CFOs often prioritise core business investments for faster and safer results, but neglecting innovation can jeopardise long-term viability. Success lies in investing in both operations and innovation, especially during economic uncertainty, writes MileZero founder, Robyn Bolton
As the CFO, you are the guardian of your company’s financial health and long-term viability. Your decisions directly impact your company’s ability to deliver quarterly and annual results, keep investors happy, and create a runway for future growth.
For this reason, you scrutinise investments and allocate scarce resources to the ones that advance strategic priorities while offering low risk and high returns.
This approach is why you are successful. It is also why you’re killing innovation.
Innovation, something new that creates value, is by nature risky. As a result, denying requests for more innovation resources is logical compared to the relatively certain ROI of investments into the core business.
This logic feels especially true in times of economic uncertainty when the instinct is to shore up the business’ foundation by cutting back on anything that doesn’t immediately offer returns.
While this approach may seem logical, research indicates that’s not the case, especially during economic downturns. In a study of 4,700 companies during three global recessions (1980 – 1982, 1990 – 1991, and 2000 – 2002), researchers found businesses “that cut faster and deeper than rivals don’t necessarily flourish”.
They also had the lowest probability in the sample of pulling ahead of competition as the economy improved. Instead, the researchers found companies that “master the delicate balance” between cutting costs to survive and investing to grow will do well after a recession.
“Within this group, a subset that deploys a specific combination of defensive and offensive moves has the highest probability—37%—of breaking away from the pack,” the research says.
“These companies reduce costs selectively by focusing more on operational efficiency than their rivals do, even as they invest relatively comprehensively in the future by spending on marketing, R&D, and new assets.”
Mastering this balance is incredibly challenging. Three essential approaches enable CFOs to do it successfully.
Defining what is and is not innovation is a critical first step in building the discipline required to be a company that repeatably generates net new growth from innovation.
While it may seem academic, defining whether innovation includes improved or only new products or services, cost-savings processes or only revenue-generating offerings, new customers and profit models in addition to new offerings, it is critical to aligning the organization on where to spend scarce resources and ensuring people understand future allocation decisions.
Defining innovation’s goal, specifically the financial return it must produce within a given timeframe is also essential. Sometimes called the ‘growth gap’, this number represents the gap between your aspiration, your current revenue trajectory, and expected returns from other growth levers like M&A and portfolio momentum.
Once the growth gap is quantified, it can be translated into revenue and EBITDA targets and cascaded down through the organization, building accountability and legitimizing resource allocation.
Innovation does not follow a linear process but shouldn’t be chaos. Start by defining your company’s ‘Innovation Playground’ – the areas where you believe there are significant growth opportunities, where you are absolutely not willing to explore, and where you are willing to explore if the data supports small investments.
Just like the definition of innovation, defining what is in and out of bounds focuses teams on the opportunities most likely to be strategically aligned with the company’s goals and deserving of financial investment.
Once your ‘innovation playground’ is defined, teams should pursue opportunities using a phased process that enables flexibility and data-based decisions.
The most successful innovation processes start by identifying and deeply understanding a customer pain point, then progress to brainstorming multiple ideas, narrowing the list to the most desirable, viable, and feasible solution, and then de-risking the solution through a series of experiments and market tests.
The burden of proof required to progress from one stage to the next phase is established up-front and reflects where the project is in the Assumption-to-Knowledge ratio.
The most effective way to manage risk is by maintaining a portfolio of investments, especially for innovation.
Research indicates that companies that “allocated about 70% of their innovation activity to core initiatives, 20% to adjacent ones, and 10% to transformational ones outperformed their peers, typically realizing a P/E premium of 10% to 20%.”
While this balance shifts a bit by industry, it serves as a helpful starting point for companies intent on using innovation as a reliable source of net-new revenue.
To maintain a portfolio that effectively manages risk, companies must invest in building a pipeline of innovation projects.
As Bill Pearson, former CFO of Nestle Waters, commented in an interview with McKinsey, “you have to treat innovation as a pipeline. It’s not about the once-in-a-while great idea.”
“It’s a regular, definable, repeatable process, and in that process some initiatives pay off earlier than others. Some pay off bigger than others, but later. That’s where the CFO comes in—to allocate resources according to the payoffs and the needs of the organisation,” he said.
Robyn Bolton is the founder and chief navigator at MileZero, an innovation consultancy that works with business leaders of to use innovation to drive repeatable growth.
