Innovation and Performance measurement Dr. Ashish Garg 9 January, 2009

Innovation and Performance measurement

Dr. Ashish Garg

9 January, 2009

Page 2

Background – Ashish Garg (Thumbnail Sketch)

► Education: Ph.D in Economics from Harvard University (1997); taught graduate and undergraduate classes

► 7 years with E&Y. Total of 11 years as a management consultant

► Before E&Y was at McKinsey Inc. (led “R&D” type group on Strategy and Economics)

► Executive Director at E&Y since July 2008

► Focus on Performance Management, Performance Measurement, Cost management , Finance Transformation etc

► Author of 50 article on Management accounting, Cost management, Performance management

Page 3

EY Perspective

Agenda

► Importance of Innovation

► Managing Innovation

► Role of the CFO in encouraging Innovation

► Performance Measurement and Innovation Metrics

► Suggestions on Reasearch Agenda

Innovation and Performance Management

Practitioner Perspective

Suggestions for Research

Page 4

EY Study: Balance Point (Innovation) Study Participants

Interviews

Page 5

Senior executives from a variety of backgrounds participated in a global online survey regarding investment in innovation

Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)

74

40

11

14

7

6

0 20 40 60 80

<$100M

$100M-$499M

$500M-$999M

$1B-$4.9B

$5B-$9.9B

>$10BIT Services

29

Communications

Equipment

21

Semiconductors

15Computer

Hardware

12

Software

71

Other or not

specified

4

Europe70

North America

75

Latin America

4

Asia Pacific 3

12

4

5

9

15

20

24

63

0 10 20 30 40 50 60 70

Other

Controller

COO

General Mgr/Bus. Unit Ldr.

CTO

Sr VP or VP

CEO/President

CFO/Mng. Dir. of Finance

Survey Respondent Titles(Number of Responses)

Industry Sector(Number of Responses)

Size—Annual Revenues(Number of Responses)

Geographic Location(Number of Responses)

Page 6

► Importance of Innovation: Executives confirm innovation remains critical

► Managing Innovation: Companies struggle to manage investments

► Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process

► Performance Measurement and Innovation Metrics : Helps focus on drivers of success

► Research Agenda

EY Study : Balance PointBringing Discipline to Investment in Innovation and Growth

Source: Ernst & Young analysis and executive interviews

“If we don’t find a good way to address innovation and make use of innovation,

then we will immediately fall behind in the competitive race.”

Page 7

Executives concur that future success depends upon effective product and service innovation

“Innovation is our number one priority as a company.”

“The core of what we do and the core of how we generate growth always boils

down to big innovations.”

“Innovation is always important. Always.”

“Innovation is, of course the name of the game in our industry.”

“Markets of the future will be developed by the skilled innovators of today who commit the right balance of internal and external resources to the innovation process.”

—Henry Chesbrough

12%

19%

20%

22%

36%

47%

66%

78%

Access to capital

Marketing and brand investments

Entry into new geographic markets

Attracting and retaining talent

M&A, strategic alliances, and/or jointventures

Cost and process efficiency

Customer service and satisfaction

Product and service innovation

In your opinion, what will be the top three drivers of your company’s success over the next two years?

Percent of Responses

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

Page 8

Large and small companies have somewhat differing views on the relative importance of innovation, but there is general agreement that it is an essential process

7%

7%

7%

33%

30%

52%

89%

74%

13%

22%

22%

20%

37%

46%

61%

78%

Access to capital

Marketing and brand investments

Entry into new geographic markets

Attracting and retaining talent

M&A, strategic alliances, and/or jointventures

Cost and process efficiency

Customer service and satisfaction

Product and service innovation

<$1B inannual sales

>$1B inannual sales

In your opinion, what will be the top three drivers of your company’s success over the next two years?


0%

4%

7%

33%

56%

2%

7%

13%

29%

49%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

Strongly Agree

<$1B inannual sales

>$1B inannual sales


Technology innovation is more important than ever in driving my company’s success

Large companies rate customer service higher than innovation, while smaller companies rank innovation as the top priority

However, almost 90 percent of surveyed large companies indicate that innovation is more important than ever in driving success

“It’s much easier to innovate as a small company because you’re creating your own religion.”

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

Page 9

R&D intensity has exhibited considerable volatility within segments of the technology sector over the past five years

Note: R&D Spending (Percent of Sales) analysis was performed on a pool of 36 companies in five sectors. The minimum representation in a sector was five companies.Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1999–2004, via FactSet 10.10M, accessed 9 February 2004

“In the past, we and most of our competitors would move R&D spending with revenue. The result was

choppiness in the product coming out, and your

products tended to come out about the same time

as your competitors’ because you were all

doing the same thing.”

0%

5%

10%

15%

20%

1999 2000 2001 2002 2003 2004

R&D Intensity by Sector1999-2004

CommunicationsEquipment

Computers

Conglomerates

Semiconductors

Software

Sector Averages

R&

D S

pen

din

g a

s a

Per

cen

t o

f S

ales

Page 10

Survey participants are committing substantial resources to theirR&D activity

7%

11% 11%

16% 16%

14%

9%

11%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

<1% 1-3% 4-6% 7-10% 11-15% 16-20% 21-25% >25%

Surveyed Annual R&D Spending Intensity R&D spending measurements do not include additional sources of innovation, including:

Half of survey respondents are spending more than 10 percent of their revenue on R&D spending

M&A activity

Joint ventures and partnerships

Externally sourced innovation and licensing fees recorded as cost of sales

Product development expenses not listed as R&D

R&D Spending(Percent of Sales)

50%

Per

cen

t o

f R

esp

on

ses

“R&D spending must be smarter, not just increased. Firms must leverage the R&D investments of others, in addition to their own.”

—Henry Chesbrough

Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

Page 11

The communications, media, and entertainment industries provide an example of how new technology waves are coming more rapidly

“Suddenly, the rate of change has definitely increased. I see different changes and innovation paths all the time; their frequency has exponentially grown.”

Source: Ernst & Young analysis; “Statistical Abstract of the United States,” U.S. Census Bureau, various years; “Historical Statistics of the United States, Colonial Times to 1970, Doc 93-78, 1920-1970,” U.S. Census Bureau; “Falling Through the Net II: New Data on the Digital Divide,” National Telecommunications and Information Administration, 28 July 1998; “Communications Industry Forecast & Report,” Veronis Suhler, July 2003; “Worldwide and U.S. DVR 2004-2008 Forecast,” IDC, March 2004; “Media Trends Track,” http://www.tvb.org/rcentral/mediatrendstrack/tv/tv.asp?c=cable (citing Nielsen Media Research); “Media Trends,” Kagan, 2004; “Consumer Devices and Services Europe,” Forrester Research Inc., October 2003

0%

25%

50%

75%

100%

1920 1926 1932 1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004

U.S. Adoption Rate of Selected Technologies1920-2004

Internet

Digital video recorders

Radio

Broadband

VHS

Television

Wireless phones

DVD player

Cable TV + DBS

Years to achieve 50 percent

69

9

na

10

6

16

35

naPer

cen

t o

f H

ou

seh

old

s o

r P

op

ula

tio

n i

n Y

ear

Note: Adoption rates are all percent of U.S. households with selected technology, except Wireless phone, which is percent of U.S. population; Years to achieve 50 percent is number of years needed to reach 50 percent adoption, beginning when technology was adopted by at least 1 percent of U.S. households or population

Page 12

Technology companies are striving to align investments closely with customer needs, while also balancing the requirements of other key stakeholders

2%

5%

7%

20%

66%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company’s technology innovation investment decisions are aligned closely with

the needs of our customers


Surveyed companies believe they are closely aligned with their customers ... ... but it is important to remember that customers

are only one (albeit important) component of the entire value chain

“If you think only about the end-user and not about the value chain along the way, you might have the

best product in the world, but it might never make it to market.”

“To get ideas, you ensure that your engineers spend time out with customers, or in our case, our

customer’s customers.”

“When we talk about customers and being customer-focused, we usually mean the companies that we are selling our technology to. But our role with respect to innovation management is to make

sure that we get to the end-user.”

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)

Page 13

Financial analysis indicates a positive relationship between R&D intensity and profitability, with some outliers

Note: Each plotted point represents a sectoral view of profitability for one of five technology industries (computers, semiconductors, communications equipment, software, and conglomerates). Observed EBITDA margin is lagged two years (e.g., 2001 R&D intensity is compared to 2003 EBITDA margin). The R2 of the trend line is 0.40.

0%

10%

20%

30%

40%

50%

0% 5% 10% 15% 20%R&D as a Percent of Revenue

(1998-2002)

R&D Intensity versus EBITDA Margin

R&D intensity (measured as a percent of revenue) appears to be correlated with lagged EBITDA margins

“You don’t invest today for revenue tomorrow. You invest

today for revenue that’s probably quite a few years out.”

“The bill for innovation is getting steeper. I’m getting more anxious about it, and I can’t tell for several

quarters whether I’m doing anything right. We’re going to

have to wait for a long time to find out.”

EB

ITD

A M

arg

in,

Tw

o-y

ear

Lag

to

R&

D S

pen

din

g

(200

0-20

04)

Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1998–2004, via FactSet 10.10M, accessed February 2005

Page 14




► Performance Measurement and Innovation Metrics :Helps focus on drivers of success

► Research agenda

“I don’t know that we have any best practices for managing innovation. It

frustrates me a great deal.”


EY Study: Balance Point Bringing Discipline to Investment in Innovation

Page 15

Many companies see room for improvement in their ability to manage investment in technology innovation

2%

7%

44%

40%

7%

Not meeting ourneeds—need to rethink

Below Average

Average

Above Average

Superior

Grade your company’s current ability to manage its investment in technology innovation


2%

9%

13%

43%

32%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company uses disciplined processes to manage investment in innovation


Approximately 75 percent of surveyed companies indicate they have disciplined processes in place to manage innovation ...

... yet less than half indicate their ability to manage technology innovation investment is above average

“We have an integrated risk and opportunity management system.”

“We don’t have control of our R&D projects yet.”


Page 16

Technology innovation management is an issue for both small and large companies

0%

15%

11%

41%

33%

2%

8%

14%

44%

32%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

<$1B

>$1B


My company uses disciplined processes to manage investment in innovation

7%

0%

37%

48%

7%

1%

9%

46%

38%

6%

Not meeting ourneeds—need to rethink

Below Average

Average

Above Average

Superior

<$1B

>$1B


Grade your company’s current ability to manage its investment in technology innovation

Small and large companies report similar levels of innovation process discipline

Larger companies are somewhat more confident in their management abilities, but over 40 percent still indicate they are average or below average

Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

Page 17

There is significant frustration over a general lack of ‘best practices’ with respect to managing innovation investments


“I don’t know that we have any best practices for managing innovation. It

frustrates me a great deal.”

“The go-to-market side is usually forgotten in this industry.”

“We are not good at the marketing and selling of innovations, so 80 percent of the

patents that are filed never become a product that you’ll see in the market.”

“We hide behind the claim that it’s impractical to come up with a process, or even a collection of processes to manage

innovation investment effectively. It seems that the judgment of the wise man is just

as good as any kind of processes you come up with.”

“The hardest thing to do is to figure out return on R&D investment.”

“It’s hard to make improvements in managing innovation because there’s an

old culture right now that sort of works, so people ask, ‘Why would I change this?’”

Many companies report a lack of discipline in their end-to-end control of the innovation process ...

... but there is no clear vision of how to improve control

The frustration over managing innovation investment creates an opportunity for a CFO to participate in the process in new ways

Page 18

Managing innovation is a challenge when failure is a common—and necessary—outcome


“The biggest problem with internal company innovation is the lack of tolerance for failure. I don’t think

corporations are well set up for people to fail at enterprises.”

“We have 60 percent failures. If you measure yourself by the number of failures

instead of return, you’d feel terrible.”

“Going into new areas, you have to start with ten initiatives to have one that’s really

successful.”

“These are big bets that we’re talking about. And we know they won’t all pay, and that’s OK—they’re allowed to fail.”

“Companies that are more sophisticated understand what control can do on the

negative side.”

“If it were up to me, I would introduce different mechanisms for managing my mature businesses and my

new initiatives.”

Measurement must reflect the need for a certain amount of failure, especially when pursuing breakthroughs

Not all innovation should be managed the same way—or innovation can be stifled

If a company is not failing at some of their innovation investments, they may not be spending enough on innovation

Page 19

Mergers and acquisitions are increasingly a part of technology companies’ innovation strategies

Companies are buying innovation in addition to developing it in-house ...

“It used to be that technology companies did not look to acquisitions as a way of growing their portfolio.

Now I think it’s an accepted strategic principle.”

“Spin-in is another way of innovating, giving the financial motivation to the individuals in the spin-in.”

... but successful integration is the key challenge to merger success. “You’re going to have to learn how to integrate. Adding an acquisition is almost like dealing with high growth.”

“You have to be humble when you’re an acquirer. Just because you happen to be fortunate enough to have the money to buy them, the fact of the matter is you

didn’t buy them from a position of strength [but] because you couldn’t develop the capability

internally.”

12%

14%

30%

24%

5%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company excels at integrating merger and acquisition deals to achieve planned benefits


Less than one-third of surveyed companies agreed that they excel at integrating M&A deals


Page 20

Effective risk assessment is a key part of the investment decision process

Understanding and communicating risks is critical to success ...

“People at the project levels think their project is the most important. You want them to be that way and have that

kind of passion. But they don’t always realize the damage that their lack of success may have on the company, or

the risk the company is taking on their behalf.”

“Good innovation management processes may not guarantee the best possible outcome, but they can maybe minimize the risk of the worst possible outcome. You can

narrow the range of probability of disaster a bit.”

... but risk analysis must go beyond the financials“It’s not just the financial return, it’s also the

technology risk, the marketing risk.”

“There are companies that partition innovation risks, so they split up risk into market risk, or execution risk, or knowledge risk, and then assign people to assess and

manage those risks. For example, the people that execute are most capable of talking about

and quantifying execution risk.”

8%

20%

19%

38%

11%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company uses project-specific risk analysis to evaluate each technology innovation

investment opportunity


Less than half of surveyed companies agreed that they used project-specific risk analysis to evaluate investment opportunities ...

“To me, if you look across the American economy, there are only two segments of the economy that probably are truly good at managing risk—the insurance industry and the financial and banking industry.”


Page 21

Companies seem to be focused on processes to ensure that they are fully compensated for their investments in technology innovation

6%

14%

17%

32%

29%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company has operational and legal processes in place that ensure we are fully compensated for

our technology innovation investments


Licensing is an important revenue stream …

“One way to manage non-core innovation is to say, ‘It would cost too much to incubate, so let’s license out this technology to anybody, even competitors,

who might have an interest.’”

… and the choice of business model is critical … “The linkage between innovation and technology is

the business model.”

“We need different business models to take on different markets.”

… to capture the most value from innovation“We have a comprehensive set of techniques to try

to create value out of the whole portfolio.”

“We are able to translate innovation into bottom-line results, and this, for me as a CFO, is the key target.”

Effective operational and assurance processes are needed to ensure that companies are not ‘leaving money on the table’


Page 22

Leading edge Analytical tools and techniques to make better decisions are not used to manage innovation

16%

31%

22%

22%

9%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company uses leading analytical tools to help make and track technology innovation

investment decisions


“Most companies track the money they spend, and some track the time they spend, but few are tracking the risk they incur. Leading companies deploy analytical tools and control processes that address all three.”

—Henry Chesbrough

Companies see the need to enhance ‘gut feel’ decision-making ...

“In the end, somebody needs to sign on the dotted line, and it comes down to a ‘gut feel’ whether to move forward or not. But you are enriching your ‘gut feel’ by exposing it to various scenarios and various analytical

techniques. You are looking at the picture in a multi-faceted way, and hopefully you make a better choice.”

... and look to Finance for help“You need the fundamental tools—transparent

numbers—so that somebody can sit down and assess the risk equation.”

47%

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

Page 23

Companies that utilize leading analytical tools are also likely to have good processes to monitor their investment results

The use of leading analytical tools is highly correlated with a company’s ability to effectively monitor investment performance, as survey respondents answered these two questions similarly

“When you depend on individual visionaries for innovation decision-

making, you have the chance of hitting it big. But even a simple process like

collecting the best opinions of the people in the various fields and making

a rational, analytical kind of assessment would help—but we do not

practice that.”

“Thirty years in Finance has taught me to halve the projected return

and double the projected cost to estimate the return of a project.”

My company’s technology innovation investment results are monitored closely against the original decision analysis,

and any variances are understood

My company uses leading analytical tools to help make and track technology innovation investment decisions

16%

31%

22%

22%

9%

8%

29%

25%

23%

14%

Strongly Disagree

SomewhatDisagree

Neutral

Somewhat Agree

Strongly Agree

“Financial discipline does not have to stifle innovation. Done well, it will drive it.”

—Henry Chesbrough

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

Page 24

Many companies do identify underperforming investments and taking action quickly

6%

18%

20%

36%

18%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

My company is able to identify and reduce funding quickly for underperforming innovation investments


Innovation portfolio reviews are critical to success ...

“The sifting process, the narrowing of the competing technologies, has to occur more

quickly.”

... but organizational inertia can prevent tough calls ...“It’s very challenging to cut projects because there are competing groups—sales wants what customers want,

engineers are focused on technology, and the CEO and marketing are in between.”

... so fact-based decision processes are key“Sometimes you have to be the enforcer and

encourage people to put an end to something that isn’t working by saying, ‘Look, I’m not going to invest any

more money—it’s going down a black hole. It doesn’t matter how enthusiastic you are, you don’t have a

business case.’”

“There’s a real focus on what milestones are going to be accomplished on what amount of money—and the

penalty for failure is terminal.”

“There should be a healthy yin and yang between the CEO and the CFO, where the CFO can close the office door and say, ‘We’ve got to

have a talk about this because this particular piece of the business isn’t going to work.’”


Page 25





► Research Agenda

“The CFO needs to be a business partner, not just a financial person.”

EY Study: Balance Point Bringing Discipline to Investment in Innovation


Page 26

The CFO and Finance organization are becoming increasingly involved in the technology innovation investment process

3%

10%

12%

40%

34%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

Over the past two years, the CFO and Finance organization have become more involved in the

technology innovation investment process


7%

20%

19%

32%

21%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

StronglyAgree

The roles of the CFO and Finance organization in technology innovation investment decisions

are clearly defined


Survey respondents clearly indicate the growing involvement of Finance in investment decisions ...

... however, the role of Finance in these decisions is less clear

“Finance should educate us technical people better about what finance does. Most engineers will think it’s just adding up numbers, and if you want to correct that simplistic view, then educate

them. Otherwise, it’s just the finance guy saying, ‘We cut the plan this quarter because we’re not going to make as much money, so you can’t spend what you were planning.’”

53%74%


Page 27

The CFO often adds value to the innovation investment process, but there is room for improvement

Technology personnel are looking for a broader level of involvement from Finance ...

“A lot of the time companies are flying by the seat of their pants. The CFO is cutting checks, but it’s not

clear that they’re adding the kind of value they could.”

“The only thing Finance tells us is, ‘We can negotiate costs down,’ and that’s a good thing, but that doesn’t

make the decision any better. It could still be a terrible loss, or it could be brilliant.”

“Before, Finance was more like bean counters—but now that has changed completely.”

... and for Finance to play the key intermediary role“In the future, the role of the Finance organization is to

fit between the product, the support, and the field organization, and aggregate the three points-of-view

into a company point-of-view—more financial modeling and advice than financial control.”

“The finance person should be the one who really facilitates, monitors, and coaches

the management team.”

“Finance is a good sounding board because they’re totally neutral on technology—they’re not grinding an axe one way or another.”

7%

13%

33%

47%

0%

2%

11%

17%

49%

21%

StronglyDisagree

SomewhatDisagree

Neutral

SomewhatAgree

Strongly Agree

CFO

CTO

The CFO and Finance organization add significant value to the management of innovation investments


CTOs rate Finance’s contribution lower than CFOs do

Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005

Page 28

CFOs can bring specific analytical tools to bear on the task of managing innovation

“The CFOs participation should be about bringing the right tools to the table.”

ANALYTICAL TOOLS FOR MANAGING INNOVATION

► Game theory

► Enterprise planning models

► Simulation models

► Sensitivity analysis

► Risk portfolio analysis

To test how competitors, customers, suppliers, and other stakeholders might respond to an innovation, and the corresponding impacts to the innovator

To provide an integrated view across all dimensions of the company (product, geography, business unit) that can test the impacts of innovation investments successes and failures on the financial performance and valuation of the innovator

To test the probable outcomes of innovation investments

To test the potential upsides and downsides of innovation investments, and help develop an innovation portfolio with relatively greater upside potential and reduced risk

To apply portfolio theory to the balancing of the risks and returns of innovation investments

To utilize consistent evaluation criteria and to track investment performance against planned results and gates

► Business case evaluation templates and performance tracking

Page 29

Finding the ‘Balance Point’ across multiple innovation investment processes is the key challenge for technology executives

Opportunity

Innovation Creativity

“It's not a ‘Let’s see what happens’ bet, it’s a ‘Let’s bet the farm’ bet.”

“You need the fundamental tools—transparent numbers—so that somebody can sit down and

assess the risk equation.”

“You want to be in control of your own destiny as much as possible.”

“It’s not just the financial return, it’s also the technology risk, the marketing risk.”

“Engineers are really focused on delivering the next degree of functionality just for the beauty of delivering it.”

“I think that the CFO’s participation should be about bringing the right tools to the table to

assess the financial aspects of innovation investment.”

“You need to make milestone reviews as objective and as measurable as you can.”

“The hardest thing to do is figure out return on R&D investment.”

Short-term Return

“They want their money tomorrow.” “I can do whatever you want next quarter, but you won’t like the answer a year from now.”

“We have an environment these days where innovation is almost being replaced by hectic last-minute improvements.”

“An innovation might be a little revenue in three years, but the revenue tail could grow

exponentially, not linearly.”

Long-term Investmentand

Riskand

Financial Disciplineand


Page 30





► Research agenda

Practioners Perspective


“Provides a tactical understanding of organization’s value drivers”

Page 31

Measurement of Innovation remains a challenge for Organizations

The kinds of innovation companies take up are diverse. Yet no matter what form of innovation they pursue, far fewer companies measure it than pursue it.

Sources: McKinsey Global Survey Results – Assessing innovation metrics

Page 32

Value of Metrics within Business Performance Management

Re-Align

►Locks measures into strategy and value

►Helps define management dialogue upwards and management focus.

►Forms the basis for performance evaluation

►Helps to set expectations for reporting and planning level of detail

►Incent the desired behavior

Page 33

Within the organization, metrics are both used to focus the dialogue upward and provide management oversight downward

1. Management Dialogue – Metrics serve to focus discussion of business results with upper management / the investment community

“The Street”

Corporate

BUs

Geographies

Dual Metric Roles

Functions

Managementfocus

Management dialogue

Management dialogue

Managementfocus

Management dialogue

Managementfocus

Management dialogue

2. Management Focus - Metrics should focus on critical measures needed to manage your business

Cascaded / linked metrics

ILLUSTRATIVE

Metrics should therefore be cascaded to enhance the dialogue and scorecards are the key performance tracking format for metrics

Metrics Fundamentals

Page 34

E&Y’s 4 step process of creating and sustaining measurable organizational value through metrics

►Review Mission, Vision, Corporate strategy and operating model

►Review Company’s industry and review key metrics used by external observers

►Review Strategic Objectives

►Value Decompostion

►Develop Outcome Metric

►Develop Input Metrics

►Collect Metric Data -

►Prioritize rankings and review with group

–A. Ranking Methodology–B. Quantitative Methodology

►Cascading the metrics across the organization

►Link to Processes

►Link to Reporting

►Link to Incentives

Understand & Articulate Strategy

Develop Outcome/Input

Metrics

Prioritize and Select Metrics

Cascade and Embed Metrics

1 2 3 4

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What is Company X’s vision of the future?

What are Company X’s differentiating activities and strategic objectives?

Why does Company X exists?

What are Company X’s guiding principles?

What must be done well in order to implement strategy?

What are the key drivers of success?

MissionMission

Ste

ps

/ bu

ildin

g b

lock

s re

qu

ired

to

det

erm

ine

met

rics

Core ValuesCore Values

Business Driver MetricsThe internal and external factors thatdirectly influence business outcomes

Outcome MetricsThe "few" measures of success for

the company's mission and strategies

Strategy & Objectives

Vision

How can Company X quantify its strategic objectives?

Sources: 1) Company X Vision: www.Company X.com/About/who-we-are/; 2) Company X Strategies: www.Company X.com/About/strategies/; 3) Corporate Scorecard Mockup

Questions

ILLUSTRATIVEMetrics Derivation Flow

Metrics should be derived from Corporate strategic objectives (Step 1)

Step 1

Step 2

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Measurement of Innovation: Innovation Outcome Metrics

Outcome Metrics :

Pros► Better aligns with ultimate strategic

objecdtives such as Revenue, Earnings and Shareholder Value

Cons : ► Difficult to measure require some

subjectivity


Examples:

► Number of new products or services launched

► Revenue growth due to new products or services

► Percentage of sales from new products/services in given time period

► Profit growth due to new products or services

► Potential of entire new product/service portfolio to meet growth targets

► Changes in market share resulting from new products/services

► Net present value (NPV) of entire new product/service portfolio

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Examples of Companies using Output Innovation Metrics

► Pepsi: Number of new products with revenue over $100M launched in the last two years

► Kellogg’s 17% of sales in 2007 were from products launched in the last 3 years.

► 3M: 25% of revenue from products introduced in the last 5 years.

Increased to 30% and shortened the period to 4 years.

(Because this metric was so much a part of the culture of 3M’s innovation teams it

took them only 2 years to exceed the new goal.)

► HP utilizes BET (break-even time) for each new product development project as their innovation metric.

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Measurement of Innovation: Innovation Input Metrics

Examples:► R&D spending as a percentage of sales► Number of ideas or concepts in the pipeline► Number of R&D projects► Number of approved R&D projects as a

percentage of ideas in the pipeline► Number of people actively devoted to

innovation► Percentage of workforce time dedicated to

innovation projects► Number of innovation tools and

methodologies available to employees► Number of ideas submitted by employees

Input Metrics:

Pros : ► Easy to measure and track► Helps manage R&D spend

Cons : ► Might relate poorly with ultimate

strategic objective


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Innovation Metrics Usage


Page 40

There are two broad techniques for prioritizing metrics (Step 3)

Metric Ranking Methodologies

Ranking Methodology Quantitative Methodology

ILLUSTRATIVE

BU and Categories should preferably use a quantitative ranking methodology for selecting metrics

Guiding Principles ... Structured Process

Metrics Qualification RankingComposite

Evaluation Criteria Op. IncomeOp. ContributionSimple 2.50 3.50Specific 4.50 4.00Measurable 2.50 2.00Meaningful 4.50 4.50Actionable 3.50 4.00Assignable 5.00 3.00Relevant 2.00 5.00Reasonable 4.50 2.50Timely 3.50 4.50

Average Score 3.61 3.67

Score

Timeframe 3.50 4.50

Outcome Metric Sensitivity Analysis

Percentage Change in Outcome Metric

Return on Invested Capital

Capital Expenditures

DiscretionaryCash Flow

OperatingIncome Margin (%)

Gross Margin (%)

Operating IncomeGrowth

Organic NetRevenue Growth

Organic VolumeGrowth

Market Share

-15% -10% -5% 0 +5% +10% +15%

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Corporate Metric SetCorporate Metric Set

BU Metric SetBU Metric Set

BU and Function metrics should include relevant cascaded Corporate metrics (Step 4)

Illustrative Metric Cascade ILLUSTRATIVE

Metric originally defined at the Corporate level

Function Metric SetFunction Metric Set

Guiding Principles ... Cascaded

Corporate Driver Metric 1




Corporate Outcome Metric 1


Corporate Outcome Metric x


Corporate Driver Metric y


BU Driver Metric a



Corporate Outcome Metric x

BU Driver Metric b

Corporate Driver Metric y

BU Outcome Metric x

BU Driver Metric c




Function Driver Metric a

Function Outcome Metric x

Function Driver Metric b

Function Outcome Metric x

Function Driver Metric c

Function Driver Metric d

Function Driver Metric e

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Selected metrics should be embedded in the planning processes and performance reporting (Step 4)

• Strategic Planning – Selected metrics will be used in the strategic planning process to form the basis for evaluating strategic options

• Annual Planning – The annual planning process set targets against a larger subset of metrics due to the shorter time horizon

• Forecasting – The forecasting process will update throughout the year targets for a subset of the metrics used in annual planning

• Performance Reporting – All metrics will be included in the performance reporting (scorecards and drill-downs) to show actual performance against targets and last year

• Compensation – Metrics will also play a role in establishing personal targets and compensation

Guiding Principles ... Structured Process

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► Research Agenda

Research agenda


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Some Suggestions for Research Agenda

1. What type of innovation should companies pursue? What kind of innovation is most valuable for a company or industry ?

2. What should be the balance between ST and LT innovation; between opportunity and risk; between in sourced and outsourced innovation

3. What should the Role of the CFO/ Finance be in innovation

4. What innovation measures best relate with share holder value – could be industry specific. Is this a case for some standards similar to financial metrics

5. Compensation for innovation ? How do you compensate for less market facing research

Page 45

Thank You

Contact information

► Presenter : Dr. Ashish Garg► Email : [email protected]► Telephone : (212) 773-8895

Links to the material► Ersnt & Young - Balance Point Survey Study -

http://www.ey.com/global/Content.nsf/US/TCE_-_Balance_Point_Discipline_Investment_-_Almassy_Video_Transcript

Documents

Innovation and Performance measurement Dr. Ashish Garg 9 January, 2009