The Play of Portfolios: Mastering Risk and Uncertainty of Digital Innovation
The circumstances of today are forcing more organizations to accelerate their digital transformation and innovation initiatives. The difference between surviving and thriving lies in the ability to adapt to the new reality and catch up with customer preferences.
Frightened organizations focusing only on the status quo will perish in the shadow of those keeping up with the pace of change — valuing growth and taking necessary risks.
But what does successful risk-taking look like in corporate environment?
For the longest time, top executives were already questioning the elusive concept of digital transformation and innovation. It raises valid concerns from boards and CEOs, questioning the real meaning of these concepts, and how to approach them.
The management of portfolios and investments is a pivotal aspect of digital innovation and not many people talk about. Despite this, we have all seen the effects of mismanaged investments.
Budgets spent on initiatives with marginal impact, while others — with the potential for becoming real game-changers–are starved or stuck in a limbo of biased top-down decision and budget approval process. Finance is a blocker and a facilitator for every strategic endeavour in a corporate world.
As a Chief Transformation and Digital Officer, I want to share some of my recommendations on how to manage funding and budgeting for transformation and innovation gained in the trenches. Here’s where finance departments can play a pivotal role by focusing their energy and resources, innovating their practices to put their organization back on the growth journey.
Leave the ‘start-up way’ to the start-ups.
We’ve heard it so many times now, that’s practically becoming a mantra:
“Established companies need to act more like start-ups.”
But is that really true? In the case of an organization that has reached a substantial size, it is naïve even to think that it is possible to act like a start-up. When it comes to investing in strategic transformation and innovation, organizations should instead draw inspiration from the venture capital world.
The key difference is in the structuring of portfolios and projects. The lesson offered by the venture capital practitioners is to invest in a portfolio of initiatives and projects at different stages, knowing and accepting that some of them will fail. The likelihood of yielding success from this structure is far greater than focusing all your resources on a single, large-scale big-bet program based solely on consultant recommendation, strategic review or often gut feel.
Why? Because both C-suite and boards even when the strategy is directionally correct rarely know how much the digital transformation or innovation initiatives should cost. They face even greater difficulties with gauging the expected returns. At senior levels, the humility of openly admitting that we don’t know is not very common. In the boardroom, you can commonly see very elaborate strategic plans that assume close to 100% success rate.
It is not because they are hell-bent on deliberately adopting a ‘let’s burn all the boats’ strategy. Rather, it comes down to inexperience with similar programs.
So, how do we overcome the overconfidence bias? The first step should be to apply the portfolio approach, cognizant that some of the initiatives will fail. Some initiatives will overlap and compete. A small portion will deliver benefits far exceeding the investment and advancing the company’s market position. Think in terms of creating a transformation fund instead of the budget — more on this later.
It might be difficult to implement at first, but with this discomfort comes significant insights and learning curves.
Align the principles, strategies and goals of CFO’s and CEO’s
You’ve probably noticed that digital innovation schemes can put CFO’s in a difficult situation.
It goes something like this: The CEO has made a series of bold promises on the digital strategy's benefits. Those benefits range from reducing operating and distribution costs, creating new sales channels, improving customer retention and satisfaction, protecting market share from digital-native competitors and start-ups. The innovation and digital transformation program are poised with a high level of uncertainty, and very few successful examples are available to be used as references.
On the other hand, CFO’s are responsible for making sure that the company resources are allocated to projects with the highest return and impact. This would typically be done by applying standard management and finance tools to review, assess and validate that committed level of investment and benefits. All this is actioned without considering the specific type of necessary risk in digital transformation — a very high degree of uncertainty. Further still, the finance department is likely not the most adept in lean and agile operating principles.
The finance team's typical knee jerk reaction is to focus on de-risking the investments by maximizing for specific KPI’s like IRR, etc. The possibility that the project can yield no benefits, in turn, makes approval almost impossible.
It putts business leaders and CFO’s in a situation straight from game theory — prisoners dilemma. A paradoxical situation where each party is focusing on their own interest and optimizing to meet the system requirements rather than optimizing for the optimal final outcome.
It results in a lengthy dance of adjusting and reviewing assumptions just to match the internal hurdle rate and rate of risk. The outcome is less than optimal, moving ever further from reality and learning opportunities.
The first step of change lies in the onboarding of the financial department in agile and lean concepts. Agile operations provide better tools and strategies to manage high complexity and uncertainty. Adopting this mindset can only help finance teams, as complexity and uncertainty is something that they are dealing with daily.
As co-founder of Netflix Marc Randolph wisely said — nobody knows anything.
Maintaining flexibility and speed in the decision process — including budget approvals and reallocation, especially for investments cutting across organizational silos — is one of the deciding factors in digital projects' success.
Take inspiration from venture portfolios to create transformation funds.
Venture capital firms provide great inspiration for CFO’s along with breadth of experience. Looking closer VC’s with investment thesis focused on a specific domain, industry or technology category are an even better reference for corporates.
The idea is simple. Manage digital transformation program and innovation projects like VC portfolio managers by developing a set of individual capabilities, services and products that are coherent and complementary to the company’s strategic direction and ambition.
The first step is to establish a transformation “fund”. They differ from typical stiff program budgets allocated to individual and siloed initiatives, which follow the long term strategic planning calendar. Transformation funds employ agile investing and portfolio management principles in the form of incremental funding release and gradual investment “rounds”.
Release of individual project funding rounds is pre-approved and incremental. It mimics what we know from the start-up world — Pre-Seed, Seed, Series A, Series B — in line with gained confidence in the delivery of impact and outcomes by individual initiative. As a guiding principle, empirical results have to be used as a base for evaluation at every stage, which is generated as a result of testing the hypothesis through a series of controlled experiments, tests, and MVPs with actual customers.
There is one difference.
Unlike the start-up world, the funding release should be pre-approved and almost automatic as long as the agreed KPIs are met. This ensures momentum, removing the grinding delays and the debilitating internal process overheads.
The key is to focus on measuring and assessing success based on outcomes, rather than how well it is aligned with the plan, milestones or business case. The latter approach is a common pitfall that immediately limits potential learning and the possibility of discovering the unexpected golden nuggets outside of the plan.
Don’t be afraid to have competing early-stage initiatives and bets. Refrain from looking at it as “waste” — consider it instead of a selection of the best possible solutions. Competition makes clear the strongest contenders and increases the chances of finding a successful solution. One example of a successful competition-based model is the creation of WeChat.
Educate on the need for higher risk-appetites
Transformation funds should incorporate risk appetites greater than the standard rates, and this should be adjusted to reflect organization tolerance and context.
Many stakeholders struggle to adjust to this concept. On the other hand, expectations of higher success rates — but not necessarily returns, in case of VC funds — is reasonable, especially if you consider that organizations can leverage existing assets, capabilities and insights to reduce uncertainty.
Established organizations need to understand that sometimes, objectives fail.
There is a dominant tendency to stick to the planning approach based on assumptions that everything will go well, and every single part of the intricate strategy will be a success. Introducing the concept of failure is the first and most challenging step to incorporating the necessary higher levels of risk appetite, and it causes a ripple effect across corporate.
It is necessary to make changes in other areas like internal audit, guidelines and corporate standards, procurement, risk control and compliance, people performance measurement and incentives, to name a few. The objective is to adjust the internal processes and systems from focusing on minimizing errors and deviations from the standard to incentivize experimentation and risk-taking to gain insights and remove the stigma of failure.
Continuously re-evaluate investment portfolios.
When adopting a “transformation fund” approach, the first step is to update an existing set of controls, approval, metrics and monitoring processes.
The update should reflect the fund strategy and enable agility in investment allocation with a short feedback loop. It should be grounded in a single principle of measuring outcomes and learnings based on results of tests and experiments as opposed to deliverables or plan execution.
This approach requires the discipline to kill all initiatives that don’t generate the expected impact based on gathered insights gathered from the empirical testing. Portfolio success is driven by the ability to double down and shift resources to winning initiatives. Systematically eliminate initiatives with lacklustre results. No organization can afford to invest time, energy and focus on weak ideas.
The good news is that CFO and finance function are well equipped to make sure that the discipline is maintained. Support from business leaders will be required to identify and interpret signals of “market product fit” and traction for each portfolio initiative. That’s why efforts should be focused on experimentation and getting feedback as early as possible.
In the early stages, the portfolio should consist of many small bets. Later stages should focus on medium and large investments with a high degree of certainty on the ability to deliver the expected results and scaling potential achieved through market and customer validation. The investments should be planned across the value chain and range from creating new capabilities, operating model changes, new products and services development and business models operated as a separate business. Move away from superficial improvements to focus on sustainable and scalable digital transformation. Sustained success requires bold changes across the whole value chain and is ready to cannibalize existing revenue sources.
Initiatives with proven returns often take time. Breakthroughs often happen only after the hypothesis is tested and scaled to a certain level of maturity. In such cases, the impact can be sudden, and internal prioritization and investment decision processes need to be rapid to fully maximize returns and impact.
Key Takeaways on Rebooting for Success
Begin by reviewing existing project portfolio governance. Shift the focus from singular initiatives with marginal impact. Shorten the project approval cycle by introducing clear thresholds for qualification, review, and approval to tie funding gates to actual results.
Success will require alignment, support and adoption of the processes across legal, compliance, operations, and procurement. For example, let’s say you have an early phase initiative focused on testing new processes or distribution channel, which then takes 4 months to sign NDA and select a vendor that will enable the necessary capabilities. Naturally, the initiative is destined to fail. For agile and lean operations, all departments need to be re-aligned to streamline decision making and actioning.
The next step is to review the existing talent pool and assess whether your organization has the necessary skills to support early and fast experimentation. Typically, large organizations don’t have the resources to support this critical phase. I highly recommend bringing outside talent in the early phase and progressively training and supporting internal resources development.
The last point is to assure abundant sharing of the early results — the failures, successes, and lessons learned. Lead by example and don’t be afraid to kill initiatives lacking the potential to deliver impact and scale. By focusing on sharing the lessons learnt, you will be able to remove the stigma from failure and stress the importance of learning through experimentation.
Personally, I am positive about the future.
This year, many organizations have been forced to experiment with mixed results imposed by the external circumstances and shifting customer demand. The uncertainty of the times provides an opportunity to build confidence in trying new things, combined with a sense of a burning platform that reduces the change management effort. This shift results in fewer organizations thinking about digital as an exotic ‘one-off’ investment. It’s not something that we have to do just because everyone is talking about it. Instead, digital innovation is being recognised as an integral part of the business, and everyone understands that every company needs to become a digital business. Undergoing continuous improvement and change, supported by agile investment and budgeting process, focuses on maximizing expected returns through successful experimentation.
This article was originally published in November 2020 on my LinkedIn pulse blog: https://www.linkedin.com/pulse/play-portfolios-mastering-risk-uncertainty-digital-tomasz-kurczyk/