Innovation Accounting 101: The Beginner’s Guide 202111 min read
Innovation is a must for survival. Business entities are doing what they can to offer new and innovative products and services to their customers.
But how can they determine its progress and measure its success?
In this article, you will get to know more about innovation accounting and figure out how it can help companies improve innovation performance.
What is the definition of innovation accounting?
Innovation accounting refers to a set of principles, tools, and relevant key performance indicators that organizations use to collect, comprehend, and introduce information regarding the progress and success of their innovation efforts.
It enhances the entire innovation system of the company by helping its leaders measure and understand innovation by providing teams with a structure of reliable benchmarks that can project the possible success and outcomes of their innovation ventures.
Interestingly, some proposed ideas may work individually. However, doing them all at once may not only be a waste of resources but may render them infeasible.
Once this happens, innovation projects become divided, incompatible, and mismatched with the organizational structures and processes of the enterprise.
Hence, as innovation accounting establishes an uninterrupted flux of workable data, it helps executives create smarter and quicker decisions regarding innovation projects and other activities, such as:
Formulating investment decisions on innovation pursuits
Assessing the progress and success of innovation projects
Analyzing the impacts of innovation on the enterprise as a whole
Elements of Innovation Accounting
The innovation accounting system of a business must observe the following qualities:
1. Present Relevant Quantitative Data
Some decisions, particularly investments, need thorough quantitative analysis. Such numerical data helps innovation leaders decide between two various projects in the same field, inherently addressing customer preferences and needs while using a specific and detailed approach.
For instance, when two parties have distinct qualitative opinions on specific innovation issues, using relevant quantitative measures can assist in setting out differences and identifying which proposed solutions are optimal and practical for the company.
Moreover, as innovation accounting deals with numbers, it must completely complement or align with the present financial accounting system of the enterprise — all while reinforcing the growth and discovery of innovative ideas.
2. Provide Insightful and Accessible Information
Aside from providing organizations with relevant numerical figures, innovation accounting must go beyond the numbers and indicate a level of transparency and accountability in areas that are vague and unfamiliar for innovation teams.
One of the main focal points is user behavior, so it validates the necessary insights concerning the growth of the business and its likely outcomes in the next few years.
Some of the information involved in innovation accounting is the number of site visitors and converted users in a given period.
Hence, it must enable entrepreneurs to rigorously track their innovation progress through a series of insightful metrics that can evaluate the market potential of all the investments they have made for innovation projects to push through.
3. Involve Projects, Strategy, and Capability
Innovation accounting must take a look at the projects of the organization with a definite yet general perspective. It should examine whether the business has all the knowledge, capabilities, and resources required to execute innovative and strategically aligned concepts.
Gathering information about these matters is of utmost significance, especially in analyzing what drives innovation in the organization and how it impacts business entities.
In addition, innovation accounting includes data regarding pertinent proficiencies that may improve and benefit innovation performance. Examples of these are management capabilities, technical expertise, workforce skills, design capabilities, and digital competencies.
What are the benefits of innovation accounting?
Innovation accounting is advantageous for your business because:
It gives the organization a structure of interrelated metrics for measuring success.
It keeps innovation teams laser-focused on essential assumptions regarding the innovation projects of the company.
It utilizes traditional terminologies for the use and allocation of resources for innovation.
It helps businesses achieve long-term growth by administering a transparent and auditable process for funding innovation and driving value creation.
It allows a thorough examination of startups to assess continuing investments for a particular value, mirroring a set of future costs and financial results.
It has a three-level structure that provides in-built dependencies that measure three different aspects: user engagement, market readiness, and market performance.
It emphasizes innovation efforts and success for innovation teams to create projects that respond to customer needs.
It helps in identifying project development issues, encouraging collaboration and teamwork.
It provides the insights needed to have a like-for-like comparison between innovation projects.
The Levels of Innovation Accounting
Business projects and innovation projects have different attributes. However, organizations sometimes measure both projects using similar KPIs, which renders them ineffective most of the time, particularly with innovation.
Hence, business entities must treat these activities individually with a tailored set of metrics that evaluate them best. As a result, companies make dashboards that exhibit clear and simple benchmarks to assess and account for progress in financial terms.
Every dashboard defines a distinct level of innovation accounting. Here are the following:
Provided that you want to know, understand, and address the problems of your customers, focus on them and determine the following:
The number of users that reached out to you on a given period — within a week, a day, month, or year — for some product or service-related discussion
The percentage of clients that bought your products
The number of users that left you with positive or a negative feedback
A specific price range that people would be willing to pay for what you are offering to the market
This level intends to accommodate the development process of innovation with the needs and opinions of the target audience. It aims to assess the involvement of customers with products and services, giving you an idea of what works well with your clients.
Level 2: Leap of Faith Assumptions
Creating products in unfamiliar fields, or even in industries that you do not specialize in, is a leap of faith as you build innovations with assumptions. Measuring and assessing these assumptions is what the second level of innovation accounting is all about.
Assumptions from this leap of faith come in two forms: one, value hypothesis, and two, growth assumptions. Value hypothesis deals with your perception regarding the worth of your innovation in the lives of your users.
Conversely, growth assumptions focus on the opinions that new users have on new products and services. For this reason, companies design MVPs (minimum viable products), prototypes, and other validated learning activities to test both assumptions out.
The results of the tests will guide the development path of innovation.
The value hypothesis intends to check for positive user behavior, such as:
Number of repeat purchases
Customer retention percentage
The inclination of customers to pay a premium price
Growth assumptions look for indications of sustainable growth like:
The capacity of the organization to sign up new customers as a result of normal usage
The ability of the company to make revenue from one customer and invest it for customer acquisition
Word of mouth referrals
In essence, the second level of innovation accounting aims to identify whether the innovation fits the market and is ready for scaling.
If not, the results must determine what business entities must do to attain measurable thresholds that enable these variables to grow sustainably.
Once the organization achieves such thresholds, its innovations are now market-fit and set for scaling.
Level 3: Determining the Net Present Value
The business plan of an entrepreneur may set sights on a specific value within a designated period. However, the net present value of innovation or its NPV exhibits its current worth.
The NPV focuses on factors that drive the value and future performance of products and services, such as:
Website visitors in a given time frame
Percentage of visitors that became users
Number of paying users (especially with companies that release a freemium and paid version)
The average price paid by each user
Another purpose of this level is to determine how the product or service performs financially. It outlines how innovation performs over time, backed with a set of success metrics and real-time data.
What activities make up the innovation accounting process?
The innovation accounting process comprises three activities, mainly:
1. Select Indicators
Choose metrics that are simple and uncomplicated. For starters, you can select the indicators listed on the first level of innovation accounting.
However, you can also ask yourself the following questions and turn your answers into relevant metrics.
Did we achieve our objectives upon innovating?
What are the changes that these innovations have caused in the organization?
Were we able to solve the problem or even address it?
What methods of growth are we exploring?
Have our users seen any improvement in our processes or even in our products and services?
2. Monitor Applicable Data
Apply the indicators you have selected for progress and success to the three levels of innovation accounting indicated above. Gather relevant data, monitor appropriate processes, and examine advancements.
3. Put Data Into Action
Determine how your data can help your innovation performance. Work on it and plan every step out. Identify your progress and establish the direction of the project.
Find out whether product development aligns with user needs and what improvements are necessary to increase customer satisfaction.
Next steps: Determine how you can apply innovation accounting to your company via Accept Mission’s consultancy services.