Digital Solutions Are the Future of Innovation Financing, But There’s One Relic of the Past They Just Can’t Shake
Overview: Our first article in this series, “Think R&D Expenditure is a Barometer of Innovation Success? Here’s What the CEO Entrepreneur Needs to Know” outlines a new approach to the allocation of resources for innovation and the organization of innovation teams or departments. We deconstruct the decision of whether to finance and resource a separate innovation department or operate ongoing creative teams. This second article digs deeper into the actual operations of a finance department to explain how changes there can support innovation for the future.
Old Metrics Don’t Translate to New Products
As with any other business activity, companies need to track the success of their investments and ROI. When it comes to innovation investments, many companies apply the same financial metrics as they do to their core business investments. One example is the “balanced scorecard” approach developed by Harvard Business School.
The approach begins by identifying what is important for the overall success of the company (ROI, reputation for excellence, growth in market share, etc.) and deriving measurable activities that reflect these goals. The activities are plotted as a spider diagram displaying the relative strengths and weaknesses across these activities.
Typical categories include general management, research and technical staff, financial management, customer satisfaction, outreach activities, communication of services, and self-assessment. The trouble is that these metrics are often narrowly focused on short-term results and aren’t conducive to the long-term fostering of intangible creativity that is so crucial for innovation.
In an empirical study presented at the 2013 MIT Asia Conference in Accounting, researchers examined the impact of accounting conservatism on corporate innovation. The authors concluded that the problems that conservatism creates have an overall stifling effect on creative efforts:
A combination of asymmetric treatment of non-R&D activities and managerial myopia hinders innovation.
Managers often cut R&D investment to meet earnings reporting.
Firms are more likely to miss pre-determined targets because accounting conservatism stymies innovation.
Fewer patents and patent citations imply less innovation.
Cash flows are reduced and have shorter horizons.
Not surprisingly, according to the study, these negative effects are more pronounced when CEO compensation is tied to company growth and financial performance, when managers are myopic and focused on short-term profits, when firms operate in innovative industries, and when accrual manipulation (deferring expenses to meet quarterly expectations, for example) is more difficult.
Innovation Accounting – A Saner Approach
Innovation accounting defines and measures the progress of innovation, such as customer retention and usage patterns for new products or business units. Traditional accounting, on the other hand, when applied to innovation, stifles the progress of the product or business unit.
Traditional accounting tends to assume that a product is already established with revenue and accompanying expenses while new products or startups have no revenue and burn resources. Few innovation ventures stand up to scrutiny based on financial ratios or cash-flow analysis.
Eric Ries is an entrepreneur and author of “The Lean Startup.” In a video interview, he discusses his concept of innovation accounting. Ries explains that innovation accounting is designed specifically for startups, although all organizations should apply it to innovation efforts. It quantifies progress and validates learning using new metrics, not traditional ones.
Steve Glaveski, CEO and Co-Founder of Collective Campus, explains why traditional metrics don’t work when it comes to evaluating innovation. According to Glaveski, companies should ask themselves the following questions before pinning down new types of metrics:
Does an idea have the potential to disrupt or is it a low-risk, low-reward incremental improvement?
Are customers overserved or underserved by existing solutions?
Does the idea solve a problem?
Can we build it?
How steep is the competition?
Has it been done before, and what were the results?
Can we test it quickly, economically, and effectively using our existing networks and ability to prototype?
Galveski’s point is that posing these questions for each innovation and rating them as far as risk is concerned is far more relevant and purposeful than going with the following statement: “We expect this new innovation to generate 5% of our revenue growth target for the year and if it doesn’t within 6 months we’ll can it.”
Jeremiah Owyang, Founder of Crowd Companies, and Jaimy Szymanski, Founding Partner at Kaleido Insights, find that the most common metric attached to innovation program success is increased revenue. But ROI they say, if measured too soon and before an innovation kicks in, is a fallacy.
Emerging Technologies in Finance Operations
Our first article in this two-parter highlights the need to take a fresh approach to innovation and consider it a business element all its own. The first article also describes the dichotomy that exists between innovation and finance: innovation’s need to break through boundaries versus finance’s need to adhere to budgets, rules, and norms. It’s curious, then, that finance was one of the first departments to defy norms and apply software systems.
Whether this uncharacteristic early adopter behavior was an omen or not, the finance department is the “gatekeeper” to funding for every organizational department. And in this digitally charged world, companies need to bring their finance and accounting systems into the fourth dimension.
Transformation of finance and accounting means that the cloud allows clients and accountants to work from the same files, which saves time and work. Mobile apps can integrate accounting software with retailer point of sale, send contractor quotes, or provide practically any other type of function a business needs. Real-time decisions can be based on data and forecasts from digital solutions. Artificial intelligence makes accounting software smarter – finding trends and identifying the most profitable business areas.
Collaboration and team communication. Digital tools for real-time communication between virtual teams anywhere in the world are more important that a focus on technical finance skills.
A digital workforce using software robotics should replace time-consuming manual processes.
Data and analytics using big data, artificial intelligence, and machine learning provide insight generation.
Agility from cloud computing and software-as-a-service (SaaS) gives businesses and startups access to tools and enterprise resource planning at far lower costs.
Cyber security through a digital CFO can proactively address security threats.
Workforce Upskilling – From Microsoft Excel to Hadoop
In addition to a digital workforce composed of software solutions, finance staff need a different skill set, even if SaaS or outsourcing is doing much of the work. Tech-savvy, digitally versed workers are the new in-demand demographic. Data scientists who are proficient in Hadoop, Oracle, and big-data-oriented computer languages such as Scala will become exceedingly hard to find.
At a time when cyber threats are increasing exponentially, the demand for security analysts to thwart them is rocketing. The Bureau of Labor Statistics reports that the percent change in employment or security analysts from 2016 to 2026 is expected to be 28 percent. Compare that to the average change expected for all occupations at seven percent.
Analysts will be required to parse big data from machine learning tools; employees that understand the SaaS model and the private, public, and hybrid cloud environment will shoulder the responsibility of integrating new systems with existing infrastructure. Firms will need talent to integrate artificial intelligence, virtual reality, the Internet of Things, and new platforms, tools, and languages to advance their automation and DevOps.
But have we jumped ahead of ourselves on the technology front?
A 2017 report by Robert Half and the Financial Executives Research Foundation collected responses from over 1,400 financial leaders in the U.S. and Canada to assess the performance and state of accounting and finance functions. The study found that almost 70 percent of U.S. executives surveyed said that they continue to use Microsoft Excel as their primary budgeting and planning tool, which marks an increase from the previous year.
Why are companies clinging to legacy systems and trusted steeds such as Microsoft Excel? Traditional software such as Excel is creating a drag on digital transition; at a time when companies need to be more nimble, clunky infrastructure holds things back.
According to ZDNET, authors of an IFS study jokingly conclude that enterprise resource planning (ERP) really stands for “Excel Runs Production” because of a reluctance among finance departments to stop using spreadsheets. Companies are delaying investing in specialized tools because of the costs associated with implementing them and the difficulties involved in fulfilling individual project and department requirements.
The truth is that it is costlier not to embrace digital. Legacy or outdated systems take more time and impose greater risk. For example, spreadsheets need to be reworked, employees need to learn how to work around Excel constraints, there are more errors (sometimes up to almost 90 percent), broken links, and susceptibility to fraud.
According to Philip Howard, research director at European IT consultancy Bloor Research, Excel is so limiting to organizations that modeling training for the software is less about how to use its advanced features and more about helping analysts cope with its constraints, particularly when finance departments resort to solutions such as ClusterSeven, a cloud-based spreadsheet manager. The problems with ClusterSeven, for example, are that there is no audit capability, no control over changes, and data analysis is unwieldy.
Digital solutions are fast and cost-effective. What’s more, they provide the infrastructure for tomorrow’s technology and prepare financial operations for the next evolution. Not digitally transforming means slowing down financing, budgeting, accounting, and the overall innovativeness of an organization.
New solutions such as Tagetik, Adaptive Insights, and Anaplan are intelligent systems. Rather than hamper creativity, they can supplement or replace Excel, provide real-time reporting and business forecasting, and perform tasks that spawn optimal business decisions based on big data for future innovation.
Companies need to be ready for the next technological movement with the right infrastructure. Blockchain is another disruptor that portends change in every aspect of our future. It has the potential to disrupt global trade, global financing, and global supply chain management, among others. It reinvents the basic building block of commerce. The ledger is recording transactions at lightning speed, driving major banks such as Canadian Imperial Bank of Commerce, Credit Suisse, HSBC, MUFG, and State Street to experiment with blockchain.
Change is just not an option if a company wants to nurture innovation and stay relevant. Combining wisely chosen solutions with a workforce that can optimize them supports innovation efforts. For the more hesitant finance managers, the new platforms are so versatile that even the King of Spreadsheets – Microsoft Excel – can be integrated into new infrastructure.
So much for progress!