At the Crossroads of Risk and Reward

—Does breakthrough innovation always have to entail large amounts of uncontrolled risk?

This question constantly arises and sparks large amounts of debate within innovative companies, as highlighted at a recent roundtable workshop led by technology and product development company Sagentia during the recent Frost & Sullivan Medical Devices MindXchange meeting held in San Francisco, Calif. The workshop roundtable was attended by 27 research and development senior executives and included a series of discussions and debates exploring the topic of how to achieve breakthrough innovation without exposing the company to undue risk. Such discussions demonstrate that there are a number of ways companies can balance their corporate risk profile while developing genuinely breakthrough innovations through active and pragmatic risk management.

This article will summarize the output from this workshop roundtable and will provide additional perspective based on our own experience.

“Despite stereotypes to the contrary, the best entrepreneurs are relentless about managing risks—indeed, that’s their core competency,” according to a recent article in the Harvard Business
Review. This contradicts the commonly held perception that entrepreneurial visionaries have their heads in the clouds when it comes to risk. Indeed, the holy grail of game-changing originality naturally carries high risk, but the more the people who are doing the innovating understand the risk, the more likely they are to successfully develop their desired products. Also, from a corporate strategy viewpoint, it is imperative that the constant need for new innovation cannot be ignored by any organization for a sustained period of time, otherwise decline is inevitable. In fact, the risk of not developing any new innovative products over a period of time incurs far more danger than taking calculated risks on significant opportunities.

Risk Management
Developing game-changing technology typically involves sailing into unchartered waters, and many questions will arise along the way. Should you accept all the risk and just go for the innovation? Absolutely not. Risk management throughout this process helps to better cope with risk as well as identify potential extra opportunities. But risk management must not be confused with risk avoidance. Risk management is about accepting risk as being inherent in all ventures and then controlling the identified risk that could damage project success.

Figure 1. Typical Risk Management Cycle.

There is no single risk and opportunity management policy that all innovative companies should follow. It is highly dependent on the nature of the company and the type of project conducted. As a general rule of thumb, the policy should be kept as simple as possible, adding value without creating onerous bureaucracy. Bureaucracy typically leads to low amounts of buy-in from people throughout the company, and if there isn’t total support for the policy—from board level down to day-to-day operator—then the efficacy of the procedure is hugely diminished. Additionally, a company’s risk
management process must be driven by, and be in line with, the company’s strategic objectives (e.g., risk appetite, level of desired innovation, need for innovation, etc.).

With this in mind, basic risk and opportunity management can be broken down into a four-stage cycle, as summarized in Figure 1. These steps are being driven by and constantly being fed back into corporate strategic objectives so as not to lose focus of the end game.

Risk Assessment
The first stage is to broadly assess potential risks and the output should be a fairly exhaustive list of potential risks and opportunities that are likely to be encountered through a project. A good starting point is looking back at lessons learned from previous projects, an activity that often is overlooked. Even for highly innovative projects, there are many risks that can be predicted from past projects. It is important that people developing highly differentiated products don’t get caught in the trap of thinking they won’t encounter things that many others have come across previously.

All too often, overall risk assessment is not sufficiently detailed and is completed by individuals who have a defined viewpoint, typically by R&D project management personnel at the start of the development phase. One way this can be improved is to bring this process forward as early as possible in the project lifetime and include more stakeholders. If the risk assessment process can be started by people earlier in the process (e.g., innovation teams) and then carried forward by people throughout a development lifecycle, it is more likely to be comprehensive and valuable.

Figure 2. Risk Through an Innovation Timeline.

One grossly underused tool is the use of workshops. This can be done by gathering a group of stakeholders with varying perspectives on the project and completing a structured risk assessment. By conducting multidisciplinary workshops you will produce exhaustive and diverse output from people who will engage with the project at different points. Workshops run by external parties with experience in the field can be especially useful for larger projects. This delivers clearer objectives and more exhaustive assessments of risk across a project by combining internal and external viewpoints. Figure 2 shows a typical innovative project timeline with potential sources of risk and the outcome if they are not sufficiently treated. People representing all stages of this cycle should be brought in for risk assessment, so that all sources of risk may be appropriately considered.

Risk Reporting and Monitoring
Once identified, the major risks of interest can be identified and plotted on a scoring matrix such as a heat map.

This allows for an easily comprehensible visual representation of the most urgent factors. Common logic normally would suggest that all factors should be pushed back as far towards the bottom left of the graph as possible. This may be the case when certain factors are well contained and many of these risks should be left in the “low” category because they pose little problem for overall project success. However, it is worth keeping in mind that this is not always the case, as risks in the bottom left corner could represent opportunities for savings or a higher innovative step (for example, if the project is too highly regulated or too conservative).

A healthy heat map should generally show most of the risks toward the middle—yellow squares where risks are managed and any potential opportunities have been exploited. Risk through a project is constantly changing and evolving. Therefore, these reports should be monitored continually throughout a project lifecycle to ensure mitigations are helping reduce risk, and new risks are captured and managed, as well as ensuring the heat maps constantly reflect a company’s corporate risk appetite.

Risk Treatment
After identifying risks and opportunities the next major stage is to develop a program for treating these factors so they can be efficiently managed. Risk treatment often is confused with risk mitigation, especially in small companies where the drive can be so focused on pushing toward an end goal that people may lose focus of the bigger picture. However, risk treatment should comprise more than just mitigation. Typically, this includes variations of tolerance, termination, transfer and mitigation itself. It is important to note that tolerance and termination are valid risk treatments.

Figure 3. Heat Map Scoring Matrix: A typical heat map evaluating risks against their potential impact and probability to arise.

Once a company has defined its risk appetite, then any risks within that level simply can be accepted or tolerated without any further action. It is important to monitor such risks closely to ensure that if they migrate out of the acceptable levels they can be acted upon quickly. Likewise, if after much thought and analysis a project is deemed too risky for a company’s corporate strategy and no other form of treatment can change this, it is essential that it gets terminated at the earliest possible stage before more time, and ultimately cost, have been wasted. This can be difficult for smaller companies with relatively few products or developments, but it still is the best decision for long-term success.

Risk transfer also can be an effective means of lowering risk, especially for highly innovative products. Potential examples of how risk can be lowered include sharing risk with another company (i.e., doing joint ventures) or planning secondary products off the back of a single development (i.e., producing technology for a medical market as well as a non-regulatory dependent market). However, this decision always must be taken with caution, as lowering your risk often means lowering potential reward. Sometimes, for particularly high-risk, high-reward projects, this is sensible, although much depends on company size, corporate strategy and risk appetite.

Figure 4. Risk mitigation strategies developed during Frost & Sullivan workshop.

Finally, there is risk mitigation, which is the most commonly discussed means of managing risk, and certainly when done correctly, the most powerful. Here, the aim is to develop methods through which any potentially damaging risks can be overcome through additional work or spend. Whether you realize it or not, most of us deal with some form of this in our day-to-day work lives and it is fair to say that for breakthrough innovation this is most likely going to be where most risk management time is spent. Figure 4 shows the output obtained at the Frost & Sullivan roundtable for potential risk mitigation strategies for breakthrough innovation through the development life cycle. This demonstrates the large amount of potentially mitigating strategies that can be developed.

Bring Risk Mitigation Forward
An interesting conclusion from the Frost & Sullivan roundtable was rather than simply accepting that risk mitigation is something that is done throughout an innovation cycle, you should pull as much risk mitigation action forward as possible. The earlier in the development timeframe potentially destructive risks can be tested the better, and potential deal-killer assumptions should never be left untested until late in the lifecycle. Although spend rates vary throughout a project, time generally means money, and the longer a project goes on the more capital it requires. Also, the longer and more money that is put in, the more that project sponsors become biased toward progressing the project further, regardless of the continually changing risk/reward potential.

Figure 5. Plotting risk against time allows for advantages of pulling mitigation forward to be visualized.

A novel way of looking at this is by completing tests early in the pipeline designed to confirm whether a risk is detrimental. For example, if a risk assessment shows that the two biggest risks are an inability to obtain intellectual property (IP) protection and uncertainty about end-user needs, then these should be looked into as early as possible, not left until the natural time in the cycle. This can be completed through an IP landscape and a voice of customer study to gain a detailed understanding of the situation. This potentially will allow for tailoring of innovations to fit within these constraints earlier, requiring less complex change. It may suggest that there isn’t actually an opportunity there at all, and terminating the project is the best course of action, and this can be completed before significant spend has been plunged into development. However, this analysis also could present opportunities such as more freedom to operate than expected, or a higher demand from users for a certain technology, and hence modifications can be made to expand the potential opportunities. Either way, by moving the risk mitigation earlier in the lifecycle it allows for more informed decisions to be made, risks to be managed, and opportunities to be exploited.

Corporate Portfolio Risk Management
Risk management often is thought of as a project-by-project activity. However, for companies that are constantly looking to develop breakthrough products it may be useful to think of risk across a company’s portfolio. Portfolio management allows projects to be judged directly against a company’s independent corporate strategy. This approach helps determine what the corporate risk appetite is for different projects depending on the potential novelty of the output. Highly innovative products, which have the potential for extremely high reward, almost always carry higher risk. Lower novelty projects still have merit, as long as they carry low risk proportional to potential reward. Measuring this across a company’s portfolio allows for development of an independent appetite line dependent on the company’s business model and circumstances. By doing this type of analysis a company can control which projects correlate well to corporate strategy and those that are above or below the line are avoided. This, in turn, should help provide a constant and consistent view to innovative projects without taking large gambles on single developments that don’t fit into a company’s risk appetite.

Figure 6. Corporate portfolio risk management showing whether individual projects match a company’s risk appetite.

Breakthrough Innovation with Controlled Risk
Fundamentally, it is possible to produce breakthrough innovation without taking large, uncontrolled risks. The most effective way of doing this is through pragmatic and simple risk management policies that everyone buys into and understands. Risk management should be addressed as early as possible in the innovation cycle, by a diverse selection of relevant stakeholders to make the process more effective. Testing risks early and cheaply for innovative developments is a must to ensure deal breakers aren’t left too late where they can be catastrophic. And, for companies with a number of innovative projects, managing a portfolio and deciding a specific corporate risk appetite against innovation/novelty can help optimize overall risk exposure and help produce game-changing innovation.

Alistair Fleming is a medical sector specialist and Simon Forster is an innovation and technology management consultant for Sagentia, a product development company with U.S. headquarters in Cambridge, Mass. The company’s global base is located—coincidentally enough—in Cambridge in the United Kingdom. For more information, please email [email protected].