment.
The framework we’ve found most useful for crafting such a portfolio is the Three Horizons of Innovation, pioneered by Steve Coley, Mehrdad Baghai and David White. To effectively innovate and achieve consistent organizational growth, an organization needs to simultaneously think and invest at three levels, or “horizons.”
1. Defend the base
The first horizon is where mature businesses live: businesses that have a proven, repeatable business model and have achieved scale. The objective at this horizon is to protect and defend the business line and improve profitability.
This is the domain of incremental innovation. Incremental innovations aren’t seeking to transform a business, but rather to optimize its profitability and efficiency, or uncover new markets. Incremental innovation usually represents the least risky type of innovation and internal team members at are very comfortable on this horizon.
2. Double down on what works
The second horizon is “rapidly growing businesses” — businesses that have identified a repeatable, proven business model but haven’t reached scale yet. The objective here is to aggressively double down on what’s working, as this horizon is where organizations will capture the most value.
Many companies don’t have innovations at this horizon. To compensate, they often think in terms of strategic acquisition, as an external startup has removed considerable risk but not yet fully captured the value of the underlying business.
3. Make a series of little bets on the future
The third horizon is “emerging businesses.” This is where the brand new stuff lives, and is what most people talk about when they talk about innovation.
The rules of the game at this horizon are dramatically different. You are trying to uncover new problems worth solving and placing small bets (ideally several at a time) on potential solutions to those problems.
This horizon is where the least amount of alignment with the existing company lies. These types of opportunities need to be staffed with different team members with different competencies, and should be measured and rewarded differently. They should be subject to “innovation accounting” which prizes the rate of learning above all else.
To successfully execute at this horizon, the organization needs a very solid understanding at all levels of decision-making about the goals of these innovations. This horizon is usually where external consultants can add the most value, as they can more effectively deal with the ambiguity and thrashing that can occur for potential businesses at this stage.
How to innovate effectively
Smart companies looking to innovate effectively need to consider all three horizons and devote appropriate resources to each. Incremental innovation work on horizon one should represent the lion’s share of the innovation output in an organization, but does not usually require the most resources.
Effective internal team member training on how to identify and validate incremental innovations, coupled with some solid processes and incentives for moving those innovations through the organization are usually sufficient. A company looking to execute here should seriously consider making incremental innovation an essential part of goal setting and compensation processes.
Horizons two and three must have sufficient resources to be viable. If an organization already has successful innovations in horizon two, they should aggressively try to capture as much value as quickly as possible. Unfortunately, many organizations simply don’t have a business or innovation that accurately fits this description, and must look outside their walls. Considerable effort should be spent on looking for disruptive businesses that have already found a product/market fit.
The third horizon of innovation should also receive considerable investment, building up its own portfolio within the larger portfolio. Rather than putting all of their eggs behind a single innovation opportunity, business owners should spread out their risk by identifying 10–20 potential innovations, give them a small amount of resources each, and use strict innovation accounting standards and stage-gate review processes to let the winners rise to the top.
This will require a heavy amount of buy-in at the top to let these fledgling portfolio opportunities thrash — it will look to the untrained eye like a lot of failure and wasted money. But as the venture capital world has already learned, predicting which innovations are going to be successful at the outset is extremely difficult. Very often, only one of the innovations will be a winner, but its victory will provide more than enough return to justify the approach.
As a rule of thumb, we advocate for devoting 50 percent of resources on incremental horizon one innovation and 25 percent on each of horizons two and three. But ultimately, it depends on the particulars of your business or industry. The primary goal of such a rule is to avoid the common mistake of investing entirely in the first horizon and little to none in the second or third.
It’s worth taking the time the do an audit of existing initiatives at each horizon and determine the allocation to each in terms of talent and capital. The right innovation portfolio can ensure you protect and expand existing business while also maximizing the likelihood of success years into the future.
This article has been edited.
Sean Johnson is a partner at Founder Equity and Digital Intent, and loves helping companies build and grow innovative new digital products. He’s a professor of digital marketing at Northwestern University’s Kellogg School of Management. A version of this article was originally published here.