Innovative Measures

by Thomas E. Ambler

Are your profits getting pounded because of pricing pressures? If so, you have lots of company and it's good company. In most markets commoditization of products and services is running rampant as a result of the confluence of a number of major forces, including global markets and supply, ease of gaining information about purchase alternatives and pervasiveness of a Wal-mart purchasing mentality. Specialty buying behavior with its premium prices has not disappeared. It has become generally less lucrative. Today, even Specialty Buyers, who have traditionally placed highest weight on high quality and superior features and benefits in their value equation, have shifted additional weight to price levels that are at least in the same universe as the lowest price. So what can you do? Is it hopeless? Of course not! One alternative used even by niche players is to devote increasingly more attention to commodity strategies focused on removing cost from their core products and services. Although this may be easy at first, it becomes progressively harder and takes real innovation. Another major strategic alternative focuses on making old products new through customer-driven functional improvements, but that takes real innovation. Yet another strategy, compelled by either commoditization or desire for growth, calls for developing entirely new products and services to replace or complement old ones, but that too takes real innovation. Finally, you can develop a totally new business concept that turns your existing market on its ear (AKA disruptive) or permits you to enter a whole new market. But again, that too takes real innovation. So, no matter how you cut it, continued SUCCESS in virtually any business TAKES REAL INNOVATION. Innovation must pervade every aspect of your business — your business model, product development, operations, sales and support.

Making Innovation Happen

Innovation can "just happen" serendipitously, but don't count on it. The kind of innovation you need for continued success requires intentionally providing the right inputs and transforming them into valuable innovative outcomes. You need an "Innovation Machine" comprised of the right processes, organization and culture. The diagram below illustrates such an "Innovation Machine" with its typical inputs and outputs. It represents this author's boiled-down visualization of much of the collective wisdom from a number of innovation experts. Please take a moment to absorb and understand the nature of this "Innovation Machine."

The use of the word "Machine" could imply that innovation is a science with inherent predictability. Nothing could be further from reality. This "Machine" at best suggests that a set of probabilistic input/output relationships exists. These relationships, even though often just vaguely defined hypotheses, can be used to increase the likelihood of successful innovation. Over time these hypothetical relationships should be tested and refined.

In many ways the recipes for success in innovation are very different from the ones that work for the ongoing operations of a core business. That is why successful innovation eludes so many companies. The people, the processes, the organizational structure and the culture needed for innovation are significantly different from those of the rest of the company. What is not different is the fact that the people involved want to be successful and, therefore, pay great attention to those things that are measured and reflect on their performance.

Consistent winners in the innovation arena like 3M, DuPont, Pfizer and HP universally utilize metrics for their innovation efforts. For example, 3M has utilized for many years a high-level corporate metric, "Percentage of Total Revenue from products introduced in the last 5 years." They had historically set a goal of 25% and were consistently hitting it. They then jacked the goal up to 30% and shortened the period of time to 4 years to accelerate their market growth. Because this metric was so much a part of the culture of 3M's innovation teams, it took only 2 years to exceed the new goal.

HP utilizes BET (break-even time) for each new product development project. It is desirable because it focuses the attention of the innovation team on 3 critical elements — (1) the Investment in the development; (2) the Profitability equation for the product; and (3) the Total Time until the accumulated profits pay back the investment.

Although many excellent examples could be cited, it should be no great revelation that properly used metrics can be great motivators in the world of innovation just as they are elsewhere.

One excellent, high-level overall measure of innovation is the Wealth Creation Index (recommended by Gary Hamel in his book, Leading the Revolution). It measures a company's relative capacity to invent new business concepts and create new wealth against that of its competitive "Domain." (Domain is defined as a relevant, broad set of existing and potential competitors, including upstream and downstream value chain players and those who possess similar core competencies.) Innovation is intended to increase the Market Value of a company. The winning company creates Market Value faster than its competitors.

WCI = Your % Current Share of the Total Market Value of all Companies in your Domain + Your % Previous Share of the Total Market Value of all Companies in your Domain

Your WCI should be greater than 1.0 for you to be better than the average competitor.

Conceptually, this metric has a lot of merit because it incorporates both the Market Value contribution of radical innovation and the change (quite possibly a decline) in the market value of the core business in the absence of radical innovation. It covers the fact that some firms have a greater need for innovation to sustain their Market Value and must, therefore, be more successful with their investment in innovation than their competitors. Unfortunately, WCI defies practicality for all but those large firms whose domain is largely publicly held with market values determined by the stock market.

A more practical, but less elegant overall company measure of the success of innovation is

Return on Innovation = (Cumulative 3-year net profits from commercialized new products)
+ (Cumulative 3-year new product total expenditures for commercialized, failed or killed products)

Note that, although this particular metric relates to new products, a similar metric can be utilized for cost reduction innovation.

Ideally, the Measures of Success or Metrics appropriate for your innovation would relate to outcomes in the marketplace. Consider the following company-wide, outcome-related metrics (recommended by Thomas Kuczmarski in his book, Innovation, Leadership Strategies For The Competitive Edge):

  • Survival Rate = # of commercialized new products still in the market + total # of new products commercialized
  • Success Rate = # of new products exceeding their original 3-year revenue forecast + total # of new products commercialized
  • R&D Innovation Effectiveness Ratio = cumulative 3-year Gross Profits from commercialized new products + cumulative 3-year R&D expenditure solely for new products
  • Innovation Sales Ratio = total 3rd year revenues from commercialized new products + total annual revenues
  • Innovation Portfolio Mix = percentage of new products (# and revenue) commercialized by type, where type includes incremental product improvements, product line extensions, new-to-the-world products, new business concepts, etc.
  • Innovation Revenues Per Employee = total cumulative 3-year annual revenues from commercialized new products + total equivalent full-time employees devoted to innovation initiatives
  • % Of Sales From Proprietary Products

Unfortunately, development cycle times may be too long and the number of stages of development too numerous for you to rely solely on outcomes for measuring and motivating innovation. As a result, you will likely need to add metrics for both the activities within the "Innovation Machine" and the levels of its key inputs. Such measures may also be crucial to gaining a clearer understanding of how your "Innovation Machine" transforms various inputs into innovation outcomes.

You cannot afford to measure everything. So what should you measure? Certainly you don't want to track a metric whose cost outweighs its benefits. But you can't always know ahead of time what the benefits are. One fruitful approach to identify what is worth measuring is to address the question, "What does it take to be a Winner at innovation?" In other words, "what are the key ingredients and what are their relative importance?" In the popular book Simplified Strategic Planning, authors Robert Bradford and Peter Duncan describe one of our company's process exercises known as Winner's Profile. This exercise can be applied to the 2 questions just posed. It will identify the few, most important innovation ingredients — the obvious candidates for appropriate metrics.

In addition to key metrics for individual inputs to the "Innovation Machine," you may want to consider including:

  • Innovation Portfolio Investment Mix = cumulative 3-yr. expenditures for each of the major types of innovation such as incremental product improvements, product line extensions, new-to-the-world products, new business concepts, etc. + cumulative 3-yr. total innovation expenditures
    (This fits well with the Innovation Portfolio Mix defined above.)

Useful Transformation Process/Organization/Culture Activity metrics include:

  • Time to Market with the next generation of products
  • Process Pipeline Flow = # of new product concepts in each stage of the development process at year-end
  • Yield at Each Stage = the % of projects that graduate from the concept stage to the feasibility stage
  • Cost At Each Stage = average cost / project at each stage or % of total development cost at each stage
  • Average Cycle Time to Complete a Stage
  • Existence of Crucial Cultural/Organizational Characteristics (these might simply be 0-1 measures for things like management acceptance of failures, CEO involvement in innovation, compensation that fosters entrepreneurship or real progress in developing Innovation as a core competency)

Some of these metrics can be benchmarked against other companies that are innovation leaders or competitors. Consider setting targets that reflect benchmarks or support the strategic needs of your company. Metrics related to input levels and outcomes are good candidates for targets. Some metrics will not lend themselves to targets and outside comparisons but still have value. Others will have meaning only in terms of their trend over time or when analyzed in combination with other metrics.

Systems that link specific people and teams to specific metrics need to put in place. Ideally, these systems promote entrepreneurial behavior with its willingness to risk failure so often associated with innovation success. The achievement of metrics, accompanied by celebration and rewards, can prove to be a highly motivational, short-term surrogate for the real goal of actually reaching fruition on new developments--often a long and always tenuous journey.

The "Innovation Machine" is different for every company. Its strategic purpose is different, the level of importance of each input is different, the processes, organization and culture are different and the number and length of stages in the development process are different. For example, there is a world of difference between a pharmaceutical company that averages 12 years to develop a new drug and a software firm where development may be measured in weeks. Likewise, there are major differences in the innovation processes that fit a giant's R&D lab environment and those of a shop floor R&D environment of a smaller company or the unique environment of your company. As result, we can never claim that "one size system of metrics fits all." We can, however, claim that the broad types of metrics and key factors of innovation that should be considered for measurement are much the same for all companies. Therefore, view the metrics offered above as an inviting "smorgasbord" of possibilities.

So, if innovation is a strategic necessity for your competitive advantage or even survival, you need the best tools you can lay your hands on. "Innovative Measures" are certainly among the best. Pick some good ones and get started!

Tom Ambler is a consultant with Center for Simplified Strategic Planning, Inc. He can be reached via e-mail at ambler@cssp.com.