Over the horizon

I’ve spent the better part of the past two years looking at the world of technology innovation through the lens of the “three horizon model”. This is a popular model for thinking about innovation. The model comes from the shape of a graph that depicts profits over time. The graph shows a logarithmic power curve, or in plain English a hill that plateaus (the horizon). The graph models a product or business that grows profitable but then hits a point of diminishing returns. There are many possible reasons for this – competition, obsolescence, market saturation.

Three horizons of innovation

The point the model is trying to make is that without innovation, eventually a business will be unable to grow profits further. Each time an innovation is applied, the curve starts all over again, but takes off from the prior base of growth. To help think about the types of innovation necessary to achieve this, we can look at the first “three” of these curves. We could look at four, two, twenty. Three conveniently aligns with how many businesses think about strategic planning (short, medium and long) so we’ll use that.

The timeframe associated with each horizon depends on the lifespan of products in a given industry, the time it takes to get a product to market and the maturity of the target market. A first horizon (H1)  market is well established and grows mostly through competition and the sporadic breakthrough into new demographics. A second horizon (H2) market is still expanding – competitors spend more time making the pie bigger than fighting over slices. A third horizon (H3) market is yet to be proven or defined. It might be pie or it might be a hollow crust. In the case of a professional services firm, the first curve might represent 1-3 years out, the second might be 2-5 years out and the third 5-10 years out. For a resources company, these times might be double. For a media company, half.

Mixed horizons

The concept of growth horizons can be applied to any situation where growth eventually will plateau and/or decline without some external impetus. However, one can easily end up in conversations where everyone is talking about three horizons, but with different conceptual models. What a first horizon innovation or business is for one party may be second or third horizon for another. For example, transit systems in Tokyo have been using automated trains for decades. But automating trains for mining operations is still considered a third horizon innovation. The horizon isn’t determined by how edgy the technology is – it’s determined by a given business’s ability to realize and grow profit due to the innovation.

Current business thinking says that to have a sustainable growth strategy there needs to be connected innovation across all of the defined horizons. The horizon model is a continuum – successful third horizon innovations eventually get scaled up and become second horizon innovations which eventually should become core business that is either continuously improved or disrupted by the next big thing. To exploit this continuum a business needs to have a process for supporting innovation in each horizon and for moving those innovations from horizon to horizon.

The capabilities necessary to support growth are different for each horizon. For most businesses, the easiest growth horizon to support is the first horizon. This is often seen as “continuous improvement” and there are numerous general and industry-specific frameworks for achieving excellence. Past the first horizon, things get tricky. Not many businesses really understand the second and third horizons. For many, the third horizon is seen as speculative exploration and therefore an attitude of “anything goes” often prevails. On the upside, this results in edgy types of experiments that can lead to good press. On the downside, this rarely ever turns in to solid core value. The second horizon is also often misunderstood – growing a new market is incredibly tough. It’s easy for the collective leadership of a business to think that because they did it once before (growing their primary market) they can easily do it again. It’s easy to forget how many similar businesses failed where they succeeded. Research by Dan Lovallo (http://hbswk.hbs.edu/archive/3630.html) shows that business leaders are often overly optimistic about their capabilities versus those of their competitors and this is one of the biggest factors in why businesses fail.

Practice makes perfect, which means that businesses need a good supply of innovations in each horizon at all times – otherwise when that perfect H3 innovation is ready for scale up the business might not know how to do it. This means waiting for H3 innovations to make it down the continuum to H1 isn’t enough – there needs to be a good supply of H1 and H2 innovations coming from outside the continuum. For H1 ideas, experience shows that crowdsourcing from business employees, customers and partners works well. They understand the business of today – what could be better and what’s not working – and their ideas for improvement tend to be the most workable. H2 innovations often come from key business decision makers and their advisors. These are the people who are constantly studying market conditions and industry trends – critical factors in successfully scaling up. H3 often comes from people who are thinking outside the box. This could be academia, entrepreneurs or trend-spotters.

In my experience, many companies struggle with H3 but don’t realize it. They either have a bunch of wacky people running around trying “edgy stuff” or they have an oversight committee that won’t let ideas through without a clear understanding of exactly how and when the innovation will deliver revenue. By their very nature, H3 ideas rarely look disruptive to the business they’re disrupting — except in hindsight. Some companies run venture funds to try and get close to startups that have potentially disruptive H3 ideas. Others try to go on early acquisition sprees. However, few corporate cultures can withstand disruptive forces working from within. As a result, the benefits that a large company might bring to a startup (brand, access to markets) can be quickly negated by the policies, procedures and organisational mores that are explicitly designed to protect against such disruptions.

The best current examples of managing H3 innovation are those companies that are comfortable spinning-out and spinning-in. This is where a company lets its employees leave as entrepreneurs but with lots of support. If the startup is successful, the company has the ability to bring them back into the fold when they’re ready for H2 scale-up. If the startup fails, the ex-employees can come back to their previous employer with no hard feelings. When there is a success, the value of the acquired startup can be large – e.g. Google recently spun-in a spin-out for $50m (http://techcrunch.com/2010/02/11/google-acquires-aardvark-for-50-million/). There was a lot of discussion as to whether Google paid too much and would have been better off never spinning this out. It misses the point – this innovation could never have gotten as far if it had stayed in Google. Furthermore, there are many more spin-outs that Google has not acquired but which would have cost Google a large amount to pursue in-house. Once you factor in risk mitigation and opportunity cost, it doesn’t look like a bad deal at all.

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