While the innovation budget is a relatively insignificant line item in the budget of most organizations, it typically receives a lot of scrutiny.
If you want to save yourselves a lot of budgeting hassle, we recommend you use the approach outlined below to determine the innovation budget needed for the upcoming year.
Getting your innovation budget right
Instead of discussing whether $100k, $1M, or $10M is needed, or that the budget should be .1%, 1% or 20% of your revenues (the latter only applies if you are Google or Amazon), follow the steps outlined below to establish how much you need to put in the budget, in order to accomplish your innovation goals.
It starts with knowing what you want to accomplish.
Create a list of the problems & opportunities you would like to address in the coming year, coming 2 years, and coming 5 years.
An example list:
- The CRM system needs an overhaul within the next 2 years
- We are losing clients in area A, need to do something about that (coming year)
- Given our sustainability promises, we must reduce our energy consumption year over year by 10% (starting next year)
- Impress our clients with a goal to go paperless by 2035
Once you have that list, then think about how much you are willing to spend on solving these problems. In other words, how painful are they? How much is it worth addressing these issues?
From the example:
- $10M for solving our existing CRM troubles
- $500k/year of revenue loss is reported from losing clients in area A
- $500k is the current annual energy bill
- $5M is a rough estimate, provided by consultants, to go paperless
Now that you have insights into what needs to be done and what solving these problems would be worth, next, determine what you would be willing to invest in each of these projects for the coming year.
- $500 for the CRM system to figure out what is needed and ready the organization for the transition
- $200k to come up with a new revenue stream/reclaim our position in area A
- $50k to reduce energy consumption with 10%
- $250k – to implement the first 5 paperless initiatives
Add up the totals from step 3.
To make the math easy, we made sure that the list of wants/needs above nicely added up to a total of $1M.
So far – a pretty straightforward exercise.
This is where most organizations stop, which is a big mistake.
You now need to apply two critical multipliers: Success rate and Overhead. These multipliers will give you a reliable number for the innovation budget you need to get these projects actually done.
Both multipliers are relatively easy to set, as they depend on the current performance of your innovation process.
The success rate is the overall success rate of your innovation process. In most organizations, this number is below 20%. That is, of all the projects you initiated last year, how many resulted in working solutions that brought in new revenue or delivered the cost savings as expected?
Below are a few examples of the multipliers that would be needed for different success rates:
10% - Multiply by 10
20% - Multiply by 5
50% - Multiply by 2
With a typical success rate of 20%, an organization would require a budget of at least $5M to ensure there are enough funds to address the challenges and opportunities identified in the $1M example above.
In addition, you have to account for overhead costs. Overhead comes from orchestrating the innovation activities. For example, it includes the salary costs of the team of people who facilitate your innovation activities.
Assuming a 10% overhead would be appropriate, it would mean that you multiply your budget by 1.1.
In the example above, this would result in a total budget of $5.5M needed to accomplish the desired results.
When I asked organizations about their innovation success rate, the firm leaders I interviewed in the past, often claimed it was around 80%-90%.
However, when I asked them how many projects they approved last year, and how many actually got executed, the numbers were quite different. For example, one manager shared with me, that of the 33 projects that were approved, 15 never truly got off the ground, and only 5 delivered tangible results. That makes for a success rate of 15%. Someone else mentioned that of the 5 big initiatives launched only 1 made it. That would be a 20% success rate.
Be honest with yourselves.
As this exercise hopefully makes clear, the multipliers are what makes innovation a costly process. Fail fast to succeed sooner can be a very expensive proposition.
For that reason, you may consider spending more on overhead, so you can provide better support to each innovation team and increase the overall success rate. For example, if you could bring up the success rate from 20% to 50%, that would be significant for multiple reasons. It is easy to see how that would make a huge difference for the organization. In addition, it would also have a major impact on the innovation budget.
Using the example above, that would mean that instead of looking at $5M after the success rate multiplier, with the improved success rate, only $2M would need to be budgeted to accomplish the desired improvements.
Even if it would take doubling your overhead cost to reduce the failure rate from 80% to 50% it would be more than worth it. In this case, $2,4M would be a realistic budget to accomplish the desired innovation goals.
And become even smarter!
With our Steering Wheel Program, we have accomplished success rates of 80% for our clients.
Using the same example above, using the Steering Wheel Program, the overhead costs would be about $26k assuming we would facilitate your 4 project teams for a period of 6 months to get from idea to the first concrete results.
That would mean that you could accomplish the list of items above for about $1.3M instead of the $5.5M or $2.4M you otherwise would need to budget to accomplish the same results.
Let us know if that sounds like an interesting proposition.