What’s Wrong With ‘Traditional’ KPIs to Measure Innovation?
Before we explore innovation-specific KPIs, it’s important to understand why traditional metrics used to measure a business’ existing operations aren’t necessarily appropriate to evaluate the success of most innovation projects.
Traditionally, organisations focus their attention on five core KPIs:
Return on Investment (ROI)
As you would expect, ROI is a critical metric for innovation projects to justify expenditure from executives. While some projects will take longer than others to yield positive results, innovative ventures need to demonstrate opportunities for financial growth by showcasing the actual results they are generating.
However, it’s important to understand that if the initiative is in its early stages, the ROI is likely to be unknown. The project will be full of assumptions that need to be validated before you can assess its long-term success or progress into the next development phase.
The recommended approach here is to present a range, rely on existing data as much as possible to infer future performance, use proxies where appropriate, etc. But crucially you need to state your assumptions very clearly when presenting an expected ROI.
Immediately afterwards, you should present a plan of next steps focussed on validating the assumptions, one by one, starting from the riskiest one.
There are two key elements to consider when it comes to cost:
- What expenses are involved in getting an idea off the ground and testing its viability?
- How much would it cost to action and implement an innovation venture into your business model?
The biggest issue here is when intrapreneurs evoke fear in executives by proposing expenditure towards an innovation project that skips too many invalidated assumptions and focus on the second element instead of the first one.
The key to managing executive expectations and controlling cost is to request more investment as long as you are able to demonstrate that uncertainty it’s decreasing. This is aligned with our four Lean Entrepreneurship principles.
Intrapreneurs should start a new venture by running low-cost experiments to validate or disprove the riskiest assumption. That is to say that if the assumption is untrue, the venture is unlikely to develop into a successful initiative and something will have to change.
However, if the intrapreneur can prove that this assumption is true, they are then in a better position to ask for more money to validate another assumption. As this process continues, the risk systematically reduces, and executives are in a better position to bear with costs with greater confidence.
Crucially, when assessing costs related to innovation, it is important to highlight what costs you would need to bear to get to the next stage of validation.
One of the most common mistakes businesses make is to assess and compare the revenue generated by an innovation venture to its existing P&L. If organisations take this approach, the comparison will immediately dwarf any innovation efforts before they have a chance to find their feet and get off the ground.
A more appropriate measure in the early stages of an innovation venture would be growth. Whether you measure month-on-month acquisition figures for a new service, track downloads for a piece of software, or even revenue figures, demonstrating scalability and growth can signal a profit-generating potential down the road and can become a powerful tool to get executives approval for further investment.
Another common error is to compare the market share of an innovative initiative with the market share of established products or services that your organisation has developed over several years.
This is a reductive exercise that shines very little light on the potential for growth. The key here is to focus on metrics that signal growth in a new market segment that your business is yet to explore.
While your current business model may be geared towards market dominance in a certain market, investing in innovation projects could open up doors to entirely new segments that can leapfrog your business to new heights and pivot your entire business model.
If we think back to Kodak at the turn of the century — despite having the technical capacity to embrace digital photography, fear of jeopardising their lucrative film business left them with an outdated business model that was unable to keep pace with the likes of Canon, Nikon and Sony.
If organisations constantly compare the market share of innovation projects to their business as usual activities, they will come unstuck if their existing business model deteriorates, and they have failed to invest in new avenues for growth.
So, when asked to present the market share of an innovation venture, make sure to use accurate market segmentation to show how you are driving growth in a previously untapped, and hopefully sizable, new market.
Measuring the success of a new initiative using current gross margin figures is unlikely to reveal any meaningful insights.
With almost all organisations, the key to profitability is to find a business model that works and then to optimise their operations to increase gross margin. Whether it’s cutting costs, improving customer experiences to charge a higher price, or a combination of the two, improving gross margin is an iterative process that can take many years to achieve.
With this in mind, the gross margin for business as usual product and services will almost always be considerably higher than early-stage innovation ventures. Besides, new ventures are likely to be lean experiments that have been put together to validate assumptions, and not to generate immediate contribution margin.
Additionally, it’s important to note that if an innovation initiative is tech-orientated, upfront investment into development fees and set-up could yield a very high gross margin down the road if a product or service demonstrates scalability. For example, the unit costs of a subscription-based SaaS venture will tend towards zero as the number of customers increases, and despite the unit gross margin being likely lower than business as usual services, its scalability will deliver higher contribution through volumes.
Bottom line is, if asked to present gross margin figures for an innovative venture, make sure to highlight the areas of improvements you have identified to increase it in the short and medium-term and show what that gross margin would like in total when you reach the expected scale.