Innovation and Performance measurement

1. Innovation and Performance measurement Dr. Ashish Garg 9 January, 2009

2. Background – Ashish Garg (Thumbnail Sketch) • Education: Ph.D in Economics from Harvard University (1997); taught graduate and undergraduate classes • 7 years with E&Y. Total of 11 years as a management consultant • Before E&Y was at McKinsey Inc. (led “R&D” type group on Strategy and Economics) • Executive Director at E&Y since July 2008 • Focus on Performance Management, Performance Measurement, Cost management , Finance Transformation etc • Author of 50 article on Management accounting, Cost management, Performance management

3. Agenda Innovation and Performance Management • Importance of Innovation • Managing Innovation • Role of the CFO in encouraging Innovation • Performance Measurement and Innovation Metrics • Suggestions on Reasearch Agenda EY Perspective Practitioner Perspective Suggestions for Research

4. EY Study: Balance Point (Innovation) Study Participants Interviews

5. Survey Respondent Titles (Number of Responses) Geographic Location (Number of Responses) Industry Sector (Number of Responses) Size—Annual Revenues (Number of Responses) Senior executives from a variety of backgrounds participated in a global online survey regarding investment in innovation Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)

6. EY Study : Balance PointBringing Discipline to Investment in Innovation and Growth • Importance of Innovation: Executives confirm innovation remains critical • Managing Innovation: Companies struggle to manage investments • Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process • Performance Measurement and Innovation Metrics : Helps focus on drivers of success • Research Agenda “If we don’t find a good way to address innovation and make use of innovation, then we will immediately fall behind in the competitive race.” Source: Ernst & Young analysis and executive interviews

7. Executives concur that future success depends upon effective product and service innovation In your opinion, what will be the top three drivers of your company’s success over the next two years? “Innovation is our number one priority as a company.” “The core of what we do and the core of how we generate growth always boils down to big innovations.” “Innovation is always important. Always.” “Innovation is, of course the name of the game in our industry.” “Markets of the future will be developed by the skilled innovators of today who commit the right balance of internal and external resources to the innovation process.” —Henry Chesbrough Percent of Responses Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

8. Large companies rate customer service higher than innovation, while smaller companies rank innovation as the top priority However, almost 90 percent of surveyed large companies indicate that innovation is more important than ever in driving success In your opinion, what will be the top three drivers of your company’s success over the next two years? Technology innovation is more important than ever in driving my company’s success Percent of Responses Percent of Responses “It’s much easier to innovate as a small company because you’re creating your own religion.” Large and small companies have somewhat differing views on the relative importance of innovation, but there is general agreement that it is an essential process Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

9. R&D Intensity by Sector 1999-2004 “In the past, we and most of our competitors would move R&D spending with revenue. The result was choppiness in the product coming out, and your products tended to come out about the same time as your competitors’ because you were all doing the same thing.” Software Semiconductors Communications Equipment R&D Spending as a Percent of Sales Sector Averages Conglomerates Computers R&D intensity has exhibited considerable volatility within segments of the technology sector over the past five years Note: R&D Spending (Percent of Sales) analysis was performed on a pool of 36 companies in five sectors. The minimum representation in a sector was five companies. Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1999–2004, via FactSet 10.10M, accessed 9 February 2004

10. Half of survey respondents are spending more than 10 percent of their revenue on R&D spending Surveyed Annual R&D Spending Intensity R&D spending measurements do not include additional sources of innovation, including: 50% • M&A activity • Joint ventures and partnerships • Externally sourced innovation and licensing fees recorded as cost of sales • Product development expenses not listed as R&D Percent of Responses “R&D spending must be smarter, not just increased. Firms must leverage the R&D investments of others, in addition to their own.” —Henry Chesbrough R&D Spending (Percent of Sales) Survey participants are committing substantial resources to theirR&D activity Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

11. U.S. Adoption Rate of Selected Technologies1920-2004 Years to achieve50 percent 9 100% Radio 6 Television 10 VHS Cable TV + DBS 35 75% DVD player 6 Internet 9 Percent of Households or Population in Year Wireless phones 16 50% Broadband na 25% na Digital video recorders 0% 1920 1926 1932 1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 The communications, media, and entertainment industries provide an example of how new technology waves are coming more rapidly “Suddenly, the rate of change has definitely increased. I see different changes and innovation paths all the time; their frequency has exponentially grown.” Note: Adoption rates are all percent of U.S. households with selected technology, except Wireless phone, which is percent of U.S. population; Years to achieve 50 percent is number of years needed to reach 50 percent adoption, beginning when technology was adopted by at least 1 percent of U.S. households or population Source: Ernst & Young analysis; “Statistical Abstract of the United States,” U.S. Census Bureau, various years; “Historical Statistics of the United States, Colonial Times to 1970, Doc 93-78, 1920-1970,” U.S. Census Bureau; “Falling Through the Net II: New Data on the Digital Divide,” National Telecommunications and Information Administration, 28 July 1998; “Communications Industry Forecast & Report,”Veronis Suhler, July 2003; “Worldwide and U.S. DVR 2004-2008 Forecast,” IDC, March 2004; “Media Trends Track,” http://www.tvb.org/rcentral/mediatrendstrack/tv/tv.asp?c=cable (citing Nielsen Media Research); “Media Trends,” Kagan, 2004; “Consumer Devices and Services Europe,” Forrester Research Inc., October 2003

12. ... but it is important to remember that customers are only one (albeit important) component of the entire value chain “If you think only about the end-user and not about the value chain along the way, you might have the best product in the world, but it might never make it to market.” “To get ideas, you ensure that your engineers spend time out with customers, or in our case, our customer’s customers.” “When we talk about customers and being customer-focused, we usually mean the companies that we are selling our technology to. But our role with respect to innovation management is to make sure that we get to the end-user.” Surveyed companies believe they are closely aligned with their customers ... My company’s technology innovation investment decisions are aligned closely with the needs of our customers Percent of Responses Technology companies are striving to align investments closely with customer needs, while also balancing the requirements of other key stakeholders Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152)

13. R&D intensity (measured as a percent of revenue) appears to be correlated with lagged EBITDA margins R&D Intensity versus EBITDA Margin “You don’t invest today for revenue tomorrow. You invest today for revenue that’s probably quite a few years out.” “The bill for innovation is getting steeper. I’m getting more anxious about it, and I can’t tell for several quarters whether I’m doing anything right. We’re going to have to wait for a long time to find out.” EBITDA Margin, Two-year Lag to R&D Spending (2000-2004) R&D as a Percent of Revenue (1998-2002) Financial analysis indicates a positive relationship between R&D intensity and profitability, with some outliers Note: Each plotted point represents a sectoral view of profitability for one of five technology industries (computers, semiconductors, communications equipment, software, and conglomerates). Observed EBITDA margin is lagged two years (e.g., 2001 R&D intensity is compared to 2003 EBITDA margin). The R2 of the trend line is 0.40. Source: Ernst & Young analysis and executive interviews; publicly available financial data for selected global technology companies for the years 1998–2004, via FactSet 10.10M, accessed February 2005

14. EY Study: Balance Point Bringing Discipline to Investment in Innovation • Importance of Innovation: Executives confirm innovation remains critical • Managing Innovation: Companies struggle to manage investments • Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process • Performance Measurement and Innovation Metrics :Helps focus on drivers of success • Research agenda “I don’t know that we have any best practices for managing innovation. It frustrates me a great deal.” Source: Ernst & Young analysis and executive interviews

15. Approximately 75 percent of surveyed companies indicate they have disciplined processes in place to manage innovation ... ... yet less than half indicate their ability to manage technology innovation investment is above average My company uses disciplined processes to manage investment in innovation Grade your company’s current ability to manage its investment in technology innovation Percent of Responses Percent of Responses “We have an integrated risk and opportunity management system.” “We don’t have control of our R&D projects yet.” Many companies see room for improvement in their ability to manage investment in technology innovation Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

16. Small and large companies report similar levels of innovation process discipline Larger companies are somewhat more confident in their management abilities, but over 40 percent still indicate they are average or below average My company uses disciplined processes to manage investment in innovation Grade your company’s current ability to manage its investment in technology innovation Percent of Responses Percent of Responses Technology innovation management is an issue for both small and large companies Source: Ernst & Young analysis; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

17. Many companies report a lack of discipline in their end-to-end control of the innovation process ... ... but there is no clear vision of how to improve control “I don’t know that we have any best practices for managing innovation. It frustrates me a great deal.” “The go-to-market side is usually forgotten in this industry.” “We are not good at the marketing and selling of innovations, so 80 percent of the patents that are filed never become a product that you’ll see in the market.” “We hide behind the claim that it’s impractical to come up with a process, or even a collection of processes to manage innovation investment effectively. It seems that the judgment of the wise man is just as good as any kind of processes you come up with.” “The hardest thing to do is to figure out return on R&D investment.” “It’s hard to make improvements in managing innovation because there’s an old culture right now that sort of works, so people ask, ‘Why would I change this?’” There is significant frustration over a general lack of ‘best practices’ with respect to managing innovation investments The frustration over managing innovation investment creates an opportunity for a CFO to participate in the process in new ways Source: Ernst & Young analysis and executive interviews

18. Measurement must reflect the need for a certain amount of failure, especially when pursuing breakthroughs Not all innovation should be managed the same way—or innovation can be stifled “The biggest problem with internal company innovation is the lack of tolerance for failure. I don’t think corporations are well set up for people to fail at enterprises.” “We have 60 percent failures. If you measure yourself by the number of failures instead of return, you’d feel terrible.” “Going into new areas, you have to start with ten initiatives to have one that’s really successful.” “These are big bets that we’re talking about. And we know they won’t all pay, and that’s OK—they’re allowed to fail.” “Companies that are more sophisticated understand what control can do on the negative side.” “If it were up to me, I would introduce different mechanisms for managing my mature businesses and my new initiatives.” If a company is not failing at some of their innovation investments, they may not be spending enough on innovation Managing innovation is a challenge when failure is a common—and necessary—outcome Source: Ernst & Young analysis and executive interviews

19. Less than one-third of surveyed companies agreed that they excel at integrating M&A deals Companies are buying innovation in addition to developing it in-house ... “It used to be that technology companies did not look to acquisitions as a way of growing their portfolio. Now I think it’s an accepted strategic principle.” “Spin-in is another way of innovating, giving the financial motivation to the individuals in the spin-in.” ... but successful integration is the key challenge to merger success. “You’re going to have to learn how to integrate. Adding an acquisition is almost like dealing with high growth.” “You have to be humble when you’re an acquirer. Just because you happen to be fortunate enough to have the money to buy them, the fact of the matter is you didn’t buy them from a position of strength [but] because you couldn’t develop the capability internally.” My company excels at integrating merger and acquisition deals to achieve planned benefits Percent of Responses Mergers and acquisitions are increasingly a part of technology companies’ innovation strategies Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

20. Effective risk assessment is a key part of the investment decision process Understanding and communicating risks is critical to success ... “People at the project levels think their project is the most important. You want them to be that way and have that kind of passion. But they don’t always realize the damage that their lack of success may have on the company, or the risk the company is taking on their behalf.” “Good innovation management processes may not guarantee the best possible outcome, but they can maybe minimize the risk of the worst possible outcome. You can narrow the range of probability of disaster a bit.” ... but risk analysis must go beyond the financials “It’s not just the financial return, it’s also the technology risk, the marketing risk.” “There are companies that partition innovation risks, so they split up risk into market risk, or execution risk, or knowledge risk, and then assign people to assess and manage those risks. For example, the people that execute are most capable of talking about and quantifying execution risk.” Less than half of surveyed companies agreed that they used project-specific risk analysis to evaluate investment opportunities ... My company uses project-specific risk analysis to evaluate each technology innovation investment opportunity Percent of Responses “To me, if you look across the American economy, there are only two segments of the economy that probably are truly good at managing risk—the insurance industry and the financial and banking industry.” Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

21. My company has operational and legal processes in place that ensure we are fully compensated for our technology innovation investments Licensing is an important revenue stream … “One way to manage non-core innovation is to say, ‘It would cost too much to incubate, so let’s license out this technology to anybody, even competitors, who might have an interest.’” … and the choice of business model is critical … “The linkage between innovation and technology is the business model.” “We need different business models to take on different markets.” … to capture the most value from innovation “We have a comprehensive set of techniques to try to create value out of the whole portfolio.” “We are able to translate innovation into bottom-line results, and this, for me as a CFO, is the key target.” Percent of Responses Effective operational and assurance processes are needed to ensure that companies are not ‘leaving money on the table’ Companies seem to be focused on processes to ensure that they are fully compensated for their investments in technology innovation Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

22. My company uses leading analytical tools to help make and track technology innovation investment decisions Companies see the need to enhance ‘gut feel’ decision-making ... “In the end, somebody needs to sign on the dotted line, and it comes down to a ‘gut feel’ whether to move forward or not. But you are enriching your ‘gut feel’ by exposing it to various scenarios and various analytical techniques. You are looking at the picture in a multi-faceted way, and hopefully you make a better choice.” ... and look to Finance for help “You need the fundamental tools—transparent numbers—so that somebody can sit down and assess the risk equation.” “Most companies track the money they spend, and some track the time they spend, but few are tracking the risk they incur. Leading companies deploy analytical tools and control processes that address all three.” —Henry Chesbrough 47% Percent of Responses Leading edge Analytical tools and techniques to make better decisions are not used to manage innovation Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

23. The use of leading analytical tools is highly correlated with a company’s ability to effectively monitor investment performance, as survey respondents answered these two questions similarly My company’s technology innovation investment results are monitored closely against the original decision analysis, and any variances are understood My company uses leading analytical tools to help make and track technology innovation investment decisions “When you depend on individual visionaries for innovation decision-making, you have the chance of hitting it big. But even a simple process like collecting the best opinions of the people in the various fields and making a rational, analytical kind of assessment would help—but we do not practice that.” “Thirty years in Finance has taught me to halve the projected return and double the projected cost to estimate the return of a project.” “Financial discipline does not have to stifle innovation. Done well, it will drive it.” —Henry Chesbrough Companies that utilize leading analytical tools are also likely to have good processes to monitor their investment results Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses); Henry Chesbrough, Open Innovation: The New Imperative for Creating and Profiting from Technology, Harvard Business School Publishing Corp., 2003

24. Innovation portfolio reviews are critical to success ... “The sifting process, the narrowing of the competing technologies, has to occur more quickly.” ... but organizational inertia can prevent tough calls ... “It’s very challenging to cut projects because there are competing groups—sales wants what customers want, engineers are focused on technology, and the CEO and marketing are in between.” ... so fact-based decision processes are key “Sometimes you have to be the enforcer and encourage people to put an end to something that isn’t working by saying, ‘Look, I’m not going to invest any more money—it’s going down a black hole. It doesn’t matter how enthusiastic you are, you don’t have a business case.’” “There’s a real focus on what milestones are going to be accomplished on what amount of money—and the penalty for failure is terminal.” My company is able to identify and reduce funding quickly for underperforming innovation investments Percent of Responses “There should be a healthy yin and yang between the CEO and the CFO, where the CFO can close the office door and say, ‘We’ve got to have a talk about this because this particular piece of the business isn’t going to work.’” Many companies do identify underperforming investments and taking action quickly Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

25. EY Study: Balance Point Bringing Discipline to Investment in Innovation • Importance of Innovation: Executives confirm innovation remains critical • Managing Innovation: Companies struggle to manage investments • Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process • Performance Measurement and Innovation Metrics : Helps focus on drivers of success • Research Agenda “The CFO needs to be a business partner, not just a financial person.” Source: Ernst & Young analysis and executive interviews

26. Survey respondents clearly indicate the growing involvement of Finance in investment decisions ... ... however, the role of Finance in these decisions is less clear Over the past two years, the CFO and Finance organization have become more involved in the technology innovation investment process The roles of the CFO and Finance organization in technology innovation investment decisions are clearly defined 53% 74% Percent of Responses Percent of Responses “Finance should educate us technical people better about what finance does. Most engineers will think it’s just adding up numbers, and if you want to correct that simplistic view, then educate them. Otherwise, it’s just the finance guy saying, ‘We cut the plan this quarter because we’re not going to make as much money, so you can’t spend what you were planning.’” The CFO and Finance organization are becoming increasingly involved in the technology innovation investment process Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005 (n=152; graphs may not total 100 percent due to rounding and exclusion of ‘not applicable’ responses)

27. The CFO often adds value to the innovation investment process, but there is room for improvement Technology personnel are looking for a broader level of involvement from Finance ... “A lot of the time companies are flying by the seat of their pants. The CFO is cutting checks, but it’s not clear that they’re adding the kind of value they could.” “The only thing Finance tells us is, ‘We can negotiate costs down,’ and that’s a good thing, but that doesn’t make the decision any better. It could still be a terrible loss, or it could be brilliant.” “Before, Finance was more like bean counters—but now that has changed completely.” ... and for Finance to play the key intermediary role “In the future, the role of the Finance organization is to fit between the product, the support, and the field organization, and aggregate the three points-of-view into a company point-of-view—more financial modeling and advice than financial control.” “The finance person should be the one who really facilitates, monitors, and coaches the management team.” CTOs rate Finance’s contribution lower than CFOs do The CFO and Finance organization add significant value to the management of innovation investments Percent of Responses “Finance is a good sounding board because they’re totally neutral on technology—they’re not grinding an axe one way or another.” Source: Ernst & Young analysis and executive interviews; “Ernst & Young’s Global Innovation Investment Survey,” 2005

28. ANALYTICAL TOOLS FOR MANAGING INNOVATION To test how competitors, customers, suppliers, and other stakeholders might respond to an innovation, and the corresponding impacts to the innovator • Game theory To provide an integrated view across all dimensions of the company (product, geography, business unit) that can test the impacts of innovation investments successes and failures on the financial performance and valuation of the innovator • Enterprise planning models To test the probable outcomes of innovation investments • Simulation models To test the potential upsides and downsides of innovation investments, and help develop an innovation portfolio with relatively greater upside potential and reduced risk • Sensitivity analysis To apply portfolio theory to the balancing of the risks and returns of innovation investments • Risk portfolio analysis To utilize consistent evaluation criteria and to track investment performance against planned results and gates • Business case evaluation templates and performance tracking “The CFOs participation should be about bringing the right tools to the table.” CFOs can bring specific analytical tools to bear on the task of managing innovation

29. Short-term Return and Long-term Investment “I can do whatever you want next quarter, but you won’t like the answer a year from now.” “They want their money tomorrow.” “We have an environment these days where innovation is almost being replaced by hectic last-minute improvements.” “An innovation might be a little revenue in three years, but the revenue tail could grow exponentially, not linearly.” Opportunity and Risk “You need the fundamental tools—transparent numbers—so that somebody can sit down and assess the risk equation.” “It's not a ‘Let’s see what happens’ bet, it’s a ‘Let’s bet the farm’ bet.” “It’s not just the financial return, it’s also the technology risk, the marketing risk.” “You want to be in control of your own destiny as much as possible.” and Innovation Creativity Financial Discipline “Engineers are really focused on delivering the next degree of functionality just for the beauty of delivering it.” “I think that the CFO’s participation should be about bringing the right tools to the table to assess the financial aspects of innovation investment.” “The hardest thing to do is figure out return on R&D investment.” “You need to make milestone reviews as objective and as measurable as you can.” Finding the ‘Balance Point’ across multiple innovation investment processes is the key challenge for technology executives Source: Ernst & Young analysis and executive interviews

30. Practioners Perspective • Importance of Innovation: Executives confirm innovation remains critical • Managing Innovation: Companies struggle to manage investments • Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process • Performance Measurement and Innovation Metrics : Helps focus on drivers of success • Research agenda “Provides a tactical understanding of organization’s value drivers” Source: Ernst & Young analysis and executive interviews

31. Measurement of Innovation remains a challenge for Organizations The kinds of innovation companies take up are diverse. Yet no matter what form of innovation they pursue, far fewer companies measure it than pursue it. Sources: McKinsey Global Survey Results – Assessing innovation metrics

32. Value of Metrics within Business Performance Management • Locks measures into strategy and value • Helps define management dialogue upwards and management focus. • Forms the basis for performance evaluation • Helps to set expectations for reporting and planning level of detail • Incent the desired behavior Re-Align

33. ILLUSTRATIVE Metrics Fundamentals Within the organization, metrics are both used to focus the dialogue upward and provide management oversight downward Dual Metric Roles 1. Management Dialogue – Metrics serve to focus discussion of business results with upper management / the investment community “The Street” Management dialogue Corporate Management dialogue Cascaded / linked metrics Management focus BUs Management dialogue Management focus Geographies Management dialogue 2. Management Focus - Metrics should focus on critical measures needed to manage your business Management focus Functions Metrics should therefore be cascaded to enhance the dialogue and scorecards are the key performance tracking format for metrics

34. E&Y’s 4 step process of creating and sustaining measurable organizational value through metrics 1 2 3 4 Understand & Articulate Strategy Prioritize and Select Metrics Develop Outcome/Input Metrics Cascade and Embed Metrics

35. ILLUSTRATIVE Metrics should be derived from Corporate strategic objectives (Step 1) Metrics Derivation Flow Questions Why does Company X exists? Mission Steps / building blocks required to determine metrics What are Company X’s guiding principles? Core Values Step 1 What is Company X’s vision of the future? Vision What are Company X’s differentiating activities and strategic objectives? Strategy & Objectives How can Company X quantify its strategic objectives? Outcome Metrics The "few" measures of success for the company's mission and strategies Step 2 What must be done well in order to implement strategy? What are the key drivers of success? Business Driver Metrics The internal and external factors that directly influence business outcomes Sources: 1) Company X Vision: www.Company X.com/About/who-we-are/; 2) Company X Strategies: www.Company X.com/About/strategies/; 3) Corporate Scorecard Mockup

36. Measurement of Innovation: Innovation Outcome Metrics Examples: • Number of new products or services launched • Revenue growth due to new products or services • Percentage of sales from new products/services in given time period • Profit growth due to new products or services • Potential of entire new product/service portfolio to meet growth targets • Changes in market share resulting from new products/services • Net present value (NPV) of entire new product/service portfolio Outcome Metrics : Pros • Better aligns with ultimate strategic objecdtives such as Revenue, Earnings and Shareholder Value Cons : • Difficult to measure require some subjectivity Sources: McKinsey Global Survey Results – Assessing innovation metrics

37. Examples of Companies using Output Innovation Metrics • Pepsi: Number of new products with revenue over $100M launched in the last two years • Kellogg’s 17% of sales in 2007 were from products launched in the last 3 years. • 3M: 25% of revenue from products introduced in the last 5 years. Increased to 30% and shortened the period to 4 years. (Because this metric was so much a part of the culture of 3M’s innovation teams it took them only 2 years to exceed the new goal.) • HP utilizes BET (break-even time) for each new product development project as their innovation metric.

38. Measurement of Innovation: Innovation Input Metrics Input Metrics: Pros : • Easy to measure and track • Helps manage R&D spend Cons : • Might relate poorly with ultimate strategic objective Examples: • R&D spending as a percentage of sales • Number of ideas or concepts in the pipeline • Number of R&D projects • Number of approved R&D projects as a percentage of ideas in the pipeline • Number of people actively devoted to innovation • Percentage of workforce time dedicated to innovation projects • Number of innovation tools and methodologies available to employees • Number of ideas submitted by employees Sources: McKinsey Global Survey Results – Assessing innovation metrics

39. Innovation Metrics Usage Sources: McKinsey Global Survey Results – Assessing innovation metrics

40. Outcome Metric Sensitivity Analysis Market Share Organic Volume Growth Organic Net Revenue Growth Operating Income Growth ILLUSTRATIVE Gross Margin (%) Operating Income Margin (%) Discretionary Cash Flow Metrics Qualification Ranking Composite Capital Expenditures Score Evaluation Criteria Op. Income Op. Contribution Return on Invested Capital Simple 2.50 3.50 Specific 4.50 4.00 -15% -10% -5% 0 +5% +10% +15% Measurable 2.50 2.00 Percentage Change in Outcome Metric Meaningful 4.50 4.50 Actionable 3.50 4.00 Assignable 5.00 3.00 Relevant 2.00 5.00 Reasonable 4.50 2.50 Timely 3.50 4.50 Timeframe 3.50 4.50 Average Score 3.61 3.67 Guiding Principles ... Structured Process There are two broad techniques for prioritizing metrics (Step 3) Metric Ranking Methodologies Ranking Methodology Quantitative Methodology • BU and Categories should preferably use a quantitative ranking methodology for selecting metrics

41. ILLUSTRATIVE Guiding Principles ... Cascaded BU and Function metrics should include relevant cascaded Corporate metrics (Step 4) Illustrative Metric Cascade Corporate Metric Set Corporate Driver Metric 1 Corporate Outcome Metric 1 Corporate Driver Metric 3 Corporate Driver Metric 2 Corporate Outcome Metric 2 Corporate Driver Metric 5 Corporate Outcome Metric x Corporate Driver Metric 4 Corporate Driver Metric y BU Metric Set Function Metric Set BU Driver Metric a Corporate Driver Metric 3 Corporate Driver Metric 2 Corporate Outcome Metric 2 Corporate Driver Metric 2 Corporate Outcome Metric 2 Function Driver Metric a BU Driver Metric b Corporate Outcome Metric x Corporate Driver Metric 4 Function Outcome Metric x Function Driver Metric b Corporate Driver Metric y Function Driver Metric d BU Outcome Metric x BU Driver Metric c Function Outcome Metric x Function Driver Metric c Function Driver Metric e Metric originally defined at the Corporate level

42. Guiding Principles ... Structured Process Selected metrics should be embedded in the planning processes and performance reporting (Step 4) • Strategic Planning – Selected metrics will be used in the strategic planning process to form the basis for evaluating strategic options • Annual Planning – The annual planning process set targets against a larger subset of metrics due to the shorter time horizon • Forecasting – The forecasting process will update throughout the year targets for a subset of the metrics used in annual planning • Performance Reporting – All metrics will be included in the performance reporting (scorecards and drill-downs) to show actual performance against targets and last year • Compensation – Metrics will also play a role in establishing personal targets and compensation

43. Research agenda • Importance of Innovation: Executives confirm innovation remains critical • Managing Innovation: Companies struggle to manage investments • Role of the CFO in encouraging Innovation : CFOs can bring new rigor to the process • Performance Measurement and Innovation Metrics : Helps focus on drivers of success • Research Agenda Source: Ernst & Young analysis and executive interviews

44. Some Suggestions for Research Agenda • What type of innovation should companies pursue? What kind of innovation is most valuable for a company or industry ? • What should be the balance between ST and LT innovation; between opportunity and risk; between in sourced and outsourced innovation • What should the Role of the CFO/ Finance be in innovation • What innovation measures best relate with share holder value – could be industry specific. Is this a case for some standards similar to financial metrics • Compensation for innovation ? How do you compensate for less market facing research

45. Thank You Contact information • Presenter : Dr. Ashish Garg • Email : ashish.garg@ey.com • Telephone : (212) 773-8895 Links to the material • Ersnt & Young - Balance Point Survey Study - http://www.ey.com/global/Content.nsf/US/TCE_-_Balance_Point_Discipline_Investment_-_Almassy_Video_Transcript