In today’s competitive environment, a differentiator which separates a great company from the rest of the pack, is the ability to be innovative and create new growth opportunities. Because CFOs can relate to the key drivers of the business, they are being tapped to take the lead role in evaluating risk and advancing their organization’s innovation agenda.
by Deloitte CFO Journal
About 95% of innovation attempts fail to return their capital, according to research from Doblin, the innovation unit of Monitor Deloitte. Yet, innovation is not a choice but a strategic necessity for companies, says John Levis, global chief innovation officer and regional managing director—Americas for Deloitte Touche Tohmatsu Limited.
With companies devoting greater attention and investment to growth through innovation, Mr. Levis describes how innovator companies work to avoid the high failure rates that plague many organizations and how CFOs can help advance their organization’s innovation agenda while managing the investment risk that comes with it.
Q: What distinguishes companies that effectively and consistently foster innovation from other organizations?
John Levis: Tone at the top, commitment to invest and a disciplined approach are the three elements that I find separates the most effective innovators from the rest of the pack. At the top innovative organizations, leadership makes it a priority to define what innovation means to the organization and is vocal about its strategic importance to the entire organization, from the C-suite and down through the organization.
When I say being committed to invest in innovation, that means making the necessary investments not only when times are good and cash is plentiful, but also when there are downturns and difficult choices need to be made. It also means investing in human resources and a variety of other areas, such as technology, that are needed for innovation. These resources go beyond what might be needed to run a steady business, and innovator companies typically make these types of investments.
Last, these companies have an innovation process that is disciplined and systematic. They pursue both incremental and radical innovation and innovate in many areas, such as business and profit model.
Q: How can CFOs support their company’s innovation agenda, while maintaining their role as steward?
John Levis: First and foremost, CFOs looking to help establish an innovative organization need to think about taking a portfolio approach to funding and investing innovation. This approach can help CFOs manage the overall level of risk in innovation projects while allowing the organization to pursue innovation initiatives that might have a higher level of risk than the standard risk threshold.
The portfolio approach entails distributing innovation investments across three categories or types of innovation. First, there’s innovation at the core, investments that aim to achieve 10% to 15% improvement on, for example, the productivity of an operation or the sales of a product, with a proportionally low risk of failure. Core innovation investments should make up the vast majority of the portfolio, up to about 70%, for a large organization. The second category is adjacent innovation, efforts to extend a product set or customer base by way of new products or a new set of business for the organization. Adjacent innovations aim for a higher impact and will likewise have a higher level of risk. They generally should account for no less than 10% and no more than 50% of an innovation portfolio. The third category—transformational innovation—is usually the smallest piece of the innovation portfolio at about 10%. These are projects that could bring a fundamental change in the direction or growth of the organization, often the ones with the biggest potential return and the highest risk of failure.
If CFOs apply the risk criteria they use for typical business investments to innovation projects—especially those that might be transformational—that could make it very hard to provide funding approval. But taking an approach that looks at the risk profile of the entire investment portfolio rather than just the risk profile of individual projects allows the organization to balance the 10% of the portfolio’s high-risk innovation projects with lower-risk investments, which typically would be the majority of the portfolio.
Q: Should CFOs be using different metrics to measure the performance of the organization’s innovation investments?
John Levis: When organizations create innovation in a consumer business or in a business-to-business model, they need to create alongside of that a value capture model―a pricing model, you could call it― that’s going to support the innovation and reflect the fact that it’s not business as usual in the organization. CFOs who say, “We’ve got to start measuring our ROI on innovation,” are missing the point because innovation is not a financial decision; it’s a strategic decision and more than that, it’s a necessity. Organizations today cannot simply opt out of innovation because it’s too difficult to establish a process to get it done or to measure it. There’s too much at stake and too much change that happens too quickly for organizations to say, “No, that’s not something for us.”
Because innovation is an iterative process of trial and error, CFOs must be careful to not burden the innovation process with a heavy ROI investment model or too many cost-benefit checkpoints too early in the innovation process. The front end of an innovation project needs to be left as unencumbered as possible, so people can explore and experiment and allow for that rapid iteration of new ideas without worrying about meeting an ROI target. That’s especially true for large organizations, where the innovation process happens when one idea is combined with another and is layered on top of a third and so on, until you truly have something that is an impactful innovation.
If you start applying cost-benefit analysis and ROI metrics too early in the innovation cycle, you may nip in the bud something that has real potential. Measuring ROI and doing a more rigorous cost-benefit analysis can start once the idea has made it through a set of pilot projects and the organization is ready to scale up the innovation across many customers or different business units.
Q: What do CFOs need from their finance talent to help them more fully support innovation?
John Levis: When it comes to innovation what CFOs need from their talent is no different than what the rest of the organization needs from talent: the willingness to be innovative. For organizations to be innovative, employees have to be encouraged to explore ideas, experiment with them and see how viral they become in the organization. Moreover, it’s critical to have a performance management model that recognizes that innovation requires failure. Ideally, the performance model not only protects employees involved in an innovation project from being dinged for failure, but even rewards it under certain circumstances, such as when an innovation journey that doesn’t work out provides a valuable learning experience.
In the same way, the CFO and finance need to be just as innovative as the rest of the organization. For example, an innovative CFO might look at the close process and ask, “Would doing the close in real-time be valuable?” If there were real value to the organization to have much faster financial reporting, if capital markets rewarded companies with a more efficient close process, for example, then asking, “What’s stopping us from doing that and what do we need to do to make that happen?” could be the front end of a whole new set of innovation.
CFOs who want a finance organization capable of innovating financial management processes or becoming a stronger business partner need to provide their people training in innovative methods and techniques like design thinking. These tools encourage looking at things differently, questioning what’s in place and looking for new solutions to challenges that perhaps were not even previously recognized as constraints.
Q: In your role as chief innovation officer, what has surprised you in terms of what works or doesn’t work in driving innovation?
John Levis: Coming in to this role, I expected the biggest challenge to be generating new ideas because being an innovative company requires coming up with a lot of new ideas on a sustainable basis. I was completely wrong about that; we had no problem with ideation. Instead, the real challenge was figuring out a process to evaluate the many ideas being proposed so that the truly top-shelf ideas could be advanced.
Another assumption I brought to the role was that establishing a culture of innovation would require bringing in a lot of young people. I’ve found, however, that innovation has nothing to do with age. We get out-of-the box ideas from all generations. What was important was convincing others that it’s OK to risk failure, that trying out new ideas that fail is even a positive. As I said earlier, for an organization to have a culture of innovation, the talent and performance model should not only tolerate experimentation and failure, but also reward those who advance innovative thinking, regardless of the outcome.