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Previous: Optimizing for innovation

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Innovation: What's your score?

By Jens-Olaf Berwig, Nathan Marston, Lauri Pukkinen, and Lothar Stein

4 September 2009

Can companies measure the impact of their innovation activities? Can they benchmark their performance on innovation against that of their peers? Can the long-term effects of innovation strategies be tracked systematically? Yes, yes, and yes. In fact, not only can companies objectively assess innovation; we believe they must. Only then will they know how to select the right strategies and execute them well.

Measuring innovation

Because innovation is the holy grail of 21st-century business, it is no surprise that many people have taken a stab at evaluating it. Typically, they focus on indicators regarding inputs (such as R&D spending) or outputs (such as number of patents filed). There are also a number of interview-based innovation assessments and rankings available.

However, these measures have some serious shortcomings. Many of them only provide a narrow view of innovation. Often, the role of successful execution or the evolution of innovation performance over time are not taken into account, and data availability remains a challenge, in particular when comparing between companies. Finally—and perhaps most important—most metrics fail to connect innovation to company performance. Furthermore, interview-based company assessments are often skewed by halo effects ¹ from other areas, such as brand image or specific products.

As a result, we propose a new way to measure innovation. It focuses on objective outcomes, is based upon publicly available data, takes a broad look at innovation, and assesses the power of good ideas over time. We are still in the early stages of applying this new concept, but the results so far have been very promising.

How do we do it? We start with McKinsey’s proprietary granularity of growth database, which contains revenue streams from more than 750 companies across 16 sectors, though the analysis could be applied to any company for which sufficient granular data is available. In many cases, we go beyond the company level by looking at data across business segments, geographies, or some other narrower gauge. We then dissect data, looking for revenue growth attributable to innovation.

To do that, we first look for revenues generated by new reporting segments within a company—either from new initiatives or from acquisitions that go beyond mere geographic expansion. This is what we call market creation (if the segment is new to the world) or market entry (if it is only new to the company). We also take into account revenues from acquisitions that lead to new products and activities, even if they are not broken out as a new reporting segment.

We then compare the revenue growth of the company to the overall market and attribute any out-performance to the company’s ability to innovate. We assume that if the company consistently outgrows the market over a significant period of time (say, five to seven years), it must be introducing new products, processes, or business models that allow it to perform better than its peers. By making these calculations over time, we eliminate the influence of short-term effects such as marketing campaigns or price cuts.

This analysis generates an innovation performance score (IPS), expressed as a percentage, which shows the compound annual growth rate for a specified period that can be attributed to innovation. For instance, in the television industry, top innovators LG, Samsung, and Sharp generated scores well above other well-known innovators. LG generated a score of 13.7 percent from 1999 to 2007, because of early and significant investments in liquid crystal display (LCD) panels, an aggressive culture, and flexibility in adapting to evolving trends.

Perhaps not surprisingly, our research so far (which covers 80 companies, mainly in consumer packaged goods, pharmaceuticals, and consumer electronics) reveals considerable differences in scores among industries. TV and telephone makers, for instance, generally score higher than beer and drug companies. We also found that business model innovation tended to generate bigger gains than product or process innovation, probably because the innovation was harder for competitors to copy and the advantage was therefore longer lasting.

In addition, for the companies we looked at, a strong IPS appears to be a reliable indicator of a company’s stock market performance. We found a relatively strong correlation (with R2 of ~0.3) ² between a company’s IPS and its total return to shareholders (TRS). This correlation is stronger than it is for other growth-related metrics—a result that suggests that innovation performance measured in IPS is strongly correlated with overall company performance.

IPS adds a new perspective to the usual discussions around innovation and growth. Choosing the right markets in which to play is critical for any company’s strategy.³ But so is figuring out how to use innovation to grow faster than competitors. That excess growth is what the IPS measures.

The lessons of IPS

Our research has revealed several insights that cut across industries and are valid throughout the business cycle.

1. We have found that strong innovators do consistently well. They achieve their success in large part (70 percent to 80 percent of IPS ⁴) by outperforming the markets that they are already in rather than by entering or creating new segments.

2, Looking at past economic downturns, such as the burst of the dot-com bubble, we found that top innovators continued to outperform their peers even during the tough times. Their agility and capacity to innovate made it easier for them to cope with the challenges. Indeed, many important products have been introduced during times of crisis. To paraphrase President Obama adviser Rahm Emanuel, these companies didn’t let a good crisis go to waste.

3. The roles of different types of innovation—product, process, and business model ⁵ — are especially interesting. While the relative importance of each will vary across industries, we found that a significant degree of business model innovation seems to be necessary for superior innovation impact.

4. There may be an optimum level of innovation. Companies with the lowest innovation performance clearly suffered in the market. However the players that have the very highest IPS aren’t always rewarded proportionally in terms of higher TRS. So, while companies must make sure that they are well-positioned in the innovation game, it’s unclear whether being a distant leader pays off in higher TRS. We are still working on this intriguing question.

Assessing corporate innovation performance

All this is interesting, but how can it be applied? We have found that understanding the details of innovation performance can help companies determine where they stand in innovation impact vis-á-vis their competition by comparing their respective innovation scores and asking the following questions: Who are the most successful innovators in my industry? Which are the most promising new markets? Are we overlooking any challengers? What has changed in our relative performance in the recent years and why?

Second, IPS can be applied internally to compare innovation performance across business units. That makes it possible to identify best practices that can be rolled out across the company and to allocate resources more productively. Taken together, this analysis provides a valuable fact base for determining future strategic options.

No question, Understanding he full dynamics of innovation performance will require additional study. But we believe that better metrics will enable companies to adjust strategies and investments and ultimately to improve their competitiveness.

¹ The halo effect is the tendency to make specific evaluations based upon other impressions related to, for example, brand, financial performance, and stock market performance. See Phil Rosenzweig, The Halo Effect:…and the Eight Other Business Delusions That Deceive Managers, New York: Free Press, 2007.

² r2 is the proportion of variance explained by a regression.

³ For more, see The Granularity of Growth by McKinsey partners Patrick Viguerie, Sven Smit, and Mehrdad Baghai (Hoboken, NJ: Wiley, 2008).

⁴ Based on a sample of about 40 companies.

⁵ A product innovation is the introduction of a good or service that is new or significantly improved with respect to its characteristics or intended uses; A process innovation is the implementation of a new or significantly improved production or delivery method; Business innovation is the creation of substantial new value for customers and the firm by creatively changing one or more dimensions of the business system, Sawhney, M. et al (2006): The 12 different ways for companies to innovate, MITSloan Management Review, vol. 47, No. 3, p. 3.

Comment [35]

Agree? Disagree? Let us know what you think. Please include your full name with your comment. Comments may be edited.

Let us take a step back and re-consider. Why is it so necessary to try to ‘measure’ Innovation? The focus on measurement may come about because of the view that what is important needs to be measured; and what is measured perhaps becomes important (hopefully correctly so). However, this thought process itself is ‘constrained’ in line with traditional thinking, antithesis of Innovation.

Creativity, Innovation, Motivation etc. need to be free of the constriant of micro-measurement. It would be better to foster an environement and then if the organization is progressing in the desired direction, it is also being innovative, apart from doing other things correctly.

Posted 9 September 2009, 06:07 by Vivek Joshi
1) What does this IPS add to the innovation part of a Balanced score card (or: didn’t you re-invent a wheel, which is a common way of waisting innovation budget)?
2) Why do you think financial measures for innovation are sufficient? It it is not just competitiveness that should be improved, but viability based on contibuting to society in general to all stakeholders (by which shareholders benefit too). See the book by Achterbergh & Vriens recently published with Springer.
3) Why do you define product innovation as ‘a new product OR service’: innovation is usually about a combination of product AND related services (a PSC or product service combination); e.g. iPod+iTunes.

Anyway: you can’t improve what you don’t measure, so making a start with the easy PI on which hard data is available, like IPS, is fine, necessary but not sufficient. The high IPS of succesful companies gives no clues to what their secret is.
To Vincente: it is not a matter of ‘this or that, but this AND that And a lot more (just read: Tidd & Bessant 2009 Managing innovation 4th ed. or Ettlie 2007 Managing innovation 2nd ed.)

Posted 9 September 2009, 03:26 by L.J. Lekkerkerk
Measuring innovation may be an interesting exercise. But — what really matters to any given organization is how many ideas were moved from concept to successful, profitable application. Unfortunately, the attrition of ideas generated in most organizations is enormous. Many, if not most, die aborning. Ask the idea people how many of their ideas that should have happened didn’t happen. Sample the research groups in places like Dupont. The news is bad. One idea in ten may see the light of day. Our organizations create their own enemies of innovation. There are three. [1] The people who generate the ideas are often inept when it comes to selling up the organization. [2] Middle management stands ready to knock off anything that promises change. [3] And top management often is extremely poor at communicating its need downward to the people who generate ideas. We know a lot about this having worked with Dupont, Hercules, ICI and others to solve the problem. So — if you want to measure innovation, measure what’s wrong with the process. We know and we know what to do about it. Others will do well to find out and take appropriate action to reduce the attrition of good, viable ideas before foreigners get the hang of it and beat us to death. If you want to talk about this, give me a call.

Posted 8 September 2009, 21:32 by Norbert Aubuchon
Good innovation planning approaches anticipate what innovation will capture the next cycle of customer needs that create wealth. Innovation planning approaches should answer the question: Where to place the bets and at what values or order of magnitude?

see

http://iphimedia.com/innovation.aspx

Posted 8 September 2009, 20:47 by Eugene Bem
The logic behind IPS makes sense. Generally companies with above average growth rates have above average TRS. Evaluation over 5-7 years will be useful to declare success/failure of the project after the fact. Isn’t the gut feel of those who support/fund the innovation an important factor? Can the gut feel of those who guided the successful innovations be modeled?

Prashant

Posted 8 September 2009, 17:33 by Prashant ranade
A lot of intelligent comment on this McKinsey article has been said here.
I like the aspect to measure innovation as its social impact is concernded too and I like the point to measure innovation internally is very important.
But: measuring innovation internally means “having data and saving data”, “Knowing what data has to be filed” and so on, in short: handling the right data right!
But what is the right data?

Anyway thanks fiscal student for the Drucker criteria! And maybe F. Vallejo has the right data to answer his questions!

Finally it is all about figures – innovation has its seeds in ideas and inventions – innovation is commercialization: quality of process from “defining the sope of the innovation project” until “after sales service” – real hard work!

And two aspects furthermore:
Often companies are not able to explain their biggest successes/outcomes with innovative products as they came unexpected though they have done market research and stuff like that as always – will this study be able to help them?

And when it comes to open innovation and the wisdom of crowds – please try to measure that – good luck!

So what is the core point: of course you can collect data on the outcome of business models, products and processes! But will that measure the seed of innovation? From the innovation managment point of view: knowing about the outcome of innovation is not sufficent – you need to know how to manage ideas and inventions also! This has to do with intellectual property, organisational and network skills and management expertise…! So the most difficult part of all is still open! Robin!

Posted 8 September 2009, 16:57 by Robin
Yet another, commonly overlooked area is that of idea management systems – those that can measure idea submissions – team/individual, the degree of on-line collaboration, idea progressions, idea to concept development, transition of ideas to working prototypes, prototypes to market.

Within this there also lies the opportunity to measure the softer issues impacting on the returns to innovation investment (ROII) such as creativity, strategic focus, appetite for risk and diversity.

Thanks for a great article

Stuart

Posted 8 September 2009, 15:28 by Stuart
Interesting study. i believe most companies especially in a country where i reside (Malaysia)would really love to get their hands on the “secret” to continuing innovation. Especially in the last 10-15 years of so, we have been trying to move up the value chain, from a manufacturing base to technology base.

i believe innovation must be supercede by creativity where by increasing the creativite ideas pool could produce innovation. i completely in agreement with mr. aubuchon, there must a commercial value to it. if i’m not mistaken, thomas edison tried 20,000 combinations before he finally came up with the right filamen. i beleive societal value is important as much as the definition for business must be changed to refelect the new global reality, instead of to maximise shareholders’ wealth, other factors like social impact and environmental impact should be incorporated in defining an innovation performance.

companies operating in different environment must come up with own definition of innovation performance to benefit the stakeholders and not only the shareholders. i am very keen to find the answer to this question.

Posted 8 September 2009, 14:02 by suhaimi ariffin
I have to agree with Roy Fuchs in that the ideology behind this is not new as he correctly states Christensen’s book clearly highlights the implications of innovation.

Furthermore Peter Drucker suggested a much simpler but possibly more affected method of measuring innovation performance.

he suggested companies should study all innovations in their field during a given time then ask the following questions

How many were truly succesful?
How many were ours?
Is our performance commensurate with our objectives? With the direction of the market? with our market standing? With our research spending?
Are our successful innovations in the growth areas?
How many of the truly important innovations did we miss?
Why did we miss them? Because we did not see them? or because we saw them and dismissed them? Or because we botched them?
How do we convert an innovation into a successful product?

Posted 8 September 2009, 13:50 by FiscalStudent
Measuring the impact, the effects of innovation, is not new. This is what not few people has been measuring when defining innovation models like Marquiss, Kline, Rosenberg, and several others. Anyway it is interesting if you collect all this data from many sectors and count it. Good Job!! However we should also measure causes of innovation.Is it a matter of good ideas or of a good process to put them into practice? or is it a matter of good partnership? or is it a matter of good communication and good managing? or is it overall a good combination of these and more factors? Invention, R&D, etc. are mainly intellectual activities whereas innovation is a social activity.

Posted 8 September 2009, 12:59 by Jose M Vicente

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