Organizing for innovation

Calculating the Return on Investment (ROI) for an Innovation Project

In a recent online ILTA session, Jennifer Mendez, Fisher Phillips and Dr. Floor Blindenbach, Organizing4Innovation, explored how traditional financial metrics like Return on Investment (ROI) often act as innovation killers. They highlighted the limitations and pitfalls of relying solely on ROI for evaluating the potential of innovative projects.

In this blog, we elaborate on this discussion and dive deeper into the more effective approach: the Reverse Income Statement.

The Downside of ROI in Innovation

ROI and similar financial metrics prioritize short-term financial gains over long-term growth. This focus on efficiency and profitability can lead to a neglect of experimentation and exploration, which are crucial for innovation. Innovation inherently involves uncertainty and risk, and traditional ROI calculations tend to favor projects with predictable outcomes and lower risk. This discourages investment in promising innovative projects that might not have immediately clear financial benefits or that carry higher levels of uncertainty. Additionally, ROI does not capture any non-financial benefits such as improved employee satisfaction or enhanced brand reputation.

However, the major concern with ROI is the potential for manipulation. Any project can be made to appear to have a 10% return on investment with a sufficiently large spreadsheet and enough hidden assumptions. This makes it difficult to pinpoint what is amiss. It also makes it challenging to hold those involved accountable for the actual value being generated.

The Need for a Better Approach

Given the shortcomings of traditional ROI, we need a better way to determine whether an investment is worthwhile and whether a project lives up to its expectations. This is where the Reverse Income Statement methodology comes into play. Based on the principles of Discovery-Driven Planning by Rita McGrath and Ian MacMillan, the Reverse Income Statement starts with defining the desired outcome and works backward to determine the necessary investments and steps.

The Reverse Income Statement

Step 1: Define the Desired Outcome

Start with your business goal. For example, if the goal is to reduce the time spent on pro-bono cases by 15%, you first need to establish the current baseline. If 1000 hours were spent on pro-bono cases in 2023, a 15% reduction would save 150 hours.

Step 2: Determine the Investment Capacity

Next, calculate the cost savings. If an associate’s hourly cost (salary, benefits, etc.) is $100 per hour (source), saving 150 hours equates to $15,000.

This means you cannot spend more than $15,000 on a solution, including subscription, training, and other costs, if you want to have a one-year return on investment.

Step 3a: Assess Feasibility

Evaluate whether the project is feasible within the budget. For instance, if a license for 30 associates costs $10,000 and the remaining $5,000 covers training, the project seems feasible investment-wise. Leaving the question: "Will this setup save the promised 150 hours?".

If the investment is approved, the project team will be held accountable for delivering this outcome.

Step 3b: Expand the Scope

If needed, the project team may choose to expand the scope to include additional goals, such as reducing write-offs. This increases the potential investment but also raises the expected return.

Step 4: Pilot the Project

Conduct a two to four-week trial focused on pro-bono and write-offs to gather data on training demands and time savings. Especially for projects with investments of over $100k, a pilot is a great way to test if the solution is indeed able to deliver on its promise.

For example, our clients who piloted Generative AI tools often learned that additional training was needed to achieve high-quality outcomes and time savings. This kind of information is invaluable when deciding if and how to scale.

Step 5: Make an Investment Decision

Based on the pilot results, decide whether to invest fully. The team is accountable for achieving the promised savings or growth.

If successful, the ROI is green and the project team is off the hook (and should be rewarded for all its efforts!!!). Until then, the team remains in the red, and more work needs to be done.

Getting Creative with Metrics

When precise metrics are hard to find, get creative. Use measures like time saved, reductions in specific types of emails, or decline in occurrences of issues etc. Be specific in your metrics to ensure clarity and accountability.

Running Effective Pilots

To be clear, pilots are not just about giving attorneys two weeks to use a tool. They should address specific questions like whether the tool will help achieve the desired outcomes.

For Generative AI pilots for example, assess how much time was actually saved on critical tasks and whether the quality of work improved. Evaluate the pilot thoroughly and continue assessments at 6 and 12 months if you decide to proceed.

Final Thoughts

For IT and Knowledge Management managers, it is critical to ensure the project team is willing to put in the necessary prework. Without this effort, even the most promising solutions will not yield good results. Bad projects never lead to good outcomes.

By shifting from traditional ROI to the Reverse Income Statement, firms can foster a more innovative environment that prioritizes long-term growth and meaningful outcomes.

If you are interested in learning more about tracking the return on investment of innovation activities in your firm, contact us. At Organizing4Innovation, we provide organizations and individuals with the tools, insights, and support needed to become innovation leaders.

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