Selling Innovation & Experimentation To A CFO

Added on by Lauren Eve Cantor.

Building a successful innovation engine involves convincing the Chief Financial Officer (CFO) to spend money on experimentation. Yet, CFOs often perceive experimentation as wasteful, because it involves failure and learning cycles. It also involves investing in ideas that might never pay off, because that’s the only way to identify the home runs.

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We came up with six alternatives using the financial language of a CFO to explain innovation expenditures. Do you think any of these might work? How do you convince your CFO?

Six Ways to Sell:

  1. Portfolio Diversification

  2. Limit the Downside / Optionality

  3. Alpha Bets

  4. Tangible vs Intangible Assets

  5. Sharpe Ratio for Innovation

  6. Missing Out - Comparison to the Competition

1) Portfolio Diversification:

Credit:  CB Insights

Credit: CB Insights

We can’t always pick the winners.  Companies must invest in the losers in order to find the winners.  In an effort to boost managed risk taking, we need to accept that there will be failures.  On average, less than 1% of startups actually turn into unicorns.  If we invest in a portfolio of new ideas, some will succeed — remember to look at the total portfolio, not the individual components.  

Investing in the Losers:  How Many Startups Turn into Unicorns

2) Limit the Downside:

Think of innovation as a call option on future performance — limited downside with unlimited upside.

“There are investments that are made to create options for the future. Unlike a core investment in which returns can be calculated using tools like the net present value rule, options can only be looked at in terms of their potential upside versus downside. Trying to use conventional methodologies to value their future benefit to the corporation will almost always lead companies to under-invest in the innovations that might represent their salvation in the uncertain years ahead. In a healthy portfolio, a certain amount of money is set aside for options, those investments that are not of the ‘bet the company’ type but which open opportunities to see and potentially create the future.” Rita McGrath

3) Alpha Bets:  

Seeking alpha refers to making investments that achieve returns above the benchmark. Expenditures on innovation can be thought of as alpha bets:   investments in opportunity, not wasted money. Although it hasn’t necessarily paid off yet, Google’s Alphabet was created with the goal of taking such bets.

4) Tangible vs Intangible Assets:

Think of experimentation and innovation like an intangible asset: it drives future growth. The asset is a commitment to human capital/intellectual capital. Companies already institutionalize spending through R&D — take it one step further to innovation.

5) Sharpe Ratio:  

The traditional Sharpe Ratio is used to help investors understand the return of an investment compared to its risk. An innovation Sharpe Ratio might be calculated using inputs such as the initial investment (cost of experiments, time used), expected failure/success ratio vs expected potential return of new business idea.(We cover most of these terms in our Innovation Metrics.) In the end, the innovation risk could be compared to high risk investments like private equity, startups or even high yield funds.  

6) Missing Out:

While not financial language, most CFOs (and C-Suite members) are type-A personalities — motivated to win and succeed.  Use a form of peer pressure to show that by not investing in innovation, we are missing out and losing to our competition.

“What’s most interesting about the best performing firms of the past 20 years, and their ability to consistently fund big, risky growth bets, is that their management teams are experts at growth anchor removal. Whether it’s addressing finance bureaucracy, short-term incentives, a “dangerous-to-fail” culture, or capacity constraints, these companies constantly produce innovative ideas to “unanchor” their businesses.”  Channel 2E

Peter Diamandis, co-founder and executive chairman of Singularity University says 40% of today’s Fortune 500 companies are predicted to disappear in the next 10 years. Competition is no longer the multinational overseas; instead, it’s the exponential entrepreneur creating companies like Uber, Airbnb, DropBox, Oculus, Whatsapp, SpaceX and Tesla”

A staggering 75% of companies with the highest growth expectations for the coming 24 months (above 10%) also own a Division-X (or equivalent). We see this result as a clear indication of Division-X actually driving growth. Deloitte

Do you think any of these frameworks might work on your CFO?  Try selling innovation and let us know.