The Economics of Innovation and Big Bets

“How do you make these big bets and when? When everyone can see that the economics makes sense, it’s usually too late.”

There was a story in The Wall Street Journal about utilities that made a big bet into renewables 15-20 years ago and are starting to see their valuations increase to match that of the traditional oil giants. How do you value and build a business case for R&D and innovation?

I have worked with the most senior leaders in oil and gas, 15-20 years ago, when they were making the decision if they should invest in renewables. Some decided to invest in renewables and some didn’t. At that time, nobody knew what was going to happen. You have to make a bet on a technology that’s unproven, but you’re betting that it will improve to the point where you start generating profit. So, how do you make these big bets and when? When everyone can see that the economics makes sense, it’s usually too late.

Can you fund the transition away from your legacy assets that will eventually decrease and die to something that will be very successful?

Big Bets and Power Stations

In the Corporate Strategy and Transformation study, which is available to FIRMSconsulting Insiders, we talk about building power stations. But one of the big debates is what type of power station do we build?

Do we build a new modular nuclear reactor?

Do we build a combined-cycle gas turbine?

Do we build a new type of gas turbine?

Do we build a new type of coal station?

Do we believe that the technology we want to install to make our coal stations carbon neutral are actually going to work? Because if they fail we actually going to be penalized for the next 40 years. Talk about big bets!

Do we go down the path of an unknown nuclear technology that’s been unproven but could potentially save us 50% of the operating and capital costs?

How do you make those decisions?

You need a hybrid, two-speed corporate strategy

The deep insight is this: You need a hybrid strategy. You need a two-speed corporate strategy.

On the one side, you have to continue maintaining and investing in your legacy assets because they produce the cash flow that’s going to fund you into your new assets, and R&D is expensive. When you take the capital from the legacy assets to make some big bets, you must make sure you’re picking a trend that makes sense. How you’re going to succeed in that trend, and where you’re going to play in the value chain—that’s corporate strategy, you can see it in the study.

But you have to do two things: have a hybrid model, two-speed model, and keep your legacy assets and you got to switch.

Start the Transition

You’re seeing many companies doing this right now. Just about every oil and gas major is looking at it, sovereign wealth funds and even Norway—which built most of its wealth from oil and gas—is still keeping the oil and gas investments, but it has a plan to migrate and transition.

You can’t abandon legacy assets; you’ve got to nurture them. But you have to start the process to transition, and the process doesn’t happen overnight. It’s a 10-15 year process. So if you haven’t started the plan to transition, you’re setting yourself up for a 15-year journey. And you might as well start now.

This is an excerpt from Monday Morning 8 a.m. newsletter, issue #9.