Net Present Value (NPV) calculations to assess the return on investment for a late-stage project, or the value of a portfolio, can be useful. However, for the most part, normal accounting doesn’t work for innovation. This is partly because demanding an overly precise financial case from an early stage initiative creates artificial results and can quickly demoralise the innovation team. In the end, this means that no one wins.
Forcing the use of stage-gate processes often leads to unrealistic quantitative forecasts on innovation initiatives far too early, creating two problems. First, innovation modelling is subject to gaming; this means that a 1% increase in revenue assumptions compounds to make a huge difference to revenues 10 years later. What’s more, the commercial world just does not have a good track record in estimating the true potential scale of innovation. The growth prospects of Facebook, Google and iTunes (not to mention Viagra) were all wildly underestimated.
Second, there’s a double uncertainty to measuring “over the horizon” innovation. Discounted cash analysis often paints an optimistic picture as it measures an uncertain upside versus steady state finances. But, in reality if a business doesn’t innovate, its state will be anything but steady. At best its future will be uncertain, but it is more likely that its prospects will be declining. But conventional accounting just isn’t built to handle this much or this kind of uncertainty.
Early-stage innovation needs people to talk frequently about the development of the idea. Working on ideas with only your immediate team, or developing an idea using the same people with the same perspectives, is not a great recipe for success. It makes sense to design measures that promote dialogue and engage stakeholders. If you have too few ideas in the pipeline, you need to talk about that. But, if there are too many ideas, well let’s talk about that, too. And if there are just the right number of ideas in the pipeline that is simply too good to be true and now we really need to talk. Introducing a few simple metrics can make these conversations more productive and promote just the right sort of dialogue around innovation.
Look top-down at the innovation pipeline on an order of magnitude basis.
Contrast the non-risk adjusted pipeline value (in other words, your estimate for the revenue of all your innovation projects, assuming they all succeed), with the amount of revenue you need to deliver from innovation (the growth gap). If the pipeline value is 10 times the target, then maybe that’s good enough. But if it is much less than that, it is likely that you might need to question how much innovation is actually going on in your organisation. This calculation can be very simple and very fast, but it is also very likely to provoke a debate.
Cross-reference the exercise above with a straightforward risk-adjusted valuation of individual initiatives and ladder up to the total risk-adjusted pipeline.
If that doesn’t hit the desired financial outcome from innovation then how many more probes and projects are needed? In other words, are we kissing enough frogs? Working this through with a client recently, we found that they probably needed three more projects to hit their objectives. That’s unwelcome, but important, news and the sooner the board becomes aware of it, the better.
Analyse the speed and success rate of initiatives flowing through the stage gate process.
How quickly are ideas being prototyped and moved on or rejected? Effectively this measures idea “flow speed” (or conversely pipeline “stickiness”). Like unsold inventory, there’s a cost to stalled ideas.
Dig underneath the financial value of an idea for the underlying value drivers.
So instead of spending time measuring, say, the value of a solar panel innovation project, track the drivers of solar panel growth such as new home construction, changes in technology efficiency or government legislation. Measuring changes in value drivers will provoke a lively discussion with the sponsor team.
Establish a market valuation model that allows innovators to put their money where their mouth is.
The value of each initiative is then decided by a venture board composed of a few wise heads and external advisors. The incubator team members can buy options, but real cash must change hands. In a similar way, the financial services sector likes predictive markets, trading ideas using a virtual currency. GE pushes many of its initiatives to joint venture, calculating this will “prove them out” better than actuarial techniques.
Monitor incubator health metrics
How engaged are the team? What is their reputation? What’s the ratio of the team’s useful time to form filling, courses and reporting? How many unsolicited job applications come in? For example, Boeing tracks how often the incubator asks for help as a useful and telling measure.
Finally there is another way to look at making a business case for innovation. Let me call it the “free bet”. Think of it as an innovation measure that gives comfort about the downside rather than raising expectation about the upside. The free bet does not make any promises about what revenue, profits or market share you are going to achieve.
This upside accounting shines a light on innovation, if the rewards are this big now, everyone will want to know what’s going on. Also it’s highly unlikely your upside estimates are going to be correct, something your boss knows very well.
Antony Jenkins, CEO at Barclays, eschews conventional investment metrics when it comes to innovation. You might think that such an august institution would have measured the hell out of everything but Jenkins believes that, “when it comes to early stage innovation, NPV calculations, models and spreadsheets have too many assumptions to be useful”. When the Oyster credit card was developed, Jenkins had not asked: “How much money will we make?” but “How much do we need to spend to find out if this works?” He adds, “on this basis we just took a decision, we didn’t want to analyse this to death.”
With innovation you are sometimes better off using this downside accounting. Work out how much it costs to get to the next significant stage of the project or maybe to get to the end of a pilot or to soft launch. If the boss knows you’re not placing a mega bet and that the worst case isn’t that bad, then they’re much more likely to agree to it. Far better to pin your colours to a minimal downside number than an aggressive upside.
Downside accounting enables an entrepreneurial approach, undercover and lean activity. You’re going to break even or lose no more than a certain amount. So now there is a green light and you can get on and do what you have to do to get the initiative to the next stage of development.
Battling the corporate machine: how to navigate roadblocks to innovation
• Take a leaf out of the innovation playbook from successful disruptors such as Amazon, Lovefilm and Google by getting small groups of people together and enabling them to work at pace, unfettered by day-to-day business activities. Swap job roles for innovation projects and remember a great innovation process will never compensate for poor innovation people.
• Pushing an idea through an organisation is much harder than having the idea in the first place. Prepare for a battle within the business before you get anywhere near the marketplace.
• How an innovation challenge is framed sets it up for success later on. Define how much innovation is needed, what type of innovation and when.
• Similarly the innovation challenge must be scoped at the outset. The more you can define what is in and out of scope, the less others will make assumptions.
• Leaders who demonstrate a love of their products cut through bureaucracy.
• A big company needs innovation safe zones staffed by people prepared to stick with the innovation all the way to launch.
• At work the grapevine is underestimated as a force for accelerating or destroying innovation. Cultivate a reputation as a good listener to attract great ideas and brilliant people to you.
• Finally organisations will always have naysayers; instead of getting depressed about these glass-half-empty people, relish the chance of winning them over.
Matt Kingdon is co-founder and co-chair of innovation consultants ?What If! and author of The Science of Serendipity: How to Unlock the Promise of Innovation in Large Organisations (Wiley)