One of the most common questions I get when discussing the digitalization of an industry and a company operating in that industry concerns resources. The typical reasoning goes along the lines of agreeing that it’s relevant and important to explore digital solutions for the company, but that unfortunately, no resources are available to allocate to this. The current business or businesses are consuming all the resources in the company and it’s impossible to free up anyone to work on innovation.
The fundamental misconception is that it’s reasonable for the current, dominant revenue generator to consume all the resources available in the company. Often the argument is used that this business is the one generating all the revenue and, consequently, it can and should consume all the resources as well. The advocates of this often forget that today’s cash cow once was an early-stage innovation that was kept alive even though revenue was highly limited, if not non-existent.
One model I frequently present in these contexts is McKinsey’s three horizons model. At one of my earlier employers, we used this model successfully and it helped the conversations around resourcing and prioritizations. As the name suggests, it organizes the businesses in which a company is involved in three horizons. Horizon 1 concerns all the existing, revenue-driving offerings that typically are mature and experience limited growth but that generate the vast majority of revenue. Horizon 2 businesses are smaller, fast-growing and hopefully future horizon 1 businesses if we can feed the growth long enough. Horizon 3 businesses are innovative ideas that are being evaluated to determine if they have the potential to become viable growth businesses for the company.
Each of these horizons has and should have different metrics for resource allocation and evaluation. In one of the companies I worked for, horizon 1 received, in total, 70 percent of all resources. These resources were divided over the various businesses that we had using their relative revenue as a metric. Interestingly, every year these resources were adjusted based on their growth percentage minus 10 percent. This meant that if your business was growing 5 percent the last year, your resources would be reduced by 5 percent. This often led to significant complaints from the leadership of that business, but the line of reasoning is that if you have a business that’s growing at the rate of GDP and consequently is flat, you need to focus on driving efficiency. Once a horizon 1 business reaches end-of-life and revenue starts to decline, the company needs to decide whether to spin out or sell the business, sunset it or milk it as long as possible with minimal investment to squeeze all the revenue out of it before it disappears altogether.
The second horizon, in this case, received 20 percent of the resources. Horizon 2 businesses are proven businesses that represent significant potential and that, typically, require outsized investment to capitalize on that potential. Hence, to accelerate growth, these businesses would receive resources beyond their growth percentage, ie growth percentage plus 10-20 percent. This means that if your business is growing at 30 or 40 percent per year, your available resources could easily increase by 50 percent annually. The key metric in horizon 2 is to drive and accelerate growth as much as possible and businesses that fail to drive growth and that are too small to become viable horizon 1 businesses are spun out or shut down.
Horizon 3 is a very different beast from the first two horizons as it’s the birthplace of innovations. Here, the metric isn’t revenue or revenue growth but rather the number of new ideas validated with customers. The third horizon receives the remaining 10 percent of resources, but the definition of what falls in horizon 3 versus the other horizons is often a source of debate. For instance, horizon 1 businesses investing in sustaining innovations for their offerings often consider this horizon 3, but that’s incorrect. Horizon 1 and 2 businesses need to fund their sustaining innovations out of their own budget and horizon 3 is concerned with uncovering unmet customer needs that offer the potential for completely new businesses. In subsequent posts, we’ll dive into the mechanisms we can use for accomplishing this, but expect to see concepts such as design thinking and lean startup principles as well as a focus on customer interaction.
Many companies struggle with resource allocation because their main revenue-driving businesses tend to consume all available resources over time. This is normal human behavior as there always is a crisis to address that requires additional help and we always seek to reduce risk by throwing more people at the problem. The role of senior leadership is to provide a counterweight and ensure resource allocation that supports ambidexterity for the company, ie creating a future while ensuring the present. The three horizons model is a simple, easy-to-understand model that provides principles and guidance to safeguard that sufficient resources are available to drive smaller, high-potential businesses and to drive innovation to create new ones. In the end, even if most of us are concerned with the priorities of the present, the future is where we spend the rest of our lives.