Three Horizons

In most large or enterprise organizations, people are used to setting yearly budgets. Most of these budgets are set in a yearly cadence. Typically, near the end of the current year, the forecasts get fixed for the next year. For certain parts of the organization, this makes a lot of sense. If the company expects to remain in the same office building for the next year, then those office costs (potentially including inflation) can be forecasted and are likely to stay the same throughout the year. When it comes to people’s wages, it’s a bit more difficult, because some people might leave, others might join, and some might move into new positions with higher salaries. Although an educated forecast can be made, the budget cannot be set in stone because HR changes can impact it, sometimes significantly.

Then there are forecasts for the products and services. These are the most difficult budgets to forecast because a company doesn’t know for sure how many new customers will join, how many existing ones will leave, how many additional revenues can be extracted with new products, and so forth. Once again, an educated guess can be made on the basis of past performance, market growth, current market share, sales goals, and other inputs, but those budgets can’t be predicted with 100 percent certainty.

One of the problems with providing a budget is that companies tend to provide a fixed budget for teams or projects, without clarifying the return period of that investment. This can lead to favoring short-term development over strategic long-term development. That is not necessarily a bad thing. In the complex domain, it is hard to get a long-term goal right. Therefore, the short-term goals that we set should drive toward validation of that long-term goal and not simply follow opportunities when they arise.

In The Alchemy of Growth,¹ Mehrdad Baghai, Stephen Coley, and David White introduced the three horizons framework. This framework provides a structure for companies to assess their potential growth opportunities without neglecting present performance. The three horizons framework is based on research into how companies sustain growth over time. Although the three horizons framework was initially designed for assessing growth potential, it can also be used effectively to classify budget forecasts with different return on investment (ROI) periods. Thinking in these horizons can help to avoid starvation of long-term developments while maintaining maneuverability for shorter-term goals.

1. Mehrdad Baghai, Stephen Coley, and David White, The Alchemy of Growth: Practical Insights for Building the Enduring Enterprise, Perseus Books, 1999.

The three horizons can be connected to your budgeting strategy as follows:

• Horizon 1: Business as usual. The first horizon relates to the company’s or product’s current business. Investments made into this horizon are done to fuel the business as usual. The purpose of budget spent on this horizon is to keep the product in a state where it continues to operate, perform well, and add value for current customers and users. Products and services in this category are usually the current cash cows of the organization and provide the greatest profits and cash flow.

• Horizon 2: Sustaining innovation. As was discussed in Part IV, “The Experimenter,” sustaining innovation is achieved by building on top of the existing products and services. Investing on horizon 2 might be needed to convince competitor customers to switch to your product. Investments on horizon 2 could also include a technology upgrade or overhaul to maintain revenue/cost ratio. Initiatives that are funded on horizon 2 are typically the larger items in the Product Backlog.

• Horizon 3: Disruptive innovation. Horizon 3 investments are big, ambitious, future ideas for growth. This type of innovation is all about taking a new approach or moving into a new field. Changing the business model or creating a whole new product for a new market, for example, are typical horizon 3 initiatives. Achieving an ROI for these initiatives usually takes time, because they are the big bets to place and potential cash cows of the future.

When deciding how to spend your product budget, it is helpful to connect the budget to these horizons, as it will help you to balance short-term, midterm, and long-term investments. The pitfall for many Product Owners is to focus too much on one of these horizons, for example, spending most of the budget on horizon 1 or horizon 3. Using these horizons and applying inspect and adapt over time helps to balance budget spending with the different needs of the product, company, and your (potential) customers.

Budgeting Is Like Product Backlog Management

One of the issues we frequently face is that the finance and control department needs a budget or financial forecast for a year or even six quarters ahead. This might be required due to regulations, but in many cases, there is an option to change the forecast after it has been made. If long-term financial forecasting and budgeting is needed in your company, then it’s best to comply and forecast one year or six quarters ahead.

However, instead of fixing the budget, use it as the forecast. That is, inspect and adapt the budget, per quarter, at clear and predictable intervals throughout the year. Doing this will allow the finance department to be compliant with regulations and compliance standards and will allow you to spend the budget more flexibly. In that sense, think of budgeting like managing the Product Backlog:

• The goals for the upcoming Sprints are clear. The Product Backlog items to be delivered can be roughly identified (although they are not set in stone). They can be connected to maintenance and improvements (horizon 1), significant product changes (horizon 2), or experiments and strategic goals (horizon 3).

• The goals, objectives, and high-level ideas for the next quarter are coarser-grained. You may have some bigger goals and objectives, some big ideas or themes, and some bigger features to build. These goals, ideas, and features could again be connected to horizon 1, 2, or 3 investments. The potential costs and benefits for these bigger ideas can be only roughly estimated—for example, using a generous budget range of $100,000 to $150,000.

• The forecast for the remaining quarters mostly contains big bets, themes, goals, and/or large future ideas. These quarters contain a couple of ideas that seem currently valuable. Although you may have more ideas than you can accommodate, select only a few of them as potential options. You want to prevent creating a long list of features that people will expect to be delivered. So, keep them on a high abstraction level (e.g., “We will work on artificial intelligence, Internet of Things, cloud, natural language processing, and/or API management. We don’t know which of these areas will be selected to work on, or which one will go first, but we will need at least some of them in order to be competitive”).

Make sure you communicate the uncertainty that exists at each level. Being reliable in the short-term forecast will help you to build credit for the longer-term high-level plan. You may be wondering how to decide how much budget to invest in each horizon. The only honest answer we can offer is one that any consultant would offer: We don’t know—it depends. You’ll surely figure it out in collaboration with your customers, stakeholders, and Scrum Team.

You could consider the product life cycle, its current value and unrealized value, the company strategy, or the needs and desires of your customers, but in general, two aspects influence the rate of innovation that determines the effective use of the budget:

• Customer adoption: People did not buy washing machines as quickly as they bought refrigerators² even though the appliances were introduced at the same time and were powered by the same electric engine technology. The market will only absorb changes or new products at a certain pace. Sometimes you need to invest in horizon 1 or 2 just to make sure the market can absorb your product. For example, Google Fiber brings the power of search (and advertising) to those who lack the infrastructure to do so.

  2. Fun fact: People bought refrigerators at almost twice the rate as washing machines. Customers first needed to change their plumbing, which contributed to the slow adoption. Sometimes companies must focus on the infrastructure to make sure their flagship product can really take off.

• Technology S-curve: The S-curve suggests that as technology reaches its mature stage, it becomes increasingly vulnerable to substitute technologies. That is, all technology will be surpassed at some point. As you get closer to this point, you will need to invest more in horizon 2 or 3 technologies.

How customers and/or users experience the “performance” of a product changes over time, as illustrated in Figure 26.1. Performance, in this case, can relate to the speed and quality of the product, but you can also relate it to customer satisfaction, or the product’s ability to solve customer problems effectively.

What you’ll notice in the image is that product performance will decrease over time with most if not all products. Think of your first phone or laptop, for example. Fresh out of the box, it was the best thing ever, but it was also already obsolete, and over time, your perception of good performance changed. So will your customers’. Perhaps your product will still be “good enough” for less demanding users, but others will seek a replacement. At some point, not even your least demanding customers will be satisfied with the product.

To prevent that situation from happening, we invest on horizon 2, with product updates, new technologies, new features, and so forth. Investing on horizon 2 helps us to keep the product alive for the near future. It contributes to sustaining the product life cycle over a longer time.

The horizon 3 lines reflect the disruptive or radical innovations that we invest in. You’ll notice that some of these investments don’t generate enough benefits or performance, as reflected by the first horizon 3 line that stops rather quickly. This effect often creates corporate antibodies, an effect where the organization uses the most demanding customers as a yardstick to measure any innovation. Much like the antibodies in our bloodstream seek out and destroy what they perceive as threats, corporate antibodies seek out and block radical ideas by underfunding, ridiculing, or outright sabotage.

If horizon 3 initiatives are to succeed, they need to be shielded from the “normal” process. They require a yardstick that is different from the most demanding customers, or they will simply not survive the budget allocation. Disruptive and radical innovations have a high failure rate. Often, they fail to reach a substantial market segment, solve a problem big enough that customers are willing to pay, or generate enough benefits for the company to keep investing money. However, if they do reach that point of success, their impact is often much bigger than expected.

A good example is the car industry, which continues to make large investments in combustion engines—marvelous pieces of technology that are past their technological peak (horizons 1 and 2). Electric engines are a horizon 3 innovation. They are not yet suitable to replace combustion engines everywhere, but they are getting there rapidly, and when they do, they will overtake the market. Similar effects can be seen in mobile phones, mobile operating systems, process automation software, airlines—basically everywhere.

When you are deciding on the budget for horizon 3, you can look at what new entrants are targeting in your market. For example, we worked with a large software company that creates a product for school administration and noticed that entrants created many small products (virtual blackboards, roster sharing, homework management, etc.) that were somewhat related but never as complete as their flagship products. These were typical horizon 2 features, but rather than trying to keep up with all competitors, they created a platform for them to run on.

A Strategy and Market Perspective on Budgeting

The final perspective we’d like to share with you allocates the budget from a product strategy and target market perspective. When investing budget in your product, you can do so for many reasons, as we’ve discussed. Another perspective to take is to allocate a budget based on your target markets. These target markets, or target audiences, can be split into four main groups: customers, competitor customers, prospect customers, and new market segments. Table 26.1 illustrates how budgeting can be approached from the perspective of strategy and target market. Each category will be explained in more detail following Table 26.1.

Let’s explore how a budget allocation to these markets could influence your product:

• Allocating budget to serve your customers: Your current customers are people who already have a solution for their problem—your product. You should have access to this group of existing customers and should be able to identify additional needs and problems to solve. When allocating a budget for serving current customers in a better way, we often notice that those companies follow a customer intimacy strategy and favor long customer relationships. For your product, this would mean spending money on keeping customers satisfied, cross-selling and upselling products and services, and reducing churn rate, for example. Good examples are Airbus and Boeing.

• Allocating budget to attract competitor customers: Competitor customers also have a solution for their problems. However, it’s not your solution. Convincing competitor customers to switch to your product has everything to do with switching costs. When allocating a budget for attracting competitor customers to your organization, we often notice that they focus on ease of switching, free trials, sign-up bonuses, loads of marketing and commercials, and active salespeople. Therefore, you can find a “switch from Android app” in the iOS App Store and a “switch from iOS” app in the Google Play store. Both parties invested in easy switching.

• Allocating budget to attract prospective customers: Prospect customers are people who do not yet have a solution for their problem. They might be aware of having a problem and are orienting themselves, or they aren’t aware of any problem at all. If you want to spend budget on this target audience, most of the budget will be spent on customer orientation, comparison of products, product branding, company branding, and the buying process for customers. Companies like Booking.com and Amazon make it as easy as possible to buy.

• Allocating budget to enter new market segments: Another target audience could be considered as entering a new market or serving a whole new target audience. Targeting new yet similar problems allows you to enter new markets. The company SAAB, for example, delivers maritime safety systems for ports and harbors. This was a saturated market in which most customers already had a solution for their problems. Once SAAB discovered that the protection systems of remotely operated oil rigs solved a very similar problem, they decided to enter this new market.

The second dimension to explore is product strategy. This ties back to the three horizons framework. We have split horizon 3 into two parts: creating a new product and creating a new business strategy. Horizon 2 can be split into sustaining the technology and sustaining the functionality of the product. Allocation of the budget to the strategy could be evaluated according to:

• Maintaining the status quo: Maintaining the status quo relates to horizon 1. This category reflects all the small changes, improvements, bug fixes, and maintenance that are done on the product.

• New technology: Adding a new technology or replacing existing technology with a new one relates to horizon 2. By adding a new front-end technology to a software product, a whole new experience can be created for customers and users. For example, we have replaced Silverlight front ends with HTML5 + JavaScript front ends. Doing so didn’t change much of the functionality but allowed us to operate on modern devices across platforms.

• Product enhancements: Enhancing the product with new features, adding new feature areas, and/or solving new customer problems and needs within the same product is also related to horizon 2. These product enhancements sustain the value of the product by keeping it interesting for customers and users.

• New product: Developing and launching new products is related to horizon 3. Launching new products is a big bet. Although we do a lot of work as product people to maximize our chances of success, some products will succeed and others will fail. Introducing a new product might be interesting for your current customers, but it might also attract competitor customers, prospect customers, and/or new markets. In the past, we have developed several additional products that complement our core product. These new products made it interesting for current customers to stay and for competitor and prospect customers to switch to our company.

• New business strategy: The last product strategy perspective is to launch a new business strategy, which relates to horizon 3. Launching a new business strategy—for example, moving from a flat-fee subscription to a pay-per-use payment model—could offer interesting new opportunities for your product. In the case of World News, adding a proposition for B2B news, in addition to or as a replacement for the B2C news, could be an interesting new business strategy to explore.

Creating a simple budget strategy table in Excel or PowerPoint, for example, may help you to identify where to invest your budget (see Table 26.1). We recommend you discuss your ideas and options with customers and stakeholders. Create transparency on how you want to spend the budget, and why. Discuss other perspectives and align on the vision and strategy for your product and how your budgeting strategy will influence the steps to take. What would happen in your organization if you, for example, asked your stakeholders to identify where they think we should be spending the budget?

Chances are that management would say it should be in new business strategies for new markets. Now ask the same question to the customer-facing teams, like customer support, account management, or operations. They will likely say to invest in current products, tools, and solutions for current customers. It is up to the Product Owner to bridge these two perspectives and align them. Doing so also helps you to create transparency about where budget will not be spent.