Increase Your Innovation Reward While Reducing Risk

Many executives believe that innovation carries a risk-reward trade-off that dictates, “Any money invested in innovation can generate higher returns only if there is a commensurate higher risk of failure.” While the risk-reward trade-off theory makes a lot of sense when investing in mutual funds, it should not be applied to innovation. Here’s why.

The risk-reward trade-off theory makes sense when investing in mutual funds because we have little insight and no control over the businesses in which we invest. But it does not apply to organizations that we lead because, contrary to popular belief, we can discover our target customers’ important unsatisfied needs and then effectively address them. This is how leading companies drive innovation ROI while reducing risk at the same time.

To understand this, it’s important to establish a good working definition for “innovation.” I like the following definition because it captures the two key steps of innovation and its proper sequencing:

“Innovation is the process of discovering unmet customer needs and then developing solutions to address them.”

As you can see from this definition that the first task is to discover your target customers’ unmet needs. An “unmet” need is an important unsatisfied need. The more important and less unsatisfied a need is, the more “unmet” it is, and the greater the opportunity for innovation and growth it presents. Only after you have discovered your target customers’ unmet needs are you ready to generate ideas for new offerings.

Consider the archer: they execute their shots with bow and arrow in a precise sequence, “Ready, aim, fire!” This enables them to consistently hit the target. It’s hard to hit a bull’s eye if you cannot see the target. Yet this is precisely what many companies are trying to do when they execute innovation by generating ideas before determining where their customers’ unmet needs lie. This is like the archer executing the process, “Ready, fire!” and then asking, “Did I hit anything?” Your customers’ unmet needs are the target and your solution ideas are the arrows. You can consistently hit your customers’ unmet needs if you identify them first. It turns out that the best creativity trigger is a well-defined customer need.

Given these two key steps in the innovation process (first discover the customers’ unmet needs, and then develop solutions to address them), the two key risks of innovation are:

1. Failure to understand the customers’ needs
2. Failure to create a solution that effectively addresses the customers’ needs

Research has consistently shown that the #1 cause of new-product failure is an inadequate understanding of the target customers’ needs (Winning at New Products, Robert G. Cooper). Professor Clayton Christensen at the Harvard Business School estimated that “About 75% of all money spent on developing new offerings is spent on offerings that don’t succeed commercially.” Some experts state that, out of all the new businesses that fail, “90% fail because no one would buy it (the offering), not because they couldn’t make it.” (Nail It Then Scale It, Furr & Ahlstrom). Organizations are experiencing these high failure rates because they don’t know what inputs to capture from their target customers, how to obtain them, or how to prioritize them. Consequently, they resort to guessing the customers’ unmet needs, generating ideas, and then failing.

Organizations that learn how to capture their target customers’ unmet needs first and then generate solution ideas to address them achieve dramatically higher returns (>80%) and reduce their innovation risk at the same time. This is how leading companies are transforming innovation from a haphazard event into a disciplined business process that consistently delivers results. You can, too.

(A version of this article first appeared in The Business Journals, February 25, 2016).