In this segment, I’ll share my thoughts on portfolio theory relative to innovation in both enterprise and product perspectives.
Seven has a special place for numerologists of all stripes. The world was created in seven days, there are seven seals and seven signs. There’s seven wonders and seventh heaven. There are seven deadly sins, seven virtues, and seven chakras.
Seven doesn’t get left out of the business world either. In interpersonal communication theory, seven is the maximum number of people who can talk in a meeting before loss sets in. This helps to explain why an Agile team should consist of 7 people, plus or minus a couple. The plus side of the Agile team composition accounts for the fact that the team members do not all have to send and receive all of the information being shared. But that’s for another segment.
In modern portfolio theory, seven is the optimal number of assets to hold in an investment portfolio. Fewer than seven assets, and the portfolio is underdiversified. Underdiversification creates risk exposure to price changes. More than seven assets, and the portfolio is overdiversified. Where underdiversification creates risk exposure, overdiversification limits upside potential.
But today, we’re going to focus on how your organisation or project can benefit from a portfolio approach.
Modern portfolio theory is borrowed from investment finance. Harry Markowitz won a Nobel prize in Economics for this concept. If it’s good enough to win a Nobel prize, it’s good enough for your project approach. The version I am talking about here stems from a 2012 article published in the Harvard Business Review.
At its core, portfolio theory is about risk diversification. We have all likely heard of the risk versus reward trade-off: Greater rewards come with greater risk; smaller risks yield smaller rewards.
The goal of portfolio theory is to optimise return or reward, by managing risk. Actual portfolio structure is contingent on many factors, including industry, market, product, and other such aspects, but what I am sharing should work as a starting point. At least, it works for the purpose of illustration.
Essentially, a portfolio should be divided into three investment groups. When I say ‘investment’, think budget. These groups are Core, Adjacent, and Transformational.
Core Portfolio Items
Core portfolio investments are low-risk, low-reward items that should make up 60 to 70 per cent of your budget. In an enterprise setting, they are the business as usual items. Keeping the lights on, rent, supplies, maintenance and repair, wages and salaries, printers, paper, and so on.
In a project setting, these are core features: basic elements, fundamental user experience design implementation, bug-free development, ensuring efficient rendering speeds, no bad links, fresh and relevant content. You have an ecommerce site, does it have all of the expected features as compared to other ecommerce sites? These are core. Nothing outside the lines.
Whether enterprise or project, these are ostensibly necessary items, and they may keep you in the game, but they aren’t going to get you to the next level.
Adjacent Portfolio Items
Adjacent portfolio investments are moderate risk and reward items. These items should comprise about 25 to 30 per cent of your budget. The items might be considered to be stretch items. They remain at the edge of your comfort zone. In some cases, they are simply expanding an existing market or customer segment. Perhaps a new product offering in the same market space. A bit further, but still adjacent, might be similar but untapped industries or segments. For example, if you are servicing engineering and construction clients, you might try something in the procurement space.
Adjacent investments relative to digital products might be made to optimise page loads, refactor processes to make them faster. Make them more modular or easier to maintain. Whilst an argument could be made that these are core items, experience indicates that management considers these to be luxury items, so let’s place them here and make sure some of them get some budget and attention.
Adjacencies are a perfect opportunity for testing and learning, for A|B, and MVT, multivariate testing. Again, some might consider these to be core activities, but if this isn’t part of your everyday experience, add it as an adjacency. You may be surprised how some of these impact your top line and customer acquisition or retention just because the experience is better than your competitors.
Transformational Portfolio Items
Transformational portfolio investments are high-risk, high-reward items. These should take up the remainder of your budget, between 5 and 10 percent. These items are outside of your comfort zone. They target different customers or markets. When discussing transformational items, I like to envisage the motion picture industry. In this model, 9 out of 10 projects fail. This ratio is fabricated, but the point is that, in a portfolio of releases, most return less than they cost. Certainly, less than projected. But the one successful project more than pays for itself. It also pays for the failed projects.
A good rule of thumb might call for a portfolio investment breakdown of 70 per cent core, 25 per cent adjacent, and 5 per cent transformational.
Most companies are risk neutral or risk averse. Many are mixed. They’ll take risks with mergers and acquisitions, but they don’t take any risk in the product space. New products come from M&A or through watching competitors, rather than through material innovation. I mention risk profiles, because this is precisely where they fail. They fail to transform themselves as enterprises, cultures, products, or services. They lack the vision to innovate, which is further exacerbated by risk aversion. This translates to organisations not investing 5 to 10 per cent in risky propositions. They fail to release some risky feature functionality, for fear it won’t return net positive value. I won’t derail this segment with a piece on the value of a test and learn approach, but you’ve received a hint.
If only accountants did a better job capturing this type of value. Not to bash accounting, but this discipline also misses opportunity cost, technical debt, design debt and so on. If these items were better accounted for, we’d see different investment decisions across the board. But shareholders don’t see opportunity costs. SEC reporting doesn’t account for opportunity costs, so they are effectively invisible. Until they’re not.
So. Speaking of opportunity costs. This is how to classify the failure to invest in the Transformational space. This is true for product management or ownership. All else equal, you aren’t going to be fired for meeting your targets. You might even get a bonus. No one will be any the wiser, because they have no idea what they’re missing. Indeed. Ignorance is truly bliss.
Besides. If you are in a risk averse culture, you might be sacked, if 9 of your first 10 risky initiatives fail on the path to the tenth that would have more than recovered your losses.
Whilst I’m on the topic of risk, attempting to manage risk comes at a cost. Derisking reduces your expected reward. Not to mention the time lost spent derisking. If gut-feeling and seat-of-the-pants ideas have any place in business, it’s here. If it fits within 5 to 10 per cent of your budget and it feels like it could work, just go for it. If it fails, no worries. If you learned something from it, great. If it has no impact, fine. Watch it for a while or pull it. Your choice. If it succeeds, don’t get a big head. One of the next ones is bound to fail. I promise.
In the words of Nike’s old brand slogan, Just do it. It’s only 5 per cent of your budget. You can take the losses. Ask your accountant if you can book the losses to testing and learning, then move on. Dust yourself off. Don’t ride off into the sunset. Instead, take another charge.
Not surprisingly, portfolio theory is the foundation of programme portfolio management. This approach can be adopted by more than investments, enterprise, functional, and project budgets. The same principles can also be used to manage an innovation portfolio. This will be a topic of another segment.