How do you measure the productivity of your innovation investment? The goal of any R&D organization is to conceive, develop and deliver product and/or services that customers will highly value and therefore be willing to pay a margin premium.
The goal is to create innovations that customers will be willing to pay a margin premium for.
The challenge is that the standard metric for innovation value is:
R&D Productivity = R&D / Sales
Every wall street analyst calculates it and many companies talk about as if it were a measurement of an organizations ability to innovate. It's been proven that this metric is meaningless … it is NOT predictive of future success. I would put forward that a better (not perfect) metric is:
R&D Productivity = Lifetime Gross Margin / Lifetime R&D
- I'm not a big fan of using quarterly metrics (snap shot view of R&D spend and sales) to make long term decisions on R&D investment. You need to look at lifetime GM and lifetime R&D
- Gross margin is a good proxy for what R&D can impact. R&D influences the cost to invent/develop, COGS (cost of goods sold) and the willingness (by building a better mousetrap) of the customer to pay a premium for the product.
- I like looking at productivity as a multiple. In this case, we're answering the question – “For every $ of R&D, we will get back X times as much in GM”. Don't ask me why … but to me it sounds better when you can say that your getting 20x return on R&D for a given project.
Some words of caution/advice …..
- Be aware that there is an offset of R&D/innovation impact. For example, if your in biotech, the R&D you spent 5 or more years ago is impacting today's gross margin. You need to account for this offset so that you don't get misled into making decisions on bad data.
- If you are wanting to use this tool as predictive of where you should spend your R&D, you need to have a future view of the R&D spend and the gross margin over the life of a product. Yes this is hard but we never said it would easy ….
- To know if you are good, bad or just plain average, you need to do an extreme benchmark (truly understand cost, investments, etc) of your competitors to establish your industry multiples. Then do the same for yourself.
When it comes to innovation value, how do you stack up?
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