Are Companies Becoming More Risk Averse in New Product Development (NPD) Decisions?

risk averseThis is an important question to consider for any company engaged in new product development. Every project is unique. Product extensions tend to be lower risk while radical, new-to-the-market products are usually higher risk. While lower risk projects are easier to manage, higher risk projects might provide a much more significant payoff if successful. In today’s economy with fierce global competition, a focus on only lower-risk projects might not be the best decision for long-term company success.

A recent Accenture study provides data that suggests companies are becoming more risk averse in their decisions related to new product development (1). This survey of 519 company executives in 12 industry sectors was conducted in France, the U.K., and the U.S. According to the study, 46% of the executives said their company had become more risk averse when considering new ideas. That may be why 64% said they were focused on product line extensions rather than big ideas. Just 27% of the executives said that introducing a new product category was a primary goal for innovation, compared to 42% surveyed in 2009.  33% of those surveyed indicated that expansion of existing product suites is their primary goal.

If you accept the argument that pursuing low-risk projects exclusively is not necessarily good for a company’s long term success, then the question becomes: Why are companies becoming more risk averse? Knowing why there is an increasing emphasis on a low-risk strategy might help management make more informed decisions. That leads to the last section of the article which will address ways that management can avoid (by default) a low-risk new product development strategy.

I believe there are five primary factors that might drive a company to become more risk averse and I describe them below. These are not necessarily in order of importance, as all five factors are related and tend to reinforce each other.

First, is the concept of the “knowledge funnel” (2). I have used this concept in other articles and it helps explain why companies tend to over time become more risk averse in my opinion. As shown in the figure below all ideas start as “mysteries”. This can relate to either a product or a process. At this stage, a company is inventing. They are struggling to make sense of a problem. At some point, engineers may develop a “heuristic”, or a rule of thumb to narrow the field of inquiry, and focus on a certain aspect of the problem.  Ultimately, every company strives to develop an “algorithm”. This allows a task or process to be done over and over again without mistakes and with a high level of quality. Moving across the stages is considered exploration or the search for new knowledge, and working within a stage is exploitation.

Knowledge Funnel

For anyone who has ever worked within any company or organization, what is the one thing that is relentlessly emphasized? It’s efficiency. We as managers strive to take every process in the business and make them as efficient as possible. We try and codify every process, whether in manufacturing, customer support, sales, etc. We purchase sophisticated software products to help us make informed, efficient decisions. With the improved computing power at our fingertips, we can now do complex computer modeling previously practical only for very large research organizations, reducing the need for multiple prototypes. All of this is meant to drive every process to maximum efficiency.

What does that mean in the context of new product development? Ask yourself this question: What kinds of projects tend to be the most “efficient”? I would contend that over time, there is a bias towards incremental projects vs. radical, new-to-the-world projects because the latter are more risky and much more difficult to manage in the today’s business environment that rewards management for being consistent and predictable. Incremental projects are much less risky and easier to manage. They are more predictable.

failureA second related factor is how we typically measure new product development success. Traditionally, projects are judged using the “triple constraint”. A project is judged successful if it 1) meets its performance targets including quality, product cost, serviceability, and manufacturability, 2) meets the schedule, and 3) meets the project cost target. In reality, you rarely can maximize all three, as one or two will likely take precedence over the others, but many organizations view projects as “successful” if they meet these three requirements. In a recent article, I proposed a better measure that takes into account other factors (3). If the “triple constraint” is the primary way an organization determines whether projects are successful or not, then there will be a natural bias, both in management and for teams, to focus on incremental projects. Incremental projects are easier to manage and less risky, and will therefore have a better chance at being deemed “successful”. The culture plays a big part in this as well, especially how management rewards or punishes teams. If teams are pushed to take risks, but are punished for “failing well”, they will be less inclined in the future to take any unnecessary career-ending risks. The problem is that over the long-term, the organization loses.

How well a company understands and manages project risk is a third factor. The risk for incremental projects tend to include normal variation and foreseeable uncertainty. These are the types of risks that most project managers are familiar with, and for which normal project management tools work just fine. More risky projects will include complexity and/or unforeseeable uncertainty, otherwise known as the dreaded “unk unks”. For anyone who has managed this type of project, a project schedule, particularly at the beginning of the project is typically worth the paper it is written on. They can be very difficult to manage, and the risk that the original project timeline slips is significant. Many senior managers push teams to take on these highly risky projects without fully understanding the ramifications, then when they fail to meet the timelines, the organization is very unhappy indeed! Again, this tends to push the organization, and particularly those in the technical organizations, to make sure they resist these types of risky projects to prevent “failure”. Again, over the long-term, the company may lose given that sometimes these risky projects can pay off substantially, not only in financial terms but the knock-on impact to other projects and the creation of tacit knowledge.

A fourth factor was cited in the Accenture article previously referenced.  Many companies who do not have robust end-to-end innovation management processes unconsciously move towards a low-risk project strategy. I believe the three factors previously described will tend to dominate the decision making if there is no process in place to manage innovation. The Accenture study found that companies with a formal process in place are twice as likely to say they are very satisfied with their initial idea generation abilities (43% vs. 24%) and 38% vs. 22% say they are very satisfied with the return on innovation investment. The study also found that those with a formal process in place are 75% more likely to believe their innovation strategy delivers competitive advantage (21% vs. 12%), twice as likely to introduce a new business process or model (32% vs. 16%), and 35% more likely to be first to market with a new product or service (50% vs. 38%). Despite the advantages of having a formalized innovation management system, on average across the 12 industrial sectors, about 38% of the respondents do not have one or it is an informal process.

Financial-CrisisA final factor that cannot be ignored and I believe has recently amplified the previous four factors, is the general global economic environment since the financial crisis of 2008. This has profoundly affected all businesses, and remains a factor today. All businesses were forced to reduce headcount, cut or freeze salaries, and generally reduce expenses including those for R&D. While businesses are generally profitable now, it is only because they have restructured their cost structure to match the existing demand, but there remains great economic uncertainty in all geographic regions for a variety of reasons that are well outside the scope of this article. The pressure for financial performance remains a steady demand of shareholders in public companies, and private companies are obviously not immune to the need for profitability, though in some cases are not as influenced by short term considerations.

The economic uncertainty is one more factor that has forced companies to become more risk averse in their new product development decisions. Given reduced headcount in all parts of businesses, including R&D, and the general defensive nature of business today, why would companies want to take on risky projects? There are a couple of data points that support this argument. First, companies are sitting on records amount of cash. According to a recent Forbes article (4) U.S. companies are sitting on a record $1.45 trillion in cash. They are not investing because of the economic uncertainty. Second, the Accenture survey already cited showed that just 27% of the executives said that introducing a new product category was a primary goal for innovation, compared to 42% surveyed in 2009. This illustrates how companies have in general become more defensive since the financial crisis of 2008.

So, if companies have become more risk averse in new product development decisions, what can be done about it? Of course, there is nothing that any company can do to impact the overall economic environment, but management can realize that the factors described above are all working together to drive companies to be risk averse. Sometimes just recognizing a problem helps management make more informed, purposeful decisions. Some of the factors, like the concept of the “knowledge funnel” are a natural outgrowth of a maturing business and might steadily influence management to become more risk averse over time, while others like the economic factors might operate on the psyche of an organization to a greater or lesser degree over time. The question that management has to answer is whether the strategy they have chosen, for instance to avoid any high-risk project, is best for the long term health of the business. While most senior managers know instinctively that they need to think long term, in many cases they act only to satisfy short term needs.

risk rewardThe “knowledge funnel” we discussed above is a very powerful conceptual model to help focus management on the need to allocate some resources to look at new “mysteries”. That translates to, for instance, embarking on some higher-risk projects where the payoff may be more uncertain. No business can survive long term by only relying on their existing knowledge. They have to generate new knowledge. If there are no resources that are devoted to looking for new knowledge and solving new mysteries, a competitor may very well be doing just that. This opens a business up to a disruption from a competitor which could dramatically impact the business in a very negative way. In the typical NPD parlance, this supports the need to have a balanced project portfolio. You need a mix of high, medium and low risk projects. The exact mix may have to consider economic realities for that business, but if the focus becomes only low-risk projects, the long term health of the business will suffer.

Another prescription is to take a more balanced approach to measuring your new product development effectiveness. In an article previously referenced (3), I proposed a methodology that incorporates not only the typical metrics of whether the project met its product performance targets, project cost target, and schedule, but other longer term metrics as well. The point is that if you measure NPD effectiveness only on short-term metrics, and reward or punish teams accordingly, then you will bias decision making to lower risk projects.

A fourth way to address the problem is to improve how project teams and the organization in general deals with project risk. Project teams and senior management must understand what kind of project risk they are dealing with and the team must choose the correct project management tools. For instance, if you have a project with significant complexity and unforeseeable uncertainty at that particular point in the project, and you are living by your Gantt chart, you are likely fooling yourself. Classical project management techniques do not work well for high levels of uncertainty or “unk unks”. Senior management needs to recognize projects with high levels of risk and not push teams to commit to unreasonable time lines. While some higher risk projects are necessary, you also don’t want to go to the other extreme and have all higher risk projects (in most cases), and do so inadvertently because the teams nor management understand the project risk. This will likely lead to missed timelines on every project, and then the pendulum will swing back the other way to all low-risk projects. It becomes a vicious cycle.

Finally, as the Accenture article points out, companies that have a formalized way to manage innovation are more likely to make more informed, purposeful decisions, rather than vacillating between all low risk and all high risk projects. An article (5) published in Research-Technology Management views “innovation as a system” and provides an excellent framework on how to think about innovation investment and the link to firm financial performance. This framework provides further evidence that a formal innovation management system is important to firm financial performance.

innovation managementWhat does having a formalized way to manage innovation mean? There are many facets, and every company will have unique needs based on the industry, technology, and culture. There are, however, some common elements. For instance, I recently wrote articles on project portfolio management and the need for a balanced portfolio (6). These articles describe the activities typically associated with the “fuzzy front end”. Other factors include a robust project definition process, using a phased development framework for managing the active projects (7), strong and empowered project managers and an emphasis on using the appropriate project management techniques given specific project risk, robust senior management involvement in the process and a culture that supports innovation, and an overall organization structure that supports effective NPD (8).

Do you believe companies in general are becoming more risk averse when it comes to making new product development decisions? Are there other factors that might lead to a company becoming more risk averse not described above? What about your company? Has it become more risk averse? What in your opinion can or should be done to avoid a purely low-risk strategy?

Notes:

(1) Accenture Study: Innovation Efforts Falling Short Despite Increased Investment. May 2013.

(2) Roger L. Martin, The Design of Business: Why Design Thinking is the Next Competitive Advantage. (Boston: Harvard Business School Publishing, 2009)

(3) For more information, see Measuring New Product Development (NPD) Success.

(4) http://www.forbes.com/sites/afontevecchia/2013/03/19/u-s-companies-stashing-more-cash-abroad-as-stock-piles-hit-record-1-45t/

(5) Patterson, Marvin L. 2009. Innovation as a System. Research-Technology Management 52(5):42-51.

(6) For more information, see Critical Aspects of Project Portfolio Management in NPD.  and The Importance of a Balanced Project Portfolio.

(7) The phased development process is not to be confused with project management techniques. Those techniques will vary based on the type of project risk. The phased development process is an overall framework to manage a group of projects and insure that they continue to make sense from an investment standpoint, that each project is meeting key milestones and deliverables, and that a management and team organization structure is defined for managing the projects. For additional information, see Is a Phased Development Process a Project Management Technique?

(8) See for instance this article on the role of a product manager, The Product Manager and New Product Development (NPD) Success.

New Product Visions is a consulting company that helps organizations improve the effectiveness of their new product development processes. We specialize in small to mid-sized companies that manufacture highly engineered products. Contact us today about how we might help you!

Specialties: NPD consultants, new product development consulting, developing new products, new product development seminars, small business consulting, new product development expert, product development process, new product development strategies, integrating NPD for mergers & acquisitions, organizing for innovation, management role in NPD, project risk analysis

2 thoughts on “Are Companies Becoming More Risk Averse in New Product Development (NPD) Decisions?

  1. Pingback: The Innovation Planning Paradox | New Product Visions

  2. You can steel yourself to risk if you are actually willing to think about it and what can happen, and realize that the downside possibilities aren t the end of the world, he says.

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