Q&A

Q&A: Innovation investment

We’re introducing a new Q&A feature as a way to let members ask questions anonymously and get useful answers from other members. If you’ve got a question, just drop us an e-mail, and let us know if you’d like an answer from a company of a particular size or industry (or even from a specific person or company.) The question below was answered by Innosight partner Pontus Siren. We thank our longstanding partner and supporter Innosight for their assistance pulling this together, and we invite your comments at the bottom…

Question:
We’re a $17 billion public company with lots of research and data around R&D, but I wouldn’t say it’s translating well to our corporate innovation and growth strategy. We have a bit of a gap there. I know this is complex, and every enterprise is different, but any thoughts or guidance or framework on the matter would be much appreciated.

Answer:
siren-pontus
“Is there a formula that companies typically employ regarding innovation investment?”

This is a question we hear all the time, but the member of Innovation Leader who posed the question above is even more specific.

If you don’t know where you are going, any road will take you there. The famous quote by British author Lewis Carroll elegantly summarizes the dilemma any large company faces when it thinks about how much to invest in innovation efforts, especially those that move beyond its core business.

While there’s no real formula for calculating innovation spend, it’s common to look at R&D expenditures to see what peers and industry leaders are investing. The problem is that these figures are difficult to extrapolate from. For example, IBM spends 6% of its revenue on R&D, Johnson & Johnson spends 11.5%, while Intel is at 20%.

But as the subscriber points out, each company faces a unique set of circumstances—different stage of their product lifecycles, how resource or capital intensive the business is, emerging disruptive forces, and so on—that will influence the amount and types of innovation they need to pursue. And R&D and innovation aren’t really synonymous because some of the most critical innovation investments happen in the marketplace rather than the lab.

So while there isn’t really a formula, I offer a few (non-exhaustive) rules of thumb for determining the right amount of innovation spend for your company:

  • The first and most important consideration is to understand your growth gap. This is the difference between your growth goals over a certain period of time and what your current operations and core innovations will be able to generate. We show a simple way to calculate your growth gap below.
  • But to make the calculation, you’ll need to define the types of innovations you want to pursue. Most companies should be pursuing at least two or more types of innovation, which will have time horizons over different time periods and different resource requirements. Disruptive or new-to-the-world innovations often take years and should be considered staged investments. Meanwhile, sustaining innovations, which are incremental improvements to your core offering, are most likely to pay off in the nearer term but are less likely to fill in big holes in your growth gap.
  • How robust is your innovation capability? If you are just getting started, it’s better to ramp up modestly without massive investments. Establishing the building blocks of innovation and generate quick wins and insights is the objective of launching a “minimum viable innovation system,” which my colleagues and I describe in our recent Harvard Business Review article.
  • More is not necessarily better, and how the funds are distributed is often more important than the absolute amount. Innovation investments should be stage-gated and should follow the best VC funding practices.
Calculating your Growth Gap

With those rules of thumb in mind, here’s how to calculate how much of a gap you need to fill:

  1. Start by setting the growth target you wish to achieve at a specific year in the future—for instance, 2025. The target could be any number of metrics — revenues, profits, total return to shareholders.
  2. Estimate how much annual revenue your current core business will generate by that time from its current offerings and improvements to them. This must be done honestly, taking in the full range of competitive forces that could, for instance, erode market share or compress margins.
  3. Project the revenue your investments in on-going new growth businesses could generate by that time.
  4. Add up the figures from lines two and three, and compare with the figures from line one.
  5. The difference is your growth gap.

Once you reach a consensus on your growth gap, you’ll see how much you need to change. The more your growth opportunities need to stretch beyond your current capabilities, the more you need to build systems to manage the unique nature of these opportunities.  Your spending on those systems, capabilities and resources determines your ongoing innovation investment.

So the overall goal here is insight not precision. You just want the right order of magnitude. That leads to one final word of advice: don’t spend too much time defining your growth gap. In many cases, a month is enough to get a useful answer that can inform all your important activities related to creating a strategic vision for innovation and growth. Then it’s time to dive in and actually do it.

 

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