ROI Levers for Innovation
Are you a company leader struggling with strategic innovation? You're not alone. Businesses across industries grapple with risk aversion, budget constraints, and haphazard approaches. However, these challenges don't have to stifle your innovation.
Unlocking innovation can be intricate, requiring customer focus, strategic finesse, adaptable financial controls, agile processes, and organizational capacity. Trust is vital, and building it begins with establishing Return on Innovation (ROI) metrics.
Absence of ROI metrics is often at the heart of corporate risk aversion and insufficient financial investment, causing ideas to fizzle out and leading to an overall lack of confidence in the innovation process.
Innovation metrics are not only essential but feasible.
Traditional backward-looking financial ratios may not cut it for measuring innovation -- innovation is forward-looking, after all. While mature innovation teams can enhance their bottom line and become more cost-efficient, innovative companies aim for top-line opportunities and ambitious alternative business models.
How can companies benchmark and track these initiatives? Enter the "Return on Innovation" formula.
Why “ROI?”
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 is still taught in business schools to manage wide-ranging enterprises. A 2013 Harvard Business Review article suggested the outlines of just such an approach for innovation.
A similar approach for innovation identifies key levers for innovation success – success rate, profitability, and investment rate – and sets the stage for metrics that can drive an innovation strategy.
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.
Simple Example
Consider Saad Trombone Co., a risk-averse business with a set 15% ROI hurdle rate and an innovation budget capped at $100. They funded 10 projects last year, only half of which succeeded. The return from these projects landed their team in the red, causing executives to question the program's viability. However, by adjusting the levers of profitability and success rate, they found that they could clear their ROI hurdle rate and improve their returns from innovation over time.
How? Of the three levers – profitability, success rate, or more trials – which lever offers the biggest return, fastest?
And which innovation strategy would be more effective? Was it best to expand or reduce funding per trial? To work on increasing innovation success rate? Or to try to increase profitability?
Simple sample model showing the impact of Innovation ROI drivers on financial performance.
STC leaders set a goal of improving performance on their innovation levers by between 2% and 10% across the board. 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.
Sample model showing drivers and constraints with the largest impact on financial performance.
Model Findings:
Here are the approaches they tried, and the result:
No: Reducing the budget by up to 10% and squeezing in more innovation would yield some improvement, but didn't clear their hurdle rate.
Almost: Insisting on a 10% success rate and profitability improvements would clear the company hurdle rate, but just barely.
Yes: In all scenarios, tinkering first with success rates created the most opportunity.
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, which was to 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.
Conclusion:
Many companies face similar dilemmas. Leaders often express confusion about executing innovation efficiently and sustainably. The rapid pace of innovation opportunities, coupled with threats from competitors' innovation, can be daunting. Lack of a shared framework and confusion about justifying ROI can lead to lost momentum for good ideas and a scattered approach to innovation efforts.
But don't despair! Establishing baseline metrics for ROI can pave the way for sufficient budgets, more time devoted to promising projects, and a foundation for a comprehensive innovation capability. It's time to grasp ROI for strategic innovation and set your company on the path to improvement.
Are you looking to improve your innovation KPIs and strategy? Reach out for a consultation to strategy@growthinnovationstrategy.com.
