Amy Radin, who serves on the board of directors of the Association of International Certified Professional Accountants, wrote an article in the December 2020 issue of FM with the headline “How CFOs Can Enable Innovation Now”.
Radin is an author, adviser, and former corporate innovation executive, so she has keen insight into the topic, including how the finance function can play a critical role. A section of her article touched on the questions organisation leaders should ask in establishing metrics for early-stage concepts. Those questions are addressed in detail in this podcast episode.
What you’ll learn from this episode:
- Radin explains why “What’s the return on investment?” is not a good early-stage innovation question.
- Why traditional metrics used to measure existing business initiatives could be the wrong metrics for measuring a new concept.
- What a good answer might be to the question “How big is the addressable market?”
- How to consider moving forward on a project when not everyone on an innovation team believes in the project.
Play the episode below or read the edited transcript:
To comment on this episode or to suggest an idea for another episode, contact Neil Amato, an FM magazine senior editor, at Neil.Amato@aicpa-cima.com.
Neil Amato: I’d like to welcome Amy Radin to the FM podcast. Hello, Amy.
Amy Radin: Hi, so great to be here with you today, Neil.
Amato: You wrote in the December issue of FM magazine that CFOs can enable innovation in three key ways: ensuring proper resource allocation, developing policies and process that facilitate innovation, and adopting relevant metrics. On that third part, the metrics, developing metrics, there are some questions that finance executives can ask, and we’re going to explore those in greater detail for this episode. Before we get into those questions, is there anything you want to say to set the stage on that topic?
Radin: I was very motivated to write this piece for FM magazine, because I’ve worked for much of my career as a digital and innovation executive inside some pretty big brands, places like Citi, American Express, E-Trade, AXA, and in each circumstance we ran into similar challenges and opportunities in building a constructive relationship with the CFO team, which is so critical to the success of an innovation effort, but which is not always aligned with the innovation or digital team in terms of what they’re trying to do. And because we had many breakthroughs and were very successful in building the right relationship, I just really enjoy sharing what we learned from our experiences and try to help other CFOs, because they were always critical to the success of any organisation trying to drive a digital transformation or to innovate persistently.
Amato: In addition to writing that article for FM and in addition to your experience that you mentioned, you’re the author of The Change Maker’s Playbook: How to Seek, Seed and Scale Innovation in Any Company. On that innovation topic, CFOs I think like to get into, “Well, what are my metrics?” So, the first question for establishing innovation metrics: How big is the addressable market? Tell me more about that question and, I guess, what answers you’re looking for.
Radin: So, first of all I’ll say one of the best ways to sink a potentially, high-potential innovation is by judging it by the wrong metrics. And so often what happens is organisations have incredibly well-defined, well-validated metrics that they use to monitor the existing business and whether the business is on track or not. And those are great, but they can be completely inappropriate for a nascent concept.
So, what I like to do is encourage CFOs, if the first question you’re asking is, “What’s the ROI?”, I would hold up a red flag. On a new concept that’s never been tried in the market, you may have no idea, and so I would encourage you to think a lot more like founders do in the startup world. When they’re looking at a brand-new concept they’re not saying, “How much money am I going to make?” or “What’s the ROI?” They’re saying, “Well, how big is the addressable market?”, so, how big is that denominator?
How many people or businesses or organisations are out there that based on my best guess at this point — because that’s what it’s going to be, intelligent guesswork hopefully backed up by some real market insight — how big is the universe of entities that for whom I think this concept would be relevant? Then of that universe, how many of those do I reasonably expect I could connect with? Right? So, however you’re defining your footprint, are they findable through the channels that you’re anticipating you would launch your distribution through? So, it’s going to be the addressable market isn’t going to be 100% of universe, it’s going to be some subset honed by just some smart assumptions.
Then I like to do, what we always used to do with my CEO and our finance team back at Citi is we do what I’d call, uh, we’d take the 1% test. So, you take the addressable market and then say, “Well, what if I got 1% market share?” Because 1% is actually pretty hard to get when you’re trying to get a foothold in a new business, like, “How would I feel about that? Would that be, would that, would that feel like it would be worth my effort to pursue this?”
So that’s the first sort of metric. The metrics that help you start to home in on, “Do I really have a business model? Do I think I could march towards a P&L and a balance sheet that I would like?” [The answers] are going to generally come through testing and learning. You’re going to be able to apply very good guesswork out of the chute, but again if it’s a new idea you can’t rely so much and sometimes not at all on the rear-view mirror, on what happened in the past, because those are metrics that come from other businesses and older ideas. So, you’ve got to test your way into finding the right metrics beyond addressable market and playing around with market-share beliefs.
Amato: What would you have to believe for this to be a concept worth pursuing? That’s the next question. So, tell me more of what you’re thinking on that question.
Radin: Right and that’s a great question. So, here’s what I’ll give you. I’ll tell you exactly what we used to do with our early-stage concepts, one of the techniques I really like. We would sit down and, say, my team would arrive at a concept that we thought had potential based on the addressable market and what the 1% test looked like.
So, then we would sit down and tap into our combined experience as business people, right, who knew our sector and knew our customer, we would sit down and say, “OK, based on our knowledge and our judgement and looking at other businesses, other organisations.” And by the way also bringing together a diverse team of people from across the organisations, because you really want diversity of thought at this stage of the game. You’d say, “Well, what would I have to believe about — what do I think the primary revenue streams might be on this concept and how big would they be?” “What do I think the drivers of expenses would be?” “Where do I think I would have to invest?”
So, starting to think at a very high level of, is this something that’s going to be very customer-service intensive? Is this going to be something that I’m going to distribute requiring a large advertising budget to build awareness? How am I going to work through partnerships?” You start to really think in very tangible terms early on about the different mechanics of the business model and how they would work. A lot of it common sense, guesswork, judgement, and the input of people who are bringing diverse perspectives to just help you outline how, you know, “What would I have to believe about the P&L and the balance sheet at a very high level?”
And when I say, “at a high level,” I can recall — I’ve gone through exercises when that first incarnation of the P&L and the balance sheet had no numbers on it. You would have high, medium, low. We would have arrows going up and down and sideways. So, we’d do symbols just to connote the size. So, you start at a very general level and through, through testing and learning and insight gathering, you’re able to constantly refine what’s going on.
I’ll add one more comment here. I think where a lot of innovators go wrong on what might be perfectly great concepts with high potential is a lot of effort is put upfront into, “Well, let me develop a prototype that my users are going to love.” Then they say, “Well, and I’ll figure out the business model later.” I’m like, “No, no, no, no, no, you don’t.” I think that’s what’s can set an innovation team up from the get-go to have — establish a void between them and the finance team, which ultimately is going to weigh in, have a lot to say about the investment, right?
So what you want to do is start this conversation about the business model, about what would you have to believe around, “Well how am I feeling about this?” and really start to talk about the drivers of revenue and expense and the balance sheet early on. What’s great about that is then as you’re prototyping and engaging with users, you’re not just validating, does the product work and is it solving their problem, but you’re going to tune in a lot more to their behaviours that ultimately translate into revenue and expenses.
Amato: We’ll get back to that question on drivers of revenue, expenses in just a sec. What I want to know is if you’ve got a team that you’ve brought in a bunch of people, and 60% of them are gung-ho about it and the others are kind of lukewarm to negative about it, is there kind of a threshold that you have to have? Is there a voting majority that you need to move forward with a project?
Radin: See, I think that’s a great question. My belief is that the customer is the one who should have the biggest vote. So I’m a very big fan of finding ways to get into the market, even if they’re only with small-scale tests, even if they’re only with what we’d call “friendly-user tests,” where you get 25 people who are sort of close friends of the company to help you try something out that you’ve got to get real market experience. The reason is that we all, all of the experience that we accumulate through our years of being in our respective professions is obviously fabulously helpful.
When you’re dealing with something brand-new, that past experience and knowledge can sometimes become inhibitors of seeing things in whole new ways. So, when you’re very internally driven in the decision-making process, you can unwittingly bias decisions to the detriment of the business.
There are so many examples of how counterintuitively things turn out to work, but you have to step back — you have to be able to step away from your own biases. There’s a concept in market research called confirmation bias, where people go after answers and they basically look for the answer that justifies what they believed all along. We don’t do that out of malice; we do it because we’re human and we like to bring certainty and the models that have worked for us in the past. With innovation you’ve got to really listen to the customer and find ways to step back from your biases.
So, voting, I would say give the customer a much heavier vote and look at your data, but you have to look at the relevant data that relates to the concept you’re exploring. Don’t overrely on historic data that may have nothing to do with the new idea that your business colleagues are exploring.
Amato: So, what does that look like in practice to find that small customer subset? Is it call up some friends and say, “Hey, check out this app”?
Radin: You start by diving into — I’ll tell you, one of the things that companies do that’s so interesting is they don’t take advantage enough of the data that relates to the relationships their existing customers already have with them and then tap into their customers to help them build products.
I think of times when we were working with very, very early-stage ideas back in my days in banking, we would involve employees, but employees from outside our team, in friendly-user tests. So, we might have — let’s face it, banking is highly regulated, right, and there could be large investments in technology to actually go into production with something
So we would sometimes do what we’d call off-systems tests, engage in small groups of employees who knew the company, and we could put them under confidentiality and all that stuff, but also manage the risk that exposure out in the market if you actually wanted to test stuff and live, something that you might not want to take on.
Here’s a great example. We’re talking about this issue of what can go wrong when you let your prior knowledge bias how you’re thinking about a new idea.
Back in the day when digital was first becoming a big factor in the credit-card space, I was leading a digital transformation of Citi cards. One of the most important engines of the business model in a credit-card business, and this is still the case, is the ability to acquire new customers who are going to extend payment and pay you back. So, it’s a risk-management business, right, where you’re really operating out on the risk spectrum, and so you’ve got to be very careful about how you lend. On the other hand, if you don’t take some risk, you’re not going to make any money, because the business is, you know, the financials are driven by people extending payment.
So there was an idea in the business, among the people in the data and analytics functions, including finance, that lending online, that the way extend offers to sign up for a credit card online was to talk all of the models, the risk-decisioning models that had been very finely honed from direct mail and put them on the internet, but, oh by the way, since it wasn’t a paper application, let’s add a lot more fields to the application. It’s a data-collection opportunity, right? What we found was that the people who were attracted to apply for the cards as a result of those decisions were multiple times riskier and not at all in our profile.
So, people internally looked at the results, and they said, “Aha, this is a bad channel for lending.” Right? And so it took all these terrific models that performed incredibly well, all of the assumptions about how people should behave based on direct mail and telemarketing-based acquisition, and all of a sudden there was an entirely different and unacceptable result and the insight was, “It’s a bad channel.”
So, we said, “Hang on there.” Let’s step back and ask and challenge ourselves on, well, maybe in this environment you need to create a different experience for people to acquire the card. Maybe if you have a lengthy application, you’re actually discouraging creditworthy people from taking the time, because a really creditworthy person doesn’t feel they have to give a lot of information. So maybe we need not only [a different] application, but an even shorter application. Maybe we should be using advanced technologies for decisioning so that the customer has an easier experience, so we actually are attracting positive-selection people versus negative-selection people. Maybe we need whole new scoring models that are specific to the channel.
Those were the kinds of questions you have to start asking that are very tied to the financial decisions and the financial outcomes that an innovation will achieve. But you have to be a question-asker, and you have to be a person who sees the value of being of asking new questions and pursuing the answers. I think so often in the corporate world, we’re in a big hurry. We’re all under a lot of pressure, we have to keep moving, we have to get the results, especially now in 2021 things are going to be very, very pressured to like, “return to normal”.
I think it’s a time when people who succeed are going to those who are especially open to asking and answering questions that help us challenge assumptions that may have worked well in the past, but we’re in a different world now.
So hopefully that example helps.
Amato: It is an excellent example. I think it does kind of underscore where things are with the need for speed, but also the need to kind of step back and actually analyse, not just move on.
So next is a question on key drivers. The question as it appeared in this info box in the article was: What appear to be the likely key drivers of revenue, expenses, and the balance sheet? Tell us what those answers might look like or should look like.
Radin: Well, I think obviously it depends upon your business and who your customer is. But let’s just say you’ve got for a given customer, are they going to pay you a flat fee for ongoing usage? Are they going to pay you per item or per usage? Is it going to be a hybrid model where people are committing to some kind of a subscription, but then they can trade up or expand their relationship with you? So, thinking about all the different dimensions of how, what are the potential sources of revenue?
If you’re working with partners, are there going to be affiliate fees that you can earn? Based on how your product is constructed what are the other B2B relationships that might be contributing a component for your product and how are those elements participating either in generating revenue, but also in creating expenses?
And then obviously on the expense side, you’re going to have, “How am I going to distribute? How am I going to go to market? How am I going to build awareness, and how am I going to get product into people’s hands?”
Is it a direct-to-customer business, or is it a salesforce-driven business? Is it going to be online, a physical world, or a hybrid? So, all of those different distribution strategies are going to create different expenses. What’s your servicing going to be? What kind of guarantees or warranties are you putting behind your offering, and how is that going to drive expense? Is it going to be something that’s supported — is there any consultative support, and what does that look like?
So really think about, “How is this going to operate?” and “How am I really creating value for the customer, and what’s really important for them?” “What’s the quid pro quo in terms of how they’re going to reward me by paying me for that?” And also, “How am I going to support delivering on the promise? What expenses are going to be generated so that I can deliver on that promise?”
And then finally, capital. “What is it going — what’s my investment going to be to get this off the ground?” The great thing is that these days technology has become so inexpensive and people are engaging in so many unique partnership models that the upfront capital to get a pilot off the ground can be incredibly small. But ultimately you have to start to think about, “OK, if my concept succeeds and then I have to scale, what’s my investment going to look like to scale?” Then it’s, “Well, am I integrating into an existing business where the costs are going to be incremental?” or “Am I building a new brand, and how am I going to do that?”
It’s just systematically going through those questions. But early on much more important to start to think about the line items and how it’s going to work than to lock into exact numbers, because you really don’t know. But you have to start thinking about it early in the game.
Amato: You mentioned scale, that is the final question on this list in the article, which is: What is the potential to scale?
Radin: Yeah, and I think as I think about my work with founders in particular over the last few years, what I’ve observed is that many startups develop incredibly good concepts and then are unable to sort of create that hockey stick of scaling. And I think even in large established companies, getting from the pilot to scale can end up being really challenging.
I think there are factors that teams really have to take into account. The first one is the talent and the people. What may have been required to get you to a valid prototype and a working business model is one set of skills. The set of skills that are required to deliver something at what I call “industrial strength”, where the pressure is on to have low defect rates, the quality bar is high, regulators could be looking at you at this point. Your customer expectations are going to be high. You’re investing a lot of money in building out your customer-service infrastructure, your manufacturing. You’ve got to recognise that what got you here may not get you there, so the talent requirements to get to scale could really change.
That said, I think businesses get into trouble sometimes when they do a complete handoff and say, “Oh you guys go away. You developed it, but now we’re going to bring in a whole new team.” You’ve got to have that DNA of the people who want to go along for the ride. So, you just have to start, but you’ve got to start adding skillsets to the team. Some people have a preference. They want to be there at that early-stage mucking around with the strange concepts and new ideas, and some people are really into, “I want to grow that thing.” So, the talent questions become really important and they absolutely affect the financials.
Obviously, from the finance functions standpoint, when you get to scaling, you’re going to get much more buttoned-up around your numbers, right? So, when it’s time to scale, it’s probably the time when the business is budgeting in the annual plan for real revenue and real expenses. So, the team is signing up for goals. There are expenses being built into the assumptions across all the areas of the business that support getting a product to market. There’s a rigour that’s being applied there around delivering that wasn’t there at the beginning. I think making that turn — you can’t go all the way to bright in one second. You’ve got to really plan that migration path, is my recommendation, and take your time to build the talent and figure out when is the right time to really build up the investment? When is the right time to expand the team?
I can remember, back to my story earlier about how we sort of cracked the code on new customer credit-card acquisition. We worked on it for a couple of years, because it was an issue that was so sensitive in the financials, in the business model, we just had to get it right. I can still remember the day that I was in my CFO’s office, and he ledgered over some serious money; we were ready to scale. We had proven the case and the business had confidence that we could really deliver, and this was the way to go. But we tested our way very carefully into getting there.
Amato: In the show notes for this episode we’ll share the article link so listeners can learn more on the topic and more about Amy. This has been an excellent conversation. Would you like to add anything in closing?
Radin: I just I want to repeat what I said at the beginning, that I think the CFO and their team have a really unique and important role to play in enabling innovation. As we head into 2021, I think that the entire function and I know there’s such a strong desire among the CFO community to play a highly strategic role in their businesses growth is to really think about these questions that are shared in the article about how can you improve the way resources are allocated so innovation is appropriately supported. How can you facilitate adapting your policies and processes so that they’re fit for the purpose of innovation? Because what worked or what works in your existing business may not be at all appropriate. And then how can you start to embrace a set of metrics that are appropriate for an early-stage concept and give new concepts time to breathe so you can really tell if they are worthy of further investment.
Amato: Amy, thank you very much.
Radin: A pleasure to be here, thank you.