Segment 1: Measuring Innovation Impact
R&D Spend % across the innovation portfolio (core products, adjacent and new)
- Core = average gross margin
- Adjacent = some improvement in gross margin (20 – 25%)
- New = significant improvement in gross margin (>50%)
R&D spend between ‘people’ and ‘programs’
- What is the % of individual contributors compared to managers in R&D?
- Where are they located? (close to customer)
R&D Impact to Product GM
- What is the GM impact for each product based on lifetime R&D investment?
Revenue and Gross Margin Based on Age of Each Product
- How much revenue and gross margin is contributed from products that are less than x years old?
Internal versus External R&D Projects
- What % of your R&D programs come from outside the company?
Segment 2: Killer Question Of The Week
Does this idea generate sufficient margin?
- Revenue of at least 10x the total R&D investment
- Gross margin of at least 2x the industry average
Segment 3: Closing Thoughts
“The best and fastest way to learn a sport is to watch and imitate a champion.” Jean-Clause Killy
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How successful have your innovation programs been? Not really sure? The ability to measure impact is key to securing the long-term support from your manager. Without that support, your innovation program will be just yet another management fad that will fade into the background. I’ll be right back.
This is the Killer Innovations Podcast with Phil McKinney. Keep in mind that the information and opinions expressed in this podcast are Phil’s, and Phil’s alone, and they don’t necessarily reflect those of his past, current, or future employers. Now, here’s Phil McKinney.
With management teams that just don’t get it, that just don’t get the idea behind innovation and the need for it within an organization, there is this impression that innovation is more art than science. They believe that innovation or creativity is a magic skill bestowed upon a few and that their job as managers is simply just to wait around and capture the lightning bolt, capture the accidents as they happen. Why is this such a strong belief? It’s because these managers have the fundamental belief that you cannot measure the impact from innovation. That it’s purely magic; you can’t measure the overall program, the success, you cannot put together the right set of metrics to incent an innovation team to go off and create those next great products. And it’s my fundamental belief that those management teams are wrong. The real issue is not the fact can you measure the impact of innovation; the real issue is that most corporate reporting systems don’t craft the right data. They’re hung up on gap financial accounting processes and forget about the both tangible and intangible assets of creativity, innovation of ideas and the impact they have on organizations. The result is that this forces many innovation teams to have to go out and create their own metrics, create their own data capture mechanisms, in order to prove their value to management teams. So, what are the right metrics that should be captured? Now, I’ve covered this topic (oh, it’s got to be 18 months or so ago, in a podcast) but felt that it was worth the effort to update it with also some new metrics that I’ve been using recently within my organization that I have found to be very useful. So what are the right metrics? Well, I’m going to run through a list of them, and this is not, by far, an exhaustive list, but these are the core metrics that I use that I look at and then I report out to management teams. First off, what is the R&D spend for the portfolio? What is your target R&D spend? Now, what I’m not talking about here is what is the overall dollar amount to be spent. What I’m talking about here is what is the mix of R&D spend across the portfolio segments, and what I mean by portfolio segment is that there should be some percentage of your R&D spend that’s invested in the core products. The products that are generating the revenue for the business today. Now these are products that have typically been around for a long period of time and there is some ongoing R&D investment that needs to happen, so what is the target spend for your core? Next is what is your target spend for adjacencies? Taking your core products and going after new geographies, going after new customer segments that you’re currently not serving today, modifying the products to go after existing customers but with a new solution offering. How much of your R&D spend is going after adjacencies? And then last but not least, how much of your R&D spend is going after fundamentally new areas? New products, new services, new programs that your customer base could not normally attribute it to you or your business? Now I’m not looking for hard dollars. I’ve actually – in my organization we define that as a split. What percentage of your total R&D spend – dollars – then what percentage of that goes to your core and what goes to your adjacencies and what goes to new? Now the key question here is go back two to three years and look at what you historically have spent. Go back and see what you’ve spent on your programs historically and then look to set new targets in order to drive those new kinds of investment areas. Now what is the real definition of adjacencies and what is really the fundamental definition of new? Now this opens up a lot of questions on definitions. And after much thought and much attempts to try to define this using some kind of descriptive words, we’ve actually fallen back on using a very simple metric, and that is gross margin. So if you’re fundamentally investing in the core product, you’re fundamentally looking to maintain, or slightly improve, your current, average gross margin for your product. Now if you’re going after some new adjacency, that adjacency, given that you’re going to offer a unique product, should be able to enjoy some premium in the gross margin. Maybe that’s 20 percent; maybe that’s 25 percent. If you’re going after fundamentally new areas, you should have a significantly higher gross margin – 50 pecent. 100 percent better gross margin than your current product, because if you’re not able to generate that kind of gross margin improvement, then why are you making the investments? So, again, our definition, or the definition that I like with regards to core is basically fundamentally maintaining the current gross margin with some slight improvement, maybe 15-20 percent, adjacencies – you’re going to get some kind of a margin premium or you should be able to get some kind of a margin premium and therefore you should be looking at 25-30 percent improvement in the gross margin. And then fundamentally new – you need to be able to at least get a 50 percent, if not 100 percent, improvement on the gross margin. And so, again, look at your spend historically and look to see how you can drive or incent the teams to invest their R&D dollars into the right areas of core adjacencies and new. Next, look at the R&D spend between people and programs. Look at where your actual dollars are being spent, how much of that is going to salaries and compensation for your teams and how much of that is actually going into programs. Building those prototypes. Doing customer beta tests, etc. And the key here is that there’s really no set percentage as to what should be people versus programs but if you are constantly seeing where you are saving on the program dollars and you’re looking at your people and program spend, that may be one metric that you can use with your manager to show where you need to expand, for instance program spend. The other thing is that when it comes to your people dollars; don’t ignore your contingent or contract employees. Include those in on your people dollar spend because those really are head counts. And in some cases they get hidden away within your financial reporting systems and don’t get tracked properly. So show your head count, both your head count of the actual employees and your headcount of contingent labor but then also show your programs. And show that to management. Show them what your total dollar spend is and then what percentage of that is programs and what percentage of that is your people and again go back a couple of years and look at the historical trend for your organization. Next is when you’re looking at your people, really dig in on your R&D resources or your head count. What percentage of your people spend goes to individual contr
ibutors versus management? Now some R&D organizations that have been around for a long time, and the average ten year for your employees is fairly long, you’re going to see a shift towards more management and less individual contributors. And that’s a bad sign. You need the real R&D people doing real work and creating real products. The general ratio here is that you should have 80 percent individual contributors to 20 percent management. If that number starts to get to 75/25, that should be a flag. Anything lower than 75 percent of your R&D staff is individual contributors then that’s a big flag from the standpoint that you’ve got people tied up in management and if had fewer actual workers, people actually delivering against creating a new product, new ideas and new services. The other question you should ask on your R&D resources is where are they located? If most of your growth is occurring, let’s say in the U.S., and you’re an overseas company but your R&D is overseas, maybe that’s not a good sign. The flip side is that if you’re a U.S.-based company and most of your growth is occurring in China or India or Brazil, and you have little to no R&D in those countries, that’s not a good sign either. You need your R&D or some portion of your R&D to be close to where your customers are located at. So where are they located? And then what skills or expertise do they have today and what skills and expertise are they going to need to have in five years given the trends in your respective industry? If need be, you need to re-train and re-skill your R&D organization ahead of the need of the marketplace. It isn’t the situation where you can sit back and wait and then begin to re-train or re-skill your R&D organization. Your R&D organization should be the first organization that is re-skilled and re-targeted with new capabilities in order to enable those growth opportunities of your business. Next, what is the R&D impact to product growth margin? Now here is the metric that I probably find the most useful from the standpoint of understanding what am I really getting for R&D spend. Now why gross margin? Well, the theory is that if you develop a better mousetrap your customers are going to be willing to give you a gross margin premium for that new mousetrap so what better financial metric can you use to measure your impact to R&D than gross margin? And so what is the gross margin impact from the R&D investment on each product? Now this is a hard one to measure in some cases because gross margin may get aggregated up by a product group or division of your company or whatever organizational segments but you need to be able to look at gross margin impact to your R&D. Now the problem also we hear is that the gross margin that you’re getting from your product today is a result of your R&D investment in the past and not all industries operate on the same time delay. Some organizations – maybe it’s one year. So R&D investment a year ago is what is the result of the gross margin impact of the product today. In some cases, it could be five or ten years. Whatever that horizon is, you need to be able to go back, capture what that R&D investment is, and then measure today’s gross margin to see what the return is on that R&D spend. And that becomes a key metric for you to report to your management as they look to drive both top-line revenue growth and with pressure from Wall Street to show continuous improvement your gross margin. Next is kind of a variation looking at what is the revenue in gross margin from the portfolio so your overall R&D spend, what is the revenue and gross margin from the entire product line based on age? So how much revenue and gross margin is coming from products that were introduced within the last year? Or within the last three years? Within the last five years? The general trend is that you’re going to have higher gross margin and potentially even higher revenue but that’s not always the case. For products that are relatively newer. Products that have been out on the market and out on the shelf for a longer period of time typically will have a lower gross margin. Why? Because your competitors have been able to see the product that you’ve built and have come into your market and have copied those products, or come up with products that are more competitive against the product that you had out for some period of time. The key here with this metric is to incent the continuous introduction of the new products. As you show that new products are contributing and delivering higher and higher percentage of your overall gross margin, then that obviously becomes a key metric to making sure that you don’t sit back and let the products in your portfolio get too old, because the older they get, the more pressure you’ll have on the revenue and the more pressure you will have on being able to deliver the gross margin that your investors are looking for. So, again, look at your revenue and gross margin across your entire product portfolio and then break it down by age and use whatever age brackets are appropriate for your industry. If you’re into the consumer electronics industry, maybe it’s every, you know, products introduced less than six months and less than 18 months and older than three-years-old. If you’re in other kinds of industries, maybe it’s every two years, two-year segments. Whatever it is come up with, whatever the age breakdown is, and look at your revenue and gross margin contribution for products that fall into each of those age categories. Next, look at your internal versus external R&D projects. Now the key here is the fact that many organizations get so wound up in developing and launching internal R&D projects because of their size or success or because they believe that they’ve got some unique perspective – they become so internally focused that the entire industry passes them right by. Some young start-up comes up with a much better idea and basically leaves them in the dust. Perfect example would be something like Google passing right by yahoo! – you know, yahoo! had a chance other invest or buy Google early on, chose not to because they felt that since they were the leaders they had the unique expertise and now look what’s happened as a result of becoming too internally focused. The key here is to set yourself some metric, some measurement you’re going to hold yourself to, to look at internal versus external R&D projects. And what I mean by external is whether that’s investing or whether that’s cooperating in an R&D program, acquiring certain inventions, accruing patents, looking external to the industry to see where the trends are going, whatever – however, you want to measure or whatever is appropriate for your industry, set a percentage of what projects you are going to be funding that’ll be externally targeted. Whether that’s look at – if you look at Procter & Gamble, they have a 50 percent target for external. In some businesses and some industries I’ve seen it go, you know, 30 percent external. Whatever is appropriate for your business and your industry, set an external target and then hold your R&D organization to meet that external target. It forces them to get up out of their chair, get outside the four walls, and see what’s going on. You’ll have less likely a risk of being blindsided by forcing the R&D organization to get up and get outside the four walls. Now with all this talk about metrics there are some metrics that are used in the industries that are absolutely meaningless. One that particularly gets under my craw is R&D as a percentage of revenue. Now this is a number that is used by Wall Street analysts, it is used by the pres
s, it is a misused metric it is absolutely meaningless. R&D as a percentage of revenue is not an indicator of future growth or future success. And it has no proven impact to the overall success of the business, whether that be share price, revenue growth, gross margin – it has no impact. Why? Because sales has so many other dependencies on it beyond just R&D whether that’s the effectiveness of marketing, the effectiveness of the sales organization, things that R&D has no ability to control and no ability to impact. That’s why I’m a big proponent towards focusing the metric on the gross margin, not on revenue. But this is one of those metrics that will never die; it is still around, it’s still used by management teams, it is used by Wall Street, but it is absolutely meaningless. Another one that I’ve heard is R&D spend per employee, or per R&D employee. Now I don’t know where this one comes – keeps coming back from, but this one ought to have been killed off a long time ago, and most financial analyst’s recognize that this is absolutely has no bearing on the R&D spend. R&D is about product, not how much each employee can spend. So I’m not sure why this metric keeps hanging around, but again it’s another one that is totally meaningless. So once you’ve got your metrics, whatever the right ones are for your industry and your segment, what is it – how often should you be reporting these out? What’s the right cadence for reporting this out? Well, my general rule of thumb is I report out the metrics for R&D on a quarterly basis, so each quarter do a benchmark against your direct competitors. Understand what you’re competitors R&D metrics are, and compare yourself. Both as gross margin impact, the portfolio investment, internal versus external, resources, split between core adjacencies and new, whatever metrics you’re using, report them out on a quarterly basis, but most importantly stack yourself up against your competitors. Understand how your competitors are driving their R&D spend to the point where you can understand how that – how your response to that R&D spend can either be an advantage or can be a disadvantage. On your core metrics, over time, pick a historical horizon that works for you and if you go back and create the metrics and whether that’s a one-year back look or a three-year back look – whatever is a appropriate for your industry – develop the core metric so that you can look at the trend lines over time and you need to use that same trend for your competitors, so if your industry typically go back and look three years historically then you need to do the same for your competitors. And then again you also need to report out on what any new projects have come into the portfolio such that management has a good insight into the right level of decision-making that’s being applied to selecting which projects you go into. On an annual basis, go back and adjust your portfolio target, so what percentage of your R&D spend is going to go into core adjacencies and new? Those – don’t get locked into a set number and then just let it sit. It’s kind of like rebalancing your 401(k) or your retirement investments between stocks and bonds. You need to adjust the portfolio mix depending on what’s happening in your industry, the risk that’s coming up in your industry – maybe you need to accelerate into new areas because there’s some fundamental shifts, but adjust those percentages on an annualized basis. And once you’ve begun to track both on the quarterly basis and on the annual basis, once you’ve begun to track and report, get the right metric to be included into the executive reporting packages. So every quarter, if you’re a public company, and there’s packages that typically get created by the finance department that gets handed up through the executive ranks, get your innovation metrics included into that executive packet. Get the executives used to looking at those innovation metrics each and every quarter. And then once you’ve got that going, get your innovation metrics to be included in annual performance targets – get executives managers and individual contributors as appropriate to include innovation metrics as performance targets. Why? Because people work to metrics. If you set the right metrics, then you’re going other have people doing the right actions. Key here though is make sure it’s the right target, it’s the right metric measurements. Now the key here is with managers, it really is about portfolio investment. If your target was X percentage for core, X – some percentage for adjacencies and some percentage for new, did you hit those levels of investments? And then also R&D impact to gross margin. Are the products that are coming out achieving the gross margin that was committed to you when the R&D program was started? And measure those people who were on that R&D team – it’ll start your new people’s thought processes, it’s not about just getting the cheapest product out or the product out on time, but you’ve got to hit the gross margin, you’ve got to deliver some form of sustained differentiation that your customer is willing to give you the premium for. Now, if you already have innovation metrics within your organization, congratulations. You’re one of the few and you’re way ahead of the game. If you don’t have metrics, if your organization does not use innovation metrics to measure it’s level of investments and its impact to the organization, a couple of things I’m going to point out to you that I think are quite obvious. One is it’s not going to be easy to get management to start tracking the metrics. You’re going to have to do the heavy lifting – you’re obviously listening to this podcast because of your interest in innovation and whether that’s in your own personal life or wither that’s in your career opportunity at the current employer or a future employer, but let’s face it, when you’re the lone wolf in there talking about innovation and how it’s going to impact the organization, the burden of proving impact, of proving value, is going to fall in your lap. So you’re going to have to do the heavy lifting to pull together the initial numbers. Consistency in producing and measuring the innovation metrics will eventually take hold. It eventually will become part of the corporate culture, but you can’t give up. This is where perseverance kicks in. You’ve got to deliver the numbers, you’ve got to show the metrics each and every quarter going forward to the point where management then almost becomes the point of expecting that number to be reviewed and therefore show the impact of innovation. And then once impact is evident, once you’ve shown the historical view of the numbers and you’ve been reporting it out consistently, and management can start to see that people’s investment decisions are being made differently, the results of the growth in gross margin and in revenue, success of key products, management is going to want to look back at the historical to see what results or what impacted that – in this case innovation, and what is it they can do now to have even a broader or better impact on the overall organization? So having the historical numbers is key and reporting those out each and every quarter is key in order to show that having the right metrics, incenting to make the right level investments is key because the impact and the results will become evident. Now as we know those of us that are involved in innovation and creativity and you as a listener of this podcast, innovation is just as important as capital investment and new machines. The ability to measure the impact from innovation investments is key to securing your executive support.
Keeping with the topic for this week’s show on measuring innovation impact, this week’s “Killer Question” is on using metrics to help come up with ideas. How do you use metrics to come up with actual ideas? In a previous podcast I’ve given you five key questions that each idea that you’re looking to rank order or coming out of a brainstorming session must be able to answer. Those questions are, “Will this idea fundamentally change the customer experience or customer expectation?” Two, “Will this idea fundamentally change the competitive landscape?” And three, “Will this idea change the financial structure of the industry?” Now for a given idea you must be able to answer yes to one of these questions. The next few questions you must be able to answer yes to both. First, does your company have some contribution to make in this space? Do you have some fundamental intellectual properties, some fundamental expertise, core competencies, something; but do you have some contribution to make in this space? And then second, will this idea generate sufficient margin? Now, using these five questions you can pretty quickly identify which ideas are going to have the biggest impact and which ones you should invest in. Now, the one question that has a metric tied to it that you need to understand is the last question. Will this idea generate sufficient margin? Well, what is sufficient? Well, sufficient really depends on your industry. What is the generally accepted gross margin that a new idea should be able to generate to be constituted as a success? Now, the metrics that I use for my organization when we’re looking at evaluating ideas are the following. One, revenue. Is the revenue at least ten times the total lifetime R&D investment? Is revenue at least ten times the total lifetime R&D investment? And with regards to gross margin, is the gross margin percentage from this product at least two times that of the industry average? Is the gross margin percentage at least two times that of the industry average? If I can’t answer yes to both of those questions, then the idea is not going to generate sufficient enough margin and therefore not deliver the return on the overall R&D investment. So, again, you can use metrics to help you filter through your ideation sessions, through your brainstorming sessions, to help rank order those ideas that are going to really be those killer ideas, those ideas that are so unique and so different in the marketplace that you will capture a sufficiently higher level of revenue and gross margin to warrant the risk, and to warrant the investment that you’re asking management to make.
This week’s closing thought is on following the leader. When it comes to using innovation to have impact on your business, the best advice I can give you is to find leading companies and copy what they are doing. Ask yourself how are they organized, how do they make decisions, how do they find or fund the right innovation investments? How do they find the right ideas and then how do they fund them? And then benchmark your organizations against the leaders. Use the innovation metrics and see where you can improve and then focus your activities about becoming the best in class for your industry. The Olympic skier Jean-Claude Killy said it best, “The best and fastest way to learn a sport is to watch and imitate a champion.” And the same applies to business.
Thanks for listening to this week’s podcast. Many of you have sent me an e-mail wondering what was up since I haven’t put out a podcast in a number of weeks. First off, the work schedule has gotten a little crazy. My travel schedule has also been a little crazy. And hopefully we’re going to be wrapping up our relocation here in another couple of weeks and settling into our new house here in California, so I have not disappeared; I am still around. I am still working on future podcasts. I am still working on the CD project. For those of you who keep asking, yes it is making progress, it is moving forward. It has been one of the other things that has been taking up a little bit of my time, so I’m still around. So please continue to send me your feedback on the podcast at firstname.lastname@example.org. Also if you are a new listener to the podcast, go out to the killerinnovations.com site and you will see the list of the archives of all the podcasts going back almost over two years now and you’ll be able to see the entire list, the entire library of podcasts. And yes, we’ve just passed over the two-year mark for the Killer Innovations Podcast. This year has been a little bit slower than the first year, in which we did 50 shows. We did another 25 shows this year. We’re going to try to pick the pace up again going into the third year of producing the podcast. So, again, I want to say thank you for taking the time out of your busy schedule to listen, provide feedback, provide comments, provide suggestive topics; so please send me your feedback, send me your comments to my e-mail address at email@example.com. Don’t forget to vote for your favorite podcast. I’m sure you listen to more than just this one podcast, so whatever podcast you are listening to, go out to the sites that you download the podcasts from, whether that’s PodcastAlley, PodcastPickle, Apple, Digg, and vote. Let other people know the podcasts that you find the most informative and the most helpful. It helps pass the word around so others can find the podcasts that you’re finding so helpful. Also, tell others about the podcast. As many of you know if you’re a regular listener of this podcast, the reason I do this podcast is really a way of paying it forward as a result of some mentoring that I got early in my career. A gentleman took time out of his schedule, one of my early managers, spent a lot of time with me helping me, coming out of college, to be successful in my career. My only requirement to him was that I had to pay it forward when I – later in my career – and this podcast is my way to pay it forward, and all I ask for you as a listener is to pay it forward by telling others. And with that, again, send me feedback, feel free to drop me an e-mail, go out and post a comment on the shownotes, whatever you find most convenience for you. Join in on the conversation that’s occurring on the Web site, and also read my personal blog. I haven’t posted to that as much as I would like to, but I’m going got try to pick that pace up also. But let’s stay in touch, send me your thoughts – I’m looking for ideas for future podcasts, so send me any ideas, questions that you’ve kind of got nagging that you’d like for me to answer in a future podcast, and I’ll see if I can’t weave that in – and with that, we’ll talk to you real soon. Bye-bye.
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