In the final installment of our portfolio management series, we’ll look at the four zone management framework.
Segmenting and Categorizing to Prioritize Investments and Tailor Approach
The challenge for well-established, successful companies is to free their company’s future from the pull of their legacy operating models and cultures. Part of this change involves moving from a traditional, hierarchical, vertically structured operating model to a cross-functional, cross-business, horizontally structured operating model that values organizational agility.
Today, customer value and business relevancy is cross-industry, cross-category, cross-channel, and cross-brand, which is completely changing how companies make money. Companies must now align how they make decisions with the new way their customers make decisions and align with maximizing customer outcomes and improving organizational agility.
The four-zone management framework is designed to enable leadership teams to discuss and evaluate these competing priorities in their portfolio of products. All four zones benefit from Agile, Lean, and DevSecOps practices, but the areas of emphasis and relative investment of talent and resources is likely to vary, along with the metrics used.
Successful business transformations are driven by a unified aspiration for a higher level of performance across the entire organization and include all levers of value creation. Segmenting the portfolio of business transformation initiatives by zone provides a very effective governance structure as well as a way to prioritize resource and budget allocation decisions to fund their implementation as shown in Figure 10.
The Four Zones
Productivity Zone: business transformation is about transforming a shared services model by redeploying scarce resources and budget away from low-value “run the business” functions to high-value “change the business” functions. This also requires a shift in focus from technical and functional outcomes to business outcomes. Companies can also create value in this zone by automating processes and systems, thereby freeing up their employees from low-value clerical tasks to higher-value work.
Performance Zone: business transformation is about transforming an operating model to enable the company’s business units to better engage with its customers, supply chain partners, and other key stakeholders. By contributing directly to creating valuable and enduring customer experiences, the company can demonstrate its ability to leverage digital technology to deliver increased revenues, margins, and profits. This transformation should include investments in continuous learning to improve the value proposition and inform the larger enterprise.
Incubation Zone: business transformation is about transforming a business innovation model through identifying, testing, and validating next-generation product, service, and business ideas and leveraging digital technology–enabled innovation to deploy them. Utilizing Agile, Lean, and DevOps processes are particularly important here in order to increase speed to market and time to value for all test-and-learn initiatives.
Transformation Zone: business transformation is about transforming a business model by launching and scaling a material, net new line of business or pivoting from the current business model to a new digitally enabled business model. It also serves as a way to evaluate the onboarding of new strategic partners or acquisitions and determining how much value additional technology resources and investments will bring to the company.
Zone Management: Different Performance Metrics for Each Zone
Less than 30% of companies have a process in place to measure the ROI of their digital technology initiatives. As such, this lack of new measurement tools puts them at a significant competitive disadvantage as they try to pivot to being a digital enterprise.
Companies measure performance in different ways. Some use key performance indicators (KPI). Others use objectives and key results (OKR). Many attempt to measure ROI and still others use Net Promoter Score (NPS). These are just a few of the traditional approaches for defining and measuring different performance goals a company aspires to achieve.
The challenge, however, is that different products should be measured differently. A product in the Incubation Zone may emphasize adoption, but a product in the Performance Zone may focus on contribution margin. The four-zone metrics framework below provides specific performance-measurement tools for each zone.
Productivity Zone: Process Metrics
The primary role of the functions in the Productivity Zone—including Finance, IT, HR, Marketing, Customer Service, Legal, Procurement, Compliance, and others—is to enable the company’s operating businesses in the Performance Zone to meet or exceed their revenue, margin, and net profits goals. As such, they need to deploy a series of process-improvement metrics that measure their ability to recover resources and budget trapped in low-value creation functions and redeploy them to higher-value functions.
A big mistake companies make in this zone is to equate cost reductions with value creation. The true measure of performance in this zone is how these support functions can leverage digital technology to directly impact and contribute to increasing revenues, margins, and profits.
Performance Zone: Investor Metrics
Investors in public or private companies reward performance that drives sustainable value creation. The metrics that measure that performance are agreed upon during the annual planning process and often don’t reflect the increasing impact digital technologies will have on the performance of the company’s business units.
Much of the value creation in this zone comes from utilizing new systems of engagement and systems of intelligence to deliver exceptional customer experiences. Depending on whether you are a B2B or B2C business, you will need to adapt new metrics that measure how well you are engaging customers using these new systems and tools.
Incubation Zone: Venture Metrics
The biggest mistake most companies make is using traditional performance-zone metrics (e.g., EBITDA) to measure new innovation initiatives. Success in this zone comes from being able to efficiently identify, test, and validate multiple next-generation products, services, and ideas. The key performance measures should be speed to market and time to value.
The reason many early-stage, venture-backed companies disrupt well-established companies is because they outperform them in this zone. They are much better at failing fast and redeploying what they’ve learned to the next innovation opportunity.
The other big mistake in this zone is trying to scale multiple transformation-zone initiatives at the same time. Reallocating existing resources and budget from current businesses in the performance zone to create a net new business that can scale to 10% of the company’s current revenues is a very disruptive exercise for any organization. Trying to do more than one is a recipe for failure.
Transformation Zone: Hypergrowth Metrics
Value creation in this zone comes from adopting and deploying digital technologies to either launch and scale a material or net new line of business or to defend the company from an existential threat. The metrics for products in the Transformation Zone are focused on measuring outcomes. A common mistake is to use Performance Zone metrics to evaluate products in the Transformation Zone.
Key consideration for products in the Transformation Zone include:
- The new business will scale to generate a 10% or greater increase in current revenues and profits for the company.
- There can only be one transformation initiative done at a time.
- Fifty percent of the discretionary compensation of all critical stakeholders is solely based on the success of this effort.
- A commitment to invest in a J-curve to get to an S-curve, knowing returns may take twenty-four months.
- A compelling business case for investors that will support investing in the J curve.
The Four Zones in Action
In the example below, we can see that Products A and B belong in the Performance Zone and should be measured by the metrics of that zone. Both products are mature, and growth has dropped below company growth targets. For products in the Performance Zone, revenue, contribution margin, and market share are the most important metrics.
Product C belongs in the Transformation Zone. It has scaled to more than 10% of the company revenues. It is also growing quickly and is highly profitable. The focus should be on maximizing revenue growth and winning in the market.
Product D is in the Incubation Zone. This product is focused on business transformation. The product is early in its life cycle, and long-term success isn’t guaranteed. Time to value and customer adoption are the most important metrics.
Effective portfolio management will always require adaptability and change in order to drive future revenues and profits. But in a time of massive disruption and volatility, having frameworks and structure in place to guide executives will help leaders maintain a sense of order and provide informed guidance.
By incorporating a historical view of the business, applying complexity science to decision making, utilizing predictive metrics, and understanding the four zones, companies will have the overarching frameworks they need to make sound decisions and thrive in the market.