Is Your Company Using the Wrong Performance Metrics?
Are you a founder or corporate innovator who is seeking to demonstrate the potential of your concept by constructing a detailed five or even 10-year profit and loss (P&L) statement with associated outlooks for key business drivers? Are you developing exhaustive business cases for your nascent concept, using models borrowed from mature business lines?
Too many potentially worthy innovation investments are defeated when characterized by the wrong metrics. Metrics that, through their very precision, convey expectations of predictable year-over-year returns are, frankly, nonsensical for an emerging concept where in-market experience will first be needed to gauge how the business model might perform. And CEOs and CFOs who apply traditional key performance indicators to new, emerging opportunities unwittingly set these innovations up to fail.
Using legacy performance measures to assess concepts that may have little resemblance to established products and services, or just treating innovation as immeasurable, both undermine potential opportunities. Why?
- They are based upon patterns of customer behavior that drive a business model that may bear no resemblance to yours.
- They run the risk of missing the customer behaviors that would drive your business model.
- They establish evaluative criteria that may be irrelevant to how your innovation’s potential should be assessed, therefore misleading your product and sales efforts.
The good news is that innovation is measurable. Any innovator using resources should be held accountable to establish and deliver upon performance expectations, and there are disciplined ways to introduce effective innovation metrics. Given the rate and degree of change happening across all sectors of the economy, now is the time to develop metrics that monitor and accelerate the conversion of insights and ideas into new sources of stakeholder value.
CEOs need to assign new metrics that can nurture their investments and judge them appropriately.
To that end, innovation metrics choices should meet three criteria:
- Be built on an understanding of the user and buyer behaviors that drive the business’ financials — these are the most important KPIs to identify, understand and manage.
- Be reasonable for the evaluation of potentially unprecedented offerings.
- Be able to hold their own even in zero-sum resource allocation processes.
Early in my career when I was seeking seed funding for a new concept, an executive gave me valuable advice that has stuck with me. In a presentation to this particular executive, my team and I shared copious financial analyses, including five years’ worth of P&Ls carried out to the penny. He waved aside our spreadsheets and, laughing, told us, “Don’t seek a level of precision that cannot be possible when you are looking at something so new.”
Instead, executive teams can adopt common-sense approaches to ensure discipline — the right kind of discipline — for evaluating and monitoring emerging business models.
For an early stage, new-to-market concept, what is most important is to ask the right questions, be confident in relying on judgment where facts simply do not exist, seek metaphors from other sectors or markets, and accept good enough data that can be refined along the way. Smart questions answered in fast test-and-learn cycles can help a team to derive the relevant metrics and keep innovation projects moving closer to success, or to the set-aside pile.
There is comfort in hard data. It is reassuring to see numbers in organized columns and rows with optimistic trends demonstrating success. But innovation is messy and it’s vital to explore, listen and dig into qualitative insights that could be important signals that are just too raw to quantify.
Here are questions to consider when determining the right metrics for your innovation.
1. How Big Is the Addressable Market?
As soon your team can characterize the potential audience, they can begin to estimate how many users and buyers exist. How big is the audience, in your geography, of people who represent the demographics, have purchasing ability and are reachable by your brand?
Once you have this estimate, do a gut check by taking the 1 percent test: Would a good result be to earn 1 percent share of the market? One percent market share is not easily earned. Your answer to this question is an early stage read on how valuable an opportunity you think this is, whether you want to forge ahead or rethink your vision.
2. What Would You Have to Believe?
In the absence of a rearview mirror’s worth of history, it’s better to look forward and envision market, customer, operational and other basics that would need to exist for a concept to appear reasonable.
For instance, what does the intensity of user reaction to prototypes reveal? Are you solving a functional problem, or are you also hitting an emotional chord with your audience, suggesting a willingness to change behavior? What breakthroughs can you discern by examining what is happening in other markets or sectors?
Useful answers to these questions assume the team’s ability to avoid clouding the future view of what is possible with too much knowledge of past precedents that may now be irrelevant.
3. What Are the Key Drivers of Revenue and Expenses?
In early iterations, set aside the spreadsheets and sophisticated models. Think conceptually about your preliminary assumptions regarding the business model. What appear to be the primary revenue drivers? What do your assumptions suggest about potential expense drivers?
Perhaps early on each of these will only be assigned “high,” “medium” or “low” designations to indicate importance, but not be any more quantifiable without alpha or beta test results.
4. Can You Figure Out the Unit Profit Model?
Looking at your financials at the level of one customer or one unit of product sold will force a focus on the details in a way that aggregate data simply will not. So factor into early tests, as you refine your prototype and begin to engage potential users, gathering insight to determine the unit profit model and how comfortable the team is that it can be delivered. Make this the focus of your efforts so you can establish the viability of the business model.
5. What Is the Potential to Scale?
With the confidence that you understand unit-level profitability dynamics, test for the path to scale. What will it take to attract each new customer or dollar of sales, for example, and how steep might the growth curve be? Your assumptions will need to be supported by investment in the product roadmap and sales and marketing efforts reflected in your financials. They should also continue to align with the market dynamics — number of customers, sales per customer, and so on.
Reframing — the ability to set aside beliefs and see concepts with a fresh eye — is a critical behavior to practice and perfect as you develop the right metrics for your organization’s innovation program. Executives who are able to reframe how they approach developing and applying metrics stand to increase their organizations’ innovation effectiveness.
Moreover, they will energize members of the organization who are drawn to creating the future because the right metrics can themselves be powerful motivators and enablers, just as the wrong metrics can demoralize a team of innovators and derail or diminish the important work they are pursuing.