How to Cut Out Unnecessary Innovation

During a recession, companies must prioritize investments on new products and services. Here are a few how-to tips, including what to avoid

By Scott D. Anthony

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When times get tough, one of the first things we do is think about what we can do without, like cutting latte consumption from five a week to two. Similarly, companies say no to some things to conserve resources and ensure remaining resources are focused on the right things.

Companies looking to shut down some innovation efforts have to evaluate their portfolio of what's in the process. Prudently pruning this portfolio will help to ensure that resources flow to the right ones. Here's a look at two typical approaches executives often take—and a third that might work better.

Approach 1: First-Year Revenues

Some companies prioritize projects based on their first-year revenues. This helps executives answer the question: "Where are my biggest ideas?" Obviously, first-year revenues are important. But they're not all that matters. A good way to reinforce this notion is to ask a group of executives which of the following innovations they would prefer:

Innovation A came out of the gates like a bullet, racking up first-year sales of more than $200 million. A clear value proposition, clever positioning, and a strong distribution network led to market success.

Innovation B had first-year revenues of a mere $220,000. The innovation had cool technology, but the paying customer and the business model were very unclear.

It's obvious, right? Innovation A is the winning proposition. But let's reveal more information. Innovation A was Vanilla Coke (COKE). It was a line extension that largely cannibalized sales of Coke's other products. Three years after launch, fizzling demand led Coke to pull the product from the market.

Innovation B was Google (GOOG). In Google's early days, it had a technology and not much else. After a couple of iterations, though, it came up with its advertising-based business model, setting the stage for one of the greatest economic success stories of current times.

Vanilla Cokes are great, but Googles are once in a lifetime. And the trick is that many great growth businesses start small and take a few years before they start exponential growth.

Approach 2: Net Present Value

Many companies make portfolio decisions based on the "net present value" (NPV) of individual innovation efforts. That is, they project future cash flows, convert those future cash flows into present-day dollars using some discount rate, and prioritize the projects with the highest NPVs. This approach helps executives answer the question, "Which project is worth the most?"

The math behind NPV calculations is quite sensible. And NPV seems to be an attractive way to compare different types of ideas. But the actual process many companies go through to make the calculations can be problematic.

One problem: Companies' assumptions are flawed when a business is under attack. In reality, a company that doesn't innovate faces declining prospects in its core business. Another problem is that companies often want to make decisions based on "the number," or a precise estimate of a project's financial potential. When companies only consider a single scenario, they almost always feel as if they have to be conservative, leading them to prioritize "sure things" in known markets over risky ventures in new markets.

While that approach might be reasonable when a company is launching a modest line extension into a known market, a new-to-the-world solution could unfold in infinite ways. It might be worth investing in a project that appears to have negative NPV, on average, if a modest investment can highlight whether outsize returns are possible. Further, if you don't invest in the long term, you increase the odds that you will fall behind existing and emerging competitors in the next economic cycle. A company that ranks all of the projects in its innovation portfolio by NPV might unintentionally stop working on projects with the greatest long-term growth potential.

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