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Innovation and Performance measurement
Dr. Ashish Garg
9 January, 2009
Page 2
Background – Ashish Garg (Thumbnail Sketch)
► Education: Ph.D in Economics from Harvard University (1997); taught graduate and undergraduate classes
► 7 years with E&Y. Total of 11 years as a management consultant
► Before E&Y was at McKinsey Inc. (led “R&D” type group on Strategy and Economics)
► Executive Director at E&Y since July 2008
► Focus on Performance Management, Performance Measurement, Cost management , Finance Transformation etc
► Author of 50 article on Management accounting, Cost management, Performance management
Page 3
EY Perspective
Agenda
► Importance of Innovation
► Managing Innovation
► Role of the CFO in encouraging Innovation
► Performance Measurement and Innovation Metrics
► Suggestions on Reasearch Agenda
Innovation and Performance Management
Practitioner Perspective
Suggestions for Research
Page 4
EY Study: Balance Point (Innovation) Study Participants
Interviews
Page 5
Senior executives from a variety of backgrounds participated in a global online survey regarding investment in innovation
Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)
74
40
11
14
7
6
0 20 40 60 80
<$100M
$100M-$499M
$500M-$999M
$1B-$4.9B
$5B-$9.9B
>$10BIT Services
29
Communications
Equipment
21
Semiconductors
15Computer
Hardware
12
Software
71
Other or not
specified
4
Europe70
North America
75
Latin America
4
Asia Pacific 3
12
4
5
9
15
20
24
63
0 10 20 30 40 50 60 70
Other
Controller
COO
General Mgr/Bus. Unit Ldr.
CTO
Sr VP or VP
CEO/President
CFO/Mng. Dir. of Finance
Survey Respondent Titles(Number of Responses)
Industry Sector(Number of Responses)
Size—Annual Revenues(Number of Responses)
Geographic Location(Number of Responses)
Page 6
► Importance of Innovation: Executives confirm innovation remains critical
► Managing Innovation: Companies struggle to manage investments
► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process
► Performance Measurement and Innovation Metrics : Helps focus on drivers of success
► Research Agenda
EY Study : Balance PointBringing Discipline to Investment in Innovation and Growth
Source: Ernst & Young analysis and executive interviews
“If we don’t find a good way to address innovation and make use of innovation,
then we will immediately fall behind in the competitive race.”
Page 7
Executives concur that future success depends upon effective product and service innovation
“Innovation is our number one priority as a company.”
“The core of what we do and the core of how we generate growth always boils
down to big innovations.”
“Innovation is always important. Always.”
“Innovation is, of course the name of the game in our industry.”
“Markets of the future will be developed by the skilled innovators of today who commit the right balance of internal and external resources to the innovation process.”
—Henry Chesbrough
12%
19%
20%
22%
36%
47%
66%
78%
Access to capital
Marketing and brand investments
Entry into new geographic markets
Attracting and retaining talent
M&A, strategic alliances, and/or jointventures
Cost and process efficiency
Customer service and satisfaction
Product and service innovation
In your opinion, what will be the top three drivers of your company’s success over the next two years?
Percent of Responses
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003
Page 8
Large and small companies have somewhat differing views on the relative importance of innovation, but there is general agreement that it is an essential process
7%
7%
7%
33%
30%
52%
89%
74%
13%
22%
22%
20%
37%
46%
61%
78%
Access to capital
Marketing and brand investments
Entry into new geographic markets
Attracting and retaining talent
M&A, strategic alliances, and/or jointventures
Cost and process efficiency
Customer service and satisfaction
Product and service innovation
<$1B inannual sales
>$1B inannual sales
In your opinion, what will be the top three drivers of your company’s success over the next two years?
Percent of Responses
0%
4%
7%
33%
56%
2%
7%
13%
29%
49%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
Strongly Agree
<$1B inannual sales
>$1B inannual sales
Percent of Responses
Technology innovation is more important than ever in driving my company’s success
Large companies rate customer service higher than innovation, while smaller companies rank innovation as the top priority
However, almost 90 percent of surveyed large companies indicate that innovation is more important than ever in driving success
“It’s much easier to innovate as a small company because you’re creating your own religion.”
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 9
R&D intensity has exhibited considerable volatility within segments of the technology sector over the past five years
Note: R&D Spending (Percent of Sales) analysis was performed on a pool of 36 companies in five sectors. The minimum representation in a sector was five companies.Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1999–2004, via FactSet 10.10M, accessed 9 February 2004
“In the past, we and most of our competitors would move R&D spending with revenue. The result was
choppiness in the product coming out, and your
products tended to come out about the same time
as your competitors’ because you were all
doing the same thing.”
0%
5%
10%
15%
20%
1999 2000 2001 2002 2003 2004
R&D Intensity by Sector1999-2004
CommunicationsEquipment
Computers
Conglomerates
Semiconductors
Software
Sector Averages
R&
D S
pen
din
g a
s a
Per
cen
t o
f S
ales
Page 10
Survey participants are committing substantial resources to theirR&D activity
7%
11% 11%
16% 16%
14%
9%
11%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
<1% 1-3% 4-6% 7-10% 11-15% 16-20% 21-25% >25%
Surveyed Annual R&D Spending Intensity R&D spending measurements do not include additional sources of innovation, including:
Half of survey respondents are spending more than 10 percent of their revenue on R&D spending
M&A activity
Joint ventures and partnerships
Externally sourced innovation and licensing fees recorded as cost of sales
Product development expenses not listed as R&D
R&D Spending(Percent of Sales)
50%
Per
cen
t o
f R
esp
on
ses
“R&D spending must be smarter, not just increased. Firms must leverage the R&D investments of others, in addition to their own.”
—Henry Chesbrough
Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003
Page 11
The communications, media, and entertainment industries provide an example of how new technology waves are coming more rapidly
“Suddenly, the rate of change has definitely increased. I see different changes and innovation paths all the time; their frequency has exponentially grown.”
Source: Ernst & Young analysis; “Statistical Abstract of the United States,” U.S. Census Bureau, various years; “Historical Statistics of the United States, Colonial Times to 1970, Doc 93-78, 1920-1970,” U.S. Census Bureau; “Falling Through the Net II: New Data on the Digital Divide,” National Telecommunications and Information Administration, 28 July 1998; “Communications Industry Forecast & Report,” Veronis Suhler, July 2003; “Worldwide and U.S. DVR 2004-2008 Forecast,” IDC, March 2004; “Media Trends Track,” http://www.tvb.org/rcentral/mediatrendstrack/tv/tv.asp?c=cable (citing Nielsen Media Research); “Media Trends,” Kagan, 2004; “Consumer Devices and Services Europe,” Forrester Research Inc., October 2003
0%
25%
50%
75%
100%
1920 1926 1932 1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004
U.S. Adoption Rate of Selected Technologies1920-2004
Internet
Digital video recorders
Radio
Broadband
VHS
Television
Wireless phones
DVD player
Cable TV + DBS
Years to achieve 50 percent
69
9
na
10
6
16
35
naPer
cen
t o
f H
ou
seh
old
s o
r P
op
ula
tio
n i
n Y
ear
Note: Adoption rates are all percent of U.S. households with selected technology, except Wireless phone, which is percent of U.S. population; Years to achieve 50 percent is number of years needed to reach 50 percent adoption, beginning when technology was adopted by at least 1 percent of U.S. households or population
Page 12
Technology companies are striving to align investments closely with customer needs, while also balancing the requirements of other key stakeholders
2%
5%
7%
20%
66%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company’s technology innovation investment decisions are aligned closely with
the needs of our customers
Percent of Responses
Surveyed companies believe they are closely aligned with their customers ... ... but it is important to remember that customers
are only one (albeit important) component of the entire value chain
“If you think only about the end-user and not about the value chain along the way, you might have the
best product in the world, but it might never make it to market.”
“To get ideas, you ensure that your engineers spend time out with customers, or in our case, our
customer’s customers.”
“When we talk about customers and being customer-focused, we usually mean the companies that we are selling our technology to. But our role with respect to innovation management is to make
sure that we get to the end-user.”
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)
Page 13
Financial analysis indicates a positive relationship between R&D intensity and profitability, with some outliers
Note: Each plotted point represents a sectoral view of profitability for one of five technology industries (computers, semiconductors, communications equipment, software, and conglomerates). Observed EBITDA margin is lagged two years (e.g., 2001 R&D intensity is compared to 2003 EBITDA margin). The R2 of the trend line is 0.40.
0%
10%
20%
30%
40%
50%
0% 5% 10% 15% 20%R&D as a Percent of Revenue
(1998-2002)
R&D Intensity versus EBITDA Margin
R&D intensity (measured as a percent of revenue) appears to be correlated with lagged EBITDA margins
“You don’t invest today for revenue tomorrow. You invest
today for revenue that’s probably quite a few years out.”
“The bill for innovation is getting steeper. I’m getting more anxious about it, and I can’t tell for several
quarters whether I’m doing anything right. We’re going to
have to wait for a long time to find out.”
EB
ITD
A M
arg
in,
Tw
o-y
ear
Lag
to
R&
D S
pen
din
g
(200
0-20
04)
Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1998–2004, via FactSet 10.10M, accessed February 2005
Page 14
► Importance of Innovation: Executives confirm innovation remains critical
► Managing Innovation: Companies struggle to manage investments
► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process
► Performance Measurement and Innovation Metrics :Helps focus on drivers of success
► Research agenda
“I don’t know that we have any best practices for managing innovation. It
frustrates me a great deal.”
Source: Ernst & Young analysis and executive interviews
EY Study: Balance Point Bringing Discipline to Investment in Innovation
Page 15
Many companies see room for improvement in their ability to manage investment in technology innovation
2%
7%
44%
40%
7%
Not meeting ourneeds—need to rethink
Below Average
Average
Above Average
Superior
Grade your company’s current ability to manage its investment in technology innovation
Percent of Responses
2%
9%
13%
43%
32%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company uses disciplined processes to manage investment in innovation
Percent of Responses
Approximately 75 percent of surveyed companies indicate they have disciplined processes in place to manage innovation ...
... yet less than half indicate their ability to manage technology innovation investment is above average
“We have an integrated risk and opportunity management system.”
“We don’t have control of our R&D projects yet.”
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 16
Technology innovation management is an issue for both small and large companies
0%
15%
11%
41%
33%
2%
8%
14%
44%
32%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
<$1B
>$1B
Percent of Responses
My company uses disciplined processes to manage investment in innovation
7%
0%
37%
48%
7%
1%
9%
46%
38%
6%
Not meeting ourneeds—need to rethink
Below Average
Average
Above Average
Superior
<$1B
>$1B
Percent of Responses
Grade your company’s current ability to manage its investment in technology innovation
Small and large companies report similar levels of innovation process discipline
Larger companies are somewhat more confident in their management abilities, but over 40 percent still indicate they are average or below average
Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 17
There is significant frustration over a general lack of ‘best practices’ with respect to managing innovation investments
Source: Ernst & Young analysis and executive interviews
“I don’t know that we have any best practices for managing innovation. It
frustrates me a great deal.”
“The go-to-market side is usually forgotten in this industry.”
“We are not good at the marketing and selling of innovations, so 80 percent of the
patents that are filed never become a product that you’ll see in the market.”
“We hide behind the claim that it’s impractical to come up with a process, or even a collection of processes to manage
innovation investment effectively. It seems that the judgment of the wise man is just
as good as any kind of processes you come up with.”
“The hardest thing to do is to figure out return on R&D investment.”
“It’s hard to make improvements in managing innovation because there’s an
old culture right now that sort of works, so people ask, ‘Why would I change this?’”
Many companies report a lack of discipline in their end-to-end control of the innovation process ...
... but there is no clear vision of how to improve control
The frustration over managing innovation investment creates an opportunity for a CFO to participate in the process in new ways
Page 18
Managing innovation is a challenge when failure is a common—and necessary—outcome
Source: Ernst & Young analysis and executive interviews
“The biggest problem with internal company innovation is the lack of tolerance for failure. I don’t think
corporations are well set up for people to fail at enterprises.”
“We have 60 percent failures. If you measure yourself by the number of failures
instead of return, you’d feel terrible.”
“Going into new areas, you have to start with ten initiatives to have one that’s really
successful.”
“These are big bets that we’re talking about. And we know they won’t all pay, and that’s OK—they’re allowed to fail.”
“Companies that are more sophisticated understand what control can do on the
negative side.”
“If it were up to me, I would introduce different mechanisms for managing my mature businesses and my
new initiatives.”
Measurement must reflect the need for a certain amount of failure, especially when pursuing breakthroughs
Not all innovation should be managed the same way—or innovation can be stifled
If a company is not failing at some of their innovation investments, they may not be spending enough on innovation
Page 19
Mergers and acquisitions are increasingly a part of technology companies’ innovation strategies
Companies are buying innovation in addition to developing it in-house ...
“It used to be that technology companies did not look to acquisitions as a way of growing their portfolio.
Now I think it’s an accepted strategic principle.”
“Spin-in is another way of innovating, giving the financial motivation to the individuals in the spin-in.”
... but successful integration is the key challenge to merger success. “You’re going to have to learn how to integrate. Adding an acquisition is almost like dealing with high growth.”
“You have to be humble when you’re an acquirer. Just because you happen to be fortunate enough to have the money to buy them, the fact of the matter is you
didn’t buy them from a position of strength [but] because you couldn’t develop the capability
internally.”
12%
14%
30%
24%
5%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company excels at integrating merger and acquisition deals to achieve planned benefits
Percent of Responses
Less than one-third of surveyed companies agreed that they excel at integrating M&A deals
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 20
Effective risk assessment is a key part of the investment decision process
Understanding and communicating risks is critical to success ...
“People at the project levels think their project is the most important. You want them to be that way and have that
kind of passion. But they don’t always realize the damage that their lack of success may have on the company, or
the risk the company is taking on their behalf.”
“Good innovation management processes may not guarantee the best possible outcome, but they can maybe minimize the risk of the worst possible outcome. You can
narrow the range of probability of disaster a bit.”
... but risk analysis must go beyond the financials“It’s not just the financial return, it’s also the
technology risk, the marketing risk.”
“There are companies that partition innovation risks, so they split up risk into market risk, or execution risk, or knowledge risk, and then assign people to assess and
manage those risks. For example, the people that execute are most capable of talking about
and quantifying execution risk.”
8%
20%
19%
38%
11%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company uses project-specific risk analysis to evaluate each technology innovation
investment opportunity
Percent of Responses
Less than half of surveyed companies agreed that they used project-specific risk analysis to evaluate investment opportunities ...
“To me, if you look across the American economy, there are only two segments of the economy that probably are truly good at managing risk—the insurance industry and the financial and banking industry.”
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 21
Companies seem to be focused on processes to ensure that they are fully compensated for their investments in technology innovation
6%
14%
17%
32%
29%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company has operational and legal processes in place that ensure we are fully compensated for
our technology innovation investments
Percent of Responses
Licensing is an important revenue stream …
“One way to manage non-core innovation is to say, ‘It would cost too much to incubate, so let’s license out this technology to anybody, even competitors,
who might have an interest.’”
… and the choice of business model is critical … “The linkage between innovation and technology is
the business model.”
“We need different business models to take on different markets.”
… to capture the most value from innovation“We have a comprehensive set of techniques to try
to create value out of the whole portfolio.”
“We are able to translate innovation into bottom-line results, and this, for me as a CFO, is the key target.”
Effective operational and assurance processes are needed to ensure that companies are not ‘leaving money on the table’
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 22
Leading edge Analytical tools and techniques to make better decisions are not used to manage innovation
16%
31%
22%
22%
9%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company uses leading analytical tools to help make and track technology innovation
investment decisions
Percent of Responses
“Most companies track the money they spend, and some track the time they spend, but few are tracking the risk they incur. Leading companies deploy analytical tools and control processes that address all three.”
—Henry Chesbrough
Companies see the need to enhance ‘gut feel’ decision-making ...
“In the end, somebody needs to sign on the dotted line, and it comes down to a ‘gut feel’ whether to move forward or not. But you are enriching your ‘gut feel’ by exposing it to various scenarios and various analytical
techniques. You are looking at the picture in a multi-faceted way, and hopefully you make a better choice.”
... and look to Finance for help“You need the fundamental tools—transparent
numbers—so that somebody can sit down and assess the risk equation.”
47%
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003
Page 23
Companies that utilize leading analytical tools are also likely to have good processes to monitor their investment results
The use of leading analytical tools is highly correlated with a company’s ability to effectively monitor investment performance, as survey respondents answered these two questions similarly
“When you depend on individual visionaries for innovation decision-
making, you have the chance of hitting it big. But even a simple process like
collecting the best opinions of the people in the various fields and making
a rational, analytical kind of assessment would help—but we do not
practice that.”
“Thirty years in Finance has taught me to halve the projected return
and double the projected cost to estimate the return of a project.”
My company’s technology innovation investment results are monitored closely against the original decision analysis,
and any variances are understood
My company uses leading analytical tools to help make and track technology innovation investment decisions
16%
31%
22%
22%
9%
8%
29%
25%
23%
14%
Strongly Disagree
SomewhatDisagree
Neutral
Somewhat Agree
Strongly Agree
“Financial discipline does not have to stifle innovation. Done well, it will drive it.”
—Henry Chesbrough
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003
Page 24
Many companies do identify underperforming investments and taking action quickly
6%
18%
20%
36%
18%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
My company is able to identify and reduce funding quickly for underperforming innovation investments
Percent of Responses
Innovation portfolio reviews are critical to success ...
“The sifting process, the narrowing of the competing technologies, has to occur more
quickly.”
... but organizational inertia can prevent tough calls ...“It’s very challenging to cut projects because there are competing groups—sales wants what customers want,
engineers are focused on technology, and the CEO and marketing are in between.”
... so fact-based decision processes are key“Sometimes you have to be the enforcer and
encourage people to put an end to something that isn’t working by saying, ‘Look, I’m not going to invest any
more money—it’s going down a black hole. It doesn’t matter how enthusiastic you are, you don’t have a
business case.’”
“There’s a real focus on what milestones are going to be accomplished on what amount of money—and the
penalty for failure is terminal.”
“There should be a healthy yin and yang between the CEO and the CFO, where the CFO can close the office door and say, ‘We’ve got to
have a talk about this because this particular piece of the business isn’t going to work.’”
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 25
► Importance of Innovation: Executives confirm innovation remains critical
► Managing Innovation: Companies struggle to manage investments
► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process
► Performance Measurement and Innovation Metrics : Helps focus on drivers of success
► Research Agenda
“The CFO needs to be a business partner, not just a financial person.”
EY Study: Balance Point Bringing Discipline to Investment in Innovation
Source: Ernst & Young analysis and executive interviews
Page 26
The CFO and Finance organization are becoming increasingly involved in the technology innovation investment process
3%
10%
12%
40%
34%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
Over the past two years, the CFO and Finance organization have become more involved in the
technology innovation investment process
Percent of Responses
7%
20%
19%
32%
21%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
StronglyAgree
The roles of the CFO and Finance organization in technology innovation investment decisions
are clearly defined
Percent of Responses
Survey respondents clearly indicate the growing involvement of Finance in investment decisions ...
... however, the role of Finance in these decisions is less clear
“Finance should educate us technical people better about what finance does. Most engineers will think it’s just adding up numbers, and if you want to correct that simplistic view, then educate
them. Otherwise, it’s just the finance guy saying, ‘We cut the plan this quarter because we’re not going to make as much money, so you can’t spend what you were planning.’”
53%74%
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)
Page 27
The CFO often adds value to the innovation investment process, but there is room for improvement
Technology personnel are looking for a broader level of involvement from Finance ...
“A lot of the time companies are flying by the seat of their pants. The CFO is cutting checks, but it’s not
clear that they’re adding the kind of value they could.”
“The only thing Finance tells us is, ‘We can negotiate costs down,’ and that’s a good thing, but that doesn’t
make the decision any better. It could still be a terrible loss, or it could be brilliant.”
“Before, Finance was more like bean counters—but now that has changed completely.”
... and for Finance to play the key intermediary role“In the future, the role of the Finance organization is to
fit between the product, the support, and the field organization, and aggregate the three points-of-view
into a company point-of-view—more financial modeling and advice than financial control.”
“The finance person should be the one who really facilitates, monitors, and coaches
the management team.”
“Finance is a good sounding board because they’re totally neutral on technology—they’re not grinding an axe one way or another.”
7%
13%
33%
47%
0%
2%
11%
17%
49%
21%
StronglyDisagree
SomewhatDisagree
Neutral
SomewhatAgree
Strongly Agree
CFO
CTO
The CFO and Finance organization add significant value to the management of innovation investments
Percent of Responses
CTOs rate Finance’s contribution lower than CFOs do
Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005
Page 28
CFOs can bring specific analytical tools to bear on the task of managing innovation
“The CFOs participation should be about bringing the right tools to the table.”
ANALYTICAL TOOLS FOR MANAGING INNOVATION
► Game theory
► Enterprise planning models
► Simulation models
► Sensitivity analysis
► Risk portfolio analysis
To test how competitors, customers, suppliers, and other stakeholders might respond to an innovation, and the corresponding impacts to the innovator
To provide an integrated view across all dimensions of the company (product, geography, business unit) that can test the impacts of innovation investments successes and failures on the financial performance and valuation of the innovator
To test the probable outcomes of innovation investments
To test the potential upsides and downsides of innovation investments, and help develop an innovation portfolio with relatively greater upside potential and reduced risk
To apply portfolio theory to the balancing of the risks and returns of innovation investments
To utilize consistent evaluation criteria and to track investment performance against planned results and gates
► Business case evaluation templates and performance tracking
Page 29
Finding the ‘Balance Point’ across multiple innovation investment processes is the key challenge for technology executives
Opportunity
Innovation Creativity
“It's not a ‘Let’s see what happens’ bet, it’s a ‘Let’s bet the farm’ bet.”
“You need the fundamental tools—transparent numbers—so that somebody can sit down and
assess the risk equation.”
“You want to be in control of your own destiny as much as possible.”
“It’s not just the financial return, it’s also the technology risk, the marketing risk.”
“Engineers are really focused on delivering the next degree of functionality just for the beauty of delivering it.”
“I think that the CFO’s participation should be about bringing the right tools to the table to
assess the financial aspects of innovation investment.”
“You need to make milestone reviews as objective and as measurable as you can.”
“The hardest thing to do is figure out return on R&D investment.”
Short-term Return
“They want their money tomorrow.” “I can do whatever you want next quarter, but you won’t like the answer a year from now.”
“We have an environment these days where innovation is almost being replaced by hectic last-minute improvements.”
“An innovation might be a little revenue in three years, but the revenue tail could grow
exponentially, not linearly.”
Long-term Investmentand
Riskand
Financial Disciplineand
Source: Ernst & Young analysis and executive interviews
Page 30
► Importance of Innovation: Executives confirm innovation remains critical
► Managing Innovation: Companies struggle to manage investments
► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process
► Performance Measurement and Innovation Metrics : Helps focus on drivers of success
► Research agenda
Practioners Perspective
Source: Ernst & Young analysis and executive interviews
“Provides a tactical understanding of organization’s value drivers”
Page 31
Measurement of Innovation remains a challenge for Organizations
The kinds of innovation companies take up are diverse. Yet no matter what form of innovation they pursue, far fewer companies measure it than pursue it.
Sources: McKinsey Global Survey Results – Assessing innovation metrics
Page 32
Value of Metrics within Business Performance Management
Re-Align
►Locks measures into strategy and value
►Helps define management dialogue upwards and management focus.
►Forms the basis for performance evaluation
►Helps to set expectations for reporting and planning level of detail
►Incent the desired behavior
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Within the organization, metrics are both used to focus the dialogue upward and provide management oversight downward
1. Management Dialogue – Metrics serve to focus discussion of business results with upper management / the investment community
“The Street”
Corporate
BUs
Geographies
Dual Metric Roles
Functions
Managementfocus
Management dialogue
Management dialogue
Managementfocus
Management dialogue
Managementfocus
Management dialogue
2. Management Focus - Metrics should focus on critical measures needed to manage your business
Cascaded / linked metrics
ILLUSTRATIVE
Metrics should therefore be cascaded to enhance the dialogue and scorecards are the key performance tracking format for metrics
Metrics Fundamentals
Page 34
E&Y’s 4 step process of creating and sustaining measurable organizational value through metrics
►Review Mission, Vision, Corporate strategy and operating model
►Review Company’s industry and review key metrics used by external observers
►Review Strategic Objectives
►Value Decompostion
►Develop Outcome Metric
►Develop Input Metrics
►Collect Metric Data -
►Prioritize rankings and review with group
–A. Ranking Methodology–B. Quantitative Methodology
►Cascading the metrics across the organization
►Link to Processes
►Link to Reporting
►Link to Incentives
Understand & Articulate Strategy
Develop Outcome/Input
Metrics
Prioritize and Select Metrics
Cascade and Embed Metrics
1 2 3 4
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What is Company X’s vision of the future?
What are Company X’s differentiating activities and strategic objectives?
Why does Company X exists?
What are Company X’s guiding principles?
What must be done well in order to implement strategy?
What are the key drivers of success?
MissionMission
Ste
ps
/ bu
ildin
g b
lock
s re
qu
ired
to
det
erm
ine
met
rics
Core ValuesCore Values
Business Driver MetricsThe internal and external factors thatdirectly influence business outcomes
Outcome MetricsThe "few" measures of success for
the company's mission and strategies
Strategy & Objectives
Vision
How can Company X quantify its strategic objectives?
Sources: 1) Company X Vision: www.Company X.com/About/who-we-are/; 2) Company X Strategies: www.Company X.com/About/strategies/; 3) Corporate Scorecard Mockup
Questions
ILLUSTRATIVEMetrics Derivation Flow
Metrics should be derived from Corporate strategic objectives (Step 1)
Step 1
Step 2
Page 36
Measurement of Innovation: Innovation Outcome Metrics
Outcome Metrics :
Pros► Better aligns with ultimate strategic
objecdtives such as Revenue, Earnings and Shareholder Value
Cons : ► Difficult to measure require some
subjectivity
Sources: McKinsey Global Survey Results – Assessing innovation metrics
Examples:
► Number of new products or services launched
► Revenue growth due to new products or services
► Percentage of sales from new products/services in given time period
► Profit growth due to new products or services
► Potential of entire new product/service portfolio to meet growth targets
► Changes in market share resulting from new products/services
► Net present value (NPV) of entire new product/service portfolio
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Examples of Companies using Output Innovation Metrics
► Pepsi: Number of new products with revenue over $100M launched in the last two years
► Kellogg’s 17% of sales in 2007 were from products launched in the last 3 years.
► 3M: 25% of revenue from products introduced in the last 5 years.
Increased to 30% and shortened the period to 4 years.
(Because this metric was so much a part of the culture of 3M’s innovation teams it
took them only 2 years to exceed the new goal.)
► HP utilizes BET (break-even time) for each new product development project as their innovation metric.
Page 38
Measurement of Innovation: Innovation Input Metrics
Examples:► R&D spending as a percentage of sales► Number of ideas or concepts in the pipeline► Number of R&D projects► Number of approved R&D projects as a
percentage of ideas in the pipeline► Number of people actively devoted to
innovation► Percentage of workforce time dedicated to
innovation projects► Number of innovation tools and
methodologies available to employees► Number of ideas submitted by employees
Input Metrics:
Pros : ► Easy to measure and track► Helps manage R&D spend
Cons : ► Might relate poorly with ultimate
strategic objective
Sources: McKinsey Global Survey Results – Assessing innovation metrics
Page 39
Innovation Metrics Usage
Sources: McKinsey Global Survey Results – Assessing innovation metrics
Page 40
There are two broad techniques for prioritizing metrics (Step 3)
Metric Ranking Methodologies
Ranking Methodology Quantitative Methodology
ILLUSTRATIVE
BU and Categories should preferably use a quantitative ranking methodology for selecting metrics
Guiding Principles ... Structured Process
Metrics Qualification RankingComposite
Evaluation Criteria Op. IncomeOp. ContributionSimple 2.50 3.50Specific 4.50 4.00Measurable 2.50 2.00Meaningful 4.50 4.50Actionable 3.50 4.00Assignable 5.00 3.00Relevant 2.00 5.00Reasonable 4.50 2.50Timely 3.50 4.50
Average Score 3.61 3.67
Score
Timeframe 3.50 4.50
Outcome Metric Sensitivity Analysis
Percentage Change in Outcome Metric
Return on Invested Capital
Capital Expenditures
DiscretionaryCash Flow
OperatingIncome Margin (%)
Gross Margin (%)
Operating IncomeGrowth
Organic NetRevenue Growth
Organic VolumeGrowth
Market Share
-15% -10% -5% 0 +5% +10% +15%
Page 41
Corporate Metric SetCorporate Metric Set
BU Metric SetBU Metric Set
BU and Function metrics should include relevant cascaded Corporate metrics (Step 4)
Illustrative Metric Cascade ILLUSTRATIVE
Metric originally defined at the Corporate level
Function Metric SetFunction Metric Set
Guiding Principles ... Cascaded
Corporate Driver Metric 1
Corporate Driver Metric 2
Corporate Driver Metric 3
Corporate Driver Metric 4
Corporate Outcome Metric 1
Corporate Outcome Metric 2
Corporate Outcome Metric x
Corporate Driver Metric 5
Corporate Driver Metric y
Corporate Driver Metric 2
BU Driver Metric a
Corporate Driver Metric 4
Corporate Outcome Metric 2
Corporate Outcome Metric x
BU Driver Metric b
Corporate Driver Metric y
BU Outcome Metric x
BU Driver Metric c
Corporate Driver Metric 2
Corporate Driver Metric 3
Corporate Outcome Metric 2
Function Driver Metric a
Function Outcome Metric x
Function Driver Metric b
Function Outcome Metric x
Function Driver Metric c
Function Driver Metric d
Function Driver Metric e
Page 42
Selected metrics should be embedded in the planning processes and performance reporting (Step 4)
• Strategic Planning – Selected metrics will be used in the strategic planning process to form the basis for evaluating strategic options
• Annual Planning – The annual planning process set targets against a larger subset of metrics due to the shorter time horizon
• Forecasting – The forecasting process will update throughout the year targets for a subset of the metrics used in annual planning
• Performance Reporting – All metrics will be included in the performance reporting (scorecards and drill-downs) to show actual performance against targets and last year
• Compensation – Metrics will also play a role in establishing personal targets and compensation
Guiding Principles ... Structured Process
Page 43
► Importance of Innovation: Executives confirm innovation remains critical
► Managing Innovation: Companies struggle to manage investments
► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process
► Performance Measurement and Innovation Metrics : Helps focus on drivers of success
► Research Agenda
Research agenda
Source: Ernst & Young analysis and executive interviews
Page 44
Some Suggestions for Research Agenda
1. What type of innovation should companies pursue? What kind of innovation is most valuable for a company or industry ?
2. What should be the balance between ST and LT innovation; between opportunity and risk; between in sourced and outsourced innovation
3. What should the Role of the CFO/ Finance be in innovation
4. What innovation measures best relate with share holder value – could be industry specific. Is this a case for some standards similar to financial metrics
5. Compensation for innovation ? How do you compensate for less market facing research
Page 45
Thank You
Contact information
► Presenter : Dr. Ashish Garg► Email : [email protected]► Telephone : (212) 773-8895
Links to the material► Ersnt & Young - Balance Point Survey Study -
http://www.ey.com/global/Content.nsf/US/TCE_-_Balance_Point_Discipline_Investment_-_Almassy_Video_Transcript