By James Janega
Frustrated company leaders, bemoaning a lack of strategic innovation in their businesses, often cite their companies’ aversion to risk, limited budgets and scatter-shot approaches.
The same problems pop up across industries. I hear them and see them in corporate meeting rooms, executive surveys, professional discussion boards, and in the hallways at innovation conferences.
A common obstacle is a definition on returns to innovation investment that the whole company can agree to.
It doesn’t have to be.
Doing innovation right can be complex. It involves attention to customers and strategy, flexible financial controls, agile business processes and organizational capacity. But progress is difficult without trust.
A lack of metrics for ROI – Returns on Innovation – is often a root cause. It underpins corporate risk-aversion and insufficient financial investment, contributes to fizzled ideas, and leads to an overall lack of confidence in the innovation process.
To build an innovation capability, metrics for innovation are essential — and aren’t impossible.
It may seem that way, because most attempts to measure innovation steal backward-looking financial ratios. Those metrics are better suited to bottom-line problems, and lead to ineffective predictions and lost faith in innovation activities.
Innovation is inherently forward-looking. While mature innovation teams can improve their bottom line and get more cost-efficient, the object of innovative companies is to aim for top-line opportunities and ambitious alternative business models.
How can companies benchmark and track those initiatives?
The initial quest for ROI offers a clue: The DuPont Corporation may have given the world Teflon, Kevlar, Freon, Lucite and Nylon, but its greatest innovation could be the formula for Return on Investment.
It was created by a company explosives salesman in 1912, was subsequently enshrined as the “DuPont Equation,” and still is taught in business schools for managing wide-ranging enterprises. A 2013 Harvard Business Review article suggested the outlines of just such an approach for innovation.
Taken a few steps further, the “Return on Innovation” formula shows where to find several key levers on the innovation machine – success rate, profitability, and investment rate – and from that, the kinds of metrics that can enable an innovation strategy.
It also allows the creation of simple financial models to understand the impacts from those levers. From there, it can help inform an organizational strategy to layer in innovation capabilities, and establish where to start implementing given the company’s constraints.
In real life, that’s where more complicated questions emerge. But it’s useful for leaders to grasp possible avenues for improvement first.
Case Study, Simple Model
Let’s consider a simplified, fictional case study for Saad Trombone Co., a risk-averse business with a 15% ROI hurdle rate, $100 invested in innovation capital expenses, another $50 to fund team operational expenses, and a capped innovation budget of $175.
The company funded 10 projects last year, half of which succeeded and half of which lost money. The $148 they got back from those projects put their team in the red, and company executives are considering whether to cut the program as a money-loser, even though they know opportunities exist.
To set things right, where to start? Which lever offers the biggest return, fastest? Is it best to expand or reduce funding per trial? Work on increasing innovation success rate? Try to increase profitability?
Simple sample model showing impact of Innovation ROI drivers on financial performance.
For simplicity’s sake, STC leaders wanted to see the possible impact to their returns from innovation of a modest effort to improve levers across the board by between 2% and 10%. They also agreed to look earlier for ways to shift between 10% and 25% of funding from losing projects to winning projects. They built an Excel model with an optimizer plug-in.
Of the three levers – profitability, success rate, or more trials – STC discovered that trying to reduce the budget by up to 10% and squeeze in more innovation would yield some improvement (if it were possible at all), but wouldn’t clear their hurdle rate. Focusing on 10% success rate and profitability improvements was more promising – it would clear the company hurdle rate, but just barely.
But they saw that improving their success rate by 7% would allow them to fund one more project a year, which could unlock up to a 27% improvement in innovation financial contributions, a comfortable margin of error.
Sample model showing drivers and constraints with the largest impact on financial performance.
The third lever, increasing the number of innovation attempts while streamlining costs, didn’t make sense until the first two had been improved, given STC’s constraints.
The pattern shifted somewhat as they modeled moderate and aggressive fixes, but the basic relationships held – and they agreed to test the idea of tinkering with success rates first.
Among other ways to improve the metric, team leaders focused on picking innovation projects with more evidence that consumers were willing to buy them. They agreed that if it worked, they’d start pulling the next best lever, increase the team’s capacity and reach for other levers. The model showed that if they optimized all three levers, they could see an up to 40% improvement in returns from innovation over time.
Many companies face similar problems.
Business fundamentals for sustaining innovation
Corporate leaders complain they don’t know how to do innovation – how to do it efficiently, how to sustain it, or where to start.
Fast-paced innovation opportunities – and sudden threats from the innovation of others – keep company leaders awake at night.
Executives often tell me and my colleagues that they lack a shared framework for priorities or progress. They describe innovation efforts all over the map, good ideas that lose momentum and confusion on how to justify the return on investment.
Many throw their hands up and blame a lack of innovation culture – but a lack of baseline metrics makes it impossible to ask for sufficient budgets, devote more time to promising projects, or lay the foundation for a more comprehensive innovation capability.
One way to build agreement around the path to improvement is getting a handle on ROI for strategic innovation.
James Janega leads the Innovation & Insights group at Slalom Chicago. He is an Entrepreneur-in-Residence at the University of Illinois’ EnterpriseWorks accelerator, a member of the Chicago Ideas Co-Op, and helps enterprise companies and startups improve the way they think about innovation strategy, customer validation, building more robust innovation capabilities and processes. You can reach him at @JamesJanega on Twitter.