Types of Innovation Programs

Innovation initiatives can be grouped into three broad categories: product, business model, and process. Product innovation is generally described as developing revolutionary new products or increasing the speed at which creative new products are introduced to the market – think of Apple's stream of new iPods, iPhones, and smart watches. Business model innovation involves developing a new approach to delivering products and services that create significant competitive advantages in cost, customer service, or other important drivers. Examples include Southwest Airlines' “low‐cost no‐frills” model in air travel and Netflix's mail‐delivery, then digital, model of movie rentals and content development.

Process innovation includes efforts to improve the quality and effectiveness of key business processes such as customer fulfillment or supply chain management. Walmart, for example, is notable as an innovator in supply chain, inventory, and vendor management. Other organizations, such as General Electric, create innovative management processes around organization and management development; still others, like Amazon, innovate processes such as business intelligence and analytics.

Some initiatives cut across two of these categories, and there is often a fine line between process and business model innovation. In addition, efforts to improve the new product development process reflect both process and product innovation. These distinctions can indeed be subtle, but the key point is that innovation is much broader than simply rolling out new products and can be directed to any business activity.

Will Innovation Efforts Move the Needle?

Before developing innovation programs and measures that can help move the needle, we first need to determine which dial we have in mind. What exactly are we trying to accomplishthrough innovation? Common objectives include growth in sales, boosts in profitability, and improvements in processes or product development effectiveness. Ultimately, most executives hope to accelerate progress on key strategic objectives, financial measures, and shareholder value.

Most consultants and academics and most independent rankings of innovation focus on two or three measures of overall performance to evaluate effectiveness. These measures, such as total return to shareholders (TRS), revenue, or profit growth, are good starting points, but they are by no means perfect or exclusive measures of innovation. Their principal deficiencies are that they are lagging indicators; historical measures don't help companies see where they are going. In addition, each of these measures is impacted by multiple factors besides innovation; TRS, for instance, is also subject to stock market variations, errors in valuation, cost reductions, and other factors.

Developing an effective set of measures necessitates the identification of leading indicators that emphasize the direct contribution from innovation. This process, the development of a “dashboard for innovation,” can be facilitated by identifying key measures and activities that cascade from the objective of creating shareholder value.

Performance and Value Creation in Innovative Organizations

How have innovative companies performed on overall financial and value creation measures? Consider the dashboard of key financial and value indicators for Apple, which includes the following measures (see Figure 10.1):

• Revenue growth
• Operating margins
• Return on invested capital
• Asset turnover
• Growth in market value

It is noteworthy that the growth rate has slowed in recent years. This is inevitable for two reasons. First, as the organization grows, it becomes more difficult to maintain a high‐percentage growth rate on larger numbers. Increasing sales by $50 million on a $100 million base is 50% growth; growing by $50 million on a $500 million base is only 10% growth. Second, maintaining the innovation edge often seems to wane over time, and it is often more difficult to identify new products and new markets for extended periods of time. Some organizations, including Amazon, have continued to refresh growth by extending offerings to new markets and even leveraging technology competencies into new business opportunities (e.g. Amazon Web Services).

The power of innovation to drive differentiation within an industry is noteworthy as well. Look at the contrast between the performance of the business model innovator Netflix (NFLX) and its traditional competitor Blockbuster (BBI) (see Figure 10.2) in the early 2000s. Netflix's innovative business model for DVD rental resulted in very rapid sales growth – at Blockbuster's expense. The Netflix business model also produced strong operating margins, even during high growth periods, while Blockbuster's profits plummeted. Blockbuster's market capitalization and price‐earnings (P/E) multiple cratered as a result, whereas Netflix created substantial value. Netflix then pivoted away from the mail order DVD business to a digital platform and ultimately began developing its own programming content. A similar transformation has been underway in retail. Amazon and other Internet retailers have transformed the retail market, taking market share from traditional retailers at levels that threaten the traditionalists' very survival.

Connecting the Dots: Innovation, Financial Performance, and Value

Innovation is most often discussed in the context of revenue growth. For this purpose, we will focus on the four key drivers of organic growth: market size and growth, new product introduction, new customer acquisition, and customer satisfaction/retention (see Figure 10.3).

The importance of each of these drivers at this level will vary over time and from company to company. Organizations should select measures that address an improvement opportunity or a specific strategic objective. For example, if new product development is a priority, measures such as revenue from new products, project status, and other key metrics can be incorporated into a new product development dashboard. (See Figure 10.4.) Such a dashboard would be appropriate for Apple but not relevant for Walmart's process focus or Netflix's focus on business model innovation. If we were to create the revenue growth drill‐down chart for Netflix, it would most likely focus on customer acquisition, retention (churn), activity, content development, and related measures.

Note that this new product development dashboard is balanced: in addition to containing vital information on new product status and development performance, it also presents information on the quality of the design process (engineering change notices [ECNs] from new products) and design for manufacturability (number of inventory parts).

Additional measures that provide insight into innovation effectiveness by specific value drivers are included in Table 10.1 and Figure 10.5. Managers should select measures from the list that best represent key business priorities and issues.

In addition to developing key measures and dashboards, we can assess the conditions for innovation, and can utilize benchmarking and process evaluation tools and project planning execution and tracking techniques. Do the culture, management systems, and practices of the company encourage or inhibit innovation? (See text box.)

What Is Business Agility?

We define business agility as the ability to anticipate, recognize, and effectively respond to do the following:

• Capitalize on opportunities.
• Mitigate risks and downside events.
• Prepare for and weather storms, including economic cycles.

It is helpful to view agility as a three‐part process as shown in Figure 10.6. First, do we have the vision to see a potential threat or opportunity? This is the most important component, since if a threat or an opportunity goes undetected, the organization cannot effectively respond. In addition, seeing the threat or opportunity at the earliest possible time extends the total time the enterprise can respond to the event. Second, the organization must be able to recognize that an event or circumstance represents a threat or an opportunity. Finally, the organization must have the ability to respond.

Can Your Organization Call an Audible?

One of the best examples of agility is found on the (American) football field. Prior to each play, the team huddles to call the next play. The plays were selected as part of a game plan (operating plan) that was tailored to address the specific competitor, accounting for strengths and weaknesses of both teams. After calling a play in the huddle, the team lines up to execute the play. As the quarterback comes to the line of scrimmage, he quickly surveys the opposing defensive personnel and formation to determine if the play he just called can be executed. If he decides that the play will not work, he can call an audible, changing the play called in the huddle to a different play that is more favorable to the defensive situation he observes. The ability to communicate this change to the team results in a different role or assignment for each player. This entire process takes only seconds.

Businesses and other organizations can learn a lot from this analogy (see Figure 10.7). Many of us look across the “field” and see very different circumstances from what we had expected when we “called the play.” Unfortunately, we do not have the ability to call an audible!

Let's examine the skills and preparation that enable the “audible” on the football field using the vision‐recognition‐response framework, and extend these to the business environment.

Vision

When the quarterback comes to the line of scrimmage, he does so with tremendous vision. While his eyes likely possess greater‐than‐average capabilities such as clarity and peripheral vision, he has been trained to survey the whole field. He scans key matchups and assignments and accounts for so‐called high‐impact opponents. At first opportunity, he will review photographs taken to see the entire defensive alignment.

Businesses must also develop and improve their vision. FP&A and BPM play a large role in developing and improving the organization's vision. Play callers (executives) must have a view of how their internal processes, players, and projects are performing to ensure they are ready to execute. Do they have the right players on the team? Does everyone understand the plan and their respective roles?

Organizations also need to focus substantial attention on external forces. The vast majority of threats and opportunities arise outside the organization. Therefore, executives must have the ability to see what is happening in the economy, in their market, and to their competitors, as well as regulatory and geopolitical events. Extending the techniques and horsepower of financial analysis and performance management to external factors can significantly improve the vision of the enterprise. Chapter 11 explores the focus on the external environment and competitor analysis.

Capturing and presenting critical information are essential to improving the organization's vision. The use of rolling forecasts and outlooks facilitates the processing of new information and events and understanding the impact on the company's performance.

Recognition

The best vision in the world would not help the quarterback if he did not have the ability to recognize and evaluate what he was seeing on the field of play. This ability comes from both preparation and experience. The preparation includes long hours spent studying films of opponents in prior games. Coaches and players review the tendencies of the other team in certain situations. The team develops different actions under various what‐if scenarios.

Similarly, in business we must be able to interpret what we see and hear and to understand the implications for our ability to execute our plans and achieve our objectives. A diversified and experienced executive team and board can increase the likelihood that events and patterns will be recognized and addressed. For example, an executive from another industry may recognize patterns from his or her experience that are new to this industry. Identifying potential surprises and considering various scenarios will improve the ability of the organization to recognize and respond.

Response

After seeing and recognizing changing circumstances, the team must have the ability to respond. One of the most important factors is having the right personnel. Since the team is not sure what it will encounter, a premium is placed on having highly versatile players who can play a variety of different roles as required. For example, a linebacker who can drop back in pass coverage or attack the line of scrimmage on a run play provides more flexibility than a specialist. The players are coached and trained and study the game plan. The hours of preparation allow the players to react at game speed. Teams practice both physical and mental agility. They practice and drill to ensure their ability to react quickly under many diverse situations.

Companies improve their ability to respond by acquiring and developing versatile (agile) associates who can be quickly redeployed to address issues and opportunities the company faces. How deep is the bench? Do we prepare for changing circumstances by anticipating potential future events and developing responsive actions? By developing planning processes that identify and evaluate critical assumptions and possible scenarios, the organization will be better able to respond to any change in circumstances. Maintaining a flexible business model and keeping some financial powder dry (cash and borrowing capacity) will facilitate developing and executing responses.

The Agile (Versatile) Associate

Since our associates are vital contributors to our overall success, it also holds that they play a huge role in enabling the organization's agility and flexibility. Agile associates are learners and are highly adaptable; they can be reassigned based on changing conditions and priorities. Characteristics of agile‐versatile associates include:

• Continual learner
• Communicator
• Analytical individual
• Project manager
• Team player
• General business perspective
• Able to jump across silos to contribute
• A go‐to person

Organizations can acquire or develop agile associates by employing the following practices:

• Identifying and evaluating key competencies when hiring
• Rotational assignments
• Training and development
• Promoting external activities and interests to broaden experience

Agility and Business and Economic Cycles

Nearly all businesses are subject to business and economic cycles (Figure 10.8). Business leaders must recognize that business downturns (and subsequent recoveries) are inevitable and must build an enterprise that can both thrive on upturns and survive on downturns:

• Develop business models that are successful across economic cycles.
• Utilize tools that provide a view forward, increasing the time to react.

In addition, all products, businesses, and markets are also impacted by a finite life cycle. New products or businesses are developed, grow, reach a peak at maturity, and then tend to decline. Successful companies are fully aware of this cycle and monitor product life cycle stages. The impact can be offset by developing and introducing new products as the older products reach maturity.

Many businesses fail to recognize that they are approaching the peak and heading toward slower or even negative growth. Signs that an organization is approaching the peak are:

• Growth rate slows.
• Revenue projections are missed.
• Product and gross margins decline.

Ignoring these signposts and reality prevents the organization from revamping the business model to adjust for the road ahead or to accelerate the development of new businesses to refresh the growth curve. As a result, these organizations suffer from significant profit hits as sales decline. In addition, pressure mounts to develop an acquisition program to replace the lost organic revenue growth.

What can FP&A do to better prepare the organization for the impact of business and life cycle changes?

Provide Context. Many executives and especially founders have great difficulty in accepting that growth may be slowing. Preparing analyses that show growth curves for products and the entire business can help. Overlaying other well‐known life cycle curves can provide further support for the alert.

Establish Signposts or Trigger Events. Predetermining KPI levels or events that clearly indicate that a kink in the curve is imminent can help to prevent denial and facilitate earlier responses.

Develop Cyclical Scenarios. As part of developing strategic plans, long‐term forecasts, and even business outlooks, a business cycle or life cycle scenario should be prepared. This will introduce the possibility of a downturn into the thinking and allow the team to contemplate signposts and contingency efforts.

Develop Business Models and Practices Accordingly. Companies that are in cyclical industries should develop a flexible business model. Shifting selected expenses from fixed to variable will afford more flexibility and reduce the impact of the shortfall on profits. For companies approaching maturity, investment levels, costs, and expense levels can be adjusted for the road that lies ahead.

Dampen Irrational Exuberance during Peaks. Human beings tend to extrapolate the present conditions into the future. Include a historical perspective in planning and analytical products to remind executives that it is not if, but when, there may be a bump in the road.

Prepare for Recovery during Downturns. Companies that participate in cyclical industries should identify signal events and prepare plans to ramp up to capitalize on the recovery.

Agility Assessment and Metrics

Key performance indicators that provide a perspective on the level of agility within an organization include:

• Percentage of Agile Employees. It is not necessary that all associates are versatile. However, it is important to establish a target level that will provide flexibility and to develop practices to move toward that level. The organization should set a clear definition of an “agile associate” incorporating characteristics from the previous list that are most relevant.
• Associate Length of Service or Time in Position. Measuring the length of service and/or time in position can provide a view of versatility and agility. If a substantial number of associates have been locked in their present positions for long periods, it may indicate a lack of mobility or a need to increase rotational development assignments.
• Breakeven Sales Level. This old‐school measure is still very useful. It estimates the level of sales required to break even based on contribution margins and fixed versus variable costs. It is an indication of preparedness, by highlighting the extent that revenue can decrease before incurring losses. Measuring the level over time will track progress in bracing for downturns; a decrease in breakeven sales is a positive result of converting fixed costs to variable costs.
• Planning Cycle. Companies should measure the length of time to generate the strategic and operating plan as well as business outlooks. A shorter cycle usually indicates a more efficient process that can lead to a timely response to any changing circumstance.
• Manufacturing/Procurement Cycles. Shorter manufacturing and procurement cycles allow for greater flexibility in responding to change in demand.
• Time to Market/New Product Development. Companies that can introduce new products in a shorter time frame have a significant advantage in general, but especially in responding to competitive threats or market needs.

These measures can be utilized as part of a periodic assessment of agility. It can also be helpful to assess the conditions for agility. Do the culture, management systems, and practices of the company encourage or inhibit agility? These measures can also be used to develop a business agility dashboard in Figure 10.9.

Critical HCM Processes and Activities

Portfolio Management

If we do view associates as assets, can we borrow techniques from financial portfolio management to evaluate and improve our talent portfolio? We can develop various views of the workforce across key elements, including demographics, performance, aptitude for growth, agility, experience, and diversity. This analysis almost always identifies issues and opportunities in our portfolio of human resources.

Periodically, as part of the HCM portfolio assessment process (Figure 10.11) or the annual organization/development review, we should look at the workforce across several variables, including:

• Turnover: general, high potential, top quartile
• Age
• Length of service
• Time in position
• Education
• Languages
• International experience
• Performance
• Aptitude for growth (high potential associates)
• Agility
• Experience
• Diversity

HCM Measures

A number of measures, analyses, and other tools can be utilized to evaluate and improve human capital. Some of these may be part of a continuous reporting process, whereas others may be utilized periodically, for example as part of an annual or quarterly review. Still others may be used on an ad hoc or when needed basis.

Human Resources (HR) Costs per Employee. How efficient is the HR department? What are the costs incurred in recruiting, providing benefits, employee development, and evaluating performance? How do these costs compare to those at other companies in the industry? To best practices companies?

Benefits per Employee. Employee benefits are a significant cost. Some of these costs, including health care premiums, have risen significantly in recent years. This measure is better than benefits as a percentage of payroll, since payroll can be skewed by the inclusion of highly compensated managers and executives. Note that reducing the cost of employee benefits by reducing benefits may have implications on retaining and attracting talent.

Headcount Analysis. People‐related costs are typically a significant percentage of total costs. Tracking headcount levels is essential to cost management. Significant changes to the cost model will result from additions or deletions to headcount. Tracking headcount by department over time can provide significant insight into changes in costs. Some companies include the full‐time equivalent (FTE) of part‐time, temporary, or contract employees in the analysis to provide a comprehensive view and to prevent gaming the measure by using resources that might fall outside the employee definition. In addition, tracking open employment requisitions, new hires, and terminations provides a leading indicator of future cost levels. An example of a headcount analysis is presented in Table 10.3.

Employee Engagement and Satisfaction Surveys. Employee surveys are typically done on a quarterly or annual basis. Occasionally, management may also want to take the pulse of the workforce after specific events, such as a change in leadership or a workforce reduction. Quantitative results can be very useful, especially when combined with commentary. Survey questions, frequency, and methods should be designed by professionals. Management must be committed to providing feedback and action, where appropriate, to associates, or the surveys can do more harm than good.

Effectiveness of Training and Development Programs. Development programs, including training, can lead to growth and improved performance. The programs must be thoughtfully chosen, and quality programs must be offered. It can be difficult to measure the effectiveness of training. Where possible, develop specific objectives for the training. For example, to improve customer service on help lines, this objective could be supported by measuring call wait times, customer survey results, and other specific measures. By putting a stake in the ground, the company can then measure improvements against that performance.

It is also useful to survey program participants and their superiors and clients. Did the participants learn from the session, and did it meet the stated objectives? Did clients and superiors see improved performance after the session? For example, after the FP&A team attended a session on presenting and communicating business information, did the clients of FP&A notice the difference?

Average Training Hours per Employee. This measure provides a good indicator of the level of training and learning within the organization. Since training needs may vary across the organization depending on the level and function of employees, this measure is often tracked separately for engineers, managers, technicians, and other groups.

Recruitment and Immersion

Time to Fill Open Positions. Since it is important to fill open positions in the shortest possible time, measuring the length of time to fill open positions is important. In keeping with balancing measures, it will be important to view this measure in the context of the overall effectiveness of recruitment. We wouldn't want to encourage hiring the wrong individuals faster!

Percentage of Openings Filled Internally. Some companies have a philosophy of promoting internally. Others prefer a mix of internal promotions and hiring from the outside. This measure captures the actual mix of hiring and provides an indication of the effectiveness of the organization in developing talent for internal growth and promotion.

Percentage of Offers Accepted. Another way to assess the recruiting and hiring process is to track offers accepted as a percentage of offers extended. A low acceptance percentage may indicate a problem in assessing the potential fit of applicants or an unfavorable perception of the company developed by the candidates during the recruiting process. This measure will also reflect the conditions in the job market.

Successful Hire Rate Percentage. While it is important to fill open positions on a timely basis, it is obviously more important to fill the positions with capable people who will be compatible with the organization. This measure tracks the success rate in hiring new employees or managers. The percentage of new employees retained for certain periods or achieving a performance rating above a certain level will be a good indication of the effectiveness of the recruiting and hiring process.

Human capital management and financial performance are shown in Figure 10.12.