Long-Term Success requires a focus on Horizon Two
With the publication of The Alchemy of Growth in the 1990s, Mehrdad Baghai and his colleagues from McKinsey & Company educated us to view portfolio management as having three time-horizons. Irrespective of the type of organisation, at different points in an economic cycle, it’s useful to have a framework for analyzing the mix and balancing investments wisely. Business strategists tend to think in portfolio terms.
For McKinsey & Company, Horizon 1 corresponds to managing the current 12 month reporting period, with all its short-term concerns; Horizon 2 refers to onboarding the next generation of high-growth opportunities in the pipeline and Horizon 3, to incubating the seeds that will sustain the organisation far into the future.
This time-horizon approach is particularly valuable for executives trying to ensure that the enterprise will endure and grow over the long term. There are no shortcuts and a successful strategy requires this The Law of the Farm approach. The rate of change in the marketplace now increases the risk for enterprises to be caught off guard. Management assumes its mistake was in failing to invest sufficiently in Horizon 3 projects. Frequently, that turns out not to be the case. It is Horizon 2 that is the point of concern.
Consider technology companies Kodak, Wang, Digital Equipment Corporation, AT&T, Xerox, Sun, Polaroid and others who lost their way over the past three decades, and others. None of them abandoned their ambitious and futuristic R&D agendas. They all invested for the long term, many brilliantly so. The issue was none of these companies could bring their long-term investments to fruition. That is, they were unable to move their businesses from Horizon 3 through Horizon 2 to Horizon 1. Is your organization suffering from a similar Horizon 2 vacuum?
A reliance upon an ageing portfolio, hoping to be rescued by next-generation offerings that seem to float forever just out of reach, is a dangerous position and executive need to recognize the business dynamics that placed the enterprise in this position. How does management counter the devastating effects of these dynamics on otherwise promising innovations? Let’s examine the common problems that make intervention necessary and how to extend and perpetuate its enterprise.
Neither one thing nor the other
The first thing to recognize is that Horizon 2 lies in a kind of no-man’s-land in the enterprise. The company’s budgeting, reporting, and management processes all focus on the current fiscal year—with compensation and incentive systems underscoring accountability for it. Financial reporting to investors forces an even more myopic concentration on the current quarter. It is Horizon 1 that stakes major claims on time, talent, and management attention.
Periodically management extracts themselves from day-to-day concerns in order to contemplate their long-range strategic options. With reference to analysts and research data, they draft multiyear plans and make long-term investments. In particular, the capital expenditure process in asset-intensive businesses ensures that Horizon 3 gets significant attention over the course of a year. This results in too little time and management attention for goals that are short of long-term but not contained in the budget year. Such projects are strategic but not yet material and tend to fall off the radar.
Intolerable contempt to nurture innovations
Horizon 2 problems commence in Horizon 3 with inventor behaviour who take no responsibility for building a stream of business to a level where operations could take it over. In their defence, their job is to stay on the leading edge. Nor do they typically have the skills required for entrepreneurial deployment. As a result, genuinely valuable opportunities go nowhere. The innovation produces massive returns for everyone but the sponsoring enterprise.
Executive often recognizes the organization’s tendency to shun offerings that are not quite ready for prime time and tries to fix the problem by mandating that they be sold to customers, exploiting their novel appeal to get meetings with current customers, only to, at the end of the day, sell more of the established Horizon 1 products and services. When initial sales are sluggish, the situation quickly becomes critical, because Horizon 2 offerings can’t pay their way.
Think of Horizon 2 offerings as the adolescents of the business world. As they’ve matured from PowerPoint to Release 1.0, they’ve acquired all sorts of blemishes. No longer darlings with limitless potential, they aren’t indulged like the babies of the family, the Horizon 3 projects. But they are still dependents. Whether or not it is explicitly acknowledged, they are subsidized by sponsors who extract resources from Horizon 1 operations sharing the same quarters.
That benevolence evaporates when Corporate calls on these resources to help meet its Horizon 1 commitments. Periodically, the pressure is on to route all the returns gained through ever more efficient Horizon 1 operation straight to the bottom line instead of using them to nurture Horizon 2 projects. This, of course, is a cycle that is hard to break once it has begun. Every target met by extreme measures only increases the need to route future savings to the bottom line. Struggling to make the current quarter’s numbers, enterprises effectively bleed their Horizon 2 innovations dry.
All these are forms of organizational neglect, but the problem can spill over into organizational aggression when Horizon 1 managers engage in resource hoarding. Compelled to make bigger and bigger numbers with offerings that are less and less differentiated, they become expert at securing the funding and personnel necessary to do so. A favourite method: stealing from Horizon 2 projects. It may be difficult for Horizon 1 people to commandeer resources that are explicitly dedicated to Horizon 2 projects, but those projects, like their older brethren, also depend on getting their portion of various shared resources such as IT, marketing, prototype manufacturing, system testing, and customer service. To a veteran Horizon 1 manager, any shared resource is subject to pillaging.
When this happens, Horizon 2 managers cry foul, and occasionally Horizon 1 must own up to the theft. The excuse, “We just borrowed it to make the quarter’s numbers, after which we returned it”, is often accepted. Given the delicate state of Horizon 2 ventures, however, this is equivalent to borrowing something for 90% of the time you needed it.
Building relentless momentum
A Horizon 2 offering has a difficult time establishing itself in an organisation for all the reasons mentioned and requires a burst of energy to get on board and even then it is resented for the original drag it generates. As the company matures and markets commoditize, keeping speed must become more and more effective. Maintaining speed must become more and more effective as the company matures and markets commoditize. Part of that discipline is the routine slapping away of Horizon 2 offerings that threaten the steady consumption of deployment resources.
Horizon 2 projects fail to be embraced because they cannot deliver the level of Horizon 1 returns but are nevertheless held to the same yardstick. All companies have their established ways of assessing performance. Many have also devised their own methods of gauging whether research and development projects are progressing as hoped. Unfortunately, few have found a way to measure Horizon 2 efforts that recognises their challenges. Instead, companies compare these projects either with those of Horizon 1 (which are much more reliable and lucrative) or with those of Horizon 3 (which are much more inspiring). Regardless of which standard Horizon 2 offerings are held to, they fall short, and whatever organization is sponsoring them is found wanting. Such has been the fate of every pen-based tablet computer ever launched.
Thus, the advantages of in-house innovations at asset-rich corporations—access to mainstream customers, friendly capital, and a mature supply chain—turn out, for the most part, to be illusory. Innovations are better off in bootstrapped start-ups because at least there they can get access to the market and suppliers, and their investors will use fairer standards of measurement. It should be no surprise that Internet telephony languished at AT&T and thrived at Skype.
If anything could make the situation worse, it would be a talent deficit. And sadly, that is inevitable. Most sensible employees stick with the battle zone of Horizon 1 or the playground of Horizon 3. In either case, they are taken care of. Horizon 2 teams, though, are often summarily dismissed. Such outcomes lead to a form of risk avoidance, a downward slide that makes regaining the summit of performance nearly impossible.
Emerging Best Practice: Rules of the Road
This litany of dysfunctions is so prevalent in established enterprises that one wonders how any of them endure. When such momentum is managed thoughtfully and nourished with incremental innovations, it can stave off commoditization’s effects for a remarkably long time, as we have seen in sectors like wholesale distribution, transportation and logistics, grocery, and hospitality.
Once a sector has been disrupted, however, such cosy dynamics disappear. Today, in addition to technology companies, enterprises in the financial services, telecommunications, general merchandise retailing, health care, entertainment, and media industries are all under enormous pressure to innovate or else become marginalized. As a result, they are scrambling to break through the barrier point of Horizon 2.
For some time, the venture community has known that the fastest way to grow a disruptive innovation into something profitable is to focus on dominating a niche market where the new technology solves a mission-critical problem. Companies routinely go from $5 million to $50 million in revenues and build strong brands by being a big fish in a small pond. It’s the strategy I described more than a decade ago as the way to cross the chasm between innovation-loving early adopters and the risk-averse mass market.
Established enterprises, however, cannot afford to be so precise in their focus. The challenge of achieving growth atop an already huge revenue base requires them to operate on a grander scale, and all their processes, metrics, and targets reflect this fact. But these norms are toxic to Horizon 2 ventures, so it is critical to negotiate exceptions to all of them for the duration of the Horizon 2 timeline.
Focus on leaders, not funding and enforce portfolio commitments.
While many companies are generous with their funding and give their young units a more than adequate headcount, they are stingy with their experienced, make-it-happen leaders. These folks inevitably get assigned to the high-revenue opportunities, leaving the adolescent projects to fend for themselves. This normally results in a series of false starts that ultimately lead the executive team to abandon the effort in disgust. These are full-time commitments in which success is measured primarily by growth coming from a timely and effective entry into a hot market category. The company has made the job one that a seasoned manager will relish, not avoid. The scarcest Horizon 2 resource is a leader who understands entrepreneurial deployment and knows how to build a business to a level where existing operations can take it over.
Each company must decide which resources and how many it wants to invest in each of the three horizons. Once that portfolio allocation is determined, management must address the resource hoarding and poaching problems that disrupt developing Horizon 2 businesses. The worst thing you can do to a Horizon 2 venture is to be fickle in your commitments. So, it is critical to determine upfront which leaders and how much funding you want to devote to it and then stick to that resolution. When enterprises that focus primarily on making their numbers organize Horizon 2 efforts inside Horizon 1 businesses, they tacitly give people permission to rob Horizon 2 to meet Horizon 1 goals, thereby initiating a downward spiral into franchise dissolution.
Horizon thinking: A Best Practice Approach
Horizon 2 projects require customized processes, metrics, and performance targets. Large enterprises excel in Horizon 1 operations and perform effectively in Horizon 3. They fail when it comes to Horizon 2, largely because the market development and organizational management demands of fledgeling enterprises don’t match up with established corporate norms. So, what should they do?
The advice can be summed up quickly. A Horizon 2 effort must be organized in such a way that its core functions are insulated and isolated until it can produce material revenues (which, depending on the size of the company, could be anywhere from $50 million to $100 million). During this adolescent phase, such projects require customized processes, metrics, and performance targets. They also require experienced entrepreneurial leaders who can navigate both the uncharted waters of emerging markets and the highly charted channels for getting things done inside the corporation.
Finally, the CEO should call out Horizon 2 ventures specifically to give them board-level visibility. At regular intervals, their progress should be measured and communicated not in terms of revenues or global market share but in terms of niche-market metrics such as customer-acquisition velocity and fish-to-pond ratio within the targeted segments.
Do this, and over time you will find you have effectively managed for the long term. The key, it turns out, is to focus intensely on the Horizon 2 challenge. Only then will your Horizon 3 investments live to support you in Horizon 1.