Innovation Accounting – Do not rock the Finance Department’s boat
Innovation intrinsically means doing “something new,” which further implicates that there will be a lot of unknowns. These unknowns make it difficult to forecast or estimate results for doing something new.
When you want to innovate in a corporate environment, you need money, and when you need money, you have to ask Finance. And when you run a proposal for something new by Finance, they typically want to value innovation opportunities and investments through traditional financial metrics like Return on Investment (ROI), Net Present Value (NPV), Internal Rate of Return (IRR), etc.
The use of these metrics typically leads to people “inflating” numbers to make the innovation proposal feasible, without a meaningful articulation of the underlying variables that will lead to success.
Looking for a better way to deal with this matter, Eric Ries in his groundbreaking book, The Lean Startup, came up with a method to measure and manage the progress of a great idea to a validated business model, and coined the term “Innovation Accounting” for this method. Said another way, Innovation Accounting quantifies the market value of new business opportunities that are fundamentally ambiguous and uncertain.
A new way of looking at the financials of Innovation
Now, I cannot make you an expert on Innovation Accounting in one short article. So, I just want to lay out the fundamental principles how it works and maybe entice you to investigate further, and who knows, perhaps even challenge your finance department when bringing your next big idea to the table!
Innovation Accounting focuses on managing the following three innovation activities:
1. Making investment decisions on different offerings at different points in their innovation journey.
2. Tracking and measuring the success of specific innovation projects.
3. Assessing the impact that innovation is having on the business as a whole.
When you search for Innovation Accounting, you will notice that many frameworks and templates have already been developed to facilitate metrics for each of these activities. I would advise against just jumping in and start using templates for metrics. You first need to understand the concepts and how it applies to your organisation’s unique environment and the specific innovation project.
In my view, it is all about choosing practical metrics. The metrics that really matter, vary from business to business, and between innovation accounting systems. Remember, innovation results are difficult to predict because of the “unknowns.”
Hence, Innovation Accounting is designed to work with the Lean Startup method, which is aimed at investigating, experimenting, testing, and iterating when innovating, to minimize the unknowns. With Innovation Accounting, the purpose is, therefore, to focus on non-financial metrics such as social media reactions, web traffic, and customer behavior analysis to track and validate the market progress of new products, processes, and business model innovations.
These metrics will give you an indication whether your assumptions and hypothesis for the “unknowns” are true or false and guide you to take the next decision, i.e., investing further in the innovation, taking a new direction (with new assumptions and hypotheses), or dropping the project entirely.
I hope you agree that this might be a much better method than “inflating” numbers and hoping for the best, and that your assumptions turn out right!
Lastly, I want to advise that you better make ready for a big fight if you are going to challenge traditional accounting practices, I would guess almost similar to the one Galileo had when he challenged the belief that the sun revolves around the earth. So you better make sure you have a proper understanding of Innovation Accounting and have some rock-solid arguments in your arsenal.
In the next delivery, I will elaborate on drawing up hypotheses and running experiments, the best way to minimize the risk of “unknowns” in innovation.
On the topic of measuring things, I conclude with a quote from Donald Sutherland: “One measurement is worth a thousand expert opinions.”
Click on the thumbnail below to order Dr Grobler’s e-book on Innovation from Amazon.