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A Value-Hill Model of Innovation February 13, 2008 C. Warren Axelrod, Ph.D. IIIP Academic Advisor PDF Version Abstract This paper outlines an approach to selecting and scheduling R&D projects leading to innovations in products, services, and processes, with the goal of maximizing the net value generated by the innovations. The model presented here relates the net innovation value to the time when a project is submitted and when deliverables will become available, as well as to the variability in the estimates of delivery dates. Knowing how the net value of a project varies over time with completion time, and determining the impact of competing projects on the subject project, one can optimize the portfolio of projects, determine when they should be started, and decide what level of resources should be applied to each project. Introduction Innovation can be difficult, if not virtually impossible, to measure and consequently the basis for managing R&D projects is often obscure. Despite these difficulties, a meaningful method for determining or estimating the net value of the project over time can provide a rudimentary basis for deciding which R&D projects to do, and when they should be done (Hubbard, 2007). A front-page article in the April 27, 2007 issue of the Wall Street Journal describes how Motorola rode the success of its super-slim cell phone, the Razr. However, as described in the article, Motorola suffered financial setbacks because management did not focus on the next innovation and gave up their lead to other manufacturers. It is clear that, in this case, timing and time to market were key requirements for successful innovation. Innovation can impact effectiveness (doing the right thing) or efficiency (doing things right) or both, depending upon the nature of the research. Some innovations take an existing process and refine it (i.e., gain efficiency) while other innovations come up with an entirely new product, service or process (i.e., yield effectiveness). The former reduces costs and may accelerate the production process, and the latter has the potential to generate new business and revenue opportunities. We will now examine a model — the value-hill model — which is intended to formalize the analysis of proposed research leading to innovation. Introducing the Value Hill Concept In my doctoral dissertation (Axelrod, 1971), I developed a model of the "net value of computing" which was based on the proposition that the net value of a perishable resource, such as computing capacity, is a function of both calendar time and of the expected turnaround time. It also postulated that net value depends upon the variability of the turnaround time, which introduces risk into the model. The model incorporates the concepts of "macro-sequencing," by which it is determined when a job, project or other activity should be submitted for processing, as well as "micro-sequencing," which is the sequence in which the items, which have already been submitted, should be run. The sequence of submissions and of scheduling impact the completion times experienced by each project, and hence its value. Factors such as priorities, budgets and pricing bear directly on macro-sequencing, whereas micro-sequencing is affected by capacity, available resources, size of project and queue handling rules. The concept is described both in an article (Axelrod, 1976) and more extensively in a subsequent book (Axelrod, 1979). In the Innovation Context While the model was developed in the context of computer resources, innovation has many of the same characteristics, such as the following: Innovation is perishable, that is, it has limited life expectancy due to the competition from other organizations, changes in affinities of consumers, and so on; The value of an innovation is sensitive to the time when the R&D project is initiated and how long it takes to complete, which in turn depends on the level of resources available to the project; Innovation projects are in competition with other projects both within the organization and external to it. Allocation Model With regard to allocating resources to a particular R&D project, there are two levels to consider. One is selecting from the entire population of those projects that will as a whole provide the highest aggregate value. Underlying this decision are a number of assumptions relating to the availability of the requisite resources at particular times. I call the process through which approved projects are submitted to the research center "macro-sequencing." Once they are lined up to be executed, there is a subsequent set of decisions whereby specific resource levels are assigned to the project and the project is kicked off. This I call "micro-sequencing." It is important to recognize that, given a limited resource pool, the progress of one project will depend on the levels of resources that are applied to competing projects. This impact is shown in the diagram below as the heavy U-shaped curve labeled "completion time" or "time to market" for the particular project under consideration. The completion time will vary over time and is very much affected by the sizes of competing projects and the relative priority assigned to them, since resources are applied based on size and priority, as well as on the sequence in which projects are scheduled. Costs and Values The inverted U-shaped lines are contours that describe the net value (i.e., value less costs) of the project for a particular start time and related completion time. Intersections of the two sets of curves describe the value garnered from a project for a particular start time. If the value functions and the resource requirements of each project are known, then the optimum mix and timing of projects can be determined. To summarize, the net value of innovation is a function of the revenues generated (effectiveness) and/or costs saved (efficiency), depending upon the nature of the innovation. The time to deliver can be impacted by the investment and resources applied to the R&D project and the implementation. The existence of competing projects affects all other projects in that they siphon off resources. Therefore, a suitable R&D portfolio needs to be determined, and this model facilitates that analysis and decision process. Use of the Model The model can be used to determine: The optimal level of investment in a particular R&D project given competing projects and resources; The relative investments to be made in a portfolio of R&D projects to maximize net value; The best times to initiate projects given their resource requirements; The required times to deliver in order to make projects worthwhile (i.e., provide an adequate return); The impact of other innovations on a particular R&D project's value and timeliness requirements; The window of opportunity beyond which value is minimal or even goes negative. Summary Innovation is ephemeral in that it generally has a window of opportunity after which it is subjected to profit-reducing competition. In a real sense, innovation activities are a perishable resource, much as are computing resources. If not used, they lose all value. Therefore, one must take an opportunistic approach and attempt to optimize the use of innovative talent by directing investments to those efforts yielding the highest return and concentrating resources so that innovations with the highest returns are completed in the timeliest manner. This value hill approach gives a multidimensional view of the factors affecting the value of innovations, and the interactions among competing projects. References Hubbard, D. W. How to Measure Anything: Finding the Value if Intangibles in Business. Hoboken, NJ: John Wiley & Sons, 2007. Axelrod C.W. Outsourcing Information Security. Boston, MA: Artech House, 2004. Axelrod, C.W. Computer Effectiveness: Bridging the Management-Technology Gap. Washington, DC: Information Resources Press, 1979. Axelrod, C.W. "Computer Effectiveness." OMEGA, Vol. 4, No. 3, 1976. Axelrod, C.W. The Allocation of Computer Resources in Organizations with Semi-Autonomous Users, Ithaca, NY: Cornell University, 1971. About the Author Dr. C. Warren Axelrod is the Chief Privacy Officer and Business Information Security Officer for a financial services company. He interfaces with the firm's business units to identify and assess privacy and security risks and to mitigate them. Dr. Axelrod was honored with the prestigious Information Security Executive (ISE) Luminary Leadership Award 2007. He also received a Computerworld Premier 100 IT Leaders Award in 2003. He represented financial services information security interests at the Y2K command center in Washington, DC during the century date rollover. He is a founder of the FS/ISAC (Financial Services Information Sharing and Analysis Center) and served two terms on its Board of Managers. He testified at a Congressional Hearing in 2001 on cyber security. Dr. Axelrod previously published two books on computer management and numerous articles on a variety of information technology and information security and risk topics. His most recent book is Outsourcing Information Security (Axelrod, 2004). He holds a PhD in managerial economics from the Johnson Graduate School of Management at Cornell University and honors bachelors and masters degrees in electrical engineering, economics and statistics from the University of Glasgow, Scotland. He is certified as a CISSP and CISM.