This is the fourth in a series of six articles that will be published over the coming weeks discussing the Innoleaps six pillar strategic methodology. In this fourth article, we focus on innovation accounting. For an overview of all six pillars, click here.
In our second pillar, we commented on the fact that companies need to pursue a broad portfolio of bets if they are to innovate effectively. Today, as we continue to explore the six essential pillars that companies must embrace if they are to combine the speed of a start-up with the scale of a long-established corporation, we’ll be taking a look at how organizations should fund their innovation gambles.
Whether funding is taken from external sources or allocated from internal budgets, innovation can be costly. In the Netherlands, a National Growth Fund was announced late last year to provide organizations with €20 billion in funding for knowledge development, infrastructure, research, and innovation. This funding will quickly be used up, although, of course, many other sources, both public and private, are also available.
As the saying goes, you need to spend money to make money, but innovating successfully is not about simply throwing enough ideas at the wall in the hope that some of them stick. Genuine innovation needs more than just an increased R&D budget – it must be underpinned by a long-term financial plan.
The idea that you need to have 100 ideas to create a couple of successful ones is problematic. Many ideas fail because of bad execution, pivoting too fast, poor team dynamics, badly managed corporate-startup tensions, or substandard integration pathways. Simply adding more ideas to your innovation portfolio does not solve these existing challenges.
As we mentioned in our previous article, businesses should expect that only one in ten of their innovation gambles will pay off. But even so, many firms are allowing these failures to drain corporate finances in a way that is simply not necessary. It is often said that failure should be celebrated when innovating, but wasting money should not.
What is innovation accounting?
When an organization starts on a particular innovation journey, it is essential that it first sets up a pre-commitment of adequate financial resources to reach its desired goal. At Innoleaps, we add structure to the funding process. If, for example, you believe that over a five-year period, you will need €250 million in funding for a particular project, it is essential that you work out how to scale this funding year-by-year. This, in turn, will help scale your innovation initiative from idea to mass market.
As with any other business process, innovation needs to be backed by formal measurements and metrics for success. Creativity can still be supported by concrete facts and figures. According to Erik Ries, a US entrepreneur with a particular interest in the start-up movement, “Innovation accounting is an organized system of principles, and KPIs established to gather, analyze and present data about a company’s breakthrough and disruptive innovation efforts - working to complement the existing financial accounting system.”
The total required funds and growth ambition should also consider the financial resources needed for the initiatives that are not followed up beyond the ideation, validation, MVP, and launch phases. Even gambles that show some initial promise may ultimately need to be abandoned. At Innoleaps, we understand that the main goal of innovation is not to create MVPs; it is to launch truly disruptive products that can scale an entire business.
Say goodbye to the budget
When it comes to allocating financial resources for innovation, there is an important difference between “budget” and “committed capital.” The “innovation budget” concerns the annual funds required to finance the initiatives in any given year; you cannot exceed it and if you don’t spend it, it’s gone.
The “innovation committed capital,” on the other hand, refers to the total funds required to finance an entire innovation portfolio for the next three to five years. Within an agreed capacity, capital is drawn when needed, with required capital immediately released. Of course, set rules can still be employed, and it is a good idea to agree on certain milestones for each particular project so that capital is released when goals are met. We call this metered funding.
With a budget-based approach, innovators have to continually ask for new funding each year – adding friction to the innovation process. Conversely, when there is a pool of committed capital set aside for innovation, it provides projects, or innovation bets, with a long-term structure that delivers reliable financial support. With our lean approach to innovation funding, investments are metered and spent over time, increasing in value as projects reach their milestones. From the ideation stage, through to validation, pilot market launches, and, finally, scale, investment goes up at each stage assuming that the relevant teams can show progress through clear business data and agreed metrics.
Funding your innovation gambles will always involve risk, but they should not be reliant on ad-hoc decision-making that leaves investors and innovators left guessing whether a project should continue or not. By putting a clear, long-term plan in place for your innovation capital related to the growth ambition of the company, organizations can bring accountability to all their projects, informing them when to increase funding for winning bets and when to give up on those that are headed for a loss.
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