A lot of lousy thinking exists regarding the relationship between risk and innovation.

At a fundamental level, many executives eschew risky investments in truly new concepts in favor of dependable incremental investments in core businesses. However, we all know that risk correlates with return. Incremental risks result in incremental returns. But executives also know they can't just bet the business every time a potential game-changing concept passes across the desk. How can we think more constructively about risk to enable our enterprises to provide acceptable or superior returns while managing the downside?

In my role as a researcher, educator and consultant in the field of innovation strategy and management, I often encounter companies that talk about innovation but fall short when it comes to investing. Considering this, my colleagues and I have uncovered a number of myths regarding risk and innovation. Let's examine a few of them, then we'll conclude with thoughts regarding the fiduciary responsibility of managers amid the realities of a competitive marketplace.

Myth:

True business innovation is risky, so we can't afford it.

Reality:

Companies must invest in innovation if they hope to have a future, much less lead.

No uncertainty = no innovation. Consider this an axiom. While uncertainty is not technically synonymous with risk, the two concepts are closely related, and we all know that established corporations tend to shun risk. In most cases, their founders embraced risk to create a major new enterprise, but over time, as more and more share owners, employees and stakeholders become engaged, the stakes become larger and the appetite for risk typically becomes less robust. As a company grows, professional managers create structure and process to increase efficiency and decrease risk. For the most part, this is good.

Particularly in larger, established companies, truly innovative investment opportunities often receive short shrift partly because of higher uncertainty. The more new-to-the-company or even new-to-the-world an opportunity is, the less clear the business case compared to investments in dependable, core business activities. This makes some sense. First, a company should invest in its core businesses. Second, incremental investments in core businesses offer more clear and validated NPVs than significantly innovative opportunities.

But an irony of a competitive marketplace is that if we avoid too much risk, we create even more risk. If we make money, then others copy. Avoiding risk to a fault means sticking to what we know and failing to invest in the future. If we continue to do what we're currently doing, competition will eventually eliminate our profitability and we'll fail. Staying competitive requires investment in constant improvement, and not simply incremental improvement, as anyone can do that. We'll never be best by pursuing best practices. As Steve Jobs proposed, "Innovation distinguishes the leaders from the followers."

Myth:

The same investment criteria should work for all investments, innovative or not.

Reality:

Truly new concepts don't stand a chance, on a risk-adjusted basis, with dependable core business investments.

This doesn't suggest we should make investments without solid business cases—quite the opposite. Innovation teams should be held to a higher standard of rigor given that the thinking required for new ventures is often more complex than that of incremental investments. By definition, new concepts require more assumptions and deeper considerations of unintended consequences and alternative paths than investments in well-understood core businesses.

Instead, we need to recognize that early stage concepts must be evaluated differently than standard investments in the core. Furthermore, some resources must be allocated specifically for future growth, or investments in what we already know will crowd out the new opportunities.

Myth:

We can't invest if a project is likely to fail. We must manage the rate of failure.

Reality:

Don't manage the rate of failure, manage the cost of failure.