Discovery and Planning: The Essential Tension of Innovation

In my previous two posts I wrote about an intersection between the arts and an emergent form of business innovation that is not yet fully defined. In this space a kind of venture model is possible that draws on the strengths of both paradigms, maximizing creative possibilities while minimizing uncertainty and risk. I affectionately and irreverently call it the Cake Machine. Cake being profit, of course.

The process is abstract, combining the best of several powerful frameworks--Stanford d.school's design thinking, emergent strategy and Rita McGrath and Ian MacMillan's discovery driven growth.

First some definitions. 

Discovery: what you practice when you don't have the data to do anything else. The process of going where there isn't a lot of information to guide the way. It is often led by hunches, intuition and incremental discoveries.The process is uncertain or leads to uncertain outcomes.

Planning: the process of making decisions and strategies that yield desired results over time. The process is predictable.

There is an essential tension between these two. Discovery wants to be an open ended process to maximize its ability to explore and make amazing things. Planning wants to reduce uncertainty to measurable risk, producing desired results next month, next quarter, next year.

The process of creating innovative companies and brands is structured as a cycle that utilizes this tension between discovery and planning. To give this rigor and structure, design thinking is formally articulated as a problem solving tool while discovery driven planning is used to model the business and define the design parameters.

This process throws off creative energy by considering design as a critical component of the entire business ecosystem and by defining design parameters using sustainable business models. It is more of an engine than an incubator. The design, discovery and planning processes are in play simultaneously.

Design thinking, emergent strategy and discovery driven growth are generally formulated as linear processes. By reconstructing them into an iterative loop, I create a cycle which holds at its center a fully formed venture whose final form is, at the start, something of a mystery. As we circle the center, considering it from all angles, we continually refine the entire business and design ecosystems using what we find there to define our design parameters.

Design thinking engages in a process that has been organized by the d.school as follows:

1. Empathy

2. Define (focus): create a clearly defined problem statement

3. Ideate (flare): generate as many solutions as possible to the problem as defined above

4. Prototype

5. Test

In this engine, design thinking is used as an essential framework for problem solving once the problems are defined more clearly by the financials. Reverse financials bring problems to light early in the process, generating clear problem statements and then flaring to generate previously unrecognized solutions. This process of focus and flare, using the business financials as a way of setting design focus early in the process, maximizes innovation within the entire business ecosystem, from the design of the user experience through the supply chain to the overall finances of the organization.

Here is a rough step by step pass through the first cycle.

1. Start with any basic concept for a product or service offering.
2. Define the basic unit of business and any alternative units. The unit of business must differentiate.
3. Build a set of reverse financials--an income statement and balance sheet--that makes the venture worthwhile. 
4. Back out of the financials as many of the assumptions that you can that have to hold true for this venture to succeed.
5. Rank assumptions by order of importance, with the most critical assumptions, the ones where everything falls apart if you get it wrong, at the top. 
6. Design tests to discover the accuracy of your assumptions.

By now you have made a circular pass around the loop with basic definitions of everything that has to hold true for your venture to succeed. You have a sketch of your variable and fixed costs in place, a required income, a sense of return on assets which gives you an allowable amount of fixed assets, and a basic model of how your entire supply chain and marketing efforts have to behave for this to work.

With these inputs you go back to your design concept and refine it based on the cost and price information that your financials have modeled. You calculate your break-even point and evaluate your offering in terms of its potential market. Using design thinking you maximize your creative input into the design within the parameters defined by the financials.

How does this work? The process can be adapted to any venture. Here is one example.

Imagine a designer who believes she can build a disruptive product to fill a perceived hole in the market at a price point of $800. The product is disruptive and differentiated because it will bring a level of quality to that price point that currently only exists in products offered by competitors at a much higher price. How will she go forward?

Her business unit is defined as a product purchased by the consumer for $800. We start with the assumptions that to make this worth the effort, the company should generate $1,000,000 in net income with a contribution margin ratio of 45% and a return on assets of 25%. To start, she believes manufacturing can be achieved with fixed costs of $600,000 per year. Now we work the income statement backwards.

Net Income	$1,000,000.00
Taxes (40%)	$666,666.67
Income	$1,666,666.67
Fixed Costs	$600,000.00
Contribution Margin	$2,266,666.67
Variable Costs (55%)	$2,770,370.37
Sales	$5,037,037.04

At an $800 price point with $600,000 in fixed costs and a contribution margin ratio of 45%, the venture must sell just over $5 million in sales or 6,250 units to make the desired net income. For this to happen, each unit must have $440 or less in direct labor and materials.

Now that we have used the basic financials (backwards) to define our design parameters, we come back to the design to ask the question, what amazing things can be done in this product space for $440 per unit? How can we disrupt and capitalize in this space? Is there an innovation in manufacturing or distribution that would allow us to disrupt the competition? What does our potential market look like? How could we sell 6,250 units a year? We have nothing so far invested in fixed assets, but our basic balance sheet will allow us up to $4,000,000 in property, plant and equipment. Can we come in under this? What is possible for that amount? How much can be outsourced? How can those investments be delayed while we refine the design?

If the initial pass around the loop is successful, then the project enters the next level in the cycle, making more detailed financial documents, more specific designs and prototypes, while testing assumptions and doing everything possible to delay major investments and keep real options open so that you can refine and discover along the way.

So why are discovery based processes and design so critical to this next wave of profitable ventures in the United States? It has to do with an understanding of how money is created by firms. So much press has been focused on the amount of money made by banking and investment firms of late. What is missed in that is just how narrow the margins are in those transactions. Contribution margins for banking firms can run as low as 3%, which means that to make $3 million they have to move $100 million. That is an amount of capital that is unavailable and those are returns that are unreasonable for most business ventures. 

A well designed venture can produce contribution margins of 50% or more. With lean business plans this can be hugely profitable. It outperforms the financial markets by orders of magnitude. In our above example, the company is represented by $4,000,000 in fixed assets and let's give it another $1,000,000 in net working capital. With $5,000,000 tied up in capital, the company spends $440 to receive $800 in income for a contribution of $360 per sale. That is a return of 80% on money invested in direct materials and labor. If this were successfully implemented it would produce $1,000,000 in net income with $5,000,000 in total assets. Of course you can't just wave a magic wand and make that happen. But you can make it happen if you structure it by design. Or at least you can work through potential projects, avoiding the ones that don't make the cake until you find the ones that do.

What cake machine does is structure the modeling of innovative ventures in ways that focus and maximize the creative input to the process while minimizing uncertainty and risk. You want to quickly discover your major problems and hurdles so you can focus your problem solving and design energy on them first, either solving them to overcome barriers to entry or stopping the process before you spend in other areas.

Giving the process rigor and structure provides discipline for the transfer back and forth between discovery and planning. If we imagine it the way the brain works, this activates both sides, giving equal weight to analysis and innovation throughout. This system is like the corpus callosum, connecting both sides of the brain at the center, with directed and disciplined discovery on the creative side and open ended financials and planning on the other.

By iterating in this way an organization can cycle through any number of ideas at a time, learning from each and focusing on the projects that have the most likelihood for success. Most importantly, the design parameters are set up in sync with the operating and financial goals of the enterprise which focuses creative activity in ways that increase the likelihood of success. To succeed, the process needs leaders who can design the entire business models and drive superb design within the financial parameters. It is a rare breed who can do both, but that is where the cake gets made.

The Avant Garde and Finance

These two disciplines seemingly couldn't be farther apart both in methods and in orientation to the world. But consider what they both seek to achieve. Finance attempts to look ahead into the future to determine the likely outcomes of investments that are dependent on the future performance of a host of variables including entire markets. Art makers attempt to make culture, which is a similar process of working towards a future encounter with a wider audience, attempting to interpret the impact of works that are also dependent on a host of variables, also attempting to create something of value. Each navigates exceedingly complex terrain using dramatically different tools.

The essential functions of finance are to determine what are, and what are not, worthwhile investments of money over time. The essential functions of design are to produce a superior user experience that also extends itself out over time, past the point of purchase and into the life of the product, process or service. The essential functions of art, or at least a major current problem being explored, is how to produce better culture and possibly better outcomes for everyone involved.

Over the past months I worked to build an iterative model that would give structure to innovation while maximizing realizable options. It is possible, with the right conditions and tolerances for innovation, to create teams that combine the strengths of all three disciplines. Bringing discovery driven planning in at the early focus stage of the design thinking process will apply profitable parameters early on. This focuses the idea generation by ruling out as many unprofitable avenues as you can, before you invest in exploring them. 

Let me try and explain how this works in plain English. First you assemble a design team to address a problem or need.  At the earliest stages in the design process, you create a set of financial statements that build on your ideas, only you build them in reverse. And this is the key. You in effect take your idea and create a ghost company or business unit entirely on paper, working backwards through all the calculations to arrive at a sense of what that idea would have to look like in order to be profitable. Within these reverse calculations will be a host of assumptions that must prove to be true in order for your idea to work profitably. With them laid out on paper, you can begin to test these assumptions upfront, working from the most consequential to the least consequential.

Testing concepts in this way has two significant benefits over implementing first and testing as you go. First it minimizes the cost of exploring a concept or idea by increasing the speed and accuracy of initially evaluating its viability. And second, by minimizing the cost and reducing the risk, it increases the number of ideas that can be explored without the expectation that every idea will be a success. By providing something of a safety net for your innovation efforts, this encourages your design teams to be more innovative, to push out to the edges of their own abilities and beyond.

This already happens in some combination in every successful venture, but it tends to happen latently and over time. There is a kind of Darwinian weening out of the weaker concepts as they are implemented. In this other model we are able to create a kind of three dimensional virtual model of an idea and back out it the assumptions that have to hold true in order for it to be a success. We are looking for the problems before they become problems.

Here we get finance and design working together at the very beginning. What happens is a very quick cycling of ideas that allows for the generation of the most possible solutions you can come up with the least possible cost in exploring how viable they are. What is absolutely critical for maximum success is to have someone in the middle who speaks both finance and design and can translate the concepts across disciplines. 

Design thinking is an extremely powerful tool for innovating. Its weakness though is that every step is very dependent on the outcomes of the previous steps. The end result is very dependent on the questions asked or problems raised at the start. Discovery driven finance adds the capability of focusing the early stages of the design thinking process to produce a greater likelihood of a profitable outcome. 

All innovators push the boundaries of their fields. By focusing design activity we actually encourage MORE innovation. When you have those kinds of people at work on your project, they are going to push the limits. Steering them in that activity increases the likelihood of smash hits and radical disruptive moves forward. 

Next week I will post one more time with a more concise how step by step description of how this works.

Where I've Been, New Avenues, and a Major Discovery

In 2009 I read a paper at a conference at Northwestern University's Department of Communication Studies. In it I sought to build a global model that would describe everything I knew about how images operate in the world, from conception and creation, through editing and distribution, to their impact on far flung audiences throughout the world.

In the end I succeeded in sketching out my understanding of how mass media, business, psychoanalytic theory, aesthetics, and so on interact in ways that define a process. It is a sort of model of how change can be made through media. This model was informed by a broad range of professional experiences from my work at Time Inc in a critical production role at a billion dollar magazine to independent and freelance image making for a wide range of clients, to my own personal work that answers to more personally defined terms of making and audience engagement.

As I was working through this paper, I intuitively sensed that something was happening along the intersection between art making and business. I was hearing about it in a broad range of terms, from evolutions in social media, to user interface design, to changes in audience engagement strategies, to instability in the global economy, to predictions that the US economy itself needs to and is transforming itself into an innovation based economy that will be able to generate profitable innovations in a turbulent world market.

As we passed through the recession and continue to transition into the new economies made possible by computers and the internet, it was becoming increasingly clear that the possibilities for cultural innovation were almost entirely dependent on the funding sources and business models that quite literally define and shape their outcomes.

You cannot innovate outside of the business models and ecosystems in which you operate. They are designed to protect their own success and survival. Your efforts to disrupt them will be defeated unless you can address the business on its own formal terms.

On a deep ontological level this is reminiscent of the problems that painting encountered as it transitioned into abstraction in the early parts of the last century. It, along with all the arts, to evolve out of the avant garde, first faced itself on its own formal terms. Something similar is happening in business.

My conclusion in my paper at Northwestern was that one cannot innovate on a large scale in ways that significantly escape the business models that you are dependent on. I had not yet read Clayton Christensen's book, the Innovator's Dilemma, in which he explores this problem for large corporations that succeed wildly, growing to dominate their industry only to find themselves irrelevant or losing to competitors that are more innovative and nimble. But I had already lived inside or around that cycle of innovation through my decade in publishing in New York City. My intuitive understanding of the problem led me to confront it on stage at Northwestern.

Plain and simple. You cannot innovate beyond the restrictions of your business model. Therefore, you must design new business models if you want to innovate. A simple, logical conclusion.

I chewed on that conclusion for almost a year, looking for ways to work around it. There wasn't any way around it. If you can't work with the finance and the accounting, you can't build innovative organizations.

At this point I quietly enrolled in a Master's of Business Administration program at Western Washington University with the intention of studying accounting and finance. The first year I just put my head down and worked hard on the quantitative skills. As an artist with an MFA, I was an unusual addition to the mix, but I brought significant personal experience and was able to quickly translate concepts into my own real world experiences.

About nine months ago I began an independent study on innovation and the arts. At that point there were 20 or so Master's of Arts Administration programs throughout the United States. I pulled all their curricula and worked through what it was that they were teaching. Almost without exception, they were extremely light on the hard quantitative business skills like accounting, operations and finance.

By now I had worked through substantial portions of all three and could recognize what a loss this was to the entire field. The weakness of the whole field was summed up in the introduction to one of the leading textbooks on arts administration. It a field that is an amalgamation of ideas where no one key differentiating point or strength has emerged. The potential weakness was that you could get light versions of an MFA and an MBA without getting the full strengths of either.

I asked myself the following question--was there something happening at the nexus of art making and business that was uniquely powerful and strong, in which the best of both worlds would come forward and new and valuable models would emerge that would contribute to both fields?

From there began nine months of research that yielded the following answer; Yes, and the possibilities are incredibly exciting. They also are not restricted to non-profit or for-profit equations. And as more and more states in the US start to adopt the formation of social purpose corporations, the possibilities only continue to grow.

I wasn't the only person asking these questions. The entire field of arts education had been shifting towards audience engagement and the recognition that art making is a conversation with the public, with broader implications and consequences. The field of social entrepreneurship emerges out the interactions between art making and current evolutions in development and social innovation. This fall the School of Visual Arts is offering the first MFA in Social Entrepreneurship. There is a clear recognition that art making is not restricted to a material or image making event.

Concurrently the business world is experiencing escalating levels of uncertainty and a need to innovate disruptively as an almost normal condition in the markets.

By combining models of design thinking, emergent strategy and discover driven planning that have been developed at Stanford, Harvard, Wharton and Columbia, and tested at places like IBM, Apple, IDEO, and Ashoka, it is possible to integrate art, accounting, finance and design in powerful ways.

Tomorrow I will post on what this space is starting to look like from my perspective, how it works, and why you need someone who speaks art, design, accounting and finance on your team, no matter what it is you are trying to do in the world.