Driving Product Development

After achieving “The 80-20 Rule” for effective and efficient Distribution Operations in the 1980s, and the same for Manufacturing Operations by the early 2000s, leading companies are now closing in on Product Development.  Industry demand is growing for overall measures of effectiveness, efficiency, productivity, execution, innovation, and R&D-based intellectual property.

While both capital-based measures as well as revenue/income-based measures are being experimented with, and noting that certain capital-intensive industries may be best measured with capital-based measures, two revenue/income-based measures appear to be heading to widespread adoption.

Vitality Index

Bleeding-edge companies started optimizing R&D in earnest in the mid-1980s.  These companies included Northern Telecom, HP, Corning, Motorola, Apple, and 3M.  It was 3M that first recognized the need for an overall measure of innovativeness.  They created a metric named the “Vitality Index” in 1988.  It measured “new product revenues as a percent of total revenues.”  Relatively easy to calculate, the only management decision is how long a launched product remained “new.”  The letter “N,” meaning the number of years a product is new, came to represent that decision.  Most companies in industry have N = 3.  A product is new for 3 years.  But, anything goes.  I have seen N = 9 months in some Silicon Valley companies to N = 5 or 7 years if you make airplanes or battleships.  Companies with long product life cycles that include spare part sales for decades often struggle to separate highly profitable maintenance and spare parts from the newness of the product.  If you are weighing a longer vs shorter N, go with the shorter N.  A shorter N will never put as big a smile on your face at meetings, but it will always be contributing more to the long term health of your company.

GGI classifies Vitality as a measure of “Effectiveness.”  It does not have a denominator.  If new products are more profitable than old products at your company, and profit is important to your company, then the Vitality Index is one of the best effectiveness measures available today.

Revenue measures remain the most popular aggregate measures of R&D today.  Measures of R&D contribution to profit are rapidly rising over the past five years however.  Ultimately, measures of “R&D Profitability” will become equal with “R&D Revenue Production.”  For two decades, we have found it useful to utilize more mundane terminology to describe the Vitality Index with that thinking in mind.  Vitality is “the current-year sales due to products released in the prior ‘N’ years.”  We recommend equally watching “the current-year profits” due to products released in the prior ‘N’ years.”  It is this profit measure that became the numerator of the Return On Innovation metric in the early 2000s.

Return On Innovation

Some time in the early 2000s, from no source in particular, a metric with a confusing acronym started to pop up.  “Return On Innovation [ROI]” [Figure 1] is often spoken, versus using the acronym, so it is not confused with “Return On Investment [ROI].”  The former is an overall measure of R&D.  The latter is most often a measure of a specific investment, R&D or not.  For this piece, ROI is Return On Innovation.

Figure 1:  Equation For Return On Innovation

GGI classifies ROI as as a measure of “Efficiency” or “Productivity.”  It satisfies all classical Industrial Engineering definitions of Output divided by Input.  ROI may possibly be a measure of “Effectiveness” at the same time, but that is on a case-by-case basis.  The only reason to make that point is some corporations are not yet “effective” in R&D.  “Efficiency” initiatives are secondary to first achieving effectiveness.  This is especially true for R&D which has a disproportionate role in generating the future health of the company.The numerator of ROI is “the current-year profits” due to products released in the prior ‘N’ years,” as described in the last paragraph of the Vitality Index section above.  The denominator of ROI is “the R&D Investment for the same “N” length of time.”  This all seems simple enough, but industry appears to be calculating this metric at least six different ways.  The two variables are whether simply to add revenues and divide by R&D expenses, or to apply Net Present Value to the numerator and Forward Value the denominator to arrive at a singular matching calendar year ROI calculation.  Some Net Present Value the numerator but simply add the denominator figures together.  The other major permutation in calculations, assuming N=3, is whether the “year 6-5-4″ expenditures lead to the “year 3-2-1″ revenues and profits.  Some companies do it that way.  Some companies use 3-2-1 in the numerator and in the denominator.  Other companies do things like “year 5-4-3″ leads to “year 3-2-1,” or other overlapping approaches.

Companies not already calculating ROI in some fashion should examine the utility of this metric.  Just pick an approach that makes sense to your company and measure against yourself.  While ROI does not have the twenty-five year familiarity of the Vitality Index, the train is on the tracks for ROI.  Smart Wall Street analysts are already asking about the Vitality Index, and so too will they eventually ask about ROI.

Industry Penetration Of ROI & Vitality

GGI has conducted research on industry’s utilization of some 88 R&D-Product Development metrics for over a decade, surveying approximately every other year.  We began our primary research activities in 1998.

The Vitality Index is approximately 25 years old.  It is used by 56% of companies.  It is the 4th most frequently used corporate R&D metric.  It is the top “performance metric” used by R&D.

Return On Innovation is approximately 10-12 years old.  It is used by 25% of companies.  It is the 19th most frequently used corporate R&D metric.  It is the 8th most frequently used performance metric by R&D.

Adapting ROI & Vitality To Research & Advanced Development

Usage of the term “Product Development” heretofore, has largely referred to the more deterministic part of R&D related to identifying, defining, developing, and commercializing products.   Basic and Applied Research, Technology Development, and Advanced Development are activities that are more “R” than they are “D” [Figure 2].

Figure 2:  The Continuum Of Corporate R&D Strategies

Some companies include the expenses for these research-oriented activities when calculating their ROI or Vitality and some do not.  It will be a number of years still before there will be a “best practice” or “industry accepted standard” of calculating ROI or Vitality.  No surprise there my friends, this is R&D.

What is interesting however, is that with corporate increases in budgets the last few years for more research-oriented activities aimed at increasing overall innovation, is that some companies are adapting ROI and Vitality to try to get a viable measure of their research-oriented expenditures in commercial terminology - dollars and sense.  Both metrics are quite easily adapted to get a handle on the contribution of advanced development activities to the commercial product portfolio.

Adapting the Vitality Index is easiest, “% Vitality Index Containing Advanced Development Content.”  The counting problems relating to determing the products that contain advance content are managable.  Some companies are able to automate counting by intelligently linking project numbers.

GGI was among the first to adapt the ROI metric, we call it “Advanced Development Return On Innovation [ADROI]” [Figure 3].  We have also called it “Research Return On Innovation.”  Early adopting companies have been using this metric, and its variations, for about a decade.

Figure 3:  Equation For Advanced Development Return On Innovation

Adapting ROI to be ADROI is a bit trickier.  The numerator is easy.  It is the same as Return On Innovation, but only includes the profits from products with advance content.  Again, the counting challenges are manageable.  The denominator has multiple considerations.  It often needs to be adjusted to include the expenses of these research activities.  Enterprising executives work hard to minimize the ROI denominator.  And, research-related expenses are sometimes structurally reported separately for several reasons.  Then, research precedes Product Development by several years and period and sunk cost issues come into play.  Visits to Iron Mountain may be necessary.  Finally, it is important to note that all advance expenses should be included and not just the ones with content in the revenue stream.  The goal of the metric is to measure the commercial output of all those early and risky bets that were taken by top management with the goal to raise corporate innovation levels.

There are no standards yet for these “advance metrics.”  They are in their infancy.  If you are up to it, just pick a logical approach for your company and do it consistently.  Measure against yourself.  If you save your detailed numbers, you will be able to adjust them to benchmark against other companies when industry begins its adoption curve.  These areas were “sandbox” and were handled differently for decades.  Management science will improve greatly in the decade ahead in the pursuit and refinement of innovation.

For general information in this subject area please visit www.goldensegroupinc.com.
For educational events that further explore these practices, please visit our upcoming Metrics Summit or Innovation Summit.

The “Innovation Era” is causing tangible changes to R&D and Product Development measurement dashboards.  Three major trends have become clear in the past couple of years.

First,  small amounts are being shaved off traditional new product budgets and are being reallocated to advanced projects that management believes either may or will have a higher return on innovation.  These reallocations often result in double-digit increases in the budgets for highly innovative and advanced products.  For instance, say the historical budget for traditional products is 90% of R&D spending and the historical budget for more risky projects is 10%.  If 2% was shaved off the 90% and reallocated to the 10% risky, then a double digit increase in risky takes place.  As a result, measures are now needed to understand the efficacy and effectiveness of these changes in the allocation of R&D spending.  As pure innovation plays often take more time to get to market, it is becoming increasingly challenging to find metrics that capture the essence of this additional risk to determine if it is resulting in premiums in the marketplace.

Second, patents and other forms of intellectual property are becoming more important.  The ability to monetize IP has increased already and that trend is continuing.  In the next decade, the ability to transact an IP sale will begin to rival the ability to transact a product sale.  Business and product plans, and their associated decision-making processes, will evolve to weight products and their associated IP equally as potential revenue/profit streams for any given R&D investment.  Product development professionals will increase the amount that they work concurrently with their IP counterparts, and the concurrency will all start earlier in concepting and inventive processes.  These historically interfaced but not integrated organizations will become much more unified.

Third, underpinning this all is the ever growing importance of maintaining core and functional competencies.  With global knowledge doubling just about every year for the last two decades, keeping staff current on the skills of today while simultaneously building new skills for the not-very-distant future is now a necessity.  Human resource management practices are adapting to facilitate the active management of individual and department competencies.  Industry has known for years that the range of individual skills for the same job grade in the same department can differ by ten to one.  This historically touchy subject is mitigating itself somewhat and competency measurement can now be addressed with less potential repercussions.

These emerging macro trends are changing the constructs of R&D-Product Development metrics and their associated dashboards.  Frameworks of the future will need to be more robust in their ability to capture results over longer time periods, to capture results that are not measured by the sale of products, and to capture results originating from flatter knowledge-based organizations.

For general information in this subject area please visit www.goldensegroupinc.com.
For educational events that further explore these practices, please visit our upcoming Metrics Summit.

Our global citizens realizing the true and ultimate importance of “Intellectual Property [IP]” is coming none too soon. “Non-Organic” Open Innovation is rapidly growing as is “Organic” Innovation; and one also begets the other after a fashion. In a couple decades, Open Innovation will become much more embedded and produce the level of financial yields that Organic currently does. The ultimate result can only be more Generation 6 Technology Push [Exhibit A], “build it and they will come.” The incubation time is still uncertain, but we will recognize its success because it will have most of the exciting aspects of the “dot com boom” of the late 1990s.

EXHIBIT A
The Seven Generations Of Concurrent R&D-Product Development-IP Practices

While all that will be wonderful, and will hopefully help restore economic health around the globe in the coming years, there is money involved at every step. Be sure that all countries and all companies and all individuals will be a lot clearer on how to strategize, identify, create, package, value, share, trade, maintain, administrate, retire, and portfolio-manage all forms and categories of intellectual property in the not too distant future.

If trends go like the explosive US bond market of the early 1980s, and there is a Mike Milliken to boot, new forms and categories and packagings of IP will emerge during this 7th Generation [Exhibit A]. Yes, some of them will be junk too. The lion’s share however will redefine the balance of value of corporations and countries in the future, not just in the financial markets but in annual corporate balance sheets and income statements [Exhibit B]. The best companies are already making provisions for this outcome.

Exhibit B
Intellectual Property Evolution Scenario For Corporations Over Five Decades

“Deliberateness with patience” will be the best approach. To get to the other side of this “IP-Enabled 7th Generation” requires that government make changes, and not just academia and industry. So far, the prior six generations [Exhibit A] of improvement in creation functions have not had to have government cooperation to get to the other side. Ultimately IP will be freely traded and exchanged as a commodity, much like wheat or soy beans or historic cars at an auction. Industry is already trading IP in open public markets and auctions. Mutual funds and ETFs based on the estimated intellectual property content in public corporations can already be bought and sold through retail brokerage firms.

From a work method viewpoint though, Intellectual Property is still a functional-sequential process in most corporations. Worse yet is that is not clear, that when compared to other common business practices and activities, if the overall internal IP process is even a rapid functional-sequential process. IP professionals are too often brought in late in product creation processes. Packages of information are too often tossed over-the-wall to the next function responsible for handling the package. IP is too often outsourced to legal entities whose domain knowledge is sometimes so limited that it relegates IP to be an administrative activity. Too often, corporate managers view IP as a pure expense. Compartmentalization and control is the result. More balanced perceptions that also view IP as a potential source of revenue and profit are necessary.

Yes, the product developers are learning more about IP. Yes, the technical capabilities of lawyers are increasing. Yes, financial professionals have increased awareness about the value of IP. However, relative knowledge and empathy is still much like the 1980s. Engineers did not know what the manufacturing people needed to know, and the manufacturing people did not know what the engineers needed to know. The empathy for IP is still too low. The touch points between product development processes and IP processes have recently started to become clearly marked on most product development and R&D process diagrams. Persons, although often physically proximal nowadays, remain largely engaged in their own process and their specific domain knowledge. There are too few integrated and concurrent practices at this time.

In the coming decade and beyond, the “IP Pipeline” will become much more congruent with the product pipeline. It will be followed by a Sales and Marketing cycle that will look and feel just like the sale of products. Likely, many Sales professionals will be responsible for representing both at any given customer account. Responsibilities will be portrayed in a common process that is inclusive of key product and IP disciplines working in a concurrent method. Business Plans will have two revenue and profit forecast sections, one for product revenues and profits and one for the IP revenues and profits. Estimates of financial returns will be calculated individually, and as a whole — in the same business plans and decision documents. It only makes sense. After all, a great percentage of both products and IP are actually derived from the same R&D spending dollars. As well, the current R&D-Product Development decision-making executives will become inclusive of IP decision-makers in an integrated and concurrent manner at every step of the inevitably congruent pipeline.

For more information on the increasing concurrency of R&D-Product Development and IP activities, please refer to an article published in Intellectual Asset Management magazine in the November-December 2009 issue, “Integral IAM and new product processes are the future.” You may contact the publisher directly for a reprint, or download a complimentary copy here.

For general information in this subject area please visit www.goldensegroupinc.com.
For educational events that further explore these practices, please visit our upcoming Innovation Summit.

Many organizations conduct research each year to determine the absolute and relative levels of R&D Spending. Many writers and editors use this research as a barometer of the health of companies and industries. These activities are essential and should not be diminished in any way. Equally important, but much less often investigated, is the allocation of funds within an R&D budget. These changing allocations are every bit the barometer as overall R&D Spending, but are harder to research and therefore to quantify. In short, for the past few years, researchers and authors have been “flowing” with the environment of these economic times. It is popular and noncontroversial to say, “companies are being more prudent with their R&D dollars and are allocating them to shorter term incremental product additions and upgrades to existing products and product lines.” This is safe to write and it feels good to read. It is practical and Wall Street likes it, especially in difficult economic times.

What we are seeing however is profoundly different. We are seeing a clear trend, since FY2005, that companies are shifting more monies to earlier stages of development in the hope of achieving more innovative products with higher margins. Our barometer, which is the “absence or presence of processes to direct and manage earlier stage activities,” is on the rise. Primary research conducted by GGI between August 2007 and February 2008, published May 15, 2008, indicates a significant growth in “process-ware” for development activities that precede product development. Expressed as a continuum, Basic Research is followed by Applied Research is followed by Advanced Development is followed by Product Development. For most companies in most industries, the lion’s share of the budget goes to Product Development. Without being too exact or industry-specific, single digit percentages of R&D Budgets usually go to the three pre-product development activities. It doesn’t take too much financial reallocation to essentially double the budget of these three earlier activities, without significantly affecting the overall budget for Product Development. This is what we see, serious process-ware is being developed as the budgets for these three earlier stages are experiencing significant growth relative to their historical baseline. Some 75% of companies in our statistically valid primary research now have one or more tailored processes to facilitate management’s ability to direct earlier-stage innovation.

It is hard to reconcile the research of the “big houses” that report budgets being focused on incremental, enhanced, and portfolio-fill products versus our own research. If they are not incorrect and we are not incorrect, then it possibly means that a sort of bimodal distribution of R&D spending is developing. Companies are making sure there is something new each year to keep their sizzle in the marketplace while investing more than they have in the past to improve their chances of bigger bangs in the future. In baseball terms, singles, triples, and home runs are a likely future with a drop in the number of doubles being hit by the company teams.

The mix and allocation of spending is equally important to the overall level of spending when it comes to the subject of innovative products that command price premiums.

For general information in this subject area please visit www.goldensegroupinc.com.
For educational events that further explore these practices, please visit our upcoming Metrics Summit or Innovation Summit.

I would like to welcome readers to GGI’s new blog. After twenty-five years as a corporation with a few hundred published articles and citations in traditional media and press, it seems appropriate to also now author a blog. In the coming months and years ahead, we hope to capture your intellectual curiosity and some of your emotional intelligence. Readers can expect to encounter thought leadership, thought provocation, facts and data, and occassionally some humor requiring very little thought.

In the near term, GGI’s founder, Brad Goldense will be penning most of the content. Over time, we expect to find ways to integrate some of the themes of our decade-long company newsletter, “GGI RapidNews,” into this forum; including book reviews, key trends, and essential news items for professionals in leading positions.

The initial purpose of GGI’s Driving Product Development™ blog is to explore the continuously evolving techniques and technologies of product strategy, creation, development, and early commercialzation that enable corporations to achieve higher returns for their shareholders.

Call us old timers, but “value-chain” and “value-added” are terms that will always ring true and are equally applicable both intra-company and inter-company. It may not be popular or voiced very often, but top managers know that all business functions are not created equal and all business-to-business relationships as well. Sure, every business function over time will have its day in the sun. Also sure is that each business-to-business relationship will have days in the sun. But, on a day-to-day basis, certain activities require unyielding focus and attention to generate the ongoing value that ultimately propels companies to outperform their competitors.  R&D and Product Development are among the most important business areas. Focus on these activities is the centerpiece of GGI’s blog.

For general information in this subject area please visit www.goldensegroupinc.com.