Innovation Accounting for Corporations
How Executives Can Measure the Return on Early-Stage Innovation
Innovation Accounting is a method to quantitatively measuring the progress of early-stage startups. By representing a new product in a quantitative, user behavior model, you can predict the return of your development efforts and whether the product will eventually be successful.
Until now, the finance department has not had the tools needed to evaluate the progress of early-stage innovation. So it’s logical why big companies have, for the past 10 years, not invested as heavily as they should in early-stage venture creation.
Discounted Cash Flow Analysis (DCF), where one discounts future cash flows of the business, is the standard weapon of financial analysis. I’ve done many during my time at the Stern School of Business. Unfortunately, they don’t prove much for early-stage ventures. Startups can be unprofitable for years, while still dramatically growing their valuation. So, how can we value an early-stage company, before it even has traction?
The Metrics Model
A Metrics Model is a quantitative model, based on how users engage with a product, which projects into the future how a product will grow and be monetized. Most models can be built by starting with the Pirate Metrics framework, but will need to be customized.
You’re going to open up Excel and start modeling out behavior from these questions:
Basic
How will my customers find me?
When they find me, how many will decide to try our product?
When they try our product, how many will be happy with it?
When they’re happy with it, how many will upgrade or pay?
Growth
How often will customers use our product?
Will increased usage lead to paying for additional services or features?
Can we become profitable quickly and reinvest profits in advertising or sales?
Is our product only usable or valuable when used with our customers friends? (viral)
Does the value of our product improve the more customers we have? (network effects)
The first model should be the ideal but achievable scenario. A simplified software-as-a-service (SaaS) subscription product might look like the below.
Once we have a model, we can build the minimum viable product (MVP). The goal of the MVP is to establish the real-world metrics that we can then plug into the model. This is called the baseline.
Now we try to close the gap between the real-world metrics and the metrics we want by building new features or improving existing ones. Through the model we should be able to identify the user behavior worth encouraging. Every week we can measure our improvements and plug them back into the model. The model shows us the real growth implications of our improvements. The faster we move towards the ideal, the faster we’re making progress.
Some products will reach a plateau, when they’re not moving closer to the ideal on a weekly basis. Or the baseline may be so far off from the ideal that it’s not worth pursuing. This is where we decide to pivot and consider other ways to achieve our vision.
The Big Picture
Innovation Accounting creates accountability and transparency in an area that was previously ambiguous. It allows entrepreneurs to measure the impact of their improvements and the financial decision-makers to to measure the macro return of their investments.
I’m writing a book with my co-author, Obie Fernandez, on corporate entrepreneurship called The Lean Enterprise.
Learn more on our book’s website:http://LeanEnterpriseBook.com
You can also follow The Lean Enterprise collection on Medium for regular updates and ideas on the subject.
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