Lean Startup Co. - The ROI of Innovation...

© 2017 Lean Startup Co., LLC. All rights reserved.

Dave BinettiDave@leanstartup.co

Hugh MolotsiHugh@leanstartup.co

11.1.2017

© 2017 Dinadesa LLC

The ROI of Innovation

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

— Mark Twain

Finance Raises

Discount Rate for Risky

Projections

Product Increases Risky Projections to Get Positive

NPV

Finance Raises Discount Rate

for Risky Projections

Product Increases Risky Projections to Get Positive

NPVNPV Death Spiral

NPV Death Spiral

So… No ROI?

The Company’s Money

You

The Accounting is the Problem

-50000

-25000

0

25000

50000

75000

100000

Start Dev Launch Growth Maturity Decline ...EOL

Growth Profit

Grow ProfitInnovate

Grow ProfitInnovate

Profitability Stability Efficiency

Grow ProfitInnovate

Growth Revenue Market Share

Grow ProfitInnovate

Grow ProfitInnovate

Costs

Extra Credit: What do we do with costs

in a large organization?

We Need Innovation Accounting

“Innovation Accounting is a way of evaluating progress when all the metrics typically used… are effectively zero.”

— Eric Ries

Grow ProfitInnovate

Costs

Grow ProfitInnovate

Optionality

On Innovation

Innovation is Not Homogenous Continuous (sustaining) is high certainty Discontinuous (disruptive) is low certainty.

The Test is Certainty

Innovate Grow Profit

Build Grow Profit

Kno

w

Innovate Grow Profit

Build Grow Profit

Grow Profit

Kno

wAs

sum

e

Innovate Grow Profit

Build Grow Profit

Grow Profit

Kno

wAs

sum

e

Innovate Grow Profit

Build Grow Profit

Grow Profit

Kno

wAs

sum

e

Innovate Grow Profit

Grow Profit

Grow Profit

Kno

wAs

sum

e

Innovate Grow Profit

Grow Profit

Grow Profit

Kno

wAs

sum

e

Cer

tain

ty

Time

Growth

Profit

Low

High

Innovate Grow Profit

Grow Profit

Grow Profit

Exec

ute

Expl

ore

Profit: High Certainty Both Growth and Profit Pure Execution

Innovate Grow Profit

Grow Profit

Grow Profit

Grow: High Certainty Growth, Low Certainty Profit Mix of Execution and Exploration

Exec

ute

Expl

ore

Innovate Grow Profit

Grow Profit

Grow Profit

Innovate: Low Certainty Both Growth and Profit Pure Exploration

Exec

ute

Expl

ore

Innovate Grow Profit

Grow Profit

Grow Profit

Exec

ute

Expl

ore

Traditional, Linear

Lean, Iterative

Certainty

Applicability

High certainty: Traditional accounting Low certainty: Innovation accounting

Grow ProfitInnovate

Grow ProfitInnovate

Grow ProfitInnovate

Transition Before Growth Stalls

Grow ProfitInnovate

Transition after Growth Known

Grow ProfitInnovate

Grow ProfitInnovate

ProfitInnovate == Grow

NPV Fails Under Uncertainty

Static and Inflexible Requires Large Up-Front Investment Encourages Obfuscation Slows Decision Making

Metered Funding

Metered Funding Implies that Value Comes from the Ability to Choose

Traditional Accounting Values Assumptions Innovation Accounting Values Knowledge Knowledge Informs the Choice

Innovation Options

Innovation Options

Measure value of optionality, not cost. Precede the main investment. Provide a positive ROI without the NPV Death Spiral. Based on well-known option pricing models.

Metered Funding

Metered Funding

Grow ProfitInnovate

Grow ProfitInnovate

MVPPre-MVP

Build

MVP

Impl

emen

t

Ideation

Gro

wth

Innovation

MVPPre-MVP

Does this idea fit strategically?

Does this idea warrant Growth?

Impl

emen

t

Ideation

Does this idea warrant an MVP?

Judge Fit

Value Proposition, Business Model Canvas, CAC/LTV Targets

Duration in Days

Investment in Hundreds

MVP

Build

MVP

Ideation

Gro

wth

Judge Conversion

Acquisition, Activation

Problem/Solution Fit

AdWords, Kickstarter, LOI, MOU, Pre-Orders

Duration in Weeks

Investment in Thousands

Pre-MVP

Does this idea warrant an MVP?

Pre-MVPIdeation

Gro

wth

Innovation

Judge Growth

Retention, Referral

Product/Market Fit

Build/Measure/Learn, Split Testing, CustDev

Duration in Months

Investment in Tens of Thousands

MVP

Does this idea warrant Growth?

Ideation Pre-MVP MVP

Goal Strategy Fit Problem/Solution Fit Product/Market Fit

Metrics Quantity Conversions Growth

Tactics Meetings Kickstarter, AdWords, LOI, MOU, Pre-Orders

BML Loop, A/B Testing, Customer Development

t Days Weeks Months

$Ks .1 - 1 1 - 10 10 - 100

Innovation Option Application

Simple and Discrete Metrics and Goals Clear and Articulated Built-In Expiration Clear Covenants for Both Product and Finance

Enables Corporate Governance

Who Processes the Applications? Growth Boards

Growth Boards

Accountability Clearinghouse Funding Decisions

Corporate Governance

Ideation DashboardWeek 1 2 3 4Starting Cash $ 1000 $ 750 $ 500 $ 250

Net Cash Flow $ (250) $ (250) $ (250) $ (250)

Ending Cash $ 750 $ 500 $ 250 $ 0

Ideas Processed

5 5 5 5

Pre-MVP DashboardWeek 1 2 3 4Starting Cash $ 5000 $ 4800 $ 4000 $ 2500

Net Cash Flow $ (200) $ (800) $ (1500) $ (2500)

Ending Cash $ 4800 $ 4000 $ 2500 $ 0

Conversions 0 5 5 90

MVP DashboardMonth 1 2 3 4Starting Cash $ 20000 $ 15000 $ 10000 $ 5000

Net Cash Flow $ (5000) $ (5000) $ (5000) $ (5000)

Ending Cash $ 15000 $ 10000 $ 5000 $ 0

Conversions 200 400 700 1200

Retention 0.8 0.8 0.8 0.8

Assumption 4 8 10 12 13 13

Users are interested in learning more about their insurance benefits

Users are willing to enter in their phone information to receive a call from a

representative

Users will answer that call and engage with the representative on their benefit

profile

Users will convert and begin accepting the new insurance benefits

Users will continue their benefits past the initial one-month trial period.

Week

Assumption 4 8 10 12 13 13

Users are interested in learning more about their insurance benefits

Users are willing to enter in their phone information to receive a call from a

representative

Users will answer that call and engage with the representative on their benefit

profile

Users will convert and begin accepting the new insurance benefits

Users will continue their benefits past the initial one-month trial period.

Measure ThisWeek

Assumption 4 8 10 12 13 13

Users are interested in learning more about their insurance benefits

Users are willing to enter in their phone information to receive a call from a

representative

Users will answer that call and engage with the representative on their benefit

profile

Users will convert and begin accepting the new insurance benefits

Users will continue their benefits past the initial one-month trial period.

Measure This

And This

Week

Assumption 4 8 10 12 13 13

Users are interested in learning more about their insurance benefits

Users are willing to enter in their phone information to receive a call from a

representative

Users will answer that call and engage with the representative on their benefit

profile

Users will convert and begin accepting the new insurance benefits

Users will continue their benefits past the initial one-month trial period.

Measure This

And This

NOT This

MVPPre-MVP

Build

MVP

Impl

emen

t

Ideation

Gro

wth

Innovation

- +

+ False Positive (Type I Error) True Positive

- True Negative False Negative (Type II Error)

Pred

icte

d

ActualDiagnostic

GO was Wrong GO was Right

GO Failure Success

NO-GO

Opportunity Benefit

OpportunityCost

Assu

mpt

ion

KnowledgeIdea

Accurate bad news is infinitely superior to inaccurate good news.

Summary

NPV Death Spiral Three Phase Product Lifecycle Types of Innovation Metered Funding/Options Innovation Stages/Applications Growth Boards/Governance

ThankYou!

Dave BinettiDave@leanstartup.co

Hugh MolotsiHugh@leanstartup.co

leanstartup.co/educationeducation@leanstartup.co

© 2017 Lean Startup Co., LLC. All rights reserved.

Backup

iCAC / iLTV Dashboard

What are we testing?

Growth Assumptions (CAC) Profit Assumptions (LTV)

Grow ProfitInnovate

Innovate Grow Profit

Grow Profit

Grow Profit

Kno

wAs

sum

e

CAC LTV

Innovate Grow Profit

CAC LTV

iCAC iLTV

Kno

wAs

sum

e

iCAC

Total Cost of Acquisition Acquisition: Units of Value Total Cost: Cash

Acquisition

Units of Value Single-Sided market: Whoever Pays Multi-Sided market: Reason Money is Paid

Cost

Total Cost (Fixed + Marginal) In the Long-Run, all Costs are Marginal Simpler, Unambiguous

Cash Only Nothing Else Matters

iCAC

Concrete Number Should go Down with Time

(Will go down precipitously if you are riding the hockey stick) Normalized Measure of Progress

iLTV

Always an Estimate Composed of Two Parts: Current Value Future Opportunity

WOM/PROM

Implications

Non-linear growth can only come from WOM PROM shifts the curve, it doesn’t change its shape.

(Meaning: better marketing doesn’t fix crappy growth; it only makes crappy growth come sooner.)

Technology Adoption Lifecycle

Rodgers

Innovators Will try new because it’s new

Early Adopters Will try new if it solves a problem

Early Majority Will try new only if other people are using.

Implications

First 16% only need PROM. Early Majority need WOM. If Innovators and Early Adopters churn out, you have the Chasm. WOM is driven by your product

MVP Threshold

The WOM/PROM ratio Need to Get this Above 1.0 Don’t Fund Until You See It

Innovation Options

Innovation Options

Measure value of optionality, not cost. Precede the main investment. Provide a positive ROI without the NPV Death Spiral. Based on well-known option pricing models.

Trinomial Pricing Model (Boyle, 1986)

$5M

$5M

$100M

$5M

$100M

$0M

$5M

$100M

$0M

$5M

$5M

$100M

$0M

$5M

$35M

$2M

$5M

$100M

$0M

$5M

$35M

$2M

$65M

$15M

$4M

$1M

$5M

$100M

$0M

$5M

$35M

$2M

$65M

$15M

$4M

$1M

$5M

$100M

$0M

$5M

$35M

$2M

$65M

$15M

$4M

$1M

$5M

$100M

$0M

$5M

$35M

$2M

$65M

$15M

$4M

$1M

Run the Numbers

$5M

$5M

Proposed: $5M

$5M

$100M

$0M

Proposed: $5M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

Terms: 4 Iterations/Year

$5M

$100M

$0M

Proposed: $5M

Range: $0 - $100M

Terms: 4 Iterations/Year

$2M

The Math

+

+

<— Current Option Value

Value Adjusts as You Iterate

Exercise

Expire

Pivot

The Difference

NPV: Deliver

OPV: Determine