It’s not because things are difficult that we dare not venture. It’s because we dare not venture that they are difficult.

Seneca

According to KPMG, since 2010 there has been a steady rise in venture capital money invested globally, from US$10 billion in the first quarter of 2010 to US$39.4 billion in the third quarter of 2017 — a compound annual growth rate of 21.6 per cent. Unfortunately, this capital has made its way to anywhere but the pre-digital incumbent. No doubt you’ve seen how a fledgling start-up can raise $1 million in a few weeks with a glossy-looking pitch deck and a few handshakes. For a similar project to be approved within a pre-digital incumbent, it could take months of waiting for the ‘right’ moment in a budget cycle, numerous meetings, endless documentation and an abundance of stakeholders to manage, most of whom may not understand your proposition. In other words, it’s an uphill battle to secure funds within an existing business unit.

There’s no two ways about it: you need capital to execute on some or all of the recommendations set out in this book. Investments in data, platforms or systems of intelligence can be significant. Staying relevant in the face of digital disruption requires speed and agility, and without the right investment mentality and processes in place, you’ll find yourself stymied as opportunity slips right past.

In this chapter, we introduce an investment management mindset designed to help you make quick and intelligent decisions when investing in your Engine B. We also explain how to manage your Engine A investments, with a heavy focus on streamlining, and optimising cost and operations. Adopting the mindset and framework outlined in this chapter will ensure your investment decisions are efficient and directly aligned to your company’s overall strategy. It’s time to kill decision-making paralysis before it kills you.

The three types of innovation

Before we discuss an investment mindset and framework, it’s important to understand the different types of innovation. After all, innovation drives investment, and investment drives growth. Author Clayton Christensen identifies three types of innovation you can use to describe the nature of an investment. Although this theory of innovation is now 20 years old, it is becoming even more relevant as digital becomes increasingly central to your business strategy. Christensen describes the three types of innovation as:

• disruptive innovation
• sustaining innovation
• efficiency-based innovation.

DISRUPTIVE INNOVATION

Disruptive innovation converts a ‘high-end’ product, such as a mainframe computer in the 1970s or an automobile in the 1930s, into something more affordable and accessible. It’s desirable in capital-rich economies as it generates economic growth and creates job opportunities in exchange for (often risky) investments. Disruptive innovation tends to start with a poorly distributed and expensive product. Think of the supercomputer in the 1970s, a machine so unwieldy that the CEO of Digital Equipment Corporation Ken Olson infamously quipped, ‘There is no reason anyone would want a computer in their home.’ Over time, innovations in miniaturisation — along with the effects of Moore’s Law, halving the cost of computing power every 18 months — put personal computers into everyone’s hands. The outcome is Apple’s 2008 iPhone, which packed as much power as a 1985 Cray-2 supercomputer. Because powerful computing products are now available to the masses rather than just a select few, they create new jobs beyond just service and support, such as app developers, and new businesses, which use the iPhone to connect with customers. This is just one example of how disruptive innovation can unlock huge amounts of value not only at the company level, but also on a global scale. For these innovations to flourish, however, they need capital.

SUSTAINING INNOVATION

In contrast to disruptive innovation, sustaining innovation is the process of fine-tuning your company’s business by making a good product or service better. These types of innovations are very important for maintaining or increasing margins relative to the competition. Sustaining innovations do not create jobs, as companies fight for customers in a mature market, which in return creates little net growth. This is a result of the fact that if you buy the latest generation of a product or service, you won’t then buy the previous version that isn’t as good. There is no new market created.

As another example, take car manufacturers. Each year they update their range, introducing new features and benefits to address increasing competition and expectations from consumers. Or, alternatively, in the finance industry, new consumer debt products provide flexibility, ease of use, loyalty point schemes or greater affordability in an effort to gain market share and address increasing expectations. These sustaining innovations generate new products to sell, but not new buyers or new economies.

EFFICIENCY-BASED INNOVATION

Last, a speciality of Japan and China is efficiency innovation, which is doing more with less. Efficiency innovations increase free cash flow but cut jobs, often dramatically. Toyota pioneered efficiency-based innovation by continuously seeking to improve its processes. In doing so, it created just-in-time manufacturing, which is the precursor to the lean manufacturing model employed by thousands, if not millions, of companies across the world.

Before we move on, there’s one more point we’d like to raise, and that’s an issue with financial metrics.

Balancing short-term returns and long-term investments

No doubt you use a number of key financial metrics, typically ratios, to determine the performance of your business. The issue with a number of these metrics is that they are designed to measure short-term results, such as efficiency or how quickly you can make a return on your assets. These ratios have become the go-to source for measuring success. This is fine if you are happy working on efficiency-based innovations. But as the leader of a company undergoing digital transformation, you’re no longer satisfied with incremental improvements, which means you face a dilemma.

Traditional economic principles and doctrines of finance favour investments where returns are optimised in the short term. This type of thinking has no doubt been inculcated into your company. In reality, ratios obscure the need to invest in the future. Simply doing what you’ve done in the past, but more efficiently, will not help you meet the needs of the digital customer. We’re not saying you should completely neglect these financial metrics — just recognise they aren’t the be-all and end-all.

Reflect on the suggestions early in chapter 2 that in order to focus on a healthy balance of short-term efficiencies and long-term investments you should establish both an Engine A and Engine B. Each engine is designed with a different set of objectives and performance metrics but connected through a common purpose. As part of this, consider the allocation of funds to Engine A and how that compares with Engine B. The funding mix will vary depending on the change taking place in your industry and the pace of change you feel is required to stay competitive.

The investor’s mindset

The biggest investing challenges you face are resource allocation and prioritisation.

In chapter 2, you learned the benefits of having both an Engine A and an Engine B — two distinct ways in which you structure and operate your business, each with different objectives. Putting this concept in investment management terms, you need to take a venture capitalist approach to your Engine B by focusing aggressively on scale and growth, as well as taking every practical measure to make it work. At the same time, you need to take a private equity approach to your Engine A, which means creating a robust and efficient business where cash flow is king. In this section, we reveal three ways to help you develop an investor’s mindset.

CREATE A CULTURE OF INNOVATION

To support these two investment styles (venture capital and private equity), company culture plays an integral role. It creates an environment in which people are willing to take calculated risks, and management isn’t afraid to fail. This freedom of action is vital when taking a venture capital approach to investing, as no matter how much due diligence a company undertakes, there is always an element of risk. Without cultural reinforcement, cash flow pressure on the new-growth business and the existing business reigns supreme. If a new disruption from a competitor hits the market, things will really start to fall apart as resources, both financial and human, diminish. At this point, a company is forced to invest frantically in the vain hope of finding a new source of revenue before it’s too late, as the company’s old, profit-making business declines. It’s a lot easier to adopt a venture capital mindset when there is money rolling in and failures can be absorbed.

MOVE FASTER

Nearly all of the financial metrics used by pre-digital incumbents rely on some measure of time. Pre-digital incumbents are also prone to over-planning and under-executing. For any new project, they fall back on their old investing methods, looking at how quickly they can make a return on investment, as well as fashioning financial models and glossy presentations to be scrutinised over in endless steering committees. All this does is waste valuable time that might better have been spent in-market, learning from customers and gaining a competitive advantage.

In many cases, the time and effort spent planning is greater than the actual project itself. Three-year strategic plans no longer work, nor do annual budget and planning cycles. How can someone plan three years ahead when technology is changing so quickly? Worse, sticking rigidly to a three-year strategic plan as the market shifts in an entirely new direction is like throwing money down the drain. As a leader, you need to emphasise the importance of getting things done and learning from mistakes along the way.

A focus on tactical execution does not mean that strategic planning is no longer valuable — it simply must be seen as a continuous process. In 2005, Steve Jobs said, ‘To me, ideas are worth nothing unless executed. They are just a multiplier. Execution is worth millions.’ The most valuable leaders today are those who can move fast, get things done and plan strategically, all at the same time. Your challenge is to speed up execution in your business. We’ve talked about the cultural drivers; now how can you enable execution from an investment standpoint? Here are five tips to help you move faster:

1. Be clear on the financial metrics you expect for each type of investment to avoid teams wasting time developing investment cases that will never hit the mark.
2. Set and communicate realistic expectations in terms of investment decision-making cycles.
3. Limit, and be clear on, who needs to be involved in an investment decision to avoid stakeholder management that’s disproportionate to the level of investment sought.
4. Discourage plans where precision is prioritised over accuracy. Too often plans are produced with numerous, interrelated assumptions that complicate and obscure the two or three key assumptions that need to be proved in order for an investment to be successful.
5. Identify a small number of points of strategic alignment that are non-negotiable, rather than trying to do everything in one project. For example, your investment objective might target a select demographic of your market, a characteristic of a competitor’s product or service, or the profile of an untapped target buyer. This uncompromising prioritisation will help ensure your investment decisions tie back to your overarching strategy for success.

ENCOURAGE INVESTMENT EFFICIENCY

Start-ups move fast and get things done because they reward and promote managers who are highly efficient and focus on execution, rather than just talking about it. But these types of managers aren’t just in start-ups. They are in every organisation; you just need to give them the space and tools to execute. When looking for leaders in your company, our experience indicates there is a particular commercially oriented mindset that will optimise your return on investment, regardless of whether you are operating in Engine A or Engine B. That mindset can be summed up by three distinct attributes:

1. They understand the cost of regret

As strange as this concept might sound, regret has a tangible cost. It is incurred when a project needs reworking or is a failure. Regret is the human response to making the wrong decision. The cost of regret can lead decision makers to spend long periods of time collecting information to make a perfect decision, and can paralyse managers from making any decision at all. Regret aversion has a particular bearing on digital transformation because many pre-digital businesses know it as a hangover from the era of traditional IT projects. There was a time when implementing technology always meant big, expensive and untested, so leaders spent years planning and building project roadmaps in an attempt to ensure success. Now, thanks to capabilities like cloud computing, companies can deliver much smaller ‘pieces of value’ for a nominal cost.

As a leader, you have a role in communicating the new truth that a single project failure no longer destroys the bottom line, and can be fixed and improved upon quickly. This will minimise the regret incurred and free your best managers to act, rather than over-engineer a solution. The cloud removes the need for costly on-premise infrastructure, and allows organisations to build and deploy solutions from anywhere in the world. It has also led to the creation of new delivery approaches that allow for rapid development times and shorter customer feedback loops, enabling a more iterative approach. Managers who understand that the cost of regret varies depending on the size and flexibility of the project will spend the appropriate amount of time collecting the minimum necessary information to make a decision, so they can spend more time on execution.

2. They focus on burn rate

Burn rate refers to the rate at which a new company spends its initial capital. But the concept has broader uses as well. Every time your teams run a meeting, for example, have your managers considered how much it costs? They could calculate the cost using this formula:

Combined salaries (as hourly rate) of participants × meeting length = cost of meeting

Have you calculated the cost of your team for a day? Thinking about projects in terms of burn rate often changes your mindset around how you make decisions and what is actually important. A project is just a controlled burn of money. It’s important to remember that the money is limited, but the results aren’t. Great managers can control this burn, get the maximum output and deliver higher quality. Here are a few tips on how they can do this:

• Measure at all times. Acknowledge the cost of time in absolute and opportunity cost terms. This will help you recalibrate decisions more regularly.
• Less is more. Managing large, expensive teams is difficult and adds unnecessary pressure in terms of the related burn rate.
• Do not conflate hourly rates and output. They are not the same thing.

3. They actively assess value

Businesses often get caught up in the projects of consulting engagements, architecture assignments and planning. These initiatives can deliver well-researched information and recommendations to the buyer of the services. Too often, however, the resulting reports are not distributed widely or contain recommendations that require a different level of executive stakeholder buy-in to implement. The reports can also be costly. Has the business realised the value of that investment? Investment-oriented leaders think differently, repeatedly questioning and assessing where the value lies. This continuous process needs to be applied to everything, from projects to personnel. This approach has less of a temporal element than return on investments, allowing the manager to focus on quality outputs, rather than just wins.