Do you remember Paretos principle? The 19th century Italian engineer Villifredo Pareto stated that 20 % of your efforts will contribute to 80 % of the created value (freely translated). This still holds true in the 21th century! It has, again and again, been proven to be valid in so many aspects of human effort. Is this also true for your Innovation portfolio?
In an article called “Which Innovation effort will pay” by Alexander Kandybin in MIT Sloan Management Review (Vol.51 No.1 2009) he conveys a different way to analyze Innovation portfolios. He drives the Pareto principle hard but does not use the traditional Pareto charts. A traditional Pareto chart have two dimensions – see Fig 1 where individual values are represented in descending order by bars, and the cumulative total is represented by the line. In this example shrink is responsible for almost 70% of all the defects.
Mr Kandybin argues that an effectiveness curve, see Fig 2, for the innovation portfolio is built upon a plotting of the annual investment per project vs. the Net Present Value (NVP) per project.
This will tell you which projects are yielding the future revenue and which only will be swallowing resources with no or little return. Like in the Pareto analysis there is a bulk and a tail in the effectiveness analysis which need management attention and analysis.
Googol has vast experience of Portfolio Management and Portfolio Analysis. We see the value of the effectiveness curve but find it is somewhat over complicated. We simply took the best of both worlds and did a Pareto analysis of the portfolio using the parameters of the Effectiveness curve. This gives a simple chart that is directly applicable in, for example, Lean Innovation work. The chart in Fig 3 is an Innovation portfolio Pareto analysis from a company we worked with. As you can see Projects A-C contributes to 70 % of the future revenue. This is what Villifredo would have called a Pareto relationship.
- In order to be effective, management need to pay attention to the tail as this represents the low contributors.
- You also need look at the composition of the curve which contains a lot of information on the performance of the innovation organization.
- An important addition to the Pareto analysis is the significance of the numbers. Typically early stage projects, and in particular early, radical projects have great uncertainty. If we plot the uncertainty together with the bar we get a better understanding of the associated risk.