Valuation Risk versus Validation Risk in Product Innovations!
Are there good and bad innovations, as much as there are right and wrong innovations? Good v/s Bad is judgmental, but maybe there can be right and wrong, purely based on how the innovators go about innovating, which then puts us in a spot: ‘How good or How bad?’ ‘How do you rate a bunch of innovations?’
But if the destination is what really counts then does the journey really matter? If so, then what is that destination for Innovation? Is it a one-thing that fits all? The same bar for every type of innovation to go over. That’s kind of like making the ‘fastest to run 100m’ the only measure of success as an athlete — just one medal for all track & field events in the olympics!
How does one compare innovations within a given domain of technology, say IoT, AI, BioTech? Let alone figure ways to compare them across domains, sectors, scientific versus industrial, fundamental science versus applied technology?
Whilst it may be very practical to have so many types of events in the olympics, and give away gold, silver and bronze medals for each, coming up with so many categories for innovations doesn’t make sense at all.
On the other hand, even within a fewer manageable number of categories, the task of ranking innovations (under each category) based on outcomes requires that we are able to define indicators or parameters and measure them.
Our focus in FORGE is specifically around Product Innovations, and in this blog I have summed up the core issues with respect to the conventional choice of outcomes used to evaluate product innovations, and have recommended an alternative approach. An approach whose primary purpose is to ensure that the highly differentiated new product ideas don’t lose out to those with lesser degree of uncertainty because they are incremental innovations.
What are the Outcomes most critical to evaluating Innovations?
Now to evaluate such Product Innovations based on outcomes, it means that the indicators or parameters chosen should be linked to the commercial success of the product, which usually include metrics related to sales & revenues, gross margins, RoI, market size & share etc.
Let’s take the case of either an existing or a new company in the FMCG sector launching a differentiated shampoo product in the market. This product innovation is based on an innovative method of manufacturing a 100% herbal Ayurvedic shampoo that also has the usual set of benefits of synthetic shampoos.
If this product innovation were to be ranked on the basis of the outcomes I will either have to wait for a minimum of 1–2 years after it to be launched, so as to be able to measure the set of market/business oriented metrics or go with estimates of these metrics based on several assumptions. The fact that the market already has several brands of shampoos differentiated on various aspects and with very accurate sales data does make it quite possible for us to estimate the best and worst case performance of the innovative shampoo product in the market.
But what if this was the first time a shampoo product is launched in the market? Wouldn’t the estimates of its performance, even the worst case be purely theoretical? How do we then link the evaluation of such a product innovation to market outcomes (or shall we say its market potential) that are purely imaginary at best?
As another case, what if this was an attempt to launch an innovative shampoo product in a part of the world where the customers have never before purchased a shampoo? Would the estimates of the product’s market performance still hold water?
Estimating the market performance of the product innovation is possibly most accurate in the case where the innovation is in a product category that already has reasonable adoption in the market. If the product innovation is a new type of a product — as in a new product category, or is a significantly (radically) changed version of an existing category, then estimates of market performance are to be taken not with a pinch but a sack of salt.
Innovation Catch 22
Innovation should ideally be recognised for how novel the idea is, and how radically differentiated it is from what already exists today. More the novelty better the innovation! Sound logical right? However — based on the shampoo example, more novel the innovation less confidence about the estimates of its market potential.
So if we are evaluating product innovations on the basis of outcomes that are linked to indicators or parameters associated with the market/business potential, then lesser the degree of novelty or differentiation in the innovation then that much the better, because we have greater confidence in the estimates of the market potential.
In many cases (specifically hardware product innovations), innovators need money to get to that point of ‘traction’. And investors need proof for the market potential before they would invest. How does one break free from this catch 22?
Paradox in evaluating Product Innovations
If fate of Product Innovations were to be linked to market/business potential, then lesser degree of innovation is safer!
This would largely explain why in big companies, very very few radically innovative ideas get encouraged whereas the entire focus is in incremental innovations aimed at sustaining the market performance of the existing products.
But surely this doesn’t make sense at all. In the world of startups, every single day tens or hundreds of product innovations that are radically innovative get the backing of investors. However it is also true that such investors give money only after the product innovations have seen some ‘traction’ in the market.
This traction is nothing but real numbers (data) for those indicators or parameters associated with the market/business potential.
Through numbers for:
+ Target customers reached through marketing campaigns
+ Prospects for product demos or sales calls/meetings
+ Leads generated for sales closure
+ Deals closed/converted
+ Avg. Revenue per customer
and a few other such metrics, the traction demonstrates ‘proof’ for the ‘potential’.
Once the data is available, it is very much possible to compute the ‘valuation’ of the market/business potential even for product innovations that have a higher degree of novelty as compared to what sells now.
Basically, the traction takes away the risk involved in the product innovation, and this makes it attractive for investment.
In the case of big companies, new product ideas (distinctly different the set of current products) lack this data required to compute the valuation of the market/business potential and in such a situation a state of ‘analysis paralysis’ sets in, and as a result very rarely do radically innovative products get launched.
Let’s call this the Valuation Risk. And I can understand the perspective of an investor from the point of view of safeguarding his interests when putting a large sum of money into a startup.
But if we are talking about offering financial support to innovators at the very early stage, where smaller amounts of money is needed to design & develop prototypes to test the feasibility of the innovations, is it realistic to expect ‘traction’ so as to be able to assess ‘Valuation Risk’? Only very few innovators can bootstrap their way to the point of ‘traction’. There are thousand others who cannot do that on their own and we need tens of thousands more in India to come up with product innovations to solve the toughest challenges being faced all around us. Our only shot at scaling up entrepreneurship, and thereby creating a much wider base of enterprise activity leading to creation of jobs, distribution of income and generation of wealth, depends entirely on how many product innovations are launched in the market.
Surely we cannot fund all the innovative ideas aiming to solve problems. So how do we select the better ideas and back them with money so they come market ready product innovations?
We need a way to evaluate product innovations from the point of view of offering early stage innovation grants. Not only does it matter as to which ideas get funded. We also have to improve the overall batting average I.e. ensure that more of these innovative ideas become better product innovations.
There is another dimension to risk when it comes to Product Innovations, and I am calling it Validation Risk.
Understanding Validation Risk
For any Product Innovation, Validation Risk is associated with the following factors:
#1 Problem definition & Customer selection and specificity
#2 Problem significance & magnitude
#3 Motivation level of target customer to solve the defined problem
#4 Quantification & its acceptance by the target customer of the value proposition offered by the innovation
#5 Adoption barriers that will prevent target customer from experiencing the value proposition
Higher the Validation Risk, lesser the possibility that this product innovation can succeed in the market. To reduce Valuation Risk the innovator is expected to demonstrate ‘traction’ and that requires a market-ready product and money to market, sell, distribute, acquire customers, and generate revenues. However to reduce Validation Risk, one requires much less money, but sure needs skills, tools, and a structured process.
