In a 2016 letter to Amazon’s shareholders, Jeff Bezos famously wrote: “Given a ten percent chance of a 100 times payoff, you should take that bet every time. But you’re still going to be wrong nine times out of ten.”
If you have a solid ROI (Return on Investment) analysis blueprint in place, those nine wrong bets won’t easily throw you off track - because you’ll know that the one bet you got right more than pays for the whole trial and error process of business innovation investments.
Measuring ROI is important for all aspects of corporate strategy financial justifications, from marketing to product pricing; but one aspect where it plays a crucial role is innovation.
When it’s properly applied to innovation projects, it can help you determine where to allocate your resources in an efficient way, recognize the areas in which your business should grow, and help you build a stronger culture of innovation within your organization.
Keep in mind, though, that traditional ROI measuring approaches aren’t always easily adaptable to innovation projects. Traditional financial metrics alone fail to take into consideration the intangible aspects of driving business innovation (developing your brand image, for example), or the staggered effects of new technology adoption.
In this article, we’ll cover how to specifically track ROI on innovation, and analyze two case studies of how innovation-driven companies apply these approaches.
By the time you’re done reading, you’ll be ready to set an innovation ROI tracking framework for your business.
ROI Methodologies
While traditional financial metrics have limitations for innovation ROI, other methodologies offer a more nuanced approach. Let’s take a look at some popular methods that incorporate both financial considerations and the unique characteristics of innovation projects:
1. Net Present Value (NPV):
This method considers the time value of money, recognizing that a dollar today is worth more than a dollar tomorrow. NPV calculates the present value of all future cash flows associated with an innovation project, factoring in both the initial innovation investment and the expected future profits.
NPV takes into account the long-term nature of innovation projects by considering the stream of cash flows over the project's lifespan, not just immediate gains. It also allows for comparison of projects with varying cash flow patterns.
On the other hand, NPV requires accurate forecasting of future cash flows, which can be challenging for the inherent uncertainty of innovation projects.
2. Internal Rate of Return (IRR):
IRR calculates the discount rate at which the NPV of a project equals zero. In simpler terms, it tells you the expected annualized return on investment for the project.
With this ROI measurement method, you can compare different innovation projects with varying cash flow patterns, as it provides a benchmark for assessing the overall profitability of an innovation initiative.
Some of the downsides of IRR, however, include a lack of consideration of a project's cash flow beyond the IRR point, potentially overlooking long-term benefits; and the fact that multiple IRR values can be set for certain projects, leading to confusion and difficulty in clearly identifying ROI values.
3. Payback Period:
Lastly, the payback period is an ROI measurement method which focuses on how quickly an innovation project will recoup its initial investment. It does so by calculating the number of years or months it takes for the project's cumulative cash inflows to equal the initial investment cost.
The payback period method is simple and easy to understand, offering a quick assessment of an innovation's liquidity. In addition, it provides insight into the project's liquidity, making it particularly useful for short-term innovation projects where faster returns are crucial.
It does have its downsides, though: It ignores the project's cash flows beyond the payback period, potentially overlooking long-term financial gains; and it doesn't consider the project's overall profitability, only the speed of recouping the initial investment.
As you can tell, none of these ROI methodologies are perfect, but each one has its pros and cons. By understanding the strengths and weaknesses of each methodology, you can pick the right approach for your project’s requirements.
Frameworks for Innovation Accounting
While the three methodologies reviewed offer businesses valuable financial insights, innovation is more than just numbers on a spreadsheet. It's about creating new ideas, exploring uncharted territory, and fostering long-term growth. That’s exactly where frameworks specifically designed for assessing innovation come into play.
With frameworks built for innovation accounting, you benefit from a more holistic approach - one that considers not just the financial implications of investing in innovation, but also the strategic and cultural aspects.
One such framework is the Three Horizons Framework (3HF). This framework conceptualizes growth as a series of three horizons, each representing a distinct type of innovation:
Horizon 1: Sustaining Innovation (Here and Now)
Focuses on maintaining and improving existing products, services, and processes.
Measured using traditional financial metrics like profitability and market share.
Horizon 2: Disruptive Innovation (Transition)
Introduces new ideas and technologies that may cannibalize existing offerings, but ultimately lead to disruption and growth.
Measured by metrics like speed to market, customer adoption rate of new products, and pilot project success rate.
Horizon 3: Transformational Innovation (Beyond the Horizon)
Envisions radically new ideas and approaches that have the potential to reshape entire industries.
Measured by more qualitative metrics like creativity, idea generation, and long-term vision.
The 3HF framework covers more than just one type of growth, and more than just one type of innovation. It helps promote strategic planning of both short-term and long-term innovation, and offers a healthy springboard for more disruptive and risky initiatives by treating it as a crucial aspect of business growth.
Additional innovation frameworks include the Innovation Maturity Model (which maps out a company’s innovation capabilities from basic to advanced) and the IDEO Design Thinking Process (which focuses on user-centered innovation), among others.
Just like with ROI methodologies, there is no perfect innovation accounting framework. The best framework to use depends on the specific needs and goals of your business.
That being said, all of these frameworks offer you these core benefits:
They help you identify course corrections where needed.
They allow you to focus on the long-term aspect of innovation.
They measure your company’s overall innovation maturity over time.
Case Studies: How Leading Companies Measure Their Innovation ROI
To help you better understand how these innovation frameworks and methodologies can be of use to you, let’s take a look at 2 world-renowned companies, and the ways in which they measure their innovation ROI.
Procter & Gamble (P&G): A Multi-Faceted Approach for Consumer Goods Innovation
P&G, a consumer goods giant, needed to measure the multifaceted value of innovation beyond just sales figures. To do so, the company developed a comprehensive framework that considers multiple aspects of innovation ROI:
Traditional financial metrics like sales growth, profit margins, and revenue are tracked for each innovation project.
Customer satisfaction surveys, market research, and brand perception studies are used to gauge the impact of innovation on customer behavior and brand loyalty.
Innovation metrics like reduced production time, lower waste levels, and improved supply chain efficiency measure how innovation optimizes operations.
P&G integrated this 3-level framework into their innovation decision-making process. Teams present innovation proposals with data on projected financial returns, anticipated customer impact, and potential operational efficiencies. This holistic approach encourages prioritizing projects that deliver a multi-faceted value proposition, not just a quick financial gain.
Ultimately, this multi-pronged approach allows P&G to build a stronger business case for innovation. It demonstrates not only the financial viability of a project, but also how it enhances brand image, improves customer experience, and optimizes internal processes - making it an easy sell for internal stakeholders.
Amazon: Continuous Innovation and Rapid Experimentation
As you can very easily deduce from its CEO’s quote that opened this article, Amazon has long prioritized continuous innovation and rapid experimentation. For such a business approach, traditional ROI calculations might not capture the full value of these initiatives.
Instead, Amazon chose to focus on metrics that encourage a culture of exploration and learning:
Innovation success is measured by how well it satisfies customer needs and enhances the user experience.
Calculated risks and failures are taken into consideration as opportunities for learning and improvement.
New features and functionalities are A/B tested on a small scale before widespread implementation. This approach allows for quick data-driven decisions about scaling successful innovations.
Amazon has implemented this approach throughout their innovation process. Teams brainstorm new ideas, conduct A/B testing, and analyze customer behavior data to measure the impact of these innovations. Success stories are widely shared within the organization to encourage further experimentation and continuous improvement.
This culture of continuous innovation has fueled Amazon’s growth and dominance in e-commerce. By prioritizing customer needs and embracing rapid experimentation, they can quickly iterate on new ideas, launch successful innovations at scale, and ultimately maintain their industry leadership in a constantly evolving landscape.
Both of these case studies demonstrate the need to recognize the needs of your business first, and decide on the right framework second. Whether you choose to adopt a pre-existing system or set up one of your own, the main thing to consider is that unlike other business initiatives, innovation ROI can’t be measured solely by financial means; you need to consider several different aspects in order to properly analyze the value you get from pursuing innovation.
Challenges in Measuring Innovation ROI
While the P&G and Amazon case studies showcase successful approaches, that doesn’t mean that measuring innovation ROI is easy. Here are some common hurdles companies face, and how to address them.
1. Attribution: Pinpointing the financial impact of a specific innovation project on the overall revenue stream can be difficult.
How to address it: Develop a clear attribution model that tracks the contribution of each innovation project - and department - to different revenue streams.
2. Long-Term Impact: Measuring the ROI of a disruptive technology might not be possible within a traditional financial reporting timeframe.
How to address it: Employ long-term forecasting models that consider the projected impact of an innovation over its entire lifespan.
3. Intangible Benefits: Innovation often generates benefits that are difficult to quantify in monetary terms.
How to address it: Develop qualitative innovation metrics to track customer satisfaction, brand perception, and employee engagement..
4. Data Availability: Measuring innovation ROI requires access to accurate and comprehensive data.
How to address it: Integrate data from different sources to create a unified view of innovation performance.
5. Lack of Resources: Measuring innovation ROI can be a resource-intensive process.
How to address it: Prioritize innovation projects based on their potential impact and resource requirements.
Remember - it’s all about prioritization. Innovation can be challenging to measure, but not pursuing it can cost you more than you’ll be able to afford. Put in the time and effort to build the right framework for your business, and innovation projects will become easier to monitor over time.
Best Practices
Before you get started, let’s go over the key best practices for executives setting up effective innovation ROI measurement systems. Make sure to follow these, and you’ll be on the right track right from the start.
1. Define Your Innovation Goals:
Start by outlining your overall business goals. Next, set specific innovation goals that are aligned with your business objectives. For example, if your goal is to increase customer satisfaction, an innovation goal might be to develop a new product feature that addresses a particular pain point.
2. Choose Relevant Metrics:
Select ROI metrics that directly connect to your innovation goals. Don't just focus on generic financial metrics. For Instance, if your goal is increased customer engagement, track innovation metrics like app downloads, user retention rates, and time spent on the platform after implementing a new feature.
3. Leverage Frameworks:
Utilize frameworks like the Three Horizons Framework to map innovation projects to specific horizons (sustaining, disruptive, or transformative). This helps you choose appropriate ROI metrics for each project. For a sustaining innovation, focus on short-term financial gains, while for a transformative one, track long-term vision and potential market disruption.
4. Consider Intangible Benefits:
Innovation often yields intangible benefits like improved brand image or a more efficient workforce. Develop qualitative innovation metrics to track these benefits, like employee satisfaction surveys and brand perception analysis, and not just the easy to see financial justification metrics.
5. Encourage Flexibility:
Your ROI measurement approach should be flexible enough to adapt to changing goals and strategies. Regularly review your metrics and adjust them as needed.
6. Foster Communication:
Ensure clear communication between innovation teams and business stakeholders. Innovation teams should understand how their projects contribute to broader business goals, and stakeholders should value the intangible benefits innovation delivers.
Conclusion
Pursuing innovation is no longer the privilege of industry leaders; it is now a business endeavor you simply can’t neglect if you don’t want to fall behind your competitors.
But the key to successful innovation lies in clearly defining what constitutes a successful project, and traditional financial analysis tools like ROI tracking simply aren’t built to measure the long-term benefits of an innovation initiative.
These methodologies often rely on historical data and well-defined parameters, which innovation projects by their very nature cannot be properly measured by. Predicting the exact benefits of a new idea, beyond revenue and financial returns, can be difficult - especially when you try to do so with an inadequate approach.
To address this, you and your business must set up a framework and methodology for properly analyzing innovation ROI. With the right elements in place, you’ll not only have a better picture of how worthwhile your resource allocation is, but also whether or not your business is heading in the right direction.
One avenue you can look at for inspiration is startup evaluation practices. When assessing the potential of startups, the business analysis focus shifts from pure financial returns to a broader assessment of potential. Metrics like market size, customer traction, competitive advantage, and the strength of the underlying technology are taken into consideration, to account for insights that traditional bookkeeping simply can’t observe.
Well-designed ROI analysis is the bridge between creative ideas and sound business decisions. To promote innovation within your organization, don’t hesitate to implement an innovative approach not just to product development, but also to how you assess business potential and risks.
Now that you’ve gotten a clear picture of how important this topic is, and how companies around the world are addressing their innovation ROI challenges, the time is right for you to be the innovation ROI tracking ambassador in your own organization.
Don't be intimidated by the process. Start small. Choose a current innovation project and apply the innovation frameworks discussed in this article. Even a basic ROI analysis will shed light on its financial justification, guide your decision-making, and make a real impact for your business.
If you need support, contact us now and we’ll help you set a plan in motion. We’ve helped many other companies innovate their operations, products and services, and we’d be happy to do the same for you.
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