McKinsey’s Three Horizons model provides a useful taxonomy for innovation yet the dynamics of how we understand it have changed significantly

neilperkin
Feb 10 · 5 min read

Silicon Valley entrepreneur Steve Blank makes a good point about McKinsey’s Three Horizons Model for innovation and how our approach to understanding how we apply it needs to change. The model famously seeks to define the different types of innovation that businesses need to focus on if they are to survive and thrive:

  • Horizon 1 is about incremental improvements or continuous innovation around a company’s existing products, models, or core capabilities. This type of innovation typically focuses on existing markets or utilises existing technologies that the company is familiar with, and is likely the easiest and most common form of innovation
  • Horizon 2 innovations are more about adjacencies, next generation products and likely focused on extending the company’s existing business model or core capabilities to new markets or customers, perhaps using new technologies. Since this extends into areas that the company is less familiar with, it likely requires different thinking and techniques to Horizon 1
  • Horizon 3 innovations are entirely new, breakthrough products or categories that are pushing the boundaries, responding to or taking advantage of disruption, and pushing the company to explore new markets or technologies

Originally articulated in the book The Alchemy of Growth in 2000 by Baghai, Coley, White, the model has become a well-referenced way of describing the need for organisations to shape focus and funding on the different types of innovation and how the ability to create ongoing competitive advantage depends on all three types. Whilst it’s easier for businesses to focus on incremental innovation which is closer to existing, well understood models (Horizon One), there is a requirement for a more comprehensive approach that recognises the need for continuous exploration in lesser known areas (Horizon 2 and 3).

Three Horizons presents a way that organisations can concurrently manage optimising for current growth opportunities whilst discovering and building potential future opportunities for growth. But it is important for businesses to recognise the differences in the way in which you manage each one. For example approaches to risk and payback, sources of value creation, measures, and the allocation of senior management time.

The source of value creation in Horizon 1 comes from superior execution, in Horizon 2 from ‘positional advantage’ (where you are trying to gain a better position relative to your competitors), and in Horizon 3 from insight and foresight around changing customer and market contexts and opportunities.

McKinsey found that Horizon 2 and 3 required more time from senior leaders, but also a commitment to avoid starving these innovations of resources due to short-term financial pressures. They also found that in Horizon 3, whilst the general hit rate may be lower, successful innovators clustered their experiments into between two to five themes depending on the size of the organisation.

Measures through the Horizons also differed. Horizon 1 is more about profit, cash flow and return on invested capital, overseen by experienced business managers. Horizon 2 is more entrepreneurial, so is supervised by ‘business builders’ whose metrics for success might be revenue milestones and net present value. Horizon 3 is far more emergent and so requires visionaries and ‘champions’ who are focused on emerging technological and commercial value milestones.

The point that Steve Blank makes concerns the delivery time for each horizon and how this has fundamentally changed. The McKinsey model accounts for the fact that different industries may have different timescales for innovations to return value (short cycle industries for example may seen value created quicker), but in general the impact on profit and cash flow, and current market value is far longer with more emergent innovations than it is for extending core capabilities. Horizon 1 may therefore deliver impact in the short-term since it is focused on models and capabilities that are already contributing the majority of value and profit today. Horizon 2 may take 3–5 years to see a return since it involves extending existing businesses and capabilities. And Horizon 3 may take as long as 5–12 years as it involves more disruptive creation of value.

In the modern environment however, Blank notes that the time it can take for disruptive ideas to be researched, engineered and scaled to market has been radically transformed by digital technologies and networks. Horizon 2 and 3 may now happen at speed. The potential for new, emergent, even disruptive, ideas to be rapidly prototyped and then to generate scale and take on a life of their own has added an entirely new dynamic:

‘These rapid Horizon 3 deliverables emphasize disruption, asymmetry and most importantly speed, over any other characteristic. Serviceability, maintainability, completeness, scale, etc. are all secondary to speed of deployment and asymmetry.’

The Three Horizons, whilst still a valid and important way of understanding the different types of innovation that businesses need to continuously focused on, is no longer bound by time. Disruptive businesses, unencumbered by legacy technologies and systems, and entrenched, slower moving processes, can move quicker towards generating return from newer, disruptive technologies and models.

Blank defines four key ways in which incumbents can counter this kind of rapid disruption:

  • Incentivising third party resources to focus on your goal or mission — open innovation initiatives, allowing external parties to innovate from your data through APIs, creating new marketplaces through platform thinking (Apple and the App store), partnering with entrepreneurs to venture build around aligned goals (Diageo and Distill Ventures), setting incentivised, inclusive challenges (DARPA Prize Challenges)
  • Acquiring external innovators that can operate at the speed of the disruptors. The challenge here though is the not-insignificant potential for corporate culture, processes, and approaches to stifle any speed advantage that the newer business has
  • Rapidly copying new, disruptive models (like Google copying Overture’s pay-per-click model) — this carries with it the risk of not properly understanding customer needs and contexts and so failing to do it well
  • Innovating better than the disruptors (like Amazon and AWS, Apple and the iPhone). This is of-course extremely difficult for a large, incumbent organisation to pull off when it is focused on execution, optimisation and protecting legacy value creation

Three Horizons remains an extremely useful taxonomy, but the trap is that we under-appreciate the impact of re-purposing existing Horizon 1 technologies into new models at speed, and the rapidity with which new, emergent propositions can be iterated and scaled.

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Originally published at Building The Agile Business.

Photo by Graham Page on Unsplash

Building The Agile Business

Thoughts on organisational agility and digital transformation in support of the book (April 2017, Kogan Page)

neilperkin

Written by

Author of Building the Agile Business. Founder of Only Dead Fish. Curator of Google Firestarters.

Building The Agile Business

Thoughts on organisational agility and digital transformation in support of the book (April 2017, Kogan Page)

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