Nothing like a beautiful weekend and a cluttered garage to highlight the importance of understanding sunk costs and opportunity costs in a good decision making process. Head over to AskDong.com for a clear description on sunk cost and opportunity cost. At the same time, realize that though definitions maybe clear, to err is human. 

I don’t like clutter in my house. However, I do value the idea of establishing a clutter zone in the garage that holds our donation and potential garage sale pile. This Memorial Day, it was time to clear up the pile and organize it. As we started to sort through the pile, our discussion quickly turned to opportunity cost analysis of whether to hold a garage sale or not: would it be worth spending a good weekend (lets be honest, those are rare in Seattle, WA) by cleaning, tagging and waiting for a possible sale and making a few bucks? 

Framing issues from the perspective of opportunity costs can simplify the decision making process. However, letting go can still be a challenge —  wouldn’t someone pay $$ for that stuff that cost me $$$??? Whatever the previous investment or expense may have been, the feeling of being invested in the past makes it difficult to change tracks. Many projects follow this trend of throwing good money after the bad.  

Regardless, acknowledge and accept the sunk costs as sunk. Put a check for a failure and celebrate your learnings. And, establish milestones for regularly scheduled reviews with clear guidelines on funding expectations to avoid unpleasant surprises.

In case you’re wondering… within 2 hours the garage was cleaned and everything in the pile was donated to Goodwill. Yet, we still had time for a 5 mile hike in the woods that afternoon, and not to forget the wonderful feeling of free space next to the car in the garage.

As research from IBM and the Boston Consulting Group captures, in today’s competitive environment, CEOs are looking at innovation to bring top line growth. In my recent “Innovation and Profitability” article posted at KiteTail.com, I discussed how different innovation types could contribute to the bottom line of the firm. Granted, there are more innovation types than one can throw a stick at, and the terminology might be different from one to the other, but it does demonstrate the linkage between innovation and profitability. However, there is still the question of how does one measure innovation and innovation’s impact, and does innovation really pay off?

It is difficult to measure the impact of innovation. The challenges stem everywhere from agreeing on common definitions, such as what constitutes a new product, to the fact that it takes on average one year to commercialize an idea while the full life cycle of the innovation is anywhere from two to five years, and that innovation is a system and should be measured as such. As with any given measurement system, having the data and the metrics is not sufficient, there is a need to incorporate how the metrics relate and impact each other. Regardless, a proper measurement system will not only provide the current state, but also highlight the areas that need improvement.

As I mentioned before, innovation is about the implementation of a new idea for the purpose of creating value: value for the firm, and value for the consumer. Given that the innovation is a system, proper measurement of innovation should incorporate every phase in the innovation cycle: from ideation thru development, commercialization and life cycle management, along with supporting systems that enable innovation to be successful: management, people and culture. Without proper support, including management, funding and innovation networks (internal and external partners), many ideas fail to make it to the market. And others that do make it might fail to bring the expected returns on the innovation investment. Boston Consulting Group’s (BCG) 2006 Innovation Survey highlights that though companies are strongly committed to innovation, and recognize it as being critical to their success, there is doubt that they are earning sufficient return on their investment. Yet, research shows that effective innovation does pay off, as highlighted in BCG’s innovation research:

Companies are increasing their emphasis on innovation for good reason, it turns out. Innovation, our research shows, translates into superior long-term stock-market performance: the 25 most innovative companies (as defined by our survey respondents) had a median annualized return of 14.3 percent from 1996 through 2005, a full 300 basis points better than that of the S&P Global 1200 median. The driver of that outperformance was these companies’ ability to expand margins at a superior rate without sacrificing growth: innovators increased median profit margins by an annualized 3.4 percentage points per year over the ten-year period, versus 0.4 percent for the median Standard & Poor’s Global 1200 company. And they did this while keeping revenue growth on pace—9 percent per annum—with the index median.

Along the same lines, Booz Allen Hamilton’s “Global Innovation 1000” looks at the impact of R&D on corporate performance, and shares their findings on “high-leverage innovators”:

Analysis of the performance screens revealed that 94 companies within the Global Innovation 1000 – our high leverage innovators – consistently outperformed their peers over the five-year period, while spending less on R&D as a percentage of sales than their industry median.

In summary, though it is difficult to measure innovation, effective innovation does pay off. And this is definitely one area that starting with a few relevant metrics wins over finding the perfect mix: just do it! Continuously monitor and check on your metrics to determine what is working and what is not. With that, here are few thoughts on implementing your own innovation measurement system.

• In determining your metrics, make sure to align them with your innovation strategy. I discussed this briefly in my “Innovation and Profitability” article. Manage your innovations as a portfolio process: know where you are spending across range of initiatives, how your resources are allocated, and using regular portfolio reviews determine if the investment is still aligned with the strategy given the latest market and business conditions. Metrics have a way to influence behavior and norms, so make sure you are walking the talk.
• Focus on all aspects of the innovation cycle from ideation all the way thru post-commercialization. Analyze your innovation cycle effectiveness both on idea generation, but also on the overall process effectiveness: idea selection, resource investment and allocation, cycle time for moving the ideas through the innovation cycle, collaboration with your innovation network (internal and external partnerships), time to market, number of new products launched, number of products that embed the idea, as well as number of ideas killed and where in the innovation cycle.
• Remember, the goal is to measure your innovation effectiveness, so focus on the metrics that matter: investment vs. the return on investment. Potential metrics could include your innovation investment’s impact on the margin (percent gross margin, impact to operating profit, innovation as percent of revenue), post-launch performance of expected vs. actual realized value of your innovation, and return on your patent portfolio.
• Don’t be self-centered: make sure you innovation metrics include measures to compare how well you do against your competitors or your industry.

With that said, don’t go metrics crazy: collecting and managing metrics takes effort, and there is a point of diminishing returns. At the same time too little may not provide the right insight. Though I don’t believe that there is a magic number for all situations, a range of four to eight is a good target. Here are additional articles on the topic of measuring innovation. Good luck!

• “Measuring Innovation 2006”, Boston Consulting Group
• “Measuring Profitable Growth and Innovation”, Accenture
• “Smart Spenders: The Global Innovation 1000”, Booz Allen Hamilton