Corporates can achieve higher returns from digital innovation than VCs (Yes, really)
There’s a common perception that, in looking for returns from digital innovation, (whether in core, adjacent or new activities) corporates set their sights too low, stifling the potential they could achieve. Corporations are often more risk-averse than VCs who typically get 80% of their returns from just 20% of their portfolio.
A four out of five failure rate would be unacceptable in most corporate settings. Does that mean, though, that corporations should have lower expectations than VCs, who seek (but rarely find) returns in excess of three times investment over 10 years?
Actually — no.
Benchmarking data can be notoriously difficult to find for corporate innovation, but we have over 100 case studies garnered over 14 years, and we’ve closely examined two dozen of these with attributable returns in terms of market, operating or financial performance. These indicate that corporates can expect returns on average as high — or even significantly higher — than VCs.
It depends a little on the type of programme. We tend to classify these in one of three categories in our own version of the three horizons framework (table below) which has been derived, bottom-up, from our real life experience.
First, there are projects that optimise the business within the constraints of the existing business model: these are lower risk and lower return. Second, there are projects that extend: create new value and capture new customers by leveraging existing capabilities — and we expect to do this by stretching, bending, even subverting the existing business model (increasing both risk and return). The third category is projects that innovate: invent new classes of product, service and business model that satisfy unmet customer needs in new ways, with minimal or zero constraints applied by existing structures. It’s much higher risk, but in the case of a burning platform or as one part of a portfolio of reasonably good bets, that might be acceptable.
The framework is designed to encourage clear thinking about means and ends and to shift focus from cost to potential returns; to concentrate on these questions: What are we trying to achieve here in terms of business impact? Does success require a change in the business or operating model? What’s the resulting risk and how do we mitigate it? What kind of overall return can we expect? These are not horizons determined by expected time to market, but by level of ambition.
When we looked at the returns for these different categories, the results surprised us. Even an “optimise” project, where a digital product or platform is used to extend or improve an existing operating/business model, yields a return of between 1.5x and 8x investment over three years, with an average of around 3x (important caveat: these returns are based on direct costs and exclude indirect/in-house corporate costs).
That’s a really high number, well in excess of VC performance, but it’s also a bit of a wake-up call as to how easy it is to improve business performance — dramatically — through the intelligent application of a digital lever.
Of course, in one sense, a corporate innovator’s task is easier than a VC’s. We’re not starting a company from scratch (or even from Series A or B). We work with large global corporates and more mature start-ups, and so we are likely to have a huge well of client assets to draw on and exploit; and remember, there’s another caveat concerning the digital operating capability or partnership involved in product origination and development: these returns weren’t achieved by novices, but by experienced, talented teams able to keep a relentless focus on customer need and business value, and with a lean and agile approach to both design and technology delivery.
In situations where the goal is to extend — to capture new markets, exploit new channels or switch the point of value capture — the case studies tell us that the returns are similar but the risks higher.
There are no negative returns in our entire portfolio of optimisation case studies, yet two out of ten “extend” cases failed: in one case, the product failed to get to market; in the other, to scale. However, the eight instances of positive returns were absolutely critical to business success, including helping a start-up over the line to win £120m round C funding and transforming the fortunes of a global fashion brand, with a return in excess of 20x.
Two out of five innovation projects produced negative returns — still better than a VC hit rate — in both cases because leadership mis-applied old business model measures to innovation investment decisions. However the successes were dramatic, including a health and household CPG that took a strategic position in the quantified health market and an innovative casual dining brand that scaled from 12 to 94 stores to achieve a valuation of £1.3bn.
The message is clear. In an established corporate context, the greatest risk to digital transformation is the hierarchy, silos and mindset created to serve the existing business model. Experienced teams can navigate across these, so long as there’s close collaboration and high fidelity communication — and also a clear investment process. The returns then available are in the order of multiples, not increments, with a hit rate well in excess of anything VCs can achieve.
This is a revised version of an article that first appeared in the Financial Times’ sifted.eu innovation supplement in October 2021. See also the companion pieces, Corporate digital innovation needs a radically new investment process: here’s what FDs can do and also Digital Innovation Frameworks: with them you win; without them you lose.
