Depending upon the metrics an organization chooses to use to track and determine the success or failure of innovation processes often goes a long way toward evaluating past actions and determining what future projects are undertaken. Such choices can also influence the incentives used to reach these goals, as well as impact the innovation leaders within an organization. Help us gain a greater understanding of the impact of metrics choices on behavior and results. -Daniel Perez

As technology evolves, particularly artificial intelligence (AI), and our processes and systems become more integrated with it, we are gaining more insight into our businesses and our organizations than ever before. Just as the advent of the Internet led to what has been referred to as the “information superhighway,” the evolution of technology and artificial intelligence has led to an “analysis superhighway” of virtually every process and structure within our businesses and organizations.

This includes the areas of innovation and the research and development that goes into that innovation. Particularly in this day and age where information travels quickly and advancements occur almost daily, businesses cannot stand still with yesterday’s breakthrough, or they will be potentially out of business by tomorrow because their competition has developed the next big thing through innovation.

Thus, innovation is vital to the survival and growth of a business over both the short and long terms. As a result, it is very important that businesses and organizations develop the processes and systems necessary to be able to continue to innovate at a high level continuously in order to stay with and even ahead of their competition. Like analysis on many processes today, innovation analysis also relies on various metrics to help businesses and organizations determine whether their current processes are effective and what can be changed within them to make them even more effective.

Common Issues With Most Innovation Metrics

There has not been as much open discussion about innovation metrics as compared to other metrics analyzing current profits and losses, and even when projecting future profits and losses. A key reason why this is the case is because most throughout the business industry think innovation metrics are too complicated to learn and apply to their businesses. There are just so many variables that need to be considered, since innovation itself can be defined in several ways. Innovation can refer to a new concept, it can refer to a new product, it can refer to a new process that leads to a new discovery or idea.

Essentially, innovation can refer to any new discovery that can improve virtually anything, whether it is reducing expenses, reducing consumption of a resource, making a resource last longer and more valuable, creating another use out of a product or service that already has an established use, and a number of other results. The multitude of possibilities is the key reason why innovation metrics are so difficult to quantify and use in one’s business or organization that many business executives have essentially given up trying to apply them to their business models, thinking that the high “cost” of learning how to apply them is not worth the information that can be gleamed from these metrics.

Add in that not many companies release much information about their research and development investments, and this also contributes to a lack of commonly described metrics, which further hinders the process of applying innovation metrics to one’s business or organization.

Why Innovation Metrics Are Being Used More Now

However, with the aforementioned advancements in technology, including greater computing power in our computers, as well as advancement in artificial intelligence and its application, more business executives are reevaluating their use of innovation metrics. Plus, the constant change and competition in their industries is making them realize that they have to remain innovative to remain competitive in their industries; even stalling for a short period of time when it comes to innovation could lead to the faltering and death of their businesses.

Some Innovation Metrics To Consider Implementing In Your Business or Organization

McKinsey senior partner Erik Roth developed a simpler form of innovation metrics that relies on just three key data points commonly available in publicly-released data: Gross margin, research and development, and new product sales. Combining these three data points has led to two new innovation metrics that are much simpler to calculate and simpler to understand, yet can give valuable insight into the innovation performance of business units within an organization as compared to each other, as well as compared to competing companies within their industries. Roth describes the first of the two metrics as being the ratio of your research and development spending versus your new product sales (over a period of years, usually calculated on a 3-year or 5-year period). This ratio tells you how many new product sales you are getting on average for every dollar of research and development spending you are putting in.

Roth describes the second of the two metrics as being the ratio of your gross margin to your new product sales, with this metric being called the product-to-margin conversion metric. This ratio tells you how many new dollars of gross margin you are gaining for every dollar of new product sales you are producing. Essentially, these metrics are designed to determine whether research and development investments are converting into meaningful profitability for the business or organization over time. These metrics have been tested in the industrial sector, the consumer-goods industry, the pharmaceuticals industry, and in the chemicals industry; all tests of these metrics in those industries showed the relationships between how companies did versus their peers when it came to using these metrics.

For organizations to use Roth’s metrics to analyze their processes as compared to their peers, they need to gather data on their own new-product-development revenues and compare that as a percentage of their overall sales. This is something most companies already do, but is easy enough to do if they do not do it already. They then need to compare that to the overall performance within their industry; this information is usually published in investor day presentations, in annual reports, and in other formats and publications.

When using these metrics, they can tell you if your innovation pipeline is healthy and productive, leading to high gross margins in the marketplace because they are that remarkable, or if the new products you are producing are not leading to high gross margins, thereby indicating the new products you are creating are not that transformative or they are too costly to continue producing because they are not providing enough return on investment (ROI).

In their Metrics for Managing Innovation White Paper for The Wharton School’s Mack Institute, George S. Day, Geoffrey T. Boisi, and Faculty Emeritus identified 58 different sets of innovation metrics for companies to consider using. They asked companies how satisfied they were with the innovation metrics of their respective dashboards. The results were as follows: 36% “very or somewhat dissatisfied.” 34% “neutral.” 22% “somewhat or very satisfied.” 8% “don’t know.” Management practice in regards to what innovation metrics to use and how instructive they were to their companies was even more telling in that 76% were “neutral at best,” with many being either “somewhat or very dissatisfied.”

In their white paper, Day and Boisi discuss how a dashboard of innovation metrics has many uses, including identifying weak links in a company’s overall innovation process, as well as costly disconnects between a company’s growth strategy and its portfolio of growth initiatives. This dashboard can also be used to hold managers accountable by establishing improvement targets and providing incentives to help reach those targets. When a carefully chosen metric with a challenging target is selected, this indicates a change in strategic priorities for a company. Day and Boisi state that a crucial key to improving a company’s innovation prowess is choosing the right innovation metrics and linking improvements on these measures to rewards. They provide Whirlpool Corporation as an example of this approach providing dividends and positive change for a company that was falling behind on innovation, recognizing the need for better innovation, and making strategic changes to improve their innovation processes, which led to them improving their overall financial stability and brand longevity in the industry.

How Whirlpool Transformed Its Innovation Process

Throughout the 20th century, Whirlpool’s innovation efforts were dependent upon engineering and marketing in order to generate and develop new product concepts and innovative features. In 1999, Whirlpool’s Chairman and CEO, David Whitwam, envisioned a company that would have innovation being “generated from everyone and from everywhere.” This would require transforming the innovation process and narrative at Whirlpool by implementing broad-based organizational change.

Instead of Whirlpool’s siloed approach to innovation, as many employees as possible would need to be equipped with tools to identify latent customer needs and emerging technologies, then combine the two into innovative new offerings. The company asked for ideas on how to implement this change from all 61,000 of its employees.

Whirlpool created a set of metrics that were passed along to all managers and employees. It also focused on an innovation goal of $1 billion added to revenue within a three-year time period. Every employee would be evaluated each year in terms of the short- and long-term success of meeting these goals, as well as how much the business plans and implementation work they did went toward moving the company toward those goals.

Whirlpool implemented a multi-faceted incentive approach in order for employees to be encouraged to meet these goals. Senior leaders were encouraged by having high financial incentives; rank-and-file employees were encouraged through team-based and intrinsic rewards.

One issue Whirlpool had to overcome when implementing this new “innovation from everyone, everywhere” approach was changing their overly bureaucratic and conservative budget control process. As many organizations of that era did, the annual budget was set each year, and once it was locked in, there were no additional costs. Thus, no new ideas could be implemented. This process was good at controlling costs, but not good at encouraging innovation and new ideas.

Whitwam had each region of the company set up a seed fund to fund innovation and told the senior team that all ideas had to be funded. If an idea was turned down, he instructed employees to come directly to him so that they could still implement the idea. The result of Whitwam’s “innovation pipeline” led to Whirlpool going from $1.3 billion in innovation funding to $3.3 billion in just two years. Additionally, in 2005, seven years after this new innovation pipeline was created, Whirlpool’s stock price hit an all-time high, while the company posted record results. Further analysis showed that $3.6 billion of the $19 billion in revenue Whirlpool generated in 2011 was because of their innovation areas. This has led to further innovation and success; in 2018, Whirlpool’s annual report showed the launch of 100 new products, while in 2019, Whirlpool received 16 International Forum Design awards and 5 Consumer Electronic Show awards.

Ordinary Capabilities and Dynamic Capabilities

Day and Boisi determined that companies can show ordinary capabilities (OC) and dynamic capabilities (DC). The former relates to doing well-defined tasks and routines that enable the efficient performance of core processes for production, supply chain management, financial management, and similar processes. The latter relates to organizations purposefully creating, extending, or modifying the resource base to where they recognize opportunities sooner than competitors, take advantage of them more effectively, and maintain the organizational transformation needed to stay ahead of their competitors in their industries. Combined with a clear strategic vision, these organizations can adapt more readily to uncertain and turbulent market conditions; that ability to adapt is innovation.

How Innovation Impacts Decision Making

As Day and Boisi mention in their white paper, innovation is risky because it involves expanding the resource base and taking on projects that are not the normal, everyday, “safe” projects. However, those projects do not really “move the needle,” so to speak, when it comes to getting ahead and staying ahead of the competition when it comes to innovation. The in-between projects that come between the routine tasks and the innovative tasks that expand the resource base are called “adjacencies” because they have a better balance of risk and reward by doing something new while drawing upon the resources and market knowledge of the business. Essentially, a business will use its current knowledge and resources to expand into a new area; USAA was an example cited in that they originally served military members auto and home insurance, then founded a profitable adjacency by offering those insurance policies to family members related to those military members.

It is also important to note that any innovation investments will only pay off in the future, not the present. In most cases, a financial investment, a clear vision and goal, a commitment to that change, and much hard, consistent work are needed in order to see the notable payoff from innovation investments. As such, innovation is not for the faint of heart, nor is it for those who expect to see immediate, tangible results. However, in this day and age when competition is numerous and fierce, not to mention transformation and innovation happening almost daily in every industry, companies must be willing to commit to innovation investments and become regularly proficient at innovation, lest they will fall behind their competition, become irrelevant in their industries, and either go out of business entirely or be acquired by another company that is more innovative and more adaptive to the ever-changing business environment of the 21st century.