Is your organization ready to build new ventures? A framework for success
Since launching in February 2020, High Alpha Innovation has partnered with innovation leaders at many of the world’s leading corporations. It’s our belief that over the next decade, the success of these corporations will be determined by the quality of their engagement with startups: fifteen years from now, most scaled enterprises will either have their own captive venture studio or a program for partnering with external venture studios. This specific corner of an innovation portfolio can yield significant – even world-changing – results, and our playbook presents a natural way for scaled enterprises to systematically and efficiently experiment by building new startups.
Before we begin building together with a partner, it’s essential to lay effective groundwork. This article outlines the steps that leaders can take to prepare a winning innovation strategy in a world where innovation is distributed and competition is abundant.
- Begin with a clear corporate strategy
Before jumping into innovation strategy, it’s important to begin with corporate strategy, which defines where the business will “play” and how the business will win. A company cannot be expected to win without a clear corporate strategy.
Good corporate strategy defines the growth objectives of the company and hypothesizes on the mix of organic vs. inorganic growth required to meet those objectives. For organic growth, the strategy should articulate how new and existing products address market needs, how much market share they can reasonably expect, and what amount of year-over-year growth is expected. Inevitably, there will be a gap between expectations for these products and total expected growth based on company goals – this is the innovation mandate: close the gap.
- Align innovation strategy to the overall corporate strategy
Just as a company cannot be expected to win without clear corporate strategy, an innovation leader will fail to execute without an innovation strategy in place. Innovation Strategy is a subset of corporate strategy: it defines how a company must innovate to continue to compete in existing markets, while accessing net-new products and markets. A useful innovation strategy starts with the question: “How much innovation do we need, and how soon do we need it?” Innovation leaders can confidently execute in alignment with their CEO and continue to prove value to the business by ensuring their innovation metrics flow from a clear alignment with corporate strategy. (For more on innovation metrics, check out this panel discussion from Alloy, High Alpha Innovation’s annual venture building summit).
The challenge for innovation leaders is that each part of their strategy requires different objectives, metrics, and tools. As described in “Dual Transformation,” in order to avoid disruption, companies must continue to invest in “Transformation A” initiatives that protect and expand the core business in existing markets, while using a portion of those profits to fund “Transformation B” initiatives that experiment in new and adjacent markets to disrupt the core business.
Transformation A initiatives often focus on existing product support, near-term new product development, and next-generation products/services. They are best funded from the P&L and thus defined by near-term metrics, such as ROI and contributions to year-over-year business growth. Transformation B initiatives, by contrast, focus on new and adjacent markets and/or enabling technologies – accessing them organically through net-new products and services or inorganically via M&A, investments, or partnerships. They are best funded from the balance sheet defined by long-term metrics (e.g. unrealized gains from innovation equity investments in startups, revenue generated / growth rate by net-new products, time to break-even) and supported by leading indicators (e.g. user adoption, speed to $100k ARR, etc.).
- Take a portfolio-driven approach to innovation
The scope of an Innovation leader’s mandate is quite broad as there is no silver bullet to address the growth gap. Innovation leaders must therefore adopt a portfolio-driven approach to innovation, transforming their identity from being an “‘innovator” to being a “portfolio manager.”
Let’s consider how a Portfolio Manager might address the growth gap and set their investment strategy by using guiding principles:
- Select the right asset class: Good portfolio managers develop investment strategies by selecting asset classes based on desired risk-adjusted returns – considering metrics like magnitude of capital invested, investment timeframe, criticality to corporate strategy, likelihood of return, expected ROI to the business – as in this framework below. Just as a personal portfolio manager would not put 100% of assets in stocks, but instead determines the asset mix based on desired returns profile, so too should an innovation portfolio manager consider asset class selection when allocating capital.
- Optionality: Good portfolio managers place multiple bets on the most critical initiatives. Much like a hedge fund manager would take a long/short strategy, so too should innovation portfolio managers consider using partnerships and investments to hedge against internal R&D. When taking this approach, it’s essential to not over-constrain investments, lest one lose the benefits of the diversified approach. For example, taking a majority stake in an external innovation initiative guarantees that the corporation must remain solely responsible for funding that initiative through the duration of its existence, since other sources of capital are likely to view a majority position as controlling. Instead, when investing externally, consider acquiring minority stakes in early-stage startups with pro rata rights that enable future investment or divestiture based on strategic relevance over time.
- Learning: Good portfolio managers extract the learnings from one area of the portfolio to alter their investment theses in other areas. Just as a personal portfolio manager would invest in stocks when they noted that bonds were going down, an innovation portfolio manager might glean a surprising customer insight by working with a startup in one market, which is also applicable to a similar customer persona in a different market for whom an internal R&D initiative is underway.
- Magnitude > Frequency of correctness: Finally, it's important to remember that long-term venture capital investments follow power-law distributions. Thus, one “good” investment often more than pays for all the other “failures”. When working with power-law asset classes, variance is the objective. You achieve variance by placing as many bets as possible. Innovation leaders should follow the pattern of venture capitalists who strive to build a portfolio of many small bets to increase the likelihood of achieving an outsized return.
- Identify opportunities for external innovation
A portfolio approach typically segments initiatives into R&D (near-term, existing markets), M&A (mid-term, adjacent markets), and startups (long-term, adjacent/tertiary markets). Within the startup segment (traditionally the smallest capital allocation) there are 3 strategies:
- Partner: utilize a channel partnership or co-branding opportunity to increase the corporation’s core business’ reach into new markets via an existing startup
- Invest: take an equity position in an existing startup with the intention of partnering and creating optionality for a strategic or financial outcome
- Build: address a new market opportunity by taking an equity position in a startup that does not yet exist
High Alpha Innovation is a category-leading partner to innovation portfolio managers focused on generating yield in the most traditionally difficult area of the portfolio: building external startups. Our most successful partners are innovation portfolio managers who have a well-defined innovation mandate from corporate strategy, clarity on how they plan to close the “gap,” a hypothesis of the adjacent market on which to focus their initial innovation thesis, and a business-unit leader serving as the project champion.
That said, not all corporations have well-defined innovation agendas. In this case, we partner with innovation leaders and portfolio managers to identify an initial external innovation thesis and refine as we go.
From there, our process will:
- Combine our VC lens of what’s “hot” for investment the market with corporation’s industry understanding of growth and opportunity
- Rapidly co-generate concepts and identify latent concepts from within the corporation
- Develop a portfolio of concepts and triage to other innovation initiatives – sharing new insights with R&D, M&A, partnerships; before choosing the ‘best’ for net-new external innovation
- Rigorously vet concepts through critical assumption testing
- Identify investable business opportunities and make capital allocation recommendations
- Launch, support, and aid the scale of these new startups while providing Portfolio Management capabilities to our partners
No matter the current stage of your innovation strategy, our team of expert builders, strategists, and designers is exceptionally well-positioned to help corporations navigate this dynamic frontier. Don’t hesitate to reach out and see how we can lay this groundwork together: drop us a note at email@example.com.