Pic’n’Mix Innovation Accounting
This is Part 2 of our series on Innovation Accounting. Part 1 can be found here.
A selective approach that adapts from the best.
Who doesn’t love a pic’n’mix aisle? In this aisle, you could custom assemble the sugar fix of your childhood dreams. You could dodge the peppermint creams, and double down on the sherbert bombs. If you needed your teeth stuck together (and maybe even some fillings pulled out) there was an industrial-strength caramel chew ready for the job. The challenge wasn’t in finding stuff you liked, it was in trying to narrow down the options. While innovation accounting may not deliver quite the same instant buzz as half a kilo of sugary treats, we think there is merit in taking a similar pic’n’mix approach when building your framework. And worry not, for we will not leave you clutching an empty cup or bag, paralysed by the brightly wrapped choice on offer.
The main reason we favour a pic’n’mix approach is that Innovation Accounting is still an emerging field. There isn’t yet a single accepted way of doing things. We think that at this point in the evolution of Innovation Accounting, corporates are best served by taking the best thinking available (which we’ll explore below) and then giving it a twist to make sure it suits their own context and business challenges.
If you read my previous article, you will know that at IE we are big on setting innovation growth objectives as part of our Innovation Accounting framework. This is because we believe a growth focus anchors innovation within the core corporate strategy and also provides a target to manage toward. In our version of the innovation accounting pic’n’mix we have purposely amped up the growth focus, as this is an area where we hear our customers most asking for help.
Having said that, your innovation portfolio may also contain initiatives which Rita Gunther McGrath refers to as Positioning and Scouting Options — investments that are expected to lead to results in the future, but you aren’t sure what those results might look like yet. It is fine to have these types of initiatives in a balanced innovation portfolio, the important thing is that everyone is clear which initiatives are expected to drive growth and which are still exploratory.
Before we take a look at the IE view on Innovation Accounting, let’s peruse some of the brightly wrapped treats competing for our attention.
The StartUp Way
Eric Ries kicked off the whole Lean Startup movement and first used the term ‘innovation accounting’ in his book ‘The Lean StartUp’. In his next book ‘The StartUp Way’ he draws on his experience working with a number of large corporates to set out a corporate innovation accounting framework. His approach is based on a three-step dashboard process, which allows the dashboard measurements to be tailored to each initiative as it matures. Eric suggests that innovation accounting should be combined with internal growth boards who allocate metered funding based on the progress demonstrated via innovation accounting. The three dashboard stages in Erics framework are:
1. Simple Dashboard — measures progress and gives a sense of what is working and what isn’t. The aim is to use measurements that align to understanding customer needs and collecting user feedback.
2. Business Case — a more detailed dashboard that looks at what Eric Ries calls the leap of faith assumptions which are critical to the success of the emerging business model. The leap of faith metrics are grouped under the headings of value hypothesis (will they buy it) and growth hypothesis (can we sustainably scale it). The point of these metrics is to understand if the initiative is achieving product / market fit.
3. Net Present Value — This stage is about ‘turning learning into dollars’. The Business Case dashboard is built out into a financial forecast model using value and growth data points which have been validated in market. The forecast can then be used to drive out an NPV calculation.
The Corporate Startup
The definition of Innovation Accounting in ‘The Corporate Startup’ gives an excellent sense of what it is that Innovation Accounting should be measuring:
“Innovation Accounting is about managing three key activities:
Making investment decisions…
Tracking and measuring the success of specific innovation projects…
Assessing the impact that innovation is having on the business as a whole…”
This infographic illustrates the three levels used in the Corporate Startup Innovation Accounting framework:
Reporting KPI’s which track innovation practice (e.g. number of ideas generated, number of experiments run, etc)
Governance KPI’s which are connected to innovation management (e.g. investment stage gate criteria, number of products at each stage, etc)
Global KPI’s which “examine the overall performance of investments in innovation in the context of the larger business” (e.g. new business models ready to scale, innovation conversion).
We spent some time with Dan Toma (one of the authors of The Corporate Startup) when he was last in Australia and exchanged some thoughts on Innovation Accounting. At that stage, Dan was experimenting with a financial model along similar lines to that used in ‘Level 3’ by Eric Ries (without using NPV) and also exploring how traditional management accounting is attempting to evolve with the digital economy. Dan and Esther Gons currently have a new book on innovation accounting in the works.
Alex Osterwalder is probably best known for the Business Model Canvas, but he and the team at Strategyzer have also turned their attention to Innovation Accounting and they too have a new book in development. Alex has already offered some clues as to what the book might contain in regards to Innovation Accounting via the Stratgyzer blog:
“…the four KPIs every innovation project should track:
Risk & Uncertainty: How much have we de-risked an idea so far? How much risk remains?
Potential Profitability: How big might the idea be in financial terms?
Learning Velocity & Time Spent: How much time have we spent so far? How much have you learned during this time?
Cost: How much have we spent?”
The Pic & The Mix
At IE, we’ve developed our own take on what growth-focused Innovation Accounting should look like. Our framework ‘pics’ many features from the experts we have already mentioned. We have also chosen to ‘mix’ in some insights from Venture Capital to help with investment decision making. Our other addition to the mix is some ‘next level pirate metrics’ from the emerging field of ‘Growth Strategy’.
So what does it look like?
It looks like this:
Progress metrics are team focused and help an innovation team and their managers understand if they are making progress over time. These metrics might include number of experiments run, learnings to date, and potentially even measurements like ‘learning velocity’ or ‘experiment velocity’ .
Traction metrics — Traction can be defined as “quantitative evidence of market demand”. This is where pirate metrics traditionally make an appearance . We can also go further to measure if we are on the path to key milestones such as ‘product market fit’
Growth Metrics are forward looking — as our increasing understanding of our customers helps to build a more granular view of market potential, as we increasingly understand the competitor landscape and as we get to grips with our underlying unit economics we can forecast our growth potential with increasing confidence.
Portfolio Metrics — At the portfolio level we abstract up from each of the individual innovation initiatives to an overall view of how the innovation portfolio is progressing. For those initiatives where we can forecast growth potential, an aggregated view can help us understand how we are tracking toward our overall innovation portfolio growth target and provide an all-important link back to the corporate growth strategy.
You added an extra layer?
Yes, the other frameworks often have three layers, but ours has four and there’s an important reason for that. We added an extra layer because we think the differentiation between traction (backwards looking) metrics and ‘growth’ (forward looking) metrics is really important.
Making this distinction between traction and growth helps us manage the transition from achieving ‘traction’ (product-market fit) to that of explicitly driving growth. Brian Balfour has a neat summation of the distinction between traction and growth. Making this distinction also allows us to zero in on a key concept that is sometimes overlooked in corporate innovation — profitable unit economics.
The unit we are talking about here is a single customer. The economics come from the cost to acquire that customer, versus the amount you expect to earn from them over the lifetime of the relationship. If you can repeatedly acquire customers for less than they are going to (eventually) pay you, you have a scale-able business model. If you are using your valuable capital to unprofitably acquire customers then you probably have customer growth, but you don’t have a sustainable (or scale-able) business model. Unless you can sort out the unit economics, your business model is basically a convoluted way to burn cash. With the concept of unit economics in mind, we can focus our efforts in the incubation stage on identifying how to profitably acquire new customers. We may still be burning more cash than we are bringing in, but with profitable unit economics in place we know we will reach overall profitability somewhere in the future.
At a high level, there are many obvious similarities between our pic’n’mix approach and the other frameworks we have outlined. The differences emerge more in the detail of how we measure progress within each of the layers and in the emphasis placed on ensuring we are using the right metrics to manage the journey from traction to transition, and then on to scale. We have designed our framework to borrow from the best, be they innovation thought leaders, startup growth experts, or venture capitalists. We have then adapted that thinking in a way that we think will best work in a corporate environment.
While we have a framework, every business environment is different and every innovation initiative is unique. With that in mind, we have a solid starting point with an adaptable framework designed to meet unique innovation challenges and set organisations up for greater innovation success, whatever their bag of treats may contain.