One of the most critical challenges facing growth-seeking executives in large companies is deciding what constraints they should be placing on their organizations’ innovation efforts. Unconstrained efforts of the “let 1,000 flowers bloom” variety feel good, but often lead to diffused progress. On the other hand, incorrectly constrained innovation efforts carry well-documented risks. Companies that set the wrong boundaries leave themselves vulnerable to disruptive, game-changing start-ups. What kinds of constraints spur innovation and which ones kill it?

Generally, we suggest that companies impose two key constraints. First, identify a handful  of  promising markets (that is, no more than five) where some change in technology or consumer behavior now makes it possible to bring to bear a unique corporate capability to address some previously unaddressed need. That sounds challenging, and it is. High-potential markets tend not to be obvious. Relying on historical market data to discover them won’t work, since that tells you about yesterday’s markets, not tomorrow’s.  So preparing that short list can require an investment in detailed ethnographic research, field visits to early-stage start-up companies or emerging markets, and numerous working sessions where a small team debates the implications of the research findings and formulates hypotheses about how to move forward. Second, define the financial parameters to which ideas must adhere. Companies typically spend a lot of time developing financial forecasts of proposed innovations and debating the implications of their analysis. That can be a big waste of time. Forecasts are nothing but the mathematical relationships between made-up numbers.

Instead, give your innovators general financial goals. What sort of revenue does an idea need to generate when it is mature? How much money is the company prepared to lose before the opportunity is realized, and for how long? What kind of margins does the offering have to provide? Set these guidelines carefully. New growth businesses generally take longer to mature than even the most optimistic projections. Focusing too single-mindedly on gross margins can blind companies to potentially lucrative innovations that make money in different ways from their mainstream business. Consider focusing on net margins instead of gross margins, allowing the team the freedom to introduce different business models. Or explicitly allow the team to accept lower gross margins in a deliberate effort to pursue disruptive innovation. Setting clear financial guidelines avoids wasting time on ideas that are sure to get killed when they don’t meet them. And pushing innovation teams to clarify what has to happen in order to reach those targets helps them identify critical assumptions that must be validated before making significant investments.

Read the rest at Harvard Business Review.

Scott Anthony is the managing partner of Innosight.

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