This article is the third and final in a series of 3 articles discussing measuring product innovation. Part 1 discussed the importance of innovation, and how it is measured today. Part 2 covered the criteria for a new and effective innovation index.
Today, Part 3 brings the series to a conclusion by proposing such index, called the Growth Innovation Index (GII).
Asking the right question is 80% of the answer. Therefore, defining the product innovation index must start with determining the question that it needs to answer. Typical questions addressed by existing metrics include “Are our current products innovative?”, and “Are we positioned to be innovative in the future?” There can be more.
However, if you follow the question “is innovation important to you?” (to which 70%+ will reply with “yes!”) with asking “why?” the answer you get is “because we want to grow, and innovative growth is the most profitable growth.” Therefore, the question should be: How innovative is our growth?
Innovation that doesn’t lead to growth should not be counted, as companies and their shareholders are not interested in innovation simply for innovation’s sake. Growth that is not the result of innovation (such as due to entering new markets with existing products) should not be counted, as it does not present the superior financial performance associated with growth that results from true innovative products that have profound impact on their markets, and command very strong market shares, revenue, and profits.
The following are the basics of the proposed Growth Innovation Index.
Where are we in the Product Life Cycle?
The question “what percentage of our revenue comes from products that did not exist 4 years ago?” is misleading. Some products have longer life cycles, while others have very short ones. A cellular phone has a life cycle of one year. Manufacturers will introduce a new phone every year. No phone would have existed 4 years ago, and thus it would be a mistake to consider every phone innovative. At the same time, products such as vacuum cleaners have life cycles in excess of 10 years. The real question to ask, then, is “where is the product in its expected life cycle?” If the product is near the end, then competition is high, differentiation is low, and profits are razor-thin. On the other hand, products at the growth or early maturity stage generate the highest profits. A product that was introduced 4 years ago but with a 20-year life cycle will be driving very profitable growth.
If we consider patentability as a measure of innovation, then we need to determine the level of innovation based on the novelty, feasibility, and usefulness of the product.
For the purpose of the proposed index, we will consider 3 factors in determining the innovativeness of a product:
- Input: the technological difference of this product compared to products that currently exist in the market (whether by your company or any other);
- Output: the difference in functionality between this product and other products in the market;
- Output: the difference in performance between this product and other products in the market;
There is a heavily subjective nature to these parameters, and thus it is important that the company either develops a rubric to determine the level of differentiation in each of the three factors, or otherwise assure consistency (year over year) in making those determinations. We acknowledge that the three are related, but we still require them to be determined individually. For example, consider the introduction of the iPhone 6S. How different will we determine it is from other products? Technologically, we will probably rank it 20% (0.2) different than other products. Functionality, given some new functions the phone has, the size of the screen, we may determine it to be 0.3. Finally, the performance improvement compared to other products might be a 0.28. Giving an equal weight to all three differentiation parameters, the overall differentiation will be 0.26. Although the rankings can be linear as described in this example, we recommend using a 3, 4, or 5 point scale with appropriate rubrics.
To comply with the requirement of measurability, listed in part 2, the input variables to the new innovation index should be easy to obtain. Since we propose a product innovation index, we will need to collect data for each product in the company, whether already generating revenue or still in development. The data will include actual data, as well as business plan projections. The data we collect will, therefore, be:
- Expected lifecycle of the product (in years);
- Years since (or to) market introduction (could be a negative number if market introduction is in the future);
- Expected lifetime revenue from the product;
- Actual revenue generated by the product since market launch to the end of last year;
- Actual revenue from the product last year; and–
- Product differentiation (will be discussed in the next section);
Business Plan Accuracy
While the actual past performance of the product is known and thus accurate (one would hope…), the future performance depends on the company’s forecasting accuracy. Estimating 25% growth based on business plan forecasts while knowing that historically the company misses its business plan goals by 50% (negatively) suggests a decline rather than growth, and therefore should be considered when estimating growth.
The Growth Innovation Index (GII)
The index should therefore be calculated as follows:
In general, both numerator and denominator are the sums of the same equation. The equation is calculated for each product separately and added at the end. Different products may be in different stages in their respective life cycles, and the different revenue (actually and forecasted) will apply the appropriate weight to them.
In the denominator, for each product, we divide the remaining revenue forecast through the rest of the product life cycle by the number of years left in the life cycle. This would give us the forecasted average per-year revenue left in the product. Since forecasts are not accurate, we multiply the forecasted per-year revenue by the experienced forecast accuracy. From the result, we subtract the product sales last year. This would give us the expected annual growth for the product. Once we add up the annual growth for all the product, the denominator will now show the expected revenue growth next year.
The numerator is the same with one exception: we multiply the growth for each product by the differentiation level discussed above, between 0 and 100%. Therefore, for each product, we get the expected revenue growth through innovation/differentiation of the product. The revenue (actual and forecasted) associated with the product will provide the weight of such differentiation. Once we add up all products, the numerator will give us, in Dollars, how much of the growth is attributed to innovation and differentiation.
Finally, dividing the numerator by the denominator will give us a factor, in %, of what percentage of growth is coming from the innovativeness of the different product, answering our original question.
Care must be taken to assure that no “divide by zero” occurs, so some safeguards were built into the actual tool used by largescalecreativity.com.
image credit: thinkwithgoogle.com
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Dr. Yoram Solomon is an inventor, a creativity researcher, coach, consultant, and trainer to large companies and their employees. For his Ph.D. he studied why people are more creative in startup companies than in mature ones. He also holds an MBA and LLB. Yoram was a professor of Technology and Industry Forecasting at the Institute for Innovation and Entrepreneurship, UT Dallas School of Management; is active in regional innovation and technology commercialization; and is also a speaker and author on predicting the technology future and identifying opportunities for market disruption.