Summary
- With experience and data, budgeting for innovation can be correlated to revenue growth. Applying innovation metrics such as vitality and RQ facilitate a predictable model with aligns innovation investment with revenue generation.
- Innovation budgets vary by industry but more so by type of innovation investment. The companies with the highest payback allocate more of their budget to transformative innovation.
- The cost of innovation is declining. Prototyping is the most lengthy and costly part of innovation, however, computer simulation, 3D printers, stereolithography, laser sintering, foamware and other malleable products are dramatically reducing prototyping time and cost.
Apple invests about 5% of its annual revenues in R&D. Facebook invests over 13%, Google over 16% and Amazon now invests more than 28% in R&D. So how much should you invest innovation?
In this blog post I'll share a few perspectives and methods to suggest how much money you may want to invest in innovation.
Aligning with Revenue Targets
Rather than an abstract investment figure, I normally recommend aligning your innovation investment with your revenue targets. Successful innovation programs leverage methods and metrics to make innovation measurable and correlate investment to payback. Key performance indicators that I track with every innovation project include investment allocation, ROI, vitality and Research Quotient.
Investment allocation shows the breakdown among incremental, transformative and disruptive innovation. This is important as each type of investment produces significantly different payback. Vitality index shows new revenues produced from innovation. It's equal to new product sales as a percentage of total sales over a set number of years. I normally use a three-year horizon for this calculation. Research Quotient (RQ) is equal to the percentage increase in revenue from a 1% increase in R&D. This metric brings a degree of predictability to innovation investment.
It can be helpful to calculate your growth-gap before budgeting innovation. The growth-gap is the additional revenue needed beyond what is forecasted with existing products and markets. Innovation can make the difference to achieve your revenue goals.
Comparing to Industry Averages
For each of my client projects, I also like to compare innovation budgets and results by industry and type.
PWCs Comparison of Innovation Spending and Revenue report was based on a survey of one thousand companies and revealed that the average investment in innovation is three to four percent of total revenue. This figure shifts depending on innovation maturity, industry and region.
IBM's most recent innovation benchmarking study shows a wide disparity among industries.
However, these figures are across the board for each sector and are somewhat deflated as many companies spend very little on innovation. When drilling deeper you discover the companies incurring the highest revenue growth make wildly larger investments in innovation than their peers.
For an additional perspective, it's helpful to separate spend targeted to existing products compared to new product development. The chart below shows the allocation of R&D targeted to more transformative innovation.
An IDC innovation study revealed "Innovation leaders spend 5% of revenue on R&D versus the 7% that laggards spend." This may seem counter-intuitive to new or novice innovators, however, the study went on to share that the innovation leaders allocate less of their budgets toward incremental innovation and more of their budgets toward transformative and disruptive innovation, hence, delivering a better ROI. Specifically, the leaders spend 29% of their R&D on new innovation, compared to 18% for the laggards.
Many innovators align budgeting with patents. They essentially correlate their budget to produce a desired number of patents. This method makes budgeting a predictable exercise and provides a comparison point as patents are published in the public domain. It can make sense for companies that derive licensing, royalty and similar revenue from intellectual property. However, for the rest of the more traditional product and service companies I've found that while patents hold value, they are a lagging performance measure and not well correlated to revenue growth.
Shared Ownership
Effective budgeting is not just about committing an amount of capital but also identifying who shares in the budget ownership. It's common to see sole ownership by R&D or product managers for industrial companies or by marketing for service companies. In manufacturing or consumer goods companies, whoever owns the modeling shop usually owns the budget and the innovation program. However, multi-disciplinary and cross-functional teams don't work as well when the budget isn't also allocated across functions and stakeholders. Allocating the innovation budget across team participants diversifies ownership and increases vested interests.
The Economics of Innovation
The economics of innovation are becoming much more economical, especially when it comes to prototyping.
Computer simulation trades computer time for assembly or construction time which dramatically reduces cost and cycle time. Computer simulations can sometimes substitute for physical prototypes.
Malleable platforms such as Ren Share and other foamware enable simplified sculpting, easy modifications and rapid iterations. 3D printers, stereolithography and laser sintering can fabricate three dimensional physical objects at a lower cost than model shops and in a fraction of the time.
Tightly coupled software also has a profound effect on prototyping speed. Design software can now be integrated to engineering software, which is integrated to manufacturing software, which is integrated to cost accounting and financial software and creates an end to end simulation to production process.
Better and cheaper modeling, simulation and prototyping tools simplify the creation of prototyping media, lower the cost of media production, accelerate iteration rhythm by enabling more iterations per cycle and decrease overall prototyping cycle time.
When prototyping media costs are reduced, innovation teams create more iterations and a more refined product in the prototype cycle. 
