This post came out of an interview on the Return on Investment (ROI) of Innovation with David Binetti, Founder of Innovation Options, and Brant Cooper, Co-Founder. To see the interview in it’s entirety, scroll to the bottom of this post.
One question kills more innovation initiatives than any other:
What’s the ROI for this innovation project?
In early-stage projects with a product that’s not in the market, projections are fiction. In the words of Mike Tyson, everyone has a plan until they get punched in the face, or as Steve Blank likes to say, “no business plan survives first contact with a customer.”
A better question to ask is:
How can we measure the return for an idea that does not yet exist?
Most large organizations don’t ask this question. It requires thinking beyond the quarterly profit cycle. As a result, many are caught in a catch 22. Without a quantifiable return a project gets no funding; and vice versa.
This puts product managers in an awkward position.
If they answer there is no foreseeable ROI, there is no funding.
If they, more accurately, show lots of up front expenses and no clear ROI, their competency and mental stability come into question.
None of this is favorable. The current model is so ill-equipped to account for innovation that the result is often no innovation at all.
This is what David Binetti, a six-time entrepreneur and pioneer of the Innovation Options framework, calls “a race to ridiculousness.” A cooperative, delusional mindset ending in failure and frustration for all involved. One that puts your innovation efforts at a dead end before they begin (and jeopardizing the company’s future).
Like many problems, the issue rests on how we approach and understand the role of innovation within large organizations.
When we innovate upon new products, what are we truly investing in?
Under what circumstances should we expect a return?
Given the ineffective language and widespread frustrations surrounding this, it’s time to take a step back and reexamine things. Asking the right questions is essential.
What is the Purpose of Innovation?
Before asking about ROI on innovation initiatives we must understand why we innovate.
“The purpose of innovation is to provide optionality,” says Benetti. It is not made to answer the call of “we demand results, now!” Rather, innovating is investing in options, in future potential.
With that said it’s important to understand the types of innovation. Our co-founder, Brant Cooper, distills it down to a simple innovation continuum.
Most innovations are sustaining.
We see it through ongoing upgrades and enhancements to existing products. Because there is history of products in the market projections are more accurate (i.e. iPhone 6 sales and the projections for iPhone 6s sales).
Disruptive innovations are less common.
When successful, they put current revenue streams and business models at risk. However, in the grand scheme of things it’s better to disrupt yourself than be disrupted. It’s hard to know something is disruptive until it is too late, and even more difficult to accurately project ROI.
But, simply because the ROI of an innovation project isn’t seen this quarter and spot on projections are impossible, that doesn’t mean it’s not crucial for the health of an organization.
Innovation is like insurance on future profits
While innovating has uncertain short-term returns, it is the best means for long-term survival. Innovation is profit insurance. It is the development of options to be used under problematic circumstances. Bad times in the market are inevitable, yet often unforeseeable. With flux comes disruption of profits.
The most adaptable and responsive organizations mitigate market uncertainty by having innovation initiatives already underway. They’re prepared for such inevitabilities by introducing and nurturing alternate revenue streams. By creating options, businesses keep moving forward with reduced risk in times of hardship.
Innovation must be seen as a safety mechanism, a planning tool protecting against future uncertainty.
But what if we fail?
While change is inevitable, return on innovation is not. 90% of innovation efforts will not pay out – and that’s fine. 99% of life insurance policies don’t pay, much to the joy of those living their lives without disruption.
In a time where technology and consumer demands are changing faster than ever, innovation allows a degree of stability, and alternate profitability, amidst great risk. Think of this the new price for doing business. A new insurance premium implemented into realistic company spreadsheets to weather an increasingly sporadic and turbulent marketplace.
Have you ever heard anyone ask for the ROI on an insurance policy?
Creating an Optimal Innovation Portfolio
Mechanisms of risk minimization exist in other industries, most notably, finance. To justify the cost of innovation, consider it an investment in the future of the corporation. An option contract.
As with a financial portfolio, to reduce risk we diversify. As a result, a large organization is an assembly of revenue streams.
Product risk portfolio theory states there are many ways to diversify for an optimal portfolio. Rational people choose more value to less over time and prefer less risk to more. By diversifying a portfolio the probability of success increases over time.
Companies like Amazon have been incredibly successful shifting the focus away from the bottom line, focusing on innovation and future success.
By investing more in innovation, innovation begins feeding into the bottom line. These companies find rewards through straddling the frontier between risk and value. Investing in a new frontier, whether or not you’ve created it, is important.
The 3 Horizon Model of Continuous Innovation
The three horizons model, established in the Alchemy of Growth by McKinsey, illustrates how to diversify innovation initiatives given the high degrees of market uncertainty. While each horizon is ongoing and continuous with respect to another, each horizon is managed differently.
Companies that win successfully manage a portfolio of initiatives across each horizon.
Horizon 1 represents core businesses providing the greatest in profits and revenue. Here, focus is improving performance to maximize remaining value. The market is well know in terms of solutions and problems. Profit is the goal.
Horizon 2 involves emergent opportunities that already have forms of market validation. Often times these come out of entrepreneurial ventures, or even just riding the wave or market trends… Here, hard metrics are applicable. Assessing cost of acquisition, market share, users, and growth inform best practices. Growth is the goal.
Horizon 3 is about ideation and experimentation. Here, products that may be successful, may not see that success on a massive scale for a couple years. and businesses that. This means research projects, pilot programs, and minority stakes in new businesses. Maintain horizons 1 and 2 while looking for new growth opportunities.
Alistair Croll did a great job illustrating this in the context of Mercedes Benz. Look at how they’ve managed their portfolio, from next year’s car, all the way to Car2Go.
Diversify Innovation Portfolio for Best ROI
An enterprise that invests in all 3 horizons is set up for long-term success.
Yes, this means reinvesting profits from horizon 1 into horizon 3, but horizon 1 doesn’t last forever.
The best excel in finding new ways to discover and incorporate revolutionary ideas into current business models.
Said organizations have a firm grasp upon the pivotal nature of assessing market uncertainty while looking to the future. Instead of focusing on how to build something, they test the waters to see if it should be built in the first place.
Focusing on learning about customer needs, goals, and existing behavior is how successful innovators navigate uncertainty. It’s how teams discover product opportunities. Therefore, investments should be made into learning, not fictional business plans.
To understand and communicate the ROI of innovation, step away from the profit cycle. Think big picture. While many businesses account for innovation efforts as overhead, thinking of innovation as insurance to future business is more practical. In the uncertain market economy, innovation is something we are sure to need, whether or not we now how soon or to what extent.
Asking specifics for something not yet materialized is unrealistic.
Take the ROI of innovation to be unpredictable, yet certain. It may save your business one day.
Regardless of how you account for it, that’s a return worth investment.
If you want to dive deeper into how to create financial projections that account for the probability of success and/or failure similar to how financial institutions value billions of dollars worth of options each day, we encourage you to read David Binetti’s post on Measuring Learning in Dollars: How to Calculate ROI without Forecasting Revenue.