Return on Innovation

Drake Associates have long held that the pathway to profitability is innovation. That as organizations mature they tend more toward efficiency (preventing mistakes) to maximize revenue, but that doesn't necessarily lead to improving profits (which requires risk taking). It is obviously more complicated than that, but it is always been a useful shorthand in discussions with clients about strategy. They need to understand the differences between efficiency and effectiveness and how these get manifested at various points in an organizations life cycle. It helps clients calibrate their expectations about likely outcomes from some initiative or action by knowing where they are along the effectiveness-efficiency continuum.

And while we've always believed it, we only ever had anecdotal evidence to support it. Granted it is evidence developed over 100+ years of practical experience between us, but circumstantial nonetheless. This article from Booz Allan Hamilton's Strategy+Business web site Raising Your Return on Innovation Investment codifies a lot of the same thoughts.

Our recent work has shown that incremental innovation investments are subject to diminishing returns — in other words, each additional dollar spent on new product development ultimately yields a lower and lower return. This observation passes the test of common sense: Spending beyond a certain point on any development portfolio should result in lower returns, since a company will naturally invest in the best projects first, the next-best after that, and so on, until it is tossing good money away on more and more dubious projects. Exhibit 1 illustrates this phenomenon by contrasting the innovation ROI of two companies with very different portfolios. We call the marginal return on innovation investment the innovation effectiveness curve. The larger the area under the curve, the better the firm’s innovation effectiveness.

The article will seem more relevant to companies at a life stage and size that is the target for BAH services (e.g. Hershey’s, Apple Computer), but it still offers insights into the process of innovation that is applicable to all. Not surprisingly the companies that are most effective tend to be the most efficient with their R&D. Companies that do the best job innovating tend to be more successful. And that companies can learn to be more innovative and more effective – regardless of where they are in life stage or size.

There are things that the firm can do internally. There are some things that firms may seek expertise or resources provided by 3rd parties. Innovation, like so many other business activities, is a process. It can be developed, improved and exploited – but only if the organization makes the commitment to do so continuously. The authors, a principal and senior associate in the BAH New York office share some of their ideas. It is worth your time to consider.