Budgeting for corporate innovation initiatives can be challenging, so corporations often fall back on the subjective judgement of CEOs and their executive team about where their company stands in the overall marketplace and how they think it will evolve. To avoid this pitfall, corporates look to create a more structured approach to budgeting.
One approach is to use stage gates, says Suman Sarkar, a consultant to multinational companies at Three S Consulting in Norwalk, Conn. With this approach, each new product or service is examined at each stage of development to review if it is successful in the marketplace.
“If at any stage they are not showing results, you kill them early so that you're not spending time, energy and money on a product that is dead," says Sarkar, the author of the forthcoming book, Source, Supply, Succeed!
Tendayi Viki, a consultant at Bennelli Jacobs, a lean innovation consultancy in London, recommends another approach to innovation budgeting—Innovation Accounting. While traditional accounting methods are fine for core products, different tools are needed for innovation, Viki says.
With the Innovation Accounting approach, firms need three types of “innovation key performance indicators (KPIs)": Reporting KPIs, designed to track work as it moves from the idea stage to scale; Governance KPIs, so that companies can determine whether or not to continue to invest in a new venture; and Global KPIs, to examine the overall performance of an innovative idea in relation to the overall company.
Determining the size of your innovation budget
Budgeting for innovation often depends on how advanced products are in their lifecycle. Sarkar says it is important to know where they lie on the technology evolution curve, not only for the company but for the company's main competition. As an example, he cites the Apple iPhone, which when it launched was highly innovative, but introduced less innovation with each new iteration. That put the iPhone lower down the technology evolution curve, requiring less investment.
“A company will have a portfolio of products where you can draw these curves for your firm and the competition, allowing you to say who is getting more revenue and profits," Sarkar says. “Once you have begun figuring out where the bigger plays in the market are, you can start prioritizing your spending."
Obviously, budgeting for innovation also depends to a large extent on where a company is in its lifecycle. A tech giant like Apple, for example, spent $8 billion last year on research and development, which seems like a lot but it was only 3% of revenues. On the other hand, Square, a high-tech payments company which had its IPO last year, spent $46 million on product development in 2012, or 24% of revenues.
Most companies budget for two types of innovation: future innovation, mainly ideas that will mature 5-10 years in the future, and current innovation, which are the products going to market in the next five years.
Indeed, many startups focus all of their innovation budgets on one product and spend nearly all of their research and development funds ensuring that it will be a success in the market.
Most mature firms also spend the lion's share of their innovation budget on a portfolio of current projects because CEOs and CFOs paychecks are linked to how much money the company can make over the next five years, Sarkar says.
“Ideally most firms are spending 20-25% of their innovation fund on the future," Sarkar says. That means they are spending more money on the near term, “because that's where revenue capture comes into play and that's where executives are focused."
Sarkar offers these specific tips for budgeting:
- Estimate the size and growth potential for the markets that could be impacted by the company's products or services in the next three to five years.
- Look at the potential technology evolution in each of these markets.
- Chart the market share held by current and possible future competitors in the market.
- Determine the size and potential competitive gaps in the market.
- Assess what funding would be needed to capture the opportunity through in-house teams or by makings acquisitions or partnerships.
If you are ready to start working with startups checkout our post on 11 Tips for How to Work with Early-stage Tech Startups.
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