As companies mature into corporate titans, innovation is often left behind for market growth and expansion. Although improving on core businesses is essential to maximize profits, it is also important to target emerging opportunities and innovative ventures. McKinsey’s Horizon Model is a classic framework to align innovation efforts with potential future challenges.
What is the McKinsey Horizon Model?
The three horizon methodology is a classic McKinsey framework. The methodology was presented in The Alchemy of Growth - a ground-breaking guidebook produced after over two years of research and focused on companies that managed to achieve the greatest growth.
As the name suggests, the McKinsey horizon model focuses on three horizons.
First horizon – your existing business
It focuses on corporate development/innovation at this very moment. In this scenario, a focus on innovation will sustain the business as usual. Obviously, however, situations change over time and innovation considered desirable right now may become obsolete on the basis of future challenges. Activity that currently contributes to the company’s revenue generation is usually classified under the first horizon.
Second horizon – a company in transition
This framework focuses on either disruptions or transformations of the first horizon. Depending on the circumstances, the effect could be neutral, positive or degenerative. The introduction of innovation begins to replace the usual aspects of business. Disruptive innovations, however, will be absorbed without a significant change to the first horizon. The return on second horizon innovations is considered fairly reliable because many of these endeavors are based on existing and already successful business models.
Third horizon – a new business emerges
The focus is entirely on the introduction of new ideas that don’t exist in the business today. In the Alchemy of Growth McKinsey guidebook, such innovations are labeled as risky, often unprofitable. The third horizon typically focuses on research, pilot programs and even brand new revenue lines.
Thus, the three-horizon methodology can be used to determine the degree of uncertainty linked to each type of innovation. First horizon innovations come with relatively low degrees of uncertainty while third horizon projects are characterized by a much bigger number of variables.
Also, great innovation is often about great timing. The correct framework being used allows a much better idea of the potential value of an innovation. Through the use of horizons, entrepreneurs and innovators can focus on broad challenges and plausible futures. The approach leads to much more sustainable innovation than a primary emphasis on the business result cycle.
When to Use the Three Horizon Methodology
The McKinsey horizon model can be used in an array of important ways:
To foster thinking about the future within the corporate structure
To create a culture of innovative initiatives, whether products or policies
To create the internal framework needed to guarantee the success of long-term innovation initiatives
To enhance business analysis that focuses on both opportunities and challenges a business could potentially face in the future
To prepare a developmental plan/strategy allowing for the vision to be fulfilled within the respective timeframe
Application starts with a thorough understanding of the first horizon. What are the company’s biggest assets today? How does the company generate revenue and is the process effective? In the case of a company like Starbucks, for example, the biggest strengths in horizon one are the company’s distribution network and the power of the brand.
A second step would be imagining the loss of your biggest strengths. What would the business need to refocus on for the purpose of surviving and thriving?
Microsoft is an excellent example of making the transition from horizon one to horizon three (thinking about completely new innovation is a jump from the first to the third horizon). Microsoft’s Xbox launch in 2001 is the company’s transition from the first directly to the third horizon. The Xbox was not a shot in the dark. Obviously, it was a massive deviation from Microsoft’s core strengths. The company relied on none of its horizon one developments in the early 2000s when entering a highly competitive niche that already featured established players like Nintendo and Sony.
The bridge between horizon one and horizon three is the horizon two process. Knowing where you are right now and where you want to go in the future will help you identify the processes that will reduce risks and enable you to be profitable in the future.
Be Careful About Horizon Two Applications
Harvard Business Review has come up with a concept termed the second horizon vacuum. According to the publication, many companies have a good grasp of where they are right now and where they’d like to take innovation in the future. All of these companies, however, failed in terms of coming up with actionable practices for getting from point A to point B (the processes that occur in the second horizon).
Kodak, Polaroid and even Xerox rank among the businesses that had innovation in mind but that didn’t quite make it there.
A second horizon vacuum could result from reliance on an outdated portfolio and hope for the introduction of next-generation technologies without an actionable plan for ensuring the long-term sustainability of the innovation.
Second horizon innovations are most challenging because they don’t come with the return on investment achieved in the first horizon and they aren’t as inspiring as third horizon innovations and their massive potential.
Cisco Systems is one company that is working continuously to break through the second horizon vacuum through the introduction of adequate measures. After thorough analysis, developing countries were identified as Cisco’s greatest growth opportunity. A new territory managed by one sales executive was created for these second horizon markets (over 130 countries). Many of the second horizon countries were rich in assets and the Cisco team focused on winning big deals with local organizations and governmental institutions.
Other countries were designated as third horizon markets.
When the industry experienced a massive downturn, Cisco was faced by a serious second horizon vacuum. To ensure growth, Cisco acquired Andiamo Systems – a move that enabled its entry into storage area networks. Airespace and Linksys acquisitions were also completed as a part of Cisco’s second horizon initiative.
Through these acquisitions, Cisco managed to enter the security and the wireless network markets in the second horizon countries. These strategic developments guaranteed sufficient return on investment in the middle term.
Through higher visibility, Cisco ensured access to resources required to drive the more profound third horizon growth. Cisco’s efforts are still ongoing and the company is experimenting with an array of options. By casting a wide net, Cisco is attempting to establish best practices that will drive the company into the future, ensuring the sustainability of third horizon innovations.
Regular progress measurement at specific intervals, reliance on market metrics, thorough communication across the organization and a predominant focus on second horizon challenges rank among the pillars of the McKinsey horizon model methodology. Such a comprehensive approach is required because the future will never stay the same and once the zone of uncertainty is entered, many businesses will lack the models required to ensure awareness and sustainability.