Choosing which ideas to invest in is an area where many companies struggle. Very often, companies will use net present value (NPV) when evaluating ideas. For incremental projects, such as a variation on an existing product or service, where you know the market well, that is a highly effective measure.
However, NPV tends to kill the most innovative projects because there are so many unknown factors involved. Other criteria that companies often use, such as “Can the new product be produced on today’s production lines?” or “Can we use today’s sales force?”, also rule out truly radical projects.
Many finance professionals don’t realise the role they can play in helping their companies drive innovation and make it a strategic tool. Where management accountants can really help is by encouraging their organisations to evaluate radical projects differently. In the early stages, the best way is to use a set of estimates including factors such as risk, return, and how aligned a new project would be with the business strategy. The management team members give the project ratings based on that set of criteria.
Wise companies break the radical projects into stages, providing funding in tranches with clear targets and expectations for each stage to unlock further funding. NPV becomes useful only in later stages, when there is more clarity and the project is much nearer to market.
It is ideal if the management accounting team can actually create the criteria for radical projects in parallel to the set used for incremental ideas, and then work to ensure that the right balance of projects is included in the portfolio to match the strategy.
One way to do this is by looking at the mix of projects that have been developed in the past and exploring whether the right balance has been struck between incremental and radical ideas. While a 90%-to-10% radical-to-incremental ideas split is not recommended, if you don’t have anything that’s risky and radical, you’re probably never going to get some of the bigger breakthroughs. A company striving to be a first-to-market leader would need a portfolio that includes at least 30% fairly radical projects.
Act like a venture capitalist
Fear of failure is a major barrier to innovation for both individuals and organisations. To foster a culture in which employees are comfortable developing their ideas and exploring their potential, companies can take a leaf out of the venture capitalists’ book. Most companies decide to fund selected ideas all the way to market. In contrast, investors minimise risk by breaking projects down into a number of different stages and staggering investment. Funding for each new phase of development is released only if the pre-defined targets for the previous stage have been achieved. This is an area where finance professionals can take the lead.
Management accountants can also work with HR colleagues to counter the perception that a cancelled project is a failure. Terminating a project before it gets to market can be considered a strength and celebrated if the idea has been explored fully and the decision has been taken on a sound business basis using market data and understanding. This scenario is actually much better for the company than going to market and losing far more money, because investments typically rocket at the later stages of development.
It’s also important to recognise that some unsuccessful ideas are an inevitable part of the innovation process — individuals and teams can’t have brilliant ideas all the time.
Case study: AXA Insurance Ireland
As part of a strategy to move the company into a stronger financial position, household and motor insurance provider AXA Ireland placed innovation firmly on the company’s agenda. Seeking to involve the whole workforce in the business transformation, AXA asked employees for suggestions. The company was deluged with ideas, many of which were not very relevant.
Management then created a range of programmes to encourage teams to come up with ideas, this time providing a more specific description of the strategic areas in which they were looking to improve.
Suggestions were filtered according to strategic fit, cost/benefit analysis, key deliverables, relevant risks/alternative course of action, feasibility, and business case. These factors also enabled the company to calculate the financial value of ideas and communicate that in the boardroom.
To make the process transparent to employees, AXA published detailed information about the ideas selected and the criteria by which they were chosen.
The “Going the Extra Mile” programme encouraged staff to implement one idea to improve customer service delivery quickly and at low cost. Ideas were registered and approved through a formalised process, and their progress could be tracked on the company intranet.
Efforts were recognised and rewarded by the company, with prizes for the best ideas awarded at a high-profile ceremony. Innovation was also incorporated into employees’ key objectives, with an impact on salary and bonus.
The long-term emphasis on innovation delivered concrete benefits to customers, employees, and the company. AXA Ireland experienced major increases in business and revenues. There was a 20-point improvement in the customer satisfaction index, and the ideas generated contributed €1.5 million ($1.6 million) per annum to profitability.
Keith Goffin is a professor of innovation and new product development at Cranfield School of Management.
Common barriers to innovation
- Focusing too heavily on generating ideas, not enough on selection and development.
- Aiming for breakthrough products rather than a mix of product, process, service, and business model innovation.
- Stifling ideas through too strong a hierarchy.
- Lack of clarity in the company about strategic direction.
- Attempting to replicate the model of a pioneering company.
- Chasing the innovation management theory of the day.
4 innovation essentials
Strategic underpinnings: One of the essential features of an innovative culture is awareness of the organisation’s strategic direction. Senior management must communicate this to staff, and requests for ideas should be clearly aligned to the priority areas. Creativity theory shows that people are more creative when they are given more specific problems or areas to work on. For instance, companies could say, “We would like ideas on how we could be more effective in this segment,” or ask, “How could we boost sales of this product?”
Clear criteria: Making the criteria by which ideas will be selected for development transparent to employees helps them hone their ideas and match future suggestions to the company’s requirements. The criteria may include fit to strategy, feasibility, and the availability of the right team to take the idea through to market.
Time: Once employees have some direction as to the type of ideas sought, they need the time and space to come up with them. It is essential that senior management break the required groups out and give them the time and resources to do this type of work.
Reward: Celebrating and rewarding innovation is another important part of culture. Some managers are reluctant to provide rewards and recognition for innovation, as it’s considered an inherent part of their employees’ job descriptions. But if managers are not happy with their innovation output, those mechanisms need to change. The reward doesn’t have to be financial;; it could be peer recognition, for instance. Find the approach that works in your organisation. If you want more innovation, you’re going to have to highlight that and celebrate what you’ve achieved.