How to measure ROI for innovation—your complete guide
Strategyzer
June 26, 2024
8
min. read
topics
BUSINESS STRATEGY
CORPORATE INNOVATION
EXPLORE VS EXPLOIT
INNOVATION METRICS
Investment in innovation is inconsistent due to challenges in articulating a clear return of investment (ROI) for it. Traditional ROI calculations don't apply as innovation involves exploring new ideas and business opportunities. So how might we account for ROI in the context of innovation, to better capture its value and potential? Find out below.
Who would have thought the business environment we thought we knew would be turned topsy-turvy by a pandemic? Recent global events have also shown how rapidly things can change. During this time, we truly witnessed companies needing to be innovative (almost overnight) and think outside the box to succeed. The traditional business ways were no longer enough—we needed innovation more than ever. To keep up, businesses must focus on innovation beyond new products or services and explore the importance of business model innovation. It also means changing how we do things and measuring success. To be successful, companies need to be adaptable and customer-focused. By taking a fresh approach to business, we can create companies that are more responsive to the needs of our customers and more relevant in today's market. This is not just about survival but also about achieving long-term growth and success.
2. Why is disruptive innovation crucial for the survival of your business?
Every organization needs to reinvent itself to survive over the long term. Disruptive innovation is essential for the survival of businesses because it represents the process of exploring and adopting new technologies, strategies, and approaches that fundamentally change how value is created and delivered. In an era where markets, consumer preferences, and technological landscapes evolve unprecedentedly, standing still is synonymous with falling behind. If you're a leader in an organization, you need to get better at exploring potential areas you can pivot toward. In times of crisis, CEOs are confronted with a critical question: How can we drive new growth at scale?
<span class="text-style-muted text-style-small">Innovation practice is the ability to explore new ideas, test them and kill (or successfully retire) those that don’t produce evidence.</span>
Businesses prioritizing innovation position themselves to anticipate and lead market changes rather than react to them.
This proactive approach allows them to uncover new opportunities, address unmet customer needs, and stay ahead of emerging competitors, ensuring long-term sustainability and growth.
As the landscape is full of potential disruptions from unexpected competitors, CEOs must excel in managing the existing business model while exploring and implementing new ones.
This dual role, this dual mindset, is often called the "ambidextrous organization."
The ambidextrous organization
An ambidextrous organization is one that can effectively manage its current business opportunities while exploring new ones, balancing innovation with stability and efficiency in its core operations.
This approach, also known as the Explore-Exploit continuum, enables companies to be agile and adaptive in rapidly changing markets while maintaining their existing strengths and business models.
The Explore-Exploit continuum in detail.
Explore = Return On Portfolio
Explore activities focus on discovering new value propositions and business models. This end of the continuum is characterized by high levels of uncertainty and unpredictability. Therefore, traditional financial metrics like ROI (Return On Investment), which require predictable cash flows and outcomes, are less effective.
Instead, success measurement should focus on learning and discovery metrics from market insights through rapid experimentation. The best way to invest in Explore projects is to use metered funding. Leaders initially make small investments in multiple ideas. Over time, they can increase their investments in pictures that show progress and traction. Projects that need to make progress based on evidence can be stopped. When using metered funding, leaders must base their investment decisions on something other than each project's expected ROI. This is because they expect some of the projects they invest in to fail. The goal is to recoup these losses and make high returns on the few successful projects. So the rate of return has to be calculated based on the entire portfolio of projects (i.e., Return On Portfolio).
The best way to invest in Explore projects is to use metered funding. Leaders initially make small investments in multiple ideas.”
Exploit = Return on Investment
On the other hand, exploitation activities involve optimizing and extending existing business models and products with a clear understanding of market demands and customer needs.
These activities can be evaluated based on their direct financial return, efficiency improvement, and market penetration rate.
With a successful business model, teams should be able to predict the net income and investment cost. While this may not be 100% accurate, the approximations should still be close enough.
<span class="text-style-muted text-style-small">With a successful business model, teams should be able to predict the net income and investment cost. This may not be 100% accurate, but the approximations should be close enough.</span>
Understanding different ROI approaches
The need for different ROI approaches depends on the nature of these activities. While Exploit activities can be assessed on a shorter timeline and more direct financial outcomes, Explore activities require a longer-term view where success is measured by potential market breakthroughs and scalability instead of immediate financial returns.
What does this mean in practice?
Companies need to balance these approaches carefully. They shouldn’t expect immediate and high ROI results from Explore initiatives. Rather, focus on the long-term strategic value these initiatives may bring and calculate projects at an aggregate level, expecting most to fail and a few outsized winners.
Exploit initiatives, however, should continue to deliver steady and predictable returns that justify their ongoing investment.
With innovation, companies adapt to the changing environment and shape it to their advantage, creating a resilient and future-proof business model. However, we must first recognize the challenge of the dual mindset, which is crucial for a company's long-term survival. Leaders need to think about allocating resources and evaluating success across their portfolios while managing exploration and exploitation within a single organizational framework — it’s all about achieving balance.
<span class="text-style-muted text-style-small">Watch the webinar and gain insights into what it takes to achieve substantial returns, shift your perspective from project-centric to portfolio-focused, and more.</span>
If you want to be successful in innovation, it's important to focus on the big picture, not just individual projects.
3. Why many innovation projects fail to generate sufficient ROI
Many companies struggle to get a good return on their investment in new ideas and products. One big reason is that they tend to look at each new project on its own, without considering how it fits in with other projects and goals.
If you want to be successful in innovation, it's important to focus on the big picture, not just individual projects.
By taking a "portfolio" approach, you can spread out the risks and rewards of innovation. This means testing out lots of different ideas, and not getting too hung up on any one of them.
It's like having a bunch of different investments, so if one doesn't work out, you have others to fall back on. Over time, this approach can help companies become more successful and innovative over the long haul.
Let's learn how to balance our ambitions with data, ensuring that our innovations are not just groundbreaking but also make economic sense.
4. ROI innovation management
Innovation management involves effectively overseeing projects to drive new value and growth within a company. Essentially, it’s about coming up with new and better ways of doing things. Metaphorically speaking, it’s like taking care of a garden — you need to oversee different areas and make sure everything is growing in the right direction.
With innovation management, you measure things like:
How risky is it?
How much could this potentially help the company?
How long would it take?
How much would it cost?
You then use this information to decide which project to continue and which to retire. The overall goal of innovation management is to re-risk ideas through systematic market testing and validation of underlying hypotheses about their:
Desirability: do they want it?
Feasibility: can we build it?
Viability: will it be profitable?
Adaptability: is it fit for today’s context?
This structured approach helps organizations avoid the common pitfall of basing decisions on intuition alone, which can lead to investing in projects without validated potential.
Time horizons for different innovations
When leaders invest in innovation, they want to know how long it will take to see results. Usually, projects focusing on improving current products or services will show results faster than projects aiming to create something entirely new. However, it's important to remember that innovation can take different forms, and the time it takes to see results will depend on the type of innovation.
Some types of innovation focus on making things more efficient, while others aim to create something completely transformative.
Usually, projects focusing on improving current products or services will show results faster than projects aiming to create something entirely new.”
The three types of innovation along the Explore - Exploit contiuum.
Three types of innovation
Innovation can take various forms, each impacting a company's growth differently. They are:
1. Efficiency innovation means improving a company's operations, distribution, or processes. These changes can make the company more effective and help it save money. The benefits of such innovations are usually seen within a year.
2. Sustaining innovation refers to creating new products or services that are meant for existing customers. This type of innovation can also involve new ways of delivering products or expanding into new regions. The benefits of these innovations are usually seen within 1-2 years.
3. Transformative innovation is about exploring new opportunities that can help a company grow substantially. This involves creating new business models or offering new types of products or services. The benefits of these innovations take longer to materialize and are usually seen within 3-5 years.
Getting your innovation accelerator up and running
When it comes to building innovation engines and propelling new growth, many companies hesitate to begin this journey, believing it requires hefty investments or a large hiring spree.
Here’s the good news:
It doesn’t have to be expensive — there is a cost-effective way to do this.
Any large company with the right leadership and mindset can get an innovation engine up and running in as little as 90 days.
Many businesses have a way of planning that works best when things are predictable. However, with the changes and uncertainties of today's world, it's better to use a strategy similar to how investors support startups.
This approach involves making investments in stages instead of one big investment, and being open to changes in plans and accepting them as opportunities to learn and grow.
To succeed, it's important to work closely with your teams, offer guidance and help shape strategies.
Achieving a 10x ROI for innovation
As a general rule of thumb, a successful innovation portfolio can be expected to produce at least 10X returns in revenues. These returns will depend on the industry, the size of the market, and other factors. But it can be used as a general rule of thumb for evaluating the success of an innovation portfolio.
Here are a few recommendations to help you get there.
A balanced portfolio to meet your growth ambitions
The journey to a 10x ROI involves strategic portfolio management and a nuanced understanding of risk and return. We recommend a balanced and dynamic approach to portfolio management depending on your growth ambitions, with projects that produce quick wins (efficiency), intermediate returns (sustaining), and long-term transformative successes, as shown in the graph below.
Leaders can play a key part in keeping the company resilient by balancing the s–curve by finding the right balance and mix of innovation projects in their portfolio. If your growth goals are more conservative you can opt for more quick wins from efficiency innovation. If more ambitious, aim to build a portfolio of projects focusing on new value propositions and business models with long-term impact
The Return on Investment in years of the three types of innovation.
Make many small bets
Contrary to popular belief, making big bets is not the best way to succeed in business. Instead, successful innovation is achieved by making numerous small bets and gradually increasing investment in the ideas that show promise.
This is a common practice in Venture Capital that allows companies to identify bad ideas and teams that are not capable of moving forward.
The misconception that big bets are necessary often leads companies to pour all their resources into one idea, when they should be spreading their investments across many small ideas and gradually increasing investment in those that show potential.
A structured approach to eliminate projects that don’t show traction
Not all ideas are good ideas. However, it's important for teams to focus on ideas that align with their company's goals and innovation guidelines.
If they work on random ideas, it may be harder to get support to bring those ideas to life. So, it's important to prioritize and focus on ideas that have the best chance of success.
5. Measuring innovation ROI—how to measure innovation ROI
Innovation is critical to business growth and requires investment. But how do you measure the return on investment in innovation?
To measure innovation ROI, you need to track four essential metrics:
Revenue potential: sets the financial stage
Innovation risk: gauges the confidence derived from risk reduction
Money spent on testing: measures investments, including time and expenses
Time spent on testing: underscores the project's developmental journey
These metrics help you understand the financial potential of your innovation, the risks involved, the resources invested, and the developmental journey of the project.
The role of metered funding in retiring projects
If you find that some of your projects are not working out, it's important to have a plan in place to retire them. The best way to do this is by using a systematic approach based on evidence.
The funnel model can help you evaluate your ideas at each stage, so you can identify which projects lack evidence and retire them. As your projects progress, you will accumulate more evidence that can help you decide whether to continue or stop.
When you're working on a project, it's important to make sure that you're focusing your time and resources on things that are going to be successful. To do this, you need to make smart decisions based on information and evidence. This process involves researching and testing your ideas, making sure that they're valuable to customers and that they can be scaled up.
By following these steps, you can make sure that you're on the right track and that you're working on things that will be successful in the long run.
Evidence-based decision making
When it comes to coming up with new ideas, it's important to follow a process that includes three main stages:
Discovering the idea
Testing if it's a good idea
Figuring out how to make it work on a larger scale
This process helps make sure that the idea is actually useful to customers and can be successful in the market.
Strategyzer’s Innovation Project Scorecard can help guide this process. It helps keep the project on track and ensures that evidence supports the idea well. The more evidence there is to support the idea, the less risky it is. It helps ensure the idea is aligned with what customers need and the market demands.
Innovation can take different forms, and the time it takes to see results will depend on the type of innovation.
6. ROI innovation examples in various industries
ROI Innovation in healthcare
The healthcare industry is always looking for new and innovative ways to improve the lives of patients. One great example of this is the story of BioCity, a company that was able to create better healthcare solutions by focusing on what their customers really needed. By listening to the people who use their products and services, BioCity was able to come up with new ideas that made a huge difference for patients and doctors alike.
ROI Innovation in pharma
In the pharmaceutical industry, ROI innovation emphasizes the need for new business models beyond mergers and acquisitions to drive growth and value creation. In this case study, we shed light on the importance for pharmaceutical companies to be innovative in their business strategies if they want to be successful in the long run.
ROI Innovation for food and beverages
The food and drink industry is known for its fierce competition, and companies often need to come up with unique and innovative ideas to stay ahead of the curve. One such company that has been successful in doing so is Schreiber Foods. They have managed to keep their competitive edge by being adaptable and embracing new approaches. To keep up with the ever-changing demands of the market, Schreiber Foods has invested in new technologies and processes, which has helped them become a leader in the industry.
Investing in new ideas and innovations is a key strategy for you to grow your organization and increase profits. But it can be difficult to predict returns from untested business models and ideas.
You're very likely to face two different worlds when it comes to investing: one that involves tried and true methods, and one that requires taking risks on new and innovative approaches. Innovation teams also play a crucial role in creating value for their organizations.
Some companies focus on running their current successful businesses. They know what works and what doesn’t work, so they try to keep doing what works and keep growing their business.
Others are trying out new ideas and business models that haven't been launched yet. There's a lot of uncertainty, so their goal is to find a good business idea that will work.
When it comes to investing in the current successful business, you can expect steady returns and dividends. Your team has the data necessary to calculate ROI, so it makes sense to base investment decisions on the expected ROI for each project.
However, things are different when investing in new ideas and business models. You can't always predict which new idea will be successful, so the financial philosophy here is more about venture capital-style risk-taking and accepting failure while expecting a few outsized winners. Therefore, the rate of return has to be calculated based on the entire portfolio of projects (i.e., Return On Portfolio).
Sure, investing in innovation can be a bit tricky—yet much needed. It's important you know what type of project you are investing in, set realistic expectations about how much you can earn from your investment, and ask the right questions at the right time. It is only by doing so that you can make informed decisions that can help you achieve your goals.
8. Further innovation tools and training courses
Strategyzer training programs
Train yourself or your team to design, test, and master innovation with our renowned tools and methods. Learn more about our self-paced training courses and our guided team training
