We know that the innovation process is risky. Nothing can guarantee the success of something new and failure is probably a good sign of a healthy innovation system. Without failures, no innovations. Of course, failure for its own sake is a ‘career-limiting move’ but successful innovation managers take the view that trials and rapid prototyping enable organizations to cycle through ideas to find the ones that create value. If most ideas will fail then the best outcome is that they fail quickly. They are also sufficiently disciplined to stop funding ideas that do not make sufficient progress.

Firms must have an appetite for risk if they are to engage with innovation. More risk potentially means greater returns and managers need to understand what types of returns shareholders or stakeholders (in the not-for-profit or public sector context) expect. Risk management and innovation is a very under explored area of corporate governance and it also means that boards need to understand the innovation process from a risk management perspective. Managing the innovation portfolio across the 3 horizons and being able to evaluate an organization’s innovation process as a value chain are both examples of how boards can engage with management of innovation strategy and not interfere with the processes of management.

While the magnitude of the risk is one dimension of innovation risk management, the other critical issues is that of owning the right risks. In an article from the Harvard Business Review from 2008, Buehler, Freeman and Hulme talk about a different way of thinking about competitive advantage. They invert the question of ‘what are we better at compared to our competitors’ into ‘what risks are we better able to manage compared to the competition’. It’s a subtle change, but it makes a lot of sense. For example, one firm may be better equipped to manage the risks associated with exporting to a new market than others and this is an important component of their competitive advantage.

In the context of innovation, the idea of owning the right risk bypasses the usual discussions of trying to eliminate risk. For example, is the risk of prototype development the best for us and should we own the risks associated with scaling up the prototype? Does our expertise in this area of technology mean that we have a competitive advantage in managing risk in the development of certain products? As you can see, the notion of owning the right risks has the advantage of including both risk management and strategy in the same analysis.

As another example, think about Westfield’s initiative to develop an online shopping mall, as reported in the Australian a few weeks ago.

Sources close to the virtual shopping mall project say it is one of the biggest software development projects in the southern hemisphere and is straining the supply of developers familiar with the Ruby programming language. The Australian 20/7/2010

Now, is this the right risk to own? Experimentation in online shopping is probably mandatory for Westfield but this looks like a very big bet in an area that isn’t core to their business. While Westfield is still the largest shopping mall manager in the world, the capabilities surrounding internet retailing are very different from shopping mall management. As a Westfield shareholder, it just looks like a “bridge too far” to me.