Why Iterative Financing Makes Sense For Product Development & Innovation

Fiscally responsible financing


Financial Sensibilities

How long will it take and how much will it cost? 'Who knows' is an honest answer, if slightly flippant. The reality is, product development, and innovation in particular, is both art and science. Ambiguity, uncertainty, and Rumsfeld’s 'unknown unknowns' are everywhere. How is it possible to say how long it will take when we don’t truly know what 'it' is? That presents an unacceptable problem when a budget has to be agreed. Then of course there’s the deadline. These things are not unreasonable asks.

There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.

– Donald Rumsfeld

Deadlines And Reliable Innovation

There’s a business precedent for financing emergent projects shrouded in uncertainty and risk. It’s called venture capital financing.

Rather than size the budget based on what can only be a guess of time, treat time and cost as constraints to ignite creativity. Set the deadline making some reasonable assumptions and taking into account say an external and important motivator like a marketing event, or a commercial deal, or cheekily a competitor launch. Set the budget based on what you’re prepared to lose if you’re wrong. Then use venture capital financing to incrementally fund innovation from the budget. Rely on iterative development and continuous delivery to put something in the hands of customers early and often, and use their feedback to inform subsequent funding increments. If you haven’t pulled the plug somewhere along the way because the data told you to do it, then be ready to witness something great by the deadline that cost less than the budget.

Funding Innovation

Products, services, and capabilities resulting from a project or venture aren’t fixed. They emerge over time. They require innovation, creating entirely anew. Planning is difficult in ambiguous circumstances and there’s plenty of adjustments required en route. The challenge is to deploy finite resources across a portfolio of investments and to manage those investments to produce the highest possible return. Bill Sahlman provides us a frame of reference.

Any new venture contains some probability that the investment will be written off completely. The spike above the -100% return mark represents this possibility.

The probability of various returns greater than -100% spreads out in the distribution represented by the bell curve.

Ultimately, an investor first wants to reduce the height of the -100% spike, i.e. to reduce the probability of a total write-off, and second, to move the distribution of returns further to the right, i.e. to increase the probability of higher returns.

Budgets Versus Incremental Funding

Investors stage their investments in an emergent venture. For example, if a company needs £10 million to develop a product and take it to market, no investor would invest the full amount at the start. Rather the investor would stage the commitment of capital over a period time, preserving both the right to invest more money and the right to abandon the venture. Essentially investors are buying information, which allows them to continuously assess ongoing risk and inform their next decisions to invest, or not. This financial model supports iteration and explicitly incorporates the need to re-conceive a venture as it progresses. Lean Startup calls this pivoting.

Conventional budgeters tend to think of projects as standard capital investment, insisting on full quantification of costs and benefits at the start. This is more like buying equipment than funding a new venture. Given the uncertainty of innovation, expenditures are better staged to buy more information about the right combinations of people, strategy, and tactics. If we lock in our original conceptions and we lock in our ignorance too. We risk dysfunctional outcomes that won’t meet evolving business needs, or business solutions that have serious concealed flaws, which we have yet to discover.

When innovation is delivering value on time, regularly even, and within budget, why add more control? The only thing more control adds is more cost. Iterative development is a means to meet deadlines reliably. This builds the trust necessary to give innovation the space it needs. A virtuous circle. Sweet. 

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