Since 1955, the average lifespan of an S&P 500 company has decreased by 44 years. And in the last 15 years alone, 52% of S&P 500 companies have disappeared.
Whichever way you slice it, it’s never been harder for companies to survive, let alone thrive. And in this environment, innovation plays a dual role: Reaper and Redeemer.
The problem is, it’s often too late to act by the time others’ innovation has crept into your market share. Even the companies that manage to benefit from innovation don’t have a reliable process by which to do so consistently.
At the crux of the issue is measurement: selecting, interpreting and acting on innovation metrics, is critical and notoriously difficult.
To provide a realistic path forward, this article will:
- Start by explaining why most approaches to measuring innovation fail.
- Given that backdrop, we’ll discuss the three success factors of innovation measurement.
- From there, we’ll show these success factors in action based on observations of how startups, venture capitalists, and management consultants approach this problem.
Why Common Innovation Metrics Fail
As McKinsey points out, most companies rely on output metrics such as R&D as a percentage of revenue, time to market, number of patents produced, or ratio of new products to sales.
These metrics fall short for 3 reasons:
1. They’re output focused.
Output metrics fail to explain how innovation and R&D teams are performing on both a project and portfolio level. Time to market, number of patents produced, or ratio of new products to sales show activity, but not always productivity. And because they don’t tell you the “why” it’s very hard to learn from the metrics and thus make better decisions over time.
2. There is no universal set of innovation metrics.
Innovation cycles vary by industry and failing to understand the unique nature of the innovation business stops executives from accurately gauging success.
For a pharmaceutical company, between research, clinical trials, and FDA approval, a perfectly successful product may take 10 to 15 years to make it to the market. In consumer electronics, 10 to 15 years to bring just about anything to market is an abject failure.
Even on the same project, metrics may need to change over time. For example, the data you use to assess an idea for a digital platform will likely change once the platform has been live for a few months.
3. You need different metrics for innovation than small improvements to the core.
Investing in innovation is simply a different kind of investment than, for example, an incremental improvement to an existing business line. Failure is the norm in innovation and it’s misleading to judge R&D’s performance the same way you judge a new enterprise software implementation, or new HR workflow.
Turning Failure on its Head: 3 Success Factors
Knowing what’s wrong is the natural precursor to knowing what’s right. Based on where common metrics fail, we’ve identified 3 success factors for selecting, interpreting and acting on a set of innovation metrics.
1. Focus on your strategy first
What are you trying to achieve? How much will you risk to achieve it? When do you know you if you’ve succeeded, or failed? The answers to these questions are what should inform the metrics you develop to measure innovation at every step.
Be warned though, these aren’t easy answers to obtain, let alone establish alignment with executives on. But they’re critical because they tell you what employee behaviors you want to incentivize. When you know what behaviors you want to incentivize, it becomes far easier to select metrics. Moreover, when you have a clear idea of your objective, you can select the metrics that show you if you’re reaching or falling short of that specific objective.
2. Say no to off the rack metrics
Innovation metrics aren’t one size fits all. So don’t expect to download a Balanced Score Card template and be off to the races.
Innovation is new to most organizations and executives have a wide variety of outcomes they expect from innovation teams. Many orgs have some set of metrics to assess new products but even these metrics need revamping in today’s age. By all means, use best practices as a foundation, but recognize that innovation—and its metrics—is irregular. There are no one-size-fits-all.
3. Practice makes perfect
It’s satisfying to check the box and mark a task done. But metrics take practice. You can’t foresee what will make the most sense a year or two years from now. But you can see what makes the most sense today. So find a set of metrics and use it, but don’t marry yourself to them. Check back in quarterly to see if your metrics are leading to useful insights, talk to stakeholders and see what they’d like to know. In short, keep iterating.
How Innovation Pro’s Measure Success
There are many ways to look at the problem of accurately gauging innovation—we’re going to look at three.
The McKinsey Approach
Eric Hannon, Sander Smits, and Florian Weig detailed their approach to measuring innovation in a formula. While they don’t claim to answer the question definitively, they believe the formula is “useful to any company that wants to establish and maintain a comprehensive and transparent overview of the R&D organization.”
The formula takes the product of a project’s total gross contribution and its maturation rate then divides that result by the project’s cost to measure R&D outcomes.
Here’s why it works for some companies:
For starters, this formula delivers a single, simple metric rather than a collection. It also measures R&D’s outputs within “the sphere of what R&D can actually influence.” Lastly, because the formula allows you to measure performance at both a project level and at the R&D organizational level, the metric is meaningful to the entire company, from board members to employees.
Within this measurement approach exist some (but not all) of the success factors we identified earlier. McKinsey safely assumes that increasing revenue is core to R&D strategy and incentivizes behaviors that drive the organization towards this strategic goal.
And though the formula is not customizable, by factoring in costs and time, you can approximate an apples to apples comparison between projects and portfolios, which is not possible with most other “off the rack” metrics.
It falls short in some areas, but more on that later.
The Startup Framework (aka, Pirate metrics)
This framework looks at innovation from the perspective of a startup. Melanie Balke explains the approach, developed by Dave McClure, a Silicon Valley entrepreneur and investor, as a simple and actionable way to measure your company’s growth.
The framework lays out five categories of metrics, which cleverly spell out AARRR (pirate speak for awesome):
1. Acquisition: These metrics help you analyze how people find your new product or service and turn into customers.
2. Activation: Activation metrics are concerned with the activities after a customer has signed up but before they realize the value of your solution.
3. Retention: Customer retention metrics are a great measure of product success because they tell you how many customers are regularly returning to your product.
4. Referral: Because, as Balke explains, “The absolute best way to drive growth is through referrals,” referral metrics help you improve the process by which your new venture incentivizes and generates referrals.
5. Revenue: Revenue tells you how viable the long-term success of your new product is by looking at things like customer lifetime value and customer acquisition cost.
The Startup Framework assumes your product has hit the market, but regardless, the takeaways are useful to anyone launching a new product or service.
The framework delivers both strategic insights for executives and tactical insights for employees. Innovation teams can dive into each stage of their customer’s journey with acquisition, activation, retention, and referral metrics to find action items that’ll have the greatest potential impact on growth.
At the same time, execs can easily digest revenue metrics to evaluate the financial viability of the product or service.
This approach hits all of our success factors—again, assuming you have a product or at least a pressure-tested concept. Within these categories of metrics, there are plenty of metrics that incentivize and contextualize the tactical behaviors and strategic decisions needed to go from product to revenue.
Moreover, within this approach, there is considerable room for customization and experimentation to drive the evolution of a suitable measurement program.
The Venture Capitalist Approach
Peer Insight has seen most success across clients when using a Venture Capitalist approach that is based on the three success factors noted earlier – the thinking behind the metrics. By approaching innovation more like a venture capitalist, corporate innovation leaders can avoid the common pitfalls of corporate innovation investments.
Here’s why this works.
Traditional corporate budgeting & metrics systems prioritize control and stability. Control and stability don’t mesh with innovation investments because there needs to be freedom to test and make decisions based on results.
Hershey’s executive Deborah Arocleo points out, “As you conduct learning experiments, the amount that you know goes up so the amount that you don’t know goes down. Then you feel more comfortable starting to invest a little bit more.”
VCs understand this and so they create a milestone-based funding structure. New funding is only released when the idea or venture has hit its milestone metric. Otherwise it’s cut.
A member of the Nike team we worked with to create their new shoe subscription service noted:
“What we’re doing is investing, which is fundamentally different than budgeting … but we’re asked to force an investment process into a corporate budgeting exercise. We don’t have a budgeting process that is optimized for investment like a VC would, and so that is incredibly challenging because we have a lot of perverse incentives.”
This is really a mindset shift from budgeting to investing, as VCs invest and corporations budget. The goal of the metrics in this case is to help a company spend money on the proofs-of-concept that are getting traction, and pivot or shelve the ones that don’t.
The change in behavior is around testing & learning: what are the 3 key assumptions your MVP is resting on? Kick those tires to confirm or disconfirm your MVP. If the tires hold up, fund the car some more.
What Does it All Mean?
A metric is a metric—it’s not inherently good or bad. It’s when companies don’t truly understand the strategy behind their innovation metrics and what behavior change will help their innovation teams operationalize that strategy.
McKinsey’s and the Startup approach inform tactical project development decisions and strategic investment decisions. The problem is, neither approach completely negates all the issues with innovation measurement.
McKinsey’s approach is simple but rigid. It’s less a universal approach and more a single, useful metric.
The Startup approach is too narrow as it’s only directly applicable if you already have a product. However, it does provide insight to those looking for an approach that informs tactical and strategic decisions.
The Venture Capitalist approach addresses these issues by first focusing on the thinking and strategy behind the metrics, then finding the right metrics to drive the right behaviors and outcomes.
Thinking like a venture capitalist widens your view and pulls you towards the right metrics for your organization. As (or more) importantly, it realigns executive gatekeepers into financial partners with their innovation teams.
Finally, it forces you to focus in on your strategy, it enables you to build a measurement framework suited to your company, and it leaves room for constant experimentation and improvement.
Of course, understanding the importance of this way of thinking is one thing. Applying it is another. Let us help you apply this learning to a project and get you on that path to clear, aligned success measuring today!