All sorts of ideas looking for funding cross the desks of the nation's chief financial officers. Often, these are in conjunction with a slogan along the lines of "creating an innovative organisation". The accepted wisdom is that new ideas are the lifeblood of any entity, but where to start, and more importantly, how much will it cost? The problem with innovation is that many business leaders think it is all about big ideas. And with the much-vaunted federal government 2020 summit stealing the limelight, it would be easy to think there's time to spare to come up with plenty. After all, aren't we in a decade-long boom?
But nothing could be further from the truth; the belief is those companies that can't come up with new ideas disappear. Today's cutting-edge product is tomorrow's run-of-the-mill commodity. The word innovation, itself, is rarely defined either; for the sake of this article, consider the whole innovation spectrum, from creating an entirely new business to "small, ongoing improvements and changes to maintain market share", which is how the Boston Consulting Group (BCG) describes the two extremes.
In other words, how to get a payback for the money spent anywhere along the spectrum. Companies that manage the challenge well can expect to outperform their peers by between about 1 and 16 percentage points in terms of total shareholder return.
The challenge in 2008 for CFOs of large companies is to come up with plans that allow their organisations to develop and implement new and profitable ideas as rapidly as their smaller, more nimble rivals, and to measure the results. Yet the demands of earnings forecasts and continuous disclosure, for example, tend to smother a risk-taking culture.
The malaise is not limited to Australian businesses. BCG, with access to hundreds of C-suite executives worldwide, has been measuring how far most companies fall short in this area, compared with the top performers in each industry.
In its 2007 analysis of executives in Australia and New Zealand, the consulting group finds that one-quarter believe innovation is a top priority and half include innovation in their top three concerns. Yet 50 per cent are dissatisfied with the payback on their innovation spending or, going a step back, are unaware of how to measure it.
This is a serious shortcoming. BCG's research clearly shows companies that can harness innovation outperform their peers on key financial ratios, such as profit margins and price-earnings multiples.
The senior partner with BCG in Australia, Patrick Forth, says it is not a lack of ideas that is a stumbling block, but a lack of process.
"People think innovation is unpredictable or it's whimsical. We say it isn't, it's a process," Forth says.
"In order to be a top-quartile performer, a company has to be able to get an innovation process working."
Among the top three issues blocking effective innovation in Australia is a risk-averse culture.
In a recent trip to Australia, Robyn Denholm, the Australian-born, Silicon Valley-based chief financial officer of Juniper Networks, noted the lack of an organised seed capital system here to encourage good ideas.
In the United States, such a seed capital system allowed Denholm's own network infrastructure firm to grow from a start-up in 1996, to a $US12 billion ($12.7 billion) company competing against the likes of industry giants Cisco Systems, Alcatel-Lucent and Nortel.
Some of the world's biggest companies have found ways to turn innovation into a smooth process. General Electric is an example.
GE's recently named CFO in Japan, Todd Smith, says: "When I first joined GE, it was known more as an execution culture than as an innovation culture. Not so these days, after [chief executive Jeff Immelt] decreed that all new ideas take just six months from thought to implementation."
The firm has what's called a "growth playbook", whereby each sub-business proposes items and ideas to the senior leadership, which includes the CFO, the chief executive, the chief risk officer and the chief marketing officer.
Typically, this results in four to six items each year becoming formal projects.
"There are two keys here: you must have a very disciplined process that you stick to with a clear operating framework; and you must have full involvement across the various business functions. So it can't just be a marketing effort or a finance or legal effort, but must involve all from start to finish," Smith says.
"We would start with the total market opportunity and we'd start firming up those numbers: we'd have volume and growth assumptions, the investment costs required, and losses or provisions for the product."
Like most finance firms, Smith says, GE would start on a cost-benefit - or return on investment or return on equity - calculation to work out at what level the product would be profitable, and how soon.
Smith says that while the ROE target varies among the different business units, the average would be about 20 per cent.
"But that's not a firm guideline. We may evaluate a product over a three- to five-year period, understanding we may need to make a substantial upfront investment in order to generate a more profitable product over the longer term.
"Part of what we're trying to encourage the teams to do is to innovate - to take some big swings, if you will - and that means taking chances on things that don't pan out."
Smith says a securitisation of assets is one example of a good idea that must be left until the state of the capital markets changes.
For companies that can't wait, there are other ways to get ahead. One of the most obvious is to partner with a government or university research organisation. But they are lifting their game, so CFOs need to be ready to part with some real money.
Foremost among government research organisations is the Commonwealth Scientific and Industrial Research Organisation. Its general manager of commercialisation and equity portfolio, Jan Bingley, has been responsible for turning its technologies into cash for five years, a reflection of CSIRO's push to earn more from its intellectual capital.
"In 1998, we received $5.3 million from commercialising IP; in 2007-08, we're forecasting earnings well in excess of $30 million," she says.
"Most industry sectors are very much on board with this. In fact, they say that if we don't value the technology that we transfer, why should we expect industry to value it?
"[However] CSIRO is never going to get rich from commercialisation, because we operate on the very high risk side," Bingley says. "We are not measured on ROI.
"We get about $600 million a year from the federal government, [although] it's only been over the last decade or so that we've decided to actively commercialise our work," she says.
"We have a couple of methods - straight licensing to existing industry partners is a very common one. The other is through spin-off companies that we create."
On average, Bingley says, the CSIRO creates four or five new companies each year.
"In the five years I've been here, we've set up 26 companies, and only two haven't succeeded. The big success stories based on CSIRO technologies have been Biota and Starpharma, which are ASX listed, and CAP-XX [which is listed on the AIM in London]," she says.
CSIRO has changed into a much more business-savvy outfit. Bingley says because it is risking taxpayer funds, there is an expectation that the organisation should get an appropriate share of the upside.
"This has been an interesting message for Australian industry to understand. It has changed a bit over recent years, from when CSIRO did affect great technical transfer by effectively giving [its IP] away," she says.
CSIRO's model differs from that of Sydnovate, Sydney University's commercial arm.
"I can certainly see why companies are reluctant to conduct basic research with a low probability of breakthroughs - that's the job of universities and government funding all over the world," Sydnovate director Isaac Shariv says.
"We need to come up with products and services that are competitive on a global scale, because if we don't, we'll lose, as other countries do.
"To rely on internal R&D facilities is not the ideal strategy - maybe it will work for incremental innovation, but breakthroughs are very expensive. That's where our system needs to be improved, to create the right incentive to bring in industry [players] willing to take risks."
Shariv says Sydnovate was established last year to make Sydney University's research more attractive to industry, and also to reduce the risk by providing researchers with
Sydnovate's approach is to license its IP and technology, rather than risk losing it all by selling out.
"Our preference is to work with existing companies, but it is important to create the right incentives for all parties involved. Stanford, Harvard, MIT - they generate $80 million to $100 million in royalties," he says.
Companies get access to Sydnovate's technology, on which millions of dollars have often been spent in the R&D phase, but there is no upfront payment.
"We only license IP - we keep ownership. If we were to assign it to a company, and that company were sold, then the IP would be gone. We make money when they make money, but they must commit to invest in the technology internally," Shariv says.
The other company's "staff will work on things like market research, or in the case of a new molecule or a drug, the commercial partner will be expected to take it through clinical trials, and that may cost $50 million."
A much smaller business that has taken the "innovation as a process" approach to heart is health insurance fund nib.
CFO Michelle McPherson joined nib in 2003, along with several other key executives. "We knew that with a relatively small market share - of the order of 5 to 6 per cent - we couldn't be all things to all people in terms of the existing model," she says.
The analysis was clear: although nib couldn't be the market leader, it could aspire to be the leader in a particular segment - the 20- to 40-year-olds.
So the group looked at product design, pricing, brand positioning and distribution models, and profitability. It also reviewed its servicing models - how it supported customers and how it retained them.
"Plus, we set ourselves targets for growth and we've been successful by these metrics," McPherson says.
In this, nib uses a few key measures: for the 12 months to June 2007, its net policy growth - sales less lapses - was 8.8 per cent, compared with an industry growth rate of 4.2 per cent. Although sixth in overall size, nib had the second-highest number of new policies (or 13.1 per cent of the market growth).
"In the six months to December, we've seen this continue. We were again second in overall growth, in a regulated environment," she says.
"So, were our innovations successful? In the six months to December, almost 80 per cent of our sales were what we call 'new to category' people, who previously didn't have private health insurance. That's an important metric, as it says we've developed products that present the right value proposition."
However, McPherson acknowledges nib can't take all the credit for this and points out the strength of the economy and people's high levels of income.
Nevertheless, around 33 per cent of new sales are online, compared with 2004-05, when it was only 4 per cent.
"As CFO, I have to make sure our work on pricing is not going to impede the business, but also ensure that the business doesn't race off with what appears to be a good idea in theory but won't drive our ROI," McPherson says.
The finance team provides a range of services to the rest of the business and makes sure the checks and balances are working. In many organisations, this can stifle or slow innovation and new product development.
For instance, the finance team will give other areas of the business an indication as to costing, correct to plus or minus 50 per cent.
"It's nowhere near perfect", McPherson says, "but is designed to keep the process [of developing new products] moving. Then we bring it back for a more refined idea on costing."
It's in treading this line that the finance team can show its mettle.
"The challenge", McPherson says, "is in balancing sound financial management
practices - and having the right pricing - with [the need for] working with other areas of the business to achieve our strategic goals. So that it isn't just about my area of
The company approaches this in a couple of ways. "One thing we've done, given our focus on innovation, is realign our corporate structure," McPherson says.
"For example, when looking at what the next generation of health funding products will look like, we're talking about a five- or 10-year time frame. We need to have a budget and resource allocation process that supports investment in that, even if we're not going to have an immediate return."
In other moves, nib has launched a pilot of a strategic alliance with another organisation, to provide an online life insurance product.
"There are a number of key performance indicators against which the success of the pilot will be measured, and then we'll decide whether to proceed to the next level,"
Nib provides seed funding for research into a number of projects to see if they have the potential to match its goal of driving growth in return on equity and earnings per share.
Fairfax Business Media
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