Evaluating R&D Initiatives
How can a management team properly track and gauge success of various R&D work streams? i.e. what are the levers to pull to ensure you're focusing on the right projects vs the ones that need to be 'killed'.
According to KBCM (formerly known as pacific crest securities), the gold standard and metric for private SaaS companies, 32% of total operating expense is the recommended best practice for scaling SaaS companies. With that number looking like 10 billion for Apple and 12 billion for intel, it is of utmost importance to take precautions in order to ensure efficiency and productivity within a company’s R&D sector. Not only is it important for a management team to properly track and gauge success of different R&D work streams to ensure that the right products are being focused on, but it is imperative to have a cutthroat vetting process, being very disciplined with the projects that need to be ‘killed’ or not pursued in the first place.
Traditionally, R&D projects can be broken down into three categories – core innovation (optimizing existing products), adjacent innovation (expanding existing business and products), and transformative innovation (developing breakthroughs). According to Nagji and Tuff, partners at Monitor Group, companies who break down their R&D activity in a 70/20/10 ratio between core, adjacent, and transformative will allow them to outperform their peers while experiencing a P/E premium of about 10-20%. Identifying what categories your R&D activities fall into will not only help you visualize your overall expense to aim for this ratio, but also reveal the healthy signs or characteristics of each one of these categories. For example, transformative innovation has a much longer time horizon, so it will be much harder to sell executives or investors on value based on metrics such as ROI, as the intrinsic value may come from learning, not necessarily “earning”. By being able to identify what ROI category a product should be in, companies will have a better understanding of how each of their projects should fit into their company-wide R&D initiative.
Once a project has been categorized into one of the three categories, it is now time for a company to consider one of many vetting processes in order to make a careful and critical evaluation of whether the project is worth pursuing or putting more resources into. Surprisingly, lots of R&D funding decisions are greatly undermined by human bias or the “novelty” of a proposal. These eye-popping issues however can be fixed by a vetting process with clear and concise parameters such as urgency, importance, investment and impact. Although this may seem small or insignificant, clearly fleshing these parameters out can actively reduce human bias in making important initiative-related decisions.
Another efficient vetting strategy is to define all attributes of the initiative in a vision document, which defines the scope, purpose and features of an R&D project/initiative. Clearly stating all attributes in a vision document can help with high-level communication of the product, establish clear and functional expectations for the product, and reduce risk of negative return. These attributes include reason/market opportunity (which will help forecast opportunity and ease of market entry), pain point observed (which focuses on how the product will address the problem that prospective customers experience), target buyer, target user, desired functionality and features (focused mainly on the “big bucket”), and the timeline with details for release for testing or ROI. Clearly stating these attributes in a vision document will help the R&D initiative stand out and illuminate hidden problems.
Although a vision document may not be the best option all the time, there are other ways to frame an initiative. When introducing an initiative, it is important to include the product/feature name, backlog item ID, why the product or feature is needed, what it will do, how it will do it, what type of action is needed now (evaluate, build, sell or kill), and mention other related or dependent items associated with the new product/feature. Regardless of the way it is done, envisioning a goal before an initiative is completed is very important as it can provide contextualization, establish success criteria and ensure executives are kept on the same page when things get off track.
At the end of the day, R&D initiatives should be treated like any other investment and maximize returns over time. Oftentimes pressures from consumers, competition, or stakeholders can cause short-term developments to be prioritized over longer ones, as a more tangible return will be seen from these shorter time horizons. Through a clear and concise vetting process, companies will be able to more efficiently track, comprehend and gauge the success of their various R&D initiatives.