How to Balance Risk in the Budget Planning Process

How to Balance Risk in the Budget Planning Process

The “barbell strategy” is a method for risk management in finance, creating a portfolio of very safe investments with low returns along with very risky bets with high returns, with no “average” investments in the middle. In other words, a portfolio has distinct assortment of low and high risk investments. Why no “medium-sized” risks? Because it’s hard to quantify, in advance, just how risky  “medium” is, which may end up exposing the investor to more risk than anticipated. It doesn’t have to be limited to just financial investments, either; it can be applied to pursuits as diverse as career development or scientific research. Organizations that invest in innovation can apply the barbell strategy by focusing on two areas: Optimization and Disruption.

How To Create The Barbell Budget

  1. Identify optimization and disruption projects. Disruption focuses on initiatives that pursue strategic whitespace with little to no attachment to the status quo or sunk costs. Optimization includes initiatives that capture immediate revenue and won’t undermine future goals. Often referred to as “incremental innovation,” it’s what happens every time you upgrade your phone or laptop: better features for the same (or cheaper) price. Get the team familiar with these two terms, and place your products and services in the following categories.
  2. Start with a baseline. Again, the barbell strategy isn’t an “either-or” solution; the goal is to fund lots of safe bets (optimization) and a few “out-there” ideas (disruption). We typically recommend that companies invest 20% of their innovation budget on disruption.
  3. Adjust for market speed. Investing 20% of an innovation budget on disruptive projects, but you should consider the rate of innovation within the market. Gauge the speed and rate of change in the industry and adjust your disruption budget accordingly.
  4. Adjust for your type of company.  Assess as a team if your company is a dominant or niche player in the market. A dominant company in an established market (one with a slower rate of innovation) can invest more in optimization, while a niche company in a rapidly evolving market should be focused more on disruption.
  5. Identify positioning. If your company is a niche solution within a rapidly changing industry, your budget is primed for investing in disruptive projects. Dominant companies in an established market resistant to change may focus on optimizing products and services.

Takeaway: It’s essential to review how your budget is allocated based on risk. All too often, it’s easy for innovation to be caught between optimization and disruption, when that work should be focused on disruption and delegating optimization to other teams.

SourceWSJ

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