How to Value Investments in Corporate Innovation: a Calculator

How to Value Investments in Corporate Innovation: a Calculator

How to Value Investments in Corporate Innovation: a Calculator

Ten to one.

That’s how triumphantly American pilots emerged from the battle in the skies during the Korean War.

It’s not because they had superior aircraft. They didn’t.

No, it was because of two fundamental reasons.

  1. The American-piloted F86s had a 360-degree bubble canopy, whereas the Soviet-issue MIGs, flown by the North Koreans, had restricted vision
  2. The F86s featured a fully hydraulic throttle, whereas the MIGs’ throttle was semi-hydraulic, requiring North Korean pilots to lift weights in order to handle it

What advantage did this give the Americans?

Vision and adaptability.

In the words of military strategist, John Boyd, they were able to observe and orient themselves to changing circumstances faster than their adversaries.

Information, adaptability, and speed are fundamental to success in uncertain environments; whether that be 20,000 feet above the ground, or in a boardroom on Lexington Avenue.

The Rate of Change

Image result for exponential technology growth
Source: WaitButWhy.com

Today, exponential technology growth, disruptive business models, changing consumer sentiment and a complex geopolitical landscape have combined to make the business climate more uncertain than ever before.

Gone are the days where companies could release five-year plans, rest their hat on that, and simply execute.

In order to survive and thrive amidst growing uncertainty, large companies have to make like an F86 and get better at adapting to changing circumstances. In order to avoid jumping to conclusions though and over-investing in the wrong things, they need to experiment. Failure to do so will leave them eating the dust of companies that do.

The challenge for many incumbents and traditional companies is that their infrastructure; their processes, systems, policies and even their culture, is more suited to a 20th Century business landscape, when things moved at a much slower rate and the future was a lot more predictable.

The Business Case is Broken

In these companies, funding for ideas are usually granted on the back of an approved several-page business case.

“Let’s review Bob’s request for $5,000 everyone…”

The business case will ask for all sorts of financial metrics — ROI, IRR, NPV, payback period — that we can’t reliably predict if we’re taking something fundamentally new and untested to an incredibly uncertain market.

As a result:

  • Employees fudge the numbers to get funding (only to lose it once revenue isn’t generated within the first few months)
  • Employees don’t pursue potentially impactful innovations
  • Too much funding is granted, reflecting a base funding amount awarded by many business cases, resulting in big teams, complex solutions, and costly failures that create a culture of fear around innovation

Not only that but getting business case approval can take months, compromising speed — a fundamental driver of innovation.

A Fundamental Conflict of Metrics

The thing is, in the world of early-stage innovation, we don't talk about ROI or IRR when measuring innovation. We use leading ‘innovation metrics’ such as click-rates, conversion-rates, opt-ins and so on. While such learning metrics help to guide us towards product-market fit, they don’t mean much to many senior executives and beancounters at most companies.

Innovation metrics like these are foreign to most financial executives

Because of this, a company’s need to innovate, and the way it goes about applying capital to new ideas, are in conflict. This means that potentially great ideas never see the light of day.

In order to address this major pitfall, innovators need to speak executive and finance’s language.

Doing so will not only help to secure buy-in, but maybe more importantly, keep it long enough to get ideas through to experimentation, and hopefully, something resembling commercial value and impact.

Common unanswered questions:

  • How do we communicate the value of an idea as it makes its way through the early-stage innovation lifecycle?
  • How do we know how much we can justify spending on an experiment, based on the risk profile and projected return of the idea?
  • How can we determine the ROI or IRR for such ideas?

Introducing our Corporate Innovation Valuation Calculator

Innovation happens at intersections of different disciplines and domains, so I reached out to a seasoned financial analyst, and by combining our experiences, we came up with a tool that can help corporate innovators — in fact, all innovators — to better answer these questions.

“So, how does it work Steve?”

Introducing Sam.

Sam works for a large Fortune 500 company and she has an idea for a product that she thinks can create a lot of value for the company.

Step 1 — She enters the following metrics into the tool

  • Required rate of return
  • Market size
  • Percent of market claimed at seed
  • Percent of market claimed at final
  • Duration of experiment stages

Step 1

In order to help us calculate the valuation of the idea at different stages of the lifecycle, we use free-cashflow (FCF) margins — a measure of a company’s profitability indicating how many dollars of free cash flow a company gets from each dollar of its sales. We add an average FCF margin based on competitor or on industry averages.

Step 2 — She adds the probability of success at different stages of the funnel

Depending on how nuanced the idea is, the probability of progressing through the stages can either be based on professional judgment or on readily available data on both corporate innovation and venture investment success and failure rates.

In this example, we have four experiment stages based on the early stage innovation lifecycle, but additional stages can be added as deemed fit.

Here, Sam thinks that the likelihood of validating the problem is 15%, the solution 15% and the business model 30%. Of course, probabilities can be revised as more information is obtained through testing.

Step 2

Step 3 — Sam enters how much she is going to invest, or ask for, at each stage of the innovation lifecycle

Note: If she needs to hit a specific ROI at every stage of the cycle to keep finance happy, she can edit how much is invested at each stage to hit the ROI, and then do her best within those financial constraints to validate the stage.

Step 3

So once all of this is done, what are we left with?

This. 👇👇👇

Step 4

We can thus communicate, based on a number of interworking financial variables:

  1. The value of the idea at each stage of the lifecycle
  2. The internal rate of return
  3. The return on investment

In this case, the numbers stack up to support Sam’s proposed investments in each stage of the lifecycle with a very healthy IRR and ROI throughout.

This tool fundamentally helps us to:

  • avoid over-investing in the wrong idea
  • avoid under-investing in the right idea

It helps us align innovation teams and finance teams, and support getting and keeping buy-in to run experiments and help companies adapt to the fast-changing environment they find themselves in.

This is, of course, the first version of this tool, and it will no doubt evolve based on the feedback I receive. With that, I welcome your feedback, opinions, comments and criticisms.

If you would like access to the tool, email me on steve@collectivecamp.us

FREE EBOOK

Stop talking, Start making: A guide to design thinking

This guide provides an overview of the five key stages of design thinking, from empathy through to test. Find out how to apply the approach and start innovating at your organisation.

No items found.

Steve Glaveski

Steve Glaveski is the CEO and Co-Founder of Collective Campus which he established to help companies and their employees to create a more meaningful impact in the world in an age of rapid change and increasing uncertainty. Steve also founded Lemonade Stand - a children's entrepreneurship program, author of Wiley book, Employee to Entrepreneur: How to Earn Your Freedom and do Work That Matters, Harvard Business Review contributor, author of the Innovation Manager's Handbook vol 1 and 2, host of the Future Squared podcast, and keynote speaker. He previously founded HOTDESK, an office sharing platform and has worked for the likes of Westpac, Dun & Bradstreet, the Victorian Auditor General's Office, Ernst & Young, KPMG and Macquarie Bank. Follow him at @steveglaveski

Ask me a question!