By Elijah Eilert
The next re-evolution
Equally to Sloan’s need for different information nearly 100 years ago, managing innovation requires us to gather information we didn’t need before. We need different information in accordance with a project’s stage within a product life cycle. It is information that, for example, enables a metered funding process, informs about perceived customer value early in the product development process and what growth engine we can expect. Information that allows us to have more agile yet comparable and accountable teams. We need a system that helps to make informed decisions about placing the maximum amount of well-measured bets on the best ideas. We need different reports about innovation projects and portfolios.
The discipline of statistics likes to extract the maximum amount of relevant information from the least amount of data. Innovation Accounting puts this principle at the heart of innovation management and uses the right information at the right time to make better decisions for innovation activities. Innovation Accounting is relevant during the search phases for new products defined by its lack of historical data that traditional accounting so heavily relies on.
Innovation’s main activity is learning. A manager’s main job might in fact be effective learning management. We are producing knowledge for the organisation, either through research or experimentation, about new ways to create, deliver and capture value. As discussed, in order to manage this, we need different KPIs. For example, we want to make sure that teams are not only learning the right thing at the right time but learning effectively and Cost Per Learning (CPL) (and Time Cost Per Learning) is a useful metric for that.
Innovation Accounting fundamentally ties money and learning together. Progress means to remove the right unknowns at the right time from a project, portfolio and strategy itself.
Information like what has been learned (Does our solution solve this particular customer problem?), how has it been learned (Smoke Test) and how much did it cost needs to be recorded. Experiment or learning report cards are nothing new for experienced Lean Startup practitioners. All report cards from all projects and portfolios together can now be thought of as constituting an innovation ledger. The more data we collect, the more accurate we can then become at budgeting future learning milestones and measuring performance. This is one example of how accounting can now do what it does best and draw on historical data to make better decisions for the future of innovation projects.
What to learn → How to learn → How much does it cost
NPV and Innovation Accounting
Of course, at some point in the innovation process, we want to include financial metrics such as NPV. It is important to note that the variables in the calculation should grow with the maturity of the product. No matter when we start demanding this calculation, Eric Ries argues that we want a system that allows for NPV to be recalculated after an experiment delivers a new data point. Combining this approach with an iterative funding model ensures a highly effective innovation budget.
Recalculating NPV each time more reliable data come in sounds logical but imagine this being done 30 times without report cards. The information used to rerun the business case are stored in a hard to find folder and a long document or over-designed PowerPoint. Once the person responsible for the document left the organisation we are not even able to schedule a meeting to understand the validity of the data point for example. Without a standard report card, this seems a lot harder and at least won’t be an easily auditable process. This is where the Innovation Ledger, containing all vital information around a new data point in a standard format i.e. report cards becomes the essential tool for costing and evaluation.
Management accounting doesn’t replace the company’s statutory requirement to report to government agencies, such as the ATO. Management accounting operates parallel to a company’s statutory obligations and serves the function of maintaining financial control and accountability to its managers. In the same way, Innovation Accounting does not replace Management Accounting; it is an additional tool. In essence, we need to understand different things at different stages of a product life cycle; break the system down just like Management Accounting does to understand the past, present and future of projects and portfolios better so we can make better decisions.
We are entering an age where companies might create their own innovation ledger. Certainly, there will be a time where managers are able to understand and create new types of reporting and companies invest more like sophisticated Angels and VC’s.
Looking forward, Forensic Innovation Accounting will be a very important job that has not yet even been imagined.
It is exciting!