Innovations: Are you creating value or diluting your business?
Originally published on LinkedIn on Jun 8th 2022.
Innovation is exciting!
The drive for innovation is incessant. Often innovation is an engine for growth and a key tool to attempt to upset the markets we play in, to redefine the rules of the game and create an unfair advantage.
By definition innovation is exciting as we are bringing something new to our businesses and it will bring us all a new toy to play with. The question to answer however isn't around how fun it might be for us as business owners / directors / managers, but rather are we really bringing something new to the business and are we creating value or are we diluting our business (destroying value)?
Today we will look at:
Where innovation comes from?
The creation of value
The validation questions - should we really innovate or make our current assets sweat more?
Where does innovation come from in a company?
If you have been around the block a few times you will by now know that innovation can come from two main directions:
A new trend is appearing in the market that we have identified and we need to capture it (e.g.: hard seltzers and you aren't the first mover)
An idea is born from within that will allow us to create the said unfair advantage in the market (e.g.: iPhone)
In everyday language: we are closing a gap that is created in the market, we have a moment of inspiration that will change the world.
The creation of value
Regardless of where the need or idea for innovation comes from the questions to answer remain the same, and the key question is: "are we creating or diluting value?".
How do we define value?
As per the definition found in McKinsey's "Valuation", Chapter 3, "the amount of value a company creates is ultimately governed by its ROIC (return on invested capital), revenue growth, and its ability to sustain both over time". The book is one of the best reading investments you can make, and I highly recommend it.
Whilst we might be shunned away by the definition above as a complex one, it in principle isn't and it makes perfect sense: we are creating new value by creating a higher return than the cash put into creating the new growth that we can sustain over time and that has a higher return than the cost of capital invested.
Creating value in everyday business
To move away from the purely financial definition of value creation let's try to translate it into concrete, tangible, business jobs to be done:
Increased brand / product / service market penetration
Increased absolute / relative revenue
Increased absolute / relative profitability (at any given level)
The above points are familiar, and if they aren't they are very easy to understand, we can grow our business "physically" by serving more people or market segments, we can grow our business in current market segments and we can make more from current business (usually via cost and process optimisation or pricing and packaging initiatives).
The validation questions
Before launching ourselves head first into the next innovation for the market or internal process innovation we need to ask ourselves the following questions and we need to make sure we are able to answer them:
Are we addressing an unaddressable part of the market with our new proposition that we aren't able to tackle with our current offering? (If the answer is "no" we should look at other opportunities to cover the mentioned market segments with our current offering)
Are we clear on what the job to be done of the innovation product actually is for the business? (If the answer is "no" how our we going to explain the use story to the ultimate intended user if even we as business owners aren't clear on its purpose?)
Are we able to secure sufficient investment in the medium to longer term behind our new business initiatives to bridge the innovation chasm? (If the answer is "no" we might be cutting vital resources from our current portfolio to sustain the brands / products / services that keep our business on its trajectory)
Are we able to evaluate potential cannibalisation of our current offering, especially if the single unit economics are less favourable than our current business? (If the answer is "no" we need to either make a conscious decision that this is a necessity, or that we have a path to improved profitability going forward)
Do we have the internal capability and competence to handle the workload demanded by the establishment of a new brand / product / service or process? (If the answer is "no" you will be creating just new workload for the current workforce drowning your new initiatives in daily business requirements and the chances of it sticking are slim. In the question of competence - we need to make sure we have people on board with sufficient knowledge and experience to make the innovation fly)
Being able to answer the above questions is vital to the success of your innovation endeavour, or concrete arguments can be built to have a very objective and data driven discussion with the originator of the innovation idea.
Diluting your business
If the answer is a "no" to any number of the above questions and you still move ahead with the innovation initiative chances are you will be diluting your business in the medium to longer term. It will not seem so initially as the whole organisation will be pumped about it, marketing will likely make a fantastic internal campaign and everyone will look at the great top line development (volume or revenue), but when you draw the line and add up all the minuses from the other elements of the business, likely the net gain will be marginal, if a gain at all.
The idea isn't to turn anyone away from launching innovations, but rather to have a solid case on why to do it, or not to do it and to "double down" on your current business which still has room to grow in its current segments might put you in a better position to launch further down the line.
I have personally experienced, and led, both value creating and value diluting innovations. What I can tell you is that initially they were all game-changing initiatives that were going to transform the business. Some of them did, and some of them didn't and created challenges with current business sustainability that the companies had to solve further down the line.
So the point is: be brave, be bold, be informed. When you do go for it be relentless as if your life depends on it. Because the company's life just might.
If you would like to discuss your innovation pipeline and need a sparring partner in validating it or refuting it drop a line!