Tuesday, February 14, 2012

What are the opportunity costs of not innovating?

A client asked me this question recently, and it has been much on my mind.  The question, when boiled down, was this - we know the costs of "business as usual" and we think we know what it will cost to innovate.  Often, the costs and uncertainties related to innovation block our innovation efforts.  But we have no way of measuring the cost of failing to innovate.  Is there a way to measure the opportunity costs of not innovating?

Wow.  If I had the answer to that one, I'd be residing on a tropical beach with a cold, fruity drink in hand (this being a recurring theme when/if I strike it rich).  But, since I don't have a crystal ball to predict the cost of foregone opportunities, we ought to ask ourselves if this is a reasonable request.  Could we compare the investment in idea generation and innovation versus the potential revenues we miss by not innovating?  Can we compare the value of the missed opportunities to the opportunities we chose to pursue?

I think the answer is a qualified "yes".  That is, we innovators should attempt to place a value on every innovation or every good idea, and suggest that the avoidance of innovation means that we miss out on new customers, new markets and most importantly, new revenues streams and new profits.  Those missed opportunities come at a cost - usually in disruption or product or service obsolescence.  This analysis requires a number of assumptions - that we can create a new product or service, that it has value or benefits to customers, and that we can assert some knowledge about the downstream revenues or profits that will be missed if we don't innovate.

Unfortunately, I can speak about this from personal experience.  We led a project with a large enterprise and presented several very valuable ideas, ideas that would disrupt the marketplace and that were relevant to consumers.  We knew the suggested products and services were attractive to consumers because we conducted rigorous testing in the marketplace.  Yet when we requested funding to accelerate the ideas to finished products, no funding was available.  The client wasn't comfortable with the risks involved and was too focused on short term concerns.   Over the next three years, competitors created products that were similar or virtually identical to the products we had suggested, and our client was forced to play "catch up" with the ideas that we had presented years before.  I know what the costs of playing catch up were, and I can also assume that the first mover commanded more margin and won more customers because they were first.  So, it is possible to get an accurate accounting of the missed opportunities, if only after the fact.

Managers are trained to ask "what's the cost" when considering a new innovation, but rarely if ever ask "what's the size of the opportunity we miss if we avoid innovating".  As a manager or executive, you must consider not only the short term costs of innovation, but also the longer term implications if you don't innovate.  What is the cost of not innovating?  What if another competitor releases a product or service before you do?  What are the costs of being forced to respond, rather than forcing other firms to respond to your great ideas?

Update (3/9/2012)

There is a nice HBR article by the man himself, Clayton Christensen, and Kaufman and Shih which address this issue nicely.  In the paper entitled Innovation Killers (from January 2008) they state that most executives consider the cost of innovation against a static, do nothing status quo, when they should really consider the costs of a decline in performance once the firm fails to innovate.  They use this graphic to make their point:
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posted by Jeffrey Phillips at 7:10 AM


Blogger Kevin McFarthing said...

Good post Jeffrey. The other question is "what happens to business we already have today if we don't innovate?". A lack of innovation reduces the competitive position, so the business misses out on growth and exposes itself to the risk of contraction.


7:27 AM  
Blogger Larry said...

Thanks for posting this Jeff. This question is one I wrestle with often. As the saying goes, hindsight is 20/20. Predicting the future is fuzzy at best. (I'd be right there with you on that island if I had a sure fire answer.)

One way that I like to present the information is a series of curves outlining all the options considered including a "Do Nothing" curve. For this I take into consideration the current costs and performance and extrapolate forward with similar assumptions to the other options.

Very often just seeing this against the alternatives provides for some interesting conversation.

That is the 30-second response. Maybe I will circle back with a more informed response after my current project reaches a conclusion.

8:03 AM  
Blogger Graham said...

I'm not sure that showing graphs is the best solution, since any graph will be based on a huge number of assumptions, which everybody in the room knows, and which makes them too easy to criticise or dismiss entirely.

i prefer using "horror" stories, such as the ice-cutters in new england 100 years ago who didn't notice their business was being eroded by ice factories, or the modern music industry neglecting to introduce what instead became apple's itunes music store.

or, if you prefer a more dramatic analogy: continuing to train cavalry in the first world war while the enemy was busy developing tanks.

3:27 PM  

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