By Rita Gunther McGrath and Alexander van Putten // This article was originally posted on hbr.org.
Many executives are fond of promising to deliver growth, but far fewer realize those ambitions. This is because many fundamentally mismanage the growth gap, which is the difference between their growth goals and what their base businesses can deliver. Filling the gap requires either innovative new offerings or acquisitions. That’s where the trouble starts — it is easy to be fooled by rosy assumptions that, when analyzed in a disciplined way, turn out not to be practical.
Let’s take the example of one large company we worked with, which posited that it needed $250 million in new revenue from innovative new products in five years. Spreadsheets were developed, resources were marshaled, budgets were approved, and the work began. It was decided that, given the company’s size, project selection should filter out new product ideas unless, at maturity, they could be expected to generate $50 million in revenue. Over the stipulated five-year time horizon, this seemed reasonable.
We started mapping future projections to resource commitments with a framework called the Opportunity Portfolio, in which projects are evaluated with respect to their market and technical uncertainty, their resource intensity, and their upside potential.
We assigned projects to four categories of opportunity (plus another category for innovations that support the core business). Positioning options have high technical but low market uncertainty, in which the major challenge is solving a technical problem of some kind. Scouting options have low technical but high market uncertainty, in which the major task is finding product/market fit to extend the reach of an existing capability. Stepping-stone options have both high technical and high marketing uncertainty. Finally, platform launches represent a new business that is ready to be scaled up. These have relatively lower uncertainty than an option. They may be generating revenue but usually not yet a lot of bottom line. They show enough promise that they will become mainstay core products in the next 12 months or so.
Projecting new revenues to the four areas in the Opportunity Portfolio was an easy exercise. As the following table shows, it led to a comforting view of the future growth potential of the current portfolio. Each block in the table denotes new revenue that year from maturing portfolio investments, resulting in cumulative new revenue, which can be found at the bottom of each column. Note that the table implicitly projects limited investment and a slow start to the new growth initiatives, with no new revenues in 2017, modest new revenues in 2018, and significant new revenues really only beginning in 2020 and 2021.
The table offers an attractive view of the firm’s growth prospects, with a projected total of $620 million in new revenues by the 2022 timeframe.
Beware of Spreadsheets
And this is where spreadsheets, which a colleague of ours dubs “quantifications of fantasy,” can lead to unrealistic conclusions. The big problem is that spreadsheets tend to reduce the world to linear models, when in reality the growth process is nonlinear, sometimes even exponential. We’ve all seen those spreadsheets in which Year 2 revenue is Year 1 revenue plus 10%, and so on, and we know they don’t represent reality.
Imposing just a bit of realistic discipline with respect to the likely times at which revenues will be realized led to a very different conclusion about when the growth program would show results and close the growth gap. We were particularly concerned about the timing of the firm’s proposed investments relative to its expectations for results.
With the growth initiative just getting under way in 2017, the company’s own projections showed that significant new revenues would not be realized until 2020, representing a three-year lag between initiating its growth projects and reaping the rewards from them. Of particular concern on our part was how long it would take for each project to achieve 50% of its target revenue, testing the assumption of linear growth embedded in the projections.
Modeling Nonlinear Growth
To do this, we modeled the assumptions in the plan with a logistic growth model, a technique that incorporates nonlinear growth functions. It uses three inputs: the revenue goal for the investment at steady state, the assumed first-year revenue, and the inflection point, which is the time the company thought would be required to reach 50% of the revenue goal.
his allowed us to create the following chart, based on the table above, for the likely trajectory of the revenue growth plans, given the assumptions about the inflection point, first-year revenue, and expected target revenue.
This analysis revealed that attractive-looking cumulative revenue numbers in the plan did not take into account the dynamics of timing. Even though the table projected cumulative new revenues from the plan of $620 million, a dynamic view that takes timing into account shows that at best the new revenue is likely to be in the $180 million range — a far cry from the target.
Projects started after 2019 would be of little help in hitting the portfolio target revenue in 2022, because they simply do not have the time needed to begin delivering results. This in turn called into question the planned strategy for resource deployment, which was essentially continuing as if these projects were still options, with small investments at the beginning that would ramp up only later on.
Making the Transition from an Option to a Major Launch
What executives often fail to realize is when you make a commitment to launching a major new growth platform, the investment logic changes. Maximum resources are needed early on. If the firm sought to drive serious growth in 2017 and 2018, a lot more resources would be required much earlier. Moreover, not all projects will succeed, so to have nine projects become revenue-generating by 2020, in all likelihood over 20 projects will need to be started.
This is a very common problem organizations experience when they decide that a project is ready to make the transition from being an option, in which the main goal is to search for a reliable, repeatable business, to a new growth platform. What many executives don’t understand is that this shift is a phase change. The project goes from essentially being an internal startup to becoming a full-fledged member of the corporate parent at scale. Often, a new team needs to be brought in, one with more operational expertise than the startup team. Organizational and technical debts need to be repaid. The metrics need to change. And all of this takes resources.
Without realizing the significance of this shift, executives are tentative about putting the talent, resources, and commitment behind the program to assure its success. Unsurprisingly, the result of such timidity is that the project experiences a slow takeoff, leading many to lose faith in it before it ever had a chance.
What is interesting is that simply as a function of timing and investment, the firm could potentially have been on track to hit its $250 million target by 2024, just not the stipulated timeframe of 2022. The executives making those rosy growth projections would justifiably have been criticized for making proclamations that were predictably unrealistic.
So how can you bring more discipline to your growth projections and avoid getting sideswiped by a growth gap that could have been foreseen? Based on our experience, four actions can help:
Take the time to assess what your growth gap potential is. It’s all too easy to assume that your current business will deliver the growth that your investors, employees, and other stakeholders are expecting. The process is not that complex: Simply look at the growth trends of your existing lines of business and compare them to where you think your strategy needs to be at some point in the future. Usually, there will be a gap.
While it seems astonishing that leaders wouldn’t do this (and boards wouldn’t insist on it), we see it all the time. Sometimes, it is because leaders just won’t take the time away from day-to-day operations. Sometimes, it is because, oddly, it is no one’s job. And sometimes, there are simply too few people with the vantage point to see the trends across the entire enterprise. And unfortunately, executives in some companies are rewarded for essentially gaming their numbers rather than being realistic.
Manage your portfolio to keep today’s business fresh while placing bets on the future. When we look at the once-great businesses that have stumbled (we’re looking at you, Blackberry), what we often see is very poorly diversified portfolios with an excessive focus on today’s core business. As PepsiCo’s Indra Nooyi observes:
“It’s been a long time since you could talk about sustainable competitive advantage. The cycles are shortened. The rule used to be that you’d reinvent yourself once every seven to 10 years. Now it’s every two to three years. There’s constant reinvention: how you do business, how you deal with the customer.”
In general, as the core business comes under pressure, you’ll need to make bets on some combination of acquisitions and organic growth. When time is tight, you’ll place more emphasis on acquisitions. If you have time and want to build a capability, organic growth or partnering makes more sense.
Don’t apply linear thinking to projecting how your growth initiatives will unfold. It is an old saw that things change less than we expect in the short term and more than we expect in the long term. This refers to the very human tendency to think in terms of linear change, when we know that patterns of change in business are nonlinear, particularly patterns of growth. Amazon Web Services, for instance, went from being a concept to being a $10 billion-plus revenue business in less than 10 years, a torrid rate of nonlinear growth.
Tools such as the logistic model above can help you test the financial assumptions in your growth plans in a way that recognizes these patterns. It may also help to look at a range of possible outcomes under different scenarios.
Don’t allow your assumptions to become facts in your own mind. One of the biggest mistakes we see over and over again is thinking about your growth businesses using the same mental models that you use to think about your operating businesses. The growth journey is about learning, about discovery, and about finding a business model. It is a mistake to begin it thinking you know what the linear, measurable path will be.
Research done on the venture capital industry found that even these expert investors in innovation learned that it took twice as long for their portfolio companies to generate half the revenue they were projecting. And, of course, the overall success rate for VC-backed startups is pretty low. There’s no reason to think your organization is going to outsmart seasoned VC investors on a regular basis. What you can expect is better results by making sure that your strategy and growth program are aligned.
Unrealistic revenue projections or assumptions about how much growth you’re really going to get can lead to career-ending misses. Misses sap investor confidence, can cause dramatic stock price declines, and can lead to investors wielding metaphorical pitchforks. Better to do some smart thinking beforehand.