01-04-2025
How To Manage Innovation Budgets With Risk-Managed Frameworks
Worried senior businessman listening presentation with coworkers during business meeting at office
Businesses are struggling to meet their innovation goals, with only 3% of companies in qualifying as "innovation ready," according to the Boston Consulting Group, BCG, Annual Innovation Report. Yet, without embracing the risk of failure, companies risk becoming laggards in a fast-pacing market. Daniel Kang, an entrepreneur and author of The Super Upside Factor, highlights the challenge of managing innovation budgets, noting that many organizations prematurely terminate promising projects after initial failures.
Kang argues that this approach runs counter to how successful innovation should function. Amazon founder Jeff Bezos underscored this mindset in his 2015 shareholder letter. Bezos emphasized in a 2015 shareholder letter that many organizations shy away from failed experiments, even though 'outsized returns often come from betting against conventional wisdom.' He argued that given 'a ten percent chance of a 100 times payoff, you should take that bet every time,' despite the risk of failure.
This sentiment raises a key question for business leaders: How should they allocate funding for innovation while managing the inherent risks?
In his book, Kang identifies three core principles for effectively managing innovation investments:
Successful innovation often requires frequent experimentation and allows for failure within budgetary limits. Kang advises allocating funding with a 90% failure rate in mind. For example, a $10 million innovation budget could support 20 projects at $500,000 each. Leaders should anticipate that only one or two of these projects might deliver a significant return. Critically, organizations must avoid depleting their entire budget on a single initiative. Amazon exemplifies this resilience: Despite its $170 million loss on the Fire Phone, the company continued to innovate, leading to successful products like Alexa and Kindle.
Given that most innovation initiatives will fail, the successful projects must generate returns that justify the overall investment. Unlike traditional strategic initiatives, which often target return-on-investment rates of 20%-50% due to their lower risk, innovation projects should aim for at least a return of 10 multiples. For instance, Amazon's initial foray into cloud computing with AWS in 2006 was a bold departure from its e-commerce roots. The investment has since yielded extraordinary results, contributing $90 billion in revenue in 2023 and accounting for 16% of the company's total revenue.
According to Kang, investment in innovative projects should inform how the company should move forward. Each failure should inform the rest of the company and create learnings to make advancements. An example he shares is on how Amazon Auctions was meant to compete with eBay, but customers preferred fixed pricing over bidding wars. Instead of abandoning the idea of third-party sales, Amazon learned from the failure and pivoted to Amazon Marketplace, where third-party sellers could offer products at set prices. Marketplace now accounts for over 60% of Amazon's retail sales, generating billions in revenue annually.
Organizations that adopt risk-managed frameworks like Google and Netflix tend to drive innovation forward. Google X embraces high-risk moonshots, funding multiple bets like Waymo and Project Loon, knowing most will fail. They celebrate fast failures and reinvest learnings into future projects. Netflix applies the same model to content, using data to iterate on audience preferences. Even flops refine algorithms, fueling megahits like Stranger Things and Squid Game. Failures aren't losses—they're investments in what works next.
When combining these frameworks—budgeting for failures, targeting transformative returns, and building feedback loops—business leaders can adopt a systematic, sustainable approach to innovation. As Kang notes, "It's easier to build a hard company than an easy one," highlighting the importance of prioritizing bold, ambitious projects over incremental improvements.
