Closing the Gap on Innovation Metrics

Businesses have lacked clear measures and tools to define and gauge the impact of innovation. Now, some are tackling the issue

All businesses rely heavily on metrics to gauge various measures of absolute and relative health. Growth rates, margin improvements, return on investment, liquidity measures, and many others are universal tools -- a language in and of themselves -- that allow businesspeople to communicate with each other in meaningful ways. Grounded in objectivity, metrics make businesspeople feel secure. For better or worse, they tell you where you stand.

The most elegant shorthand in the business world, metrics drive many things that make business go -- stock prices, the cost of capital, industry performance, productivity, employee evaluations, bonuses and the like. We would be lost without our algorithms.

So it's very curious to note that at a time when the business world uses such sophisticated tools to measure just about everything, this same type of universal yardstick has yet to emerge for innovation.


  "At Motorola (MOT), we can measure innovation by looking at the market success of our inventions -- from the world's first car radio to the iconic Razr," says David Burrage, research portfolio and processes manager. "But traditional measures of innovation such as market success are significantly lagging indicators. We're interested in measures that are timely, meaningful, and, most importantly, actionable." And that pretty much sums up the situation in most big businesses.

I have been working with Kaiser Associates, a boutique strategy and management-consulting firm, on this issue, and as Mark Stein, Kaiser's innovation practice leader, states, "Companies are more and more often reporting to Wall Street on their Percentage of Revenue from New Products, but that tells us very little about the business impact of innovation. Consider some of the problems with this approach: Is this 'new' revenue profitable? Is it doing more than cannibalizing the existing base [of revenue]? What's counted as a new product? Feature addition? Line extension? What about services and embedded innovation? What conclusions can we draw about what drives success?"

After years of working with leading S&P 500 companies that were searching for a means to quantify performance in a meaningful way, Stein launched an initiative to codify innovation performance according to a set of rules, metrics, and definitions. "Most often, clients come to us looking for a results-driven scorecard that can measure the impact of innovation year-over-year, relative to peers and across their businesses," he says. "The major problem with many solutions is that they mix a set of inputs, intermediaries, and qualitative factors like R&D spend, number of patents filed, and level of innovation culture in the enterprise. All of this data goes into a black box and they come out with a score. At best, these items are potential indicators of performance. At worst, these composite scores are distractions."


  Innovation metrics have been so poor that senior leadership and Wall Street alike pay little if any attention to them at face value. Some companies have measures that are used internally, but more often than not those measures are weak indicators that are used to justify someone's cost center rather being an efficient measure of enterprise-wide productivity.

For example, in the face of a plethora of new ideas being generated and developed (a common productivity measure), the failure of any of those ideas post-launch is explained away -- "Well, marketing didn't execute properly." Fingerpointing abounds at the departmental level, with little accountability at the enterprise level. Meanwhile, budget is being spent chasing new ideas, but are they the right ideas?

What seems to make Wall Street stand up and take notice is forward growth and earnings projections -- more sales and more margin on a sustainable basis. For lack of anything better, top-line and bottom-line improvement are used as proxies, but these don't necessarily reflect corporate capability for innovation because the effect of acquisitions are typically part of those equations. What if M&A activity is curtailed by market forces? How do we then reasonably assess a company's capability for organic growth?


  In today's fast-paced environment, that capability for organic growth reveals a number of other important health factors: How fast can a company change? How nimble are its people in acting on trends? Are top decisionmakers driving innovation, or is the culture they've created too afraid -- or muddled -- to make bold moves? Factors like these can take years to change. Unmasked, will Wall Street tolerate indifference to innovation?

Stein and team claim that defining "innovation" has been one of the major hurdles to providing the business and investment communities with a standardized metric for measuring the impact of innovation. In calculating revenue from new products (and in an effort to get a bump on Wall Street), many companies count incremental product improvements that merely refresh older product types -- "innovation inflation," as Stein puts it. Unlike financial performance indicators such as ROI or ROA, innovation lacks a common set of rules around what's included and what isn't -- a problem that Stein's team is tackling head-on.

"A company's ability to measure results of innovation is critical to achieving sustained growth and profitability. But it's also critical for getting the resources it needs to get the job done. Measurement helps identify what's working best in terms of growing the business and in putting money behind those projects and processes that have proven effective," says Stein.


  But one thing is sure: When companies fail to measure and appreciate the financial impact of innovation, it will be neglected by the organization. Insufficient resources, skill, know-how, and executive attention will be applied that will beget at best what we at Peer Insight call "little 'i' innovation" -- that which can be derived from continuous improvement efforts -- but no big "I" innovation, the kind that can disrupt an industry, as Apple (AAPL) has been able to do to digital music with its iPod ecosystem.

No doubt innovation metrics will be taken more seriously when a tool is finally invented that will shine an objective light on how companies are performing with respect to their capability to increase the top and bottom line organically. Stein's team at Kaiser is currently testing a novel algorithmic approach for measuring innovation. Jeremy Schwab, an analyst in the Cadbury Schweppes Beverages (CSG) business who's participating in the effort, says, "We're constantly raising the bar in innovation. Achieving greater success by leveraging and sharpening tools that link these efforts to business results is something that we know will ultimately help us win in the marketplace."

If we think innovation is having a boom now, just wait until a commonly understood measure of performance finally emerges. Those companies that have long been in the business of supporting an innovation capability will get a long overdue report card on their efforts. Those companies that have ignored the trend won't be ignoring it for long.