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R&D/BUSINESS STRATEGY

MANAGING THE OPPORTUNITY PO

Innovation and corporate strategy must feed off each other through dialogue. The portfolio planning process described here provides the foundation for that dialogue.

Christian Terwiesch and Karl Ulrich

OVERVIEW: Portfolio planning involves five basictasks: identifying current as well as future gaps in the portfolio relative to the firm’s overall business strategy,

striking a balance between strengthening the firm’scurrent strategic position and the exploration of newmarkets or technologies, creating a portfolio with thehighest potential financial value, and exploring theextent to which the competition can be redefined. Tools for accomplishing these tasks include the “traffic light”

approach, analysis of technology positions and product attributes, identification of discontinuous change,creating new dimensions of merit, lifecycle analysis,

portfolio/scenario analysis, and the strategic bucket framework. Not every tool will work for everyone, buused as needed, these tools will help managers to build arigorous portfolio strategy.

KEY CONCEPTS: innovation strategy, portfolio management, R&D strategy.

Imagine you have to take over a struggling soccer teamAs coach, you would face two difficult questions: whatype of soccer you want your team to play—you coulstress offense or defense—and which players you should pick. The composition of your team has insights for thmanagement of an innovation portfolio, the subject othis paper:

• You cannot choose a strategy without knowing theskills of your players, and you cannot pick the playerwithout knowing your strategy. The decisions are intertwined.

• You cannot evaluate a player in isolation. You canhave the best player in the league, but without capablsupport for him, your team will not win. The value of thteam matters, not the value of each individual player.

What players are to a soccer team, opportunities are to aninnovation portfolio. And portfolio planning is whereindividual opportunities collide with firm-level objec-tives: opportunities get created unpredictably and singly,while company resources have to be allocated quarterlyand managers have to tend to the performance of the firmas a whole. Inventors fret about the success of their individual opportunities, while managers worry aboumeeting firm-wide financial targets. This paper outlines

the essential tools for a rigorous portfolio planning process.

Christian Terwiesch teaches M.B.A. and executiveclasses in operations management and product develop-ment at The Wharton School of the University of Penn- sylvania, in Philadelphia. His research on product development and supply chain management appears in such journals as Management Science, OperationsResearch, Marketing Science, OrganizationScience, and The Journal of Product Innovation Management. Prof.Terwiesch has researchedwith and consulted forvariousorganizations, including a project on concurrent engi-neering for BMW, supply chain management for Intel and Medtronic, R&D pipeline management for Merck, product customization for Dell, and operations improve-ments for several large hospitals. He is the co-author of Matching Supply with Demand, a widely used textbook

in operations management. He received his master’sdegree in business and information technology from Mannheim University and a Ph.D. from [email protected]

KarlUlrich is CIBCProfessor and Chair in the Operations Management Department at The Wharton School of theUniversity of Pennsylvania. His research and teaching are focused on innovation, entrepreneurship and product development. He is a founder of several technology-based ventures. Professor Ulrich holds bachelor’s,master’s, and doctoral degrees in mechanical engineer-

ing from the Massachusetts Institute of [email protected]



Portfolio Planning Process

An oft-used concept in portfolio management is that of balance, a means by which a firm can achieve itsfinancial objectives in a world of competing demandsand incomplete information. From one side, you have theflow of opportunities, which arrives as a result of your overall innovation process. In process parlance, this flowcorresponds to a push — the arrival of these opportunities

is not triggered by the need for them (demand) but bytheir availability (supply). The second flow, from upper-level managers, moves in the opposite direction. Unlikeinventors and project managers pushing opportunitiesforward and hoping for resources, here you confront a pull. Top managers see gaps in the current portfolio and want them addressed. They try to pull them through the process.

Complicating matters, innovators also have to find a balance between using their existing strategies to assessopportunities and exploring the possibility that innova-tions can enable them to redefine their strategies. Takingexisting strategy as given and using it to shape the inno-vation portfolio is often referred to as a top-downapproach to managing an innovation portfolio, while

using innovation to redefine a strategy can be thought ofas a bottom-up approach as seen in Figure 1.

Given this balancing act, any portfolio-planning processwill always require some iteration, and it is unlikely thatyou will immediately find a perfect balance between thecompeting strategic demands.

Despite the necessary improvisation, we believe that portfolio planning can be executed with the same meth-odological rigor that applies to other parts of the innova-tion process. We will outline a portfolio planning process(Figure 1) and provide a toolbox for applying it. Notevery tool will work for everyone. But used as needed,these tools will help you address the five basic tasks,listed below, that are critical to building your portfoliostrategy. The tools outlined in this paper will help you to:

• Identify current gaps relative to business strategy.Tools such as the traffic-light method and analysesof your technology position and product and serviceattributes can help you identify gaps and the need forinnovations.

• Identify future gaps. — Based on expected changes iyour business environment, you can envision future

Figure 1. — The portfolio planning process balances the supply of new opportunities (push) with the demand for

opportunities reflecting current portfolio gaps (pull). It also balances the top-down perspective of portfolio planning with the bottom-up perspective.



gaps. Tools such as scenario analysis and technologicallife cycles help you to identify these gaps and anticipatethem in your planning.• Balance between strengthening your current strategic position and exploring future strategies. — Decide on theextent to which you want to lead in the exploration of new markets or technologies. A firm aiming for leader-ship needs to allocate a larger part of its innovation

budget to opportunities with high uncertainty (opportu-nities so risky that you cannot even consider a formalfinancial valuation). The strategic-bucket framework helps to allocate resources across the different horizons.• Create the innovation portfolio for each horizon or strategic bucket. — Based on your opportunities with lowuncertainty and medium uncertainty (i.e., opportunitiesassociated with risks that are hefty enough to prompt thecancellation of the project during either development or following launch), aim to create a portfolio with thehighest potential financial value. Add a set of high-

uncertainty opportunities to strengthen your future position or hedge against changes in your industry.• Seek opportunities to redefine strategy. — Alwaysexplore the extent to which you can redefine the compe-tition in your industry. Analyzing dimensions of meritand identifying discontinuous change help you decidewhen you should redefine your strategy.

In the remainder of this paper, we outline how to accom- plish these five tasks. We shall then discuss two portfoliotools that are commonly used in practice and point totheir shortcomings.

Identify Current Gaps In Business Strategy

When formulating your innovation strategy, it can behelpful to ask some basic strategy questions ( 1 – 3).• Who are your target customers?• What products or services do you offer?• Why do customers buy your products or services and what value proposition distinguishes you from competi-tors?

• How do you create a product or service that meets thisvalue proposition and what is your competitiveadvantage?• What if a specific change in the competitive environ-ment happens?

The answers to these questions will give you a good picture of your firm ’ s strategic intent as top managementdefines it. Unfortunately, this intent might not — in fact, itoften does not — correspond with the current realities of the market. We live in a rapidly changing world.

Products or services that once led the market can quicklyfall behind and markets that once grew quickly can

plateau. This creates a set of gaps that require innova-tions to close them. The following three tools are helpfulin identifying these gaps.

1. Evaluating your current competitive position

Start the search for gaps in your portfolio by mapping outthe strategic position for your most important product or service offerings. The following simple “ traffic lighapproach is one way to visualize your current position(Figure 2).

The rows in Figure 2 correspond to ABB ’ s product lineThe “ market position ” column is black where thcompany is the market leader, gray where it is one of thetop five players, and white otherwise (to extend thetraffic-light analogy, make the colors green, yellow and red). The “ technology position ” column evaluates yotechnology relative to competitors ’ offerings. Here, thcriteria are specific to ABB, with its emphasis on tech-nology leadership. A consumer-product manufacturer might use “ brand position ” instead of “ IP (intellectu property) position. ” In other words, the criteria shoulreflect your business strategy by defining relevantmarkets and outlining the areas in which you seek competitive advantage.

Once you have identified areas of concern, dive into thedetails. As a next step, you need to tease apart the productor service ’ s essential characteristics in one of two waysYou either evaluate its technology positions by breakiit into its component technologies (or a service processinto sub-processes), or you can evaluate its attributes breaking up the product into a set of product features bytaking the customer ’ s perspective. Depending on thresult of the traffic-light analysis as well as your businessstrategy, you can use either of the two approaches or both.

2. Evaluating the current technology position

Figure 3 shows how ABB breaks up its product offeringsinto nine technologies, including “ conduction and ins

The “traffic lighapproach is one w

to visualize youproduct’s currentposition.



lation, ” “ switching ” and “ power electronics. ” Two of them are differentiating technologies ( b and i), ones thatdistinguish the firm from its competitors, three others areenabling technologies ( a, f and h), ones that ABB needs but that competitors also have, and the other four, shaded half gray and half white, fall in between the two catego-ries.

When doing this sort of analysis, compare your capabil-

ity in each technology with its importance to your strategy. This leads to the natural question of how youmight move some of the bubbles into the upper-rightquadrant of the box. For a differentiating technology,that might entail further investment in research. For anenabling technology, it might require partnering with asupplier to limit the cash outlay.

3. Evaluating offerings from customer ’ s perspective

Instead of examining product offerings from an engi-neer ’ s perspective, you can also eye them from the cus-tomer ’ s point of view. A customer does not care whichkind of battery powers her laptop. She just wants themachine to run without a recharge through a trans-Atlantic flight. She cares about attributes, not novel tech-nologies.

Again, compare the importance of an attribute withcurrent performance. The latter is typically measured based on customer satisfaction surveys, competitive benchmarking, and other forms of market research.Figure 4 summarizes this approach for the educationalofferings of a major business school. Former students saythe school effectively covers dealing with ethicaldilemmas, building effective relationships, and strategicimplementation, but pays insufficient attention tostrategic thinking and integrated business perspectives,to name a few examples. As with the technology-basedanalysis, attribute-based onesquickly identify gaps in thestrategic position of the firm.

Identify Future Gaps in Strategic Position

In addition to closing existing gaps, you also want toanticipate future gaps in your strategic position. Innova-tion can do this in two ways:• Innovations can explore newly emerging markets and technologies and allow you to benefit from their growth.In mature markets, you can also investigate opportunitiesto delay the decline of a technology or even to rejuvenatea product lifecycle.

Figure 2. — For each product line or serviceoffering of the firm, we evaluate the current strategic position with respect to a set of criteria. This can be visualized using different shades or colors, including, ideally, the green, yellow and red of a traffic light.

Figure 3. — For each technology, the companyassesses both its capability and the importanceof that capability. Gaps can be spotted if differentiating capabilities are not in theupper-right corner. Two of them aredifferentiating technologies ( b and i ), threeothers are enabling technologies ( a, f and h ),

and the other four, shaded half gray and half white, fall in between the two categories.

Figure 4. — For each attribute the customer considers when purchasing the product or service, the firm compares its current position(as assessed by customers) and the importance

of that attribute. Gaps can be spotted byattributes in the lower right of the graph.



• Innovations can help you protect your strategic position with respect to future changes in your market.

Assessing the long-term attractiveness of markets

Industries follow lifecycles that are often described asS-curves. Almost every new market segment starts withslow growth early on, followed by an exponentialincrease, and then matures and sees sales stabilize or

decline. This trajectory has two implications for innova-tors: 1) you want to ensure that you identify and innovatein growth markets as opposed to mature or decliningones; and 2) you must understand how your innovationactivities must change over an industry ’ s lifecycle.Figure 5 shows the trajectory of music album sales over the last three decades. Initially, music was sold on bigdisks of black plastic. Technology changed, and turn-tables were replaced by tape recorders, which in turnwere replaced largely by compact disk players. At the beginning of the 21st century, CD sales are falling (thoughstill high in absolute numbers), and online music distri-

bution through outlets like iTunes has begun to take off.In most cases, an individual company cannot resist therise and fall of a technology. Industry lifecycles haveunderlying trajectories that no amount of smart planningor prudent investment can change. Sony, for example,may have wanted to continue to distribute music only on8-track tapes, but to do so would have been a deathsentence. At the beginning of the 21st century, no largeentertainment company can afford to ignore online dis-tribution.

The role of innovation also changes as an industrymatures. Each stage offers new challenges for theinnovator as follows ( 4,5):

• Embryonic phase — A characteristic of this period ithe absence of a dominant design. No technologicsolution has established itself as a standard. In such asetting, you should make several small bets unless yourfirm has sufficient market power to dictate the dominantdesign.• Growth phase — Once a dominant design has emergedthe amount of uncertainty falls. Along with the dominantdesign, a dimension of merit — a set of attributes thcustomers prefer — emerges. The focus of your innovation should become enhancing performance along thedimension of merit, using the gap identification tooldiscussed above.• Mature phase — The focus of competition shifts morand more to the efficiency. Firms fight to gain scale anddiversify their offerings to appeal to different marketsegments, yet they share a big chunk of common tech-nology. The automotive industry, for example, hasmanaged to stay in this phase for almost a century.• Declining phase — As an industry ages and sales dropyou slow your investment in innovation. You continue tofocus on efficiency and also experiment with new products that have the potential to shift the dimension ofmerit and redefine the industry. If this succeeds, a newlifecycle starts, and the industry is reborn.

Evaluating portfolio robustness

Innovations help you to prepare for an uncertain future.Most firms are exposed to all manner of uncertainty:fluctuating supply prices for inputs, aggressive moves bycompetitors, regulatory changes, and the emergence of formerly unimportant regions as key markets. By sys-tematically making bets across a range of possiblescenarios, you can close future gaps before they open.When Toyota developed the Prius, with its gas-electrichybrid engine, for example, the company took a bet onrising oil prices and global warming — a bet that looklot more attractive today than when Toyota began itseffort. Yet, the company also prepared for a low-oil-price

future by maintaining a full line of burly SUVs andtrucks.

In most cases, anindividual compa

cannot resist atechnology

’

s riseand fall.

Figure 5. — Most products experience a sales pattern like that illustrated here. Sales areinitially low and then accelerate quickly.Ultimately, the market saturates, and salesdecline again. If, instead of looking at per-year sales we look at cumulative sales, we see anoverall S-shaped curve. Data provided by the

Recording Industry Association of America(RIAA).



You improve the robustness of your firm ’ s strategy and innovation portfolio by first creating a list of uncertain-ties such as those listed in Table 1, which shows the biggest sources of uncertainty for a European utilitycompany providing electricity and gas to households and industry.

Typically, you can group the uncertainties into a smaller set of scenarios, each describing a potential futuresituation. From an innovation perspective, you want toensure that you are reasonably prepared for each of themost likely scenarios. You therefore analyze how each

market will pay off under the various scenarios. SeeTable 2 for an example of how to do this. You list yourcurrent product offerings in the rows of the matrix andthe scenarios in the columns. For each product, you sub- jectively rate your likely payoff from each scenario. Bythen eyeballing a column, you can identify whichscenarios entail the biggest threats.

One does not need to be the CEO of a utility company tosee the implications of Table 2. The company is in a perfect position — but only if the future looks exactly likethe past. The three alternative scenarios are likely to leadto a dramatic drop in income. In other words, thecompany places a huge bet on the status quo and is no prepared for change.

How can innovation help the company? It needs tosearch for opportunities that either have good payoffs

across all scenarios or are attractive only for the oppor-tunities in which it seems weak. Analyzing the robust-ness of the current portfolio thus helps us to identify a setof future potential gaps and address them before theyarise. Therefore, it is important to know what the biggestuncertainties in your industry are and how well prepared you are to handle each of the scenarios you set for yourservices or products. Do you explicitly search for oppor-tunities that could help to hedge a weak position?

Strengthening Current Position vs. Exploration

In our forthcoming book, Innovation TournamentsCreating, Selecting, and Developing Exceptional Opportunities, (Harvard Business School Press, 2009)we describe another innovation process wherein youclassify your opportunities according to their novelty intechnology and markets. This classification enables youto compare opportunities of different uncertainty levelsand thereby create tournaments (collective comparisons)of similar opportunities.

In light of the different methods of selecting opportuni-ties for low uncertainty and medium uncertainty versus

high uncertainty, you cannot create a single portfolio-optimization algorithm that allocates resources for inno-

Do you explicitsearch for

opportunities thacould help to heda weak position?

Table 1.—Scenarios Are Formed by First Listing Major Uncertainties and Then Grouping Them into a Handful

of Scenarios ( 13)

Uncertainties

Scenarios

A : S t a t u s Q u o

B : E x i t O u t o f

N u c l e a r P o w e r

C : M u c h H i g h e r

E n e r g y P r i c e s

D : I n c r e a s e d

C o m p e t i t i o n a n d

M a r k e t E n t r y

1. Increase in oil prices X2. Political change with

environmentalists in thegoverning coalition X

3. Technical problemswith a nuclear plant X

4. European communityrequires a separation

in ownership between power plants and the power grid X

5. Open Europeanenergy markets X

6. Renewable energysources become profitable X

Table 2.—The Payoff Matrix Evaluates the Position of Each Product or Service Offering under Each Scenario.

This Helps to Evaluate Your Firm’s Overall Risk

Exposure. Pluses are Positives, “o” is Neutral and Minuses are Negative

Uncertainties

Scenarios

A : S t a t u s Q u o

B : E x i t o u t o f

N u c l e a r P o w e r

C : M u c h H i g h e r

E n e r g y P r i c e s

D : I n c r e a s e d

C o m p e t i t i o n a n d

M a r k e t E n t r y

Electric homes ++ − o −Electricity to industry ++ − o − Natural gas to homes ++ o − o Natural gas to industry ++ o o −



vation across all levels. Instead, you allocate resources inthree steps:

1. Define a set of innovation domains, or strategicbuckets, each corresponding to a combination of marketand technology novelty.

2. Allocate resources across the buckets, reflecting their importance in supporting your business strategy.

3. Select the best opportunities within each bucket.

This idea of the strategic-bucket framework is illustrated in Figure 6. In the case of an established automotivecompany, the nine combinations of market and tech-nology novelty are grouped into three buckets, corre-sponding to our three levels of uncertainty. Existinginnovations (low uncertainty) such as improvements in painting or tweaks to existing models receive 60 percentof the company ’ s innovation resources. Adjacent oppor-tunities in relative markets and improved technologies(medium uncertainty) get 30 percent. And new opportu-nities (high uncertainty), such as a one-person trans- porter, an experimental fuel cell or an emerging market,

receive the rest. No exact science underpins the creationof strategic buckets.

The strategic-bucket framework helps firms to achieve a balance between protection of their current position and the creation of future options. It has three strengths:

First, by simply mapping out all current innovationactivities in the firm, you can quickly spot the obvious,yet common, mistakes of either focusing too much on thedistant future by investing in “ cool ” technologi(common among engineers) or investing mostly in line-extensions without making the small but critical bets onthe future ( 6 ).

Second, the bucket framework dovetails with a top-downapproach to innovation and thus supports overall business strategy. Bucket sizes are based on the firmgrowth strategy and on the previously identified gaps inthe innovation portfolio. No general rule about the“ optimal ” bucket sizes exists — it crucially depends owhich strategy you pursue. Your firm ’ s strategies fgrowth and innovation have to be aligned. You cannotexecute a strategy such as “ provide the latest technolog

Figure 6. — A firm should consider opportunities in familiar areas (lower left) but also

explore new territory, thereby creating options for future strategic moves. Project examples for a large automotive firm are shown in italics.



for home entertainment ” if all you do is incrementalinnovation. Your innovation portfolio would have largestrategic buckets for developing new technologies. So asa by-product of the bucket approach, you find additionalgaps in both current and future strategic positions.

Third, the strategic-bucket framework ensures theapples-to-apples comparison of opportunities. Instead of comparing the opportunity to explore emerging markets

with improvements in the paint shop, you compare theexploration of fuel-cell technology with, say, the possibility of a purely electric vehicle. Of course, this third advantage is also a weakness of the bucket framework. Itrequires that the resource allocation for each strategic bucket be made independent of the opportunitiesavailable for funding in other buckets. Consequently, amarginal opportunity in bucket 1 might be funded whilean attractive one in bucket 2 gets postponed or ditched.

Create a Portfolio for Each Strategic Bucket

After defining the strategic buckets, you have to “ fill ”

them with opportunities. To do this, you have to factor inthe interdependencies among opportunities. The mostimportant interdependencies are:• Market cannibalization. — If you target four opportu-nities in the same market, you typically will notquadruple the market ’ s revenue potential. Despite thesuccess that Pixar had with its movie Finding Nemo, it isunlikely that it also could have launched Finding Sam,the story of a small camel lost in the desert, in the sameyear and seen equal success. This partly explains why wecannot define the most valuable portfolio by simply picking the opportunities that seem most valuable inisolation.• Resource use and financial targets. — Multiple oppor-tunities might require access to the same scarce resource.If you fund many opportunities using this resource, someof them might have to be delayed. A drug maker, for example, has only limited capacity for analyzing the datafrom clinical trials unless it finds a way to temporarilyhire an army of biostatisticians and pharmacologists.Likewise, you want your innovations to support a smoothcurve of sales growth rather than have it zigzag unpre-dictably.

Sensitivity to these interdependencies means keepingyour eyes on the value of the entire portfolio as opposed to jumping too quickly into opportunities that appear financially attractive in isolation. At times, the objectivesof closing current or future gaps in the innovation portfolio and maximizing financial value might conflict.The most financially attractive portfolio might not lineup with your strategy. And the role of management, of course, is to create value, not to blindly follow a strategy.

As an illustration of this point, consider the erectile-dysfunction drug Viagra, a big win for Pfizer, but one

that happened by accident. Pfizer discovered the drugsexual effects during clinical trials for the treatment ofanother problem. Once confronted with a compound likeViagra, what should management do? Stick to its initialstrategy or adjust course and collect a jackpot? Think ofinnovation as a search for gold. Would you walk awayfrom a mine discovered by accident simply because your exploration strategy had told you to dig elsewhere?

Pfizer did not, and its shareholders were grateful —

evif most of the world by now is tired of Viagra spam in our email inboxes.

The Bottom-up Force

Why would you want to consider innovation opportuni-ties that do not mesh with your business strategy? After all, does your CEO not have a vision that all of your inno-vation activities support? The weakness of a top-downapproach is that it suffers from the Soviet syndrome:eventually, discrepancies arise between your plans and the realities of the world. Research has repeatedly shownthat firms often stick with a strategy for too long. Theyare like the driver who falls asleep behind the wheel andmisses the right exit. Their strategies tend to be biasedtoward fighting for share in established markets andignore innovations that might lead to the creation of new,uncontested markets. From your last five successes(failures), how many were top-down and how many were bottom-up?

Sticking to your strategy for too long

To see why it is dangerous to stick to a strategy for too

long, consider the data provided in Table 3; it comesfrom a study of the disk-drive industry ( 7 ). Over tdecades, the main markets for using disk drives shifted from mainframe computers, to workstations, to desktopPCs, to laptops and now to the music players such as theiPod.

The startling thing about this history is that every timethe main market for disk drives shifted from one appli-cation to another, most firms died. Technologies thatonce were capabilities became rigidities ( 8), and treasons for the incumbents ’ prior successes became mill

stones dragging them down. This paradox is oftenreferred to as the Innovator ’ s Dilemma (7 ). Note th

A firm’ s strategiesfor growth and

innovation have be aligned.



some of this dilemma can be avoided by using the future-gap analysis discussed above.

Fighting in dying markets

As industries mature, products become commoditized and margins shrink. This often accompanies a decline intotal industry sales, leading to overcapacity and pricewars. Instead of fighting for share in a dying market, you

need to find ways to redefine the industry and move it toa new lifecycle.

A second look at Figure 5 offers an interesting insight.When the music industry moved from cassettes to CDs,incumbent music publishers anticipated the change: CDswere showing substantial sales by the time cassette sales peaked. But the publishers do not seem to be managingtransition from CDs to online distribution as deftly. Thatmay be because a CD is sold in the same way that acassette is: in both cases, publishers were selling small plastic boxes in bricks-and-mortar stores. When online

distribution began, the dimensions of merit changed fun-damentally.

The value map is one tool we can use to search for a potential shift in the dimension of merit and thereby jump out of the existing battle for market share ( 9).Consider the example of the iPod, which Apple intro-duced in October 2001. At that time, Diamond Multime-dia ’ s player, the Rio PMP300, already had been on themarket for more than three years. Like almost all of itscompetitors, it consisted of a piece of flash memory thatwas able to hold 10 to 30 songs. The industry had com-moditized relatively quickly, bringing pressure tocompete on price. None of the players had been able todifferentiate themselves.

With the iPod, Apple launched a music player thatviolated the conventional wisdom of the industry. It waslarger, heavier and, with a $400 price tag, triple the priceof competing products (See Figure 7.). Yet, it could hold

1,000 songs and had a very fast PC connection and outstanding music management software (now known aiTunes).

Apple ’ s move fits an innovation approach called the BOcean strategy (10); instead of battling in the existin

market and competing on price, Apple redefined whamattered in music players. The iPod ’ s success is wknown. Less known is another part of its history: unchar-acteristically for Apple, the company did not develop the player in-house. It used a Toshiba disk drive and basethe iPod software on a platform developed by PortalPlayer. The music management software was developed by Pixo (11 ).

At the time, music did not seem to fit Apple ’ s strategycreating high-end computers for professionals andeducators. But it was simply time to change that strategy,

and some relatively small high-uncertainty investments(again, most of the work was outsourced, licensed odone by freelancers) created the option for the move.

Bottom-up moves to redefine strategy by shifting a valuecurve are always risky. They may appear brilliant inhindsight, but like any innovation strategy, they have to be ana ly zed th ro ug h yo ur pl annin g pro ce ss anevaluated beside other equally risky investmentstypically in your high-uncertainty strategic bucket.

For every iPod, or any high-uncertainty opportunity, youcan find dozens of failures. High-uncertainty opportuni-

ties are not silver bullets and —

despite what consultanand academics sometimes suggest — Blue Ocean stragies do not guarantee successful innovation. As wdiscuss in our forthcoming book, the evaluation anexecution of these opportunities should focus on tryingto understand and resolve uncertainty, not hitting jackpot.

Bottom-up innovation leads to entrepreneurial thinking

The third and final benefit of the bottom-up approacrelates to an obvious motivational effect. People do no

innovate on command. Ideas can germinate by accidentand creative employees may toy with ideas for opportu

Research hasrepeatedly shown

that firms often stwith a strategy fotoo long.

Table 3. — A Study of the Disk Drive Industry Shows That Whenever Drive Technology Moved to a Smaller Size

(Here from 8 to 5.25 Inches) and the Major Buyers of Drives Shifted (Here from Microcomputer to PC Makers)Companies Stuck with Their Old Customers and Old

Technologies for Too Long. Table from ( 7 )

Attribute 8-Inch Drives 5.25-Inch Drives

Target Market Microcomputer Desktop PCCapacity (megabyte) 60 10Physical volume

(cubic inches) 566 150Weight (pounds) 21 6Access time

(milliseconds) 30 160Cost per megabyte $50 $200Unit cost $3000 $2000



nities without even informing their managers. Youdestroy a culture of innovation like this by overempha-sizing the top-down approach. Companies such asGoogle or 3M leave their employees a certain amount of slack time with which employees can explore their ownideas.

Two Common Approaches(and Their Shortcomings)

Two other portfolio tools are widely used: POS chartsand the BCG matrix. However, while it lies in the natureof portfolio tools that they cannot be right or wrong per se, we caution against their usage.

POS charts

Many companies rely on graphical ways to visualizetheir potential financial investments in innovation.Figure 8 provides an example of such a portfolio graph based on a set of pre-clinical compounds considered atMerck ’ s research labs.

The portfolio chart shows the probability of success(POS) on the x-axis and the reward for a success on they-axis. We obviously like innovations that are in theupper right of the picture because we prefer to have ahigh chance of getting lots of money over a low chance atlittle money! The fact that this interpretation is rather obvious illustrates the first shortcoming of such graphs.They really provide us with little additional informationrelative to reporting the possible returns and the prob-abilities of success and then multiplying these two valuesto obtain the expected returns. The other shortcoming isthat portfolio charts do not capture the interdependencies

among the opportunities —

and, thus, they really miss thefocal point of portfolio management.

BCG matrix

Probably the most widely known framework for portfolio planning is the BCG-matrix, made famous bythe Boston Consulting Group. Books have been writtenabout portfolio planning, and every business studentlearns to laud “ stars ” and “ cash cows ” and dism“ dogs. ” While the matrix itself is static — it does ninclude a timeline — it implicitly embraces an innovationtrajectory. Innovations start out as question marks. Youinnovate in new or attractive markets but initially havelittle market share. Some of the markets you serve may become stars; others may end up with the dogs. Evenstars at some point reach maturity and then become cowsthat you milk for cash. Eventually, an industry will enter its death throes, and you will stop investing in innovationand exit. BCG ’ s framework provides an easy way to mapyour market positions.

The BCG matrix attempts to capture a dynamic phenom-enon: the emergence, growth, maturation, and decline of

Figure 7. — The big difference between the iPod and the competing MP3 players along the three attributes on the right suggests that the iPod created another dimension of merit, making the introduction of the player a “ Blue Ocean strategy ” move. Note that alow relative position for weight corresponds to a heavy device. Similar logic applies toaffordability in this exhibit.

Figure 8. — POS charts are commonly used to

visualize the probability of success (POS) and the associated pay-offs.



markets. However, it does so without actually showing atemporal dimension. For this reason, we find it to bemore effective to map out the industry life cycle directly(see above).

Consider the situation faced by the U.S. whaling fleet inthe 19th century. In whaling ’ s 1835 – 45 heyday, millionsof homes used the clean, warm, even light of sperm-oillamps andcandles (an example of the distantpast, yet, we

believe, one with high current relevance). As illustrated in Figure 9, the U.S. sperm oil production peaked around 1840. At that time, sperm whales got scarcer and other species of whales were hunted instead, leading to a peak in whale oil production around 1850. However, with“ town gas ” and “ coal-based oil ” kerosene, two verydifferent competing technologies emerged. It took lessthan 10 years for the U.S. to almost fully abandon whale- based oil for illumination ( 12). What once were cashcows (or maybe “ cash whales ” might be more appropri-ate) turned into dogs.

Of course, the success of kerosene-based lamps did notlast long either, and in 1879 Edison ’ s electric lampstarted its way into U.S. households. Once again, whathad originally been cash cows turned into dogs. Whatcould a firm active in the market around 1850 have donedifferently? The companies in the industry failed toexperiment with high-uncertainty, radical innovations —

specifically, new technologies (non-whale-based oils,electricity-based lighting) — serving their existingmarkets.

By the time your cash cow has turned into a dog, it is toolate for corrective management action. Thus, in additionto using the lifecycle mapping, we recommend using the

strategic bucket framework and the robust portfolio planning tool. These tools are especially important as anindustry matures and is threatened with disruption in thesame way that electric lamps disrupted the years of prof-itable growth for our whale hunters.

Summing UpStructured planning helps to identify gaps in your inno-vation portfolio. It is the starting point in any top-downstrategy implementation. You can identify gaps usingtools such as the traffic-light method or an analysis ofyour firm ’ s technology positions and product attributes.Smart innovators strive to see future potential gaps, too.Scenario analysis helps to spotlight changes in yourindustry for which you are ill-prepared. An industry/market life cycle analysis can ensure that you are activein growing markets. The strategic bucket framework helps to balance incremental innovation with the explo-ration of future opportunities.A firm ’ s strategy is not carved in stone: innovationopportunities can help to redefine your strategy. Even

Innovators canno just take

orders fromsenior managers

Figure 9. —

U.S. sperm oil production peaked in 1840, followed by whale oil 10 yearslater. Graph reproduced based on (12).



successful companies stick to their strategy for too long,and too often they are biased in their strategy formula-tion. They fight for a larger share of the current marketand fail to see the opportunity for creating new, uncon-tested spaces.

Innovators cannot just take orders from senior managers.Instead, innovation activitiesand corporate strategy mustfeed off each other through dialogue. The process

outlined in this paper and an information flow consistingof the push and pull of innovative ideas as well as top-down and bottom-up analysis can provide the foundationfor that dialogue.

References and Notes

1. For an elegantway of articulating a business strategy based on a setof simple questions, see Markides, C. C. 1999. A dynamic view of strategy. Sloan Management Review, Spring, pp. 55 – 63.2. For an excellent application to the R&D setting, see A. DeMeyer and C. Loch 1996. Chapter 2: Technology Strategy, ” in Handbook of New Product Development Management, C. Loch and S. Kavadias,eds. Hoboken, N.J.: Wiley.

3. Loch and Tapper also use the Markides framework and show howone can translate the business strategy into an R&D strategy. Loch,C. H. and S. Tapper. 2002. Implementing a Strategy-Driven Perfor-mance Measurement System for an AppliedResearch Group. Journal of Product Innovation Management Vol. 19, August, pp. 185 – 198.4. For an excellent discussion of this topic, see DeMeyer, A. and C.Loch. 1996. Chapter 2: Technology Strategy, in Handbook of New Product Development Management, C. Loch and S. Kavadias, eds.Hoboken, N. J.: Wiley. The initial research in this area goes back to

Abernathy, W. J. and J. M. Utterback. 1978. Patterns of IndustrialInnovation. Technology Review, June/ July, pp. 41 – 47.5. Moore ’s recent work discusses how several industries evolveMoore, G. A. 2005. Dealing with Darwin: How Great Companie Innovate at Every Phase of Their Evolution. New York: Portfolio6. For more discussions on this topic, see Wheelwright, S. C. andK. B. Clark. 1992. Revolutionizing Product Development: Quantum Leaps in Speed, Efficiency, and Quality. New York: Free Press. AlCooper, R. G., S. J. Edgett and E. J. Kleinschmidt. 2001. Portfo Management for New Products, 2nd ed. New York: Perseus BookGroup.7. Christensen, C. M. 1997. The Innovator ’ s Dilemma: When NTechnologies Cause Great Firms to Fail. Boston: Harvard BusineSchool Press.8. See Leonard-Barton on the concepts of core capabilities and corerigidities and their implications for innovation. Leonard-Barton, D.1992. Core Capabilities and Core Rigidities: A Paradox in Managing New Product Development. Strategic Management Journal VolIssue 5, pp. 111 – 125.9. For a more detailed discussion of value maps (although any goodmarketing textbook should offer the same methodological insights),see Kim, W. C. and R. Mauborgne 2005. Blue Ocean Strategy: Hoto Create Uncontested Market Space and Make Competition Irrel-evant. Boston: Harvard Business School Press.10. The term “ Blue Ocean Strategy ” was coined by Kim aMauborgne to reflect an uncontested market space (see ref. 9).11. Wikipedia, “‘ iPod ’ , ‘MP3 players ’ ,” Wikipedia, the free encycl

pedia website, h t tp : / /en .wikipedia .org/wiki / Ipod, h t tp : /en.wikipedia.org/wiki/Mp3_player, accessed July 2007.12. This example is takenfrom A. B. Lovins, et al. 2004. WinningOil End Game. Rocky Mountain Institute. The original referencquoted in Lovins, et al. is Goode 1887.13. For an excellent treatment of scenario analysis and the implica-tions for strategy, see Schoemaker, P. J. H. 1995. Scenario Plannin A Tool for Strategic Thinking. Sloan Management Review, Winte pp. 25 – 40.

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