Monday, April 23, 2007

Real Options Approach to Innovation Management - Part I

Most strategic decisions require significant investments and therefore it is critical that organizations manage these investments carefully for continued growth and survival of firms. Pursuing innovations are strategic decisions too, especially strategic innovations, which are product or process innovations with unproven business models that have potential to change the rules of the existing business. What separate strategic innovations from regular product or process improvements is the degree of expense of a single experiment, the duration of each experiment, and the ambiguity of results. Strategic innovations require huge investments, over a long period of time, and with uncertain financial rewards. The rewards, however, of successful strategic innovations can be manifold: high growth in revenue and profitability, market dominance, and renewed faith of investors and analysts. A few of the celebrated examples of strategic innovations are: online book retailing by Amazon, direct selling by Dell, introduction of mini-mills by Nucor, low cost no-frills airline service by Rynair.

Strategic investment decisions, like strategic innovation, have three important characteristics. First, the investments made are either partially or fully sunk and cannot be recovered, in other words investments are irreversible. Second, returns on these investments are uncertain or the future benefits from investments are uncertain. Third, organizations have some flexibility with respect to the timing of the investment, or timing of different phases of investments. A good example of strategic innovation, showcasing the above three characteristics, can be of pharmaceutical companies entering into alliances with biotechnology companies and universities. Pharmaceutical companies invest into research projects led by biotechnology companies or universities and these investments are irreversible and the outcomes of most of these projects are uncertain. The development phase of these projects run up to a decade before commercialization can begin. Therefore, most of the alliance contracts have provision of payments over a period of time depending upon the successful progress of the project. If the projects do not show promise of product development and commercialization, the contracts have provision of stopping future investments. This flexibility in investment decisions limits exposure to risks while providing opportunity to invest further based on future assessments. These characteristics of strategic investment decisions make them especially relevant to be analyzed through real options approach.

Real option approach to investment decisions can be discovered in various settings and we discuss two of them here to showcase its applicability to wide range of situations. The two examples which employ real options thinking are hiring of professors and the process of awarding grants by National Science Foundation (NSF). There seems to be a real options thinking in the way academia generates knowledge by hiring professors. Most professors come in with a limited contract and then they need to show promise in the development of new ideas and knowledge. If they are successful the contract options are renewed (i.e. most untenured professors start out with a 3 year contract and then it is extended for another 3 years). Upon successful demonstration of innovative capabilities and output – tenure is given. The other interesting example of real option thinking is the process of awarding grants by NSF. NSF gives out grants, for exploratory projects, then they may choose to continue their investment if initial results are found to be acceptable or else stop further investments if the project does not show promise. This restricts wastage of resources to initial funding and provides opportunity to work with applicants incase the projects become worthwhile.

[Posted by: Sanjeev Jha]

Friday, April 20, 2007

Reflections from the I3M Meeting

I have now had three days to reflect on the I3M symposium. The symposium was exciting and stimulating. I gained a lot from the informal discussions with an eclectic group of executives. There were executives who asked me pointed questions which helped me refine my thinking. Some others asked me to share more detailed accounts of case findings. Yet, others asked if they could help out in future research. What was most interesting is the fact that no two executives asked me the same question. This is probably the first time this has ever happened. Each executive shared questions from their vantage point, and the audience was truly diverse. Here are a few key themes that kept emerging from various discussions:

1. Balancing risks and rewards in innovation – how should organizations manage a portfolio of ideas so as to gain maximum returns. Moreover, how should an organization fund innovative ideas? The possibility of using real-options as a framework was brought up several times.

2. Measuring the innovation process – how do we measure the performance of the innovation process, do we measure the process or the output, do we use qualitative or quantitative methods, do we measure using the unit of analysis of a firm, unit, or group…the answer, we use a combination of metrics and personalize metrics for different problems

3. The difference between large (public) and small (private) firms in terms of their innovation capabilities…are there differences, are there differences in the diversity of ideas they pursue, etc

4. The role of culture in innovation…my thoughts on this was that culture is determined by innovation capacities and not the other way. Too often, we use (organizational) culture too loosely and inappropriately. Yes, having the right culture is important, but creating the culture for innovation is also important.

5. How does legal oversight and regulations impact innovation…A lively discussion on this topic took place…my answer, laws are meant to be broken and they are always a step behind…being innovative helps you be ahead of the laws and find creative, and legal, ways to get your work done…Not the most politically correct response, but my opinion…

Overall, exciting day and I thank all those who attended…it was good fun…Cheers!

Tuesday, April 17, 2007

More Pictures from I3M Symposium

I3M Meeting: A Smashing Success…

We had an exciting day yesterday…By all accounts, the I3M Symposium was a success. The morning started with a keynote presentation by Phil Fawcett of Microsoft Research. This was followed by our research presentation – Demystifying the Link between Business Value and Innovation. This was followed by a panel discussion exploring the various issues surrounding innovation and business value. The evening concluded with presentations on potential research projects, and a wine and o' devours reception. A more detailed note on the symposium will be posted soon…

Saturday, April 14, 2007

Peter Baloh at the UW

My doctoral student, Peter Baloh (, from the University of Ljubljana (Slovenia) is in Seattle. He is here to attend the I3M (Institute for Innovation in Information Management) Spring Symposium. Peter has been working with me on issues of strategic innovation and knowledge management. Peter was a lead contributor one two i4i papers. The first paper examined the role of ICTs (Information and Communication Technologies) in innovation. The second paper examined strategies used by organizations to innovate with their business partners. In addition, Peter contributed to our papers on customer innovation and communication strategies for innovation.
Peter took a few pictures as I was giving him the tour of the UW.

36 hrs...The Final Countdown

The I3M meeting is just around the corner…People are flying in, phones have started to ring, the editing and final touches are coming along nicely, and the wine is flowing…Looking forward to seeing all of you on Monday morning…

Friday, April 13, 2007


We have been cited again…See ( has several interesting posts about innovation practices in leading organizations.

Sunday, April 08, 2007

Communicating the Business Value of Innovation

Innovation affects all aspects of a business, from operational procedures to strategic goals. Because of the widespread, often dispersed nature of innovation projects, it can be quite difficult to establish methods of communicating the business value of successful innovation projects. Innovation projects may have delayed costs or benefits, sometimes have unexpected effects on other aspects of the business and can change the culture or use of resources at an organization in ways difficult to measure and difficult to communicate. While working on an innovation project, new knowledge may be discovered that is not immediately usable to the project but which can lead to future efforts and open up new markets. For instance, Pasteur was working on a solution to prevent beer from becoming stale when he discovered the principles underlying fermentation, which led to understanding of microbiology and eventually antibiotics, one of his major contributions to science. Innovation projects can also lead to a culture of energy and high enthusiasm which can stir creativity and increase the likelihood of the firm to hire new talented people -- the most common example of this is the environment at Google.

In addition, strict return on investment (or ROI) measures are notoriously bad at uncovering the true business value (or BV) of innovation. ROI evaluates resources allocated to a project and the return upon those resources, but innovation rarely has easily identifiable returns. Innovation often affects many aspects of a business and can underlie perceptual shifts as well as altering levels of efficiency and sometimes competitive advantages. For these reasons, accurately measuring the resources saved, gained or developed because of innovation projects is nearly impossible. In addition, innovation projects involve a degree of uncertainty and adaptation. Discussions of innovative projects usually revolve around promises, risks and opportunities, not around concrete examples or assurances. For this reason, communication about innovative projects needs to be carefully thought out to encourage innovation while hanging onto a healthy dose of skepticism and evaluation.

We will be presenting our findings from the BVI research project at the I3M symposium on April 16 at the University of Washington. To learn more about how to successfully communicate the business value of innovation, please stay tuned for our research paper and we also look forward to seeing you at our symposium [see].

Monday, April 02, 2007

Infosys cites Ideas4Innovation work

Infosys Technologies (the Technology and Outsourcing Giant) maintains a series of blogs. These blogs talk about various issues related to IT, outsourcing, and innovation. One of their blogs, Managing Offshore IT ( cited our work on Outsourcing Innovation. The post More Companies Outsourcing Innovation: But what does it mean to you? (, discusses the changing nature of outsourcing innovation. We are working on a project called Managing Risks for Rewards: The Case of Outsourcing Innovation (we call it IRO). Stay tuned for more details…

APQC Best Practice Partners: Successfully Embedding Innovation

Executives from CSC Corporation...

Executives from Ethicon Endo-Surgery (a Johnson & Johnson Company)...

Executive from Boston Scientific...

Executives from Air Products and Chemicals, Inc...