Academic journal article Research-Technology Management

Tools for Managing Early-Stage Business Model Innovation: Innovation Readiness Levels Provide a Key Measure of the Stress a Business-Model Innovation Is Likely to Inflict on an Organization

Academic journal article Research-Technology Management

Tools for Managing Early-Stage Business Model Innovation: Innovation Readiness Levels Provide a Key Measure of the Stress a Business-Model Innovation Is Likely to Inflict on an Organization

Article excerpt

As the articles in this special issue illustrate, constructing a portfolio of innovative ideas and projects is always a subtle undertaking. The goals are to ensure that ideas with the highest return are selected for investigation, that the risk-return profile matches the objectives of the firm, and that the projects address the correct mix of market areas. At the early stages of innovation, when innovative ideas are mostly just kernels of ideas, the first two goals are particularly challenging. Basic feasibility may reasonably be questioned.

Even assuming feasibility, there is often dramatic uncertainty around even the most basic of financial parameters, such as sales, price, revenue, income, and required investment. In this context, computing and comparing return on investment for ideas is not a meaningful exercise. While one can expend resources to generate "detailed" estimates, these estimates are highly questionable since uncertainty results from factors that, if they can be resolved at all, would require significant investment to do so.

These challenges are even more acute in the case of business model innovation, which requires a company to reorder its behavior in order to create value in fundamentally new ways. Business model innovation typically involves two components: a strategy or vision for organizing the firm to create value and a set of capabilities the firm must possess in order to execute the strategy (see Johnson, Christensen, and Kagermann 2008, 52-53). Business model innovation often requires that multiple functions--not just technology and manufacturing--actively participate in their own reinvention. At this point, uncertainties proliferate and traditional financial metrics to assess risk and value become meaningless.

What, then, is a more useful approach? At Lockheed Martin, we have been experimenting with a new approach that has worked reasonably well. This approach combines a modified risk-return framework with a new concept, Innovation Readiness Levels (IRLs). IRLs offer a measure of the amount of stress an idea is likely to inflict on the organization, and is thus a surrogate metric for both required investment and the risk associated with the investment.

At Lockheed Martin, we have been utilizing this approach as part of our Innovate the Future Program, which has solicited and evaluated thousands of ideas from both employees and the general public. As part of the program, trained evaluators perform rapid evaluations of ideas using the IRE approach. The results of that evaluation are provided to the management team, which works with innovation managers to create an investment portfolio matching the company's strategic objectives. The IRL approach has enabled the company to more quickly and effectively evaluate the total risk, not just the technical risk, associated with ideas and has significantly improved the quality of the company's innovation portfolio.

The Risk/Return Framework for Early-Stage Ideas

Evaluating investment opportunities typically involves a series of calculations intended to define the return on investment (ROI) as a function of uncertainty. ROI is computed as the net present value (NPV) of free cash flows (revenues--expenses from the sale of the product) divided by the NPV of the investment required. At the early stages of idea development, uncertainty makes these computations meaningless. First, free cash flow is a difference of two approximately equal yet highly uncertain numbers, and can thus swing positive or negative depending on the assumptions made. Similarly, the ratio of cash flows to investments is the ratio of two numbers that are typically about equal (or more accurately, equal within a factor of ten). Again, variations in the numerator and denominator can lead ROI to fluctuate widely.

Instead of evaluating return on investment, we ask two related questions: First, if all goes well and the idea pans out, is it likely the business venture will be material to the business? …

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