Tuesday, February 12, 2008

Justifying Innovation

We were asked recently to consider speaking on the topic of justifying innovation. That's a difficult topic but one that needs to be addressed, since many individuals are being asked to start an innovation initiative, but also justify the investment in resources and dollars, and the opportunity costs.

As I told the conference coordinator, if I had all of the answers to justifying the investment in innovation, I wouldn't be speaking at conferences but would be instead relaxing under a palm tree in a tropical resort with a tasty beverage in hand. However, even if we don't have all the answers, I think we do have a number of the questions. So, let's start there.

First question we ask when someone wants to "justify" innovation is: Innovation project or innovation program? I see these are very different, and the ability to justify or build a potential ROI for a project is fairly straightforward. If we take these actions to create this new product or service, we project that we'll have this return. Then you can apply your standard ROI or IRR models and make a decision. What if the real goal is to justify an innovation program - putting in place a longer term capability to encourage innovation broadly, to provide techniques, tools and processes to encourage everyone to innovate? How does one justify what is for all intents and purposes infrastructure?

Next question - why do we need to justify innovation at all? No one would ever question the relative value of a purchasing team and process and software, or a sales team. These are functions and people we need to run a business. We may argue about the size or expense of those teams, but rarely do we attempt to justify their existence. So, why do we need to justify the existence of an innovation capability? If the one key competitive advantage you have left is in creating new products and services faster and more effectively than your competition, do you need to justify the infrastructure to do that? Or is it only the initiatives that stand to create greater revenue and margins that must be justified, not the transactional, cost cutting items? Recognize that all of this is a bit tongue in cheek, but really - if organic growth and innovation is so important, why do we demand such rigorous attempts to justify it while birthing it?

Next, what's the value of one good idea? Do you think that Proctor&Gamble has recouped all of its innovation investments from the Swiffer alone? Do you think that the iPod has recovered all the investment that Apple has placed into its innovation capabilities by itself? A major firm is likely to spend between $300K and $3M dollars to build and fund an innovation capability. These numbers of course may vary, but the point is that it's easy to see how one or two significant ideas a year will repay these investments 100 fold. Ah, you may say, but I may get these ideas anyway without any investment. Are you really willing to take that chance? And even if you get the ideas without any investment, can you recognize and commercialize them fast ehough? A firm I worked with over two years ago to generate ideas identified several industry leading ideas but then failed to act on them. Recently a competitor launched a service that my client had identified over two years ago but not acted on. How many times have you said - we thought of that first?

Finally, the last thought around innovation. There are two metrics you can use to measure how well innovation is working. For the first year, most likely, you'll need to use process based metrics. How many ideas did we create? How many ideas moved into new product or service development? How many people are participating? You need to establish your goals and use these metrics early on because it takes time for ideas to prove their value. Few companies can convert an idea immediately into revenue and profts. The second metric is what we call outcome based metrics. Over time as the ideas you generate have impact, you should be able to trace the revenues and margin back to your innovation team. Recognize that probably 85 to 90 percent of your original ideas may not provide a payback, but some will break even and some will return returns far beyond what your entire investment in the innovation capability.

Ok, let's review. First, what are you trying to justify? A project is ok but not consistent or sustainable. Focus on the innovation capability or program over the long run. Second, if innovation is really important to your firm, why do you need to justify it at all? This is really addressing the mindset and culture of the organization, of course you'll need to provide some rationale for the investment, but you need to encourage the teams to think about innovation as a critical infrastructure component that is sustainable, rather than a short term quick fix. Third, since you can't predict the outcome in advance - which ideas will be generated, which ideas will succeed in the marketplace, you have the choice of making up a statistical model of probable success, or asking yourself what the value of one good idea well implemented could be. Finally, the realistic answer is that in the short term, you will measure benefits and results by the activities and process outcomes, and over the middle term and long term measure results by returns, market share and differentiation.
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posted by Jeffrey Phillips at 1:06 PM


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