Funding What's Next

Funding What's Next

Illustration of computer, mouse and keyboard

In today’s fast-paced and competitive business landscape, the pursuit of innovation stands as a fundamental driver of growth and success. As organizations strive to maintain a competitive edge and respond to evolving market demands, the ability to finance innovation becomes a pivotal factor in their strategies. According to a 2015 Accenture survey, 84% of executives considered their future success to be very, or extremely, dependent on innovation.

One of the biggest obstacles for innovation is funding. Oftentimes, the process involves a delicate balancing act — allocating resources to explore new opportunities while maintaining the stability of ongoing operations. And at today’s breakneck pace of new technology and advancements, the pressure is on for companies to step up and innovate.

“Innovation is crucial for growth and continued survival for a company,” said Brett Olsen, head of finance at the Wilson College of Business. “Innovation provides a competitive advantage. Competitors can’t quit if they fall behind. Either they need to innovate to catch back up or try to become the new leader. And as innovation increases in speed, as we see with technology, a company’s survival may depend upon how nimble it can be.”

Typically, innovation funding comes from three sources, Olsen said: internally, issuing new shares or borrowing money. In the United States, most of the innovation financing comes internally. According to statistics from the National Center for Science and Engineering Statistics, businesses spent $538 billion on research and development in 2020. Nearly $466 billion, or 87%, was internal financing.

Different sectors finance innovation differently, too. It’s probably no surprise the software industry leads the way globally, accounting for almost 20% of all business research and development funding in 2021. The health sector was second, at 17%. In total, global R&D spending reached 2.3 trillion U.S. dollars in 2021.

A Balancing Act of Risk and Return

One of the biggest struggles businesses have when discussing innovation is balancing the potential risk and rewards. In many cases, innovation fails. In fact, it’s often cited that more than 90% of innovations don’t make it to market, providing no return for the business. It’s true innovation can sometimes feel like a betting game, but there are ways to approach it which can encourage innovation without significantly hurting the core business.

Scott Breon (Finance and Economics, ‘12), head of finance for YouTube’s emerging products division, explained how Google categorizes its business into “Core Business” and “Other Bets,” allowing for differentiated resource allocation based on the level of risk. While the “Core Business” focuses on incremental enhancements to core products, “Other Bets” engages in ventures with higher risks and potentially greater rewards. They also have a division called “Google X” which looks at what the next frontier of innovations could be.

“Innovation is very much a part of the culture at Google,” Breon said.

Breon added, it’s important to set predefined metrics, or key performance indicators (KPIs), to determine commercial viability. Google performs a lot of alpha and beta testing, just like startups do, then gathers as much data as they can before moving forward. They used this method with YouTube Shopping in South Korea and Japan – two target markets – before launching globally.

David Petratis (Management, ‘81) is currently the chair of the board at MasterBrand, Inc. and served as the president and CEO at Allegion plc, a global provider of security products and solutions, from 2013 to 2022. He lives by the motto that businesses must adapt to survive. For him, having a clear vision and roadmap for how innovation will be monetized and integrated into the business models is essential.

At Allegion, he split off an organization called Allegion Ventures. Their goal was to be the eyes and ears in the industry and jump on innovations as they saw them, helping reduce overall risk. One of the new technologies that came out of the venture was a smart lock that could be controlled from a phone.

“Not all bets come in,” Petratis said. “A business needs to go out and understand where the innovation is coming from and the resources you’ll need. What are the investments we need to make to increase our odds of success? Reducing that risk was an important part of that model for Allegion Ventures. It still operates today at Allegion.”

Olsen has seen other businesses put money toward dedicated “Innovation Tanks” which serve as a reservoir for testing and nurturing new concepts without jeopardizing ongoing operations. The evaluation of innovation projects based on predetermined KPIs becomes a crucial factor in assessing potential value, whether in terms of user engagement, adoption rates or revenue growth.

There’s also a need for business agility, which helps reduce risk. The ability to reallocate funds based on changing market dynamics, consumer feedback and emerging opportunities becomes a critical component of successful innovation financing.

“There’s risk associated with innovation. Not everything’s going to work,” Olsen said. “But the idea is to find the point where you decide to either stop, change direction or just keep going. That’s going to depend on how risk averse the company is.”

Allocating Time, Resources and Learning Toward Innovation

Different businesses integrate and finance research and development differently. For example, at Google, they implement something called the “20% Project,” Breon said. The 20% Project gives all employees 20% of their time to be creative and innovative. The approach is one of the reasons Google has the reputation it does, and it has led to groundbreaking developments, including the creation of Gmail and Google Assistant.

“It instills in the culture that we want you to think about a new product at Google, even if you’re in legal, or in HR, or an accountant,” Breon said. “You shouldn’t be bound by your day-to-day skills. If you have an idea that you think is beneficial to Google, we want to give you the free time and the brain space to get that out.”

Google also uses the practice of “blameless postmortems” to foster a culture of embracing failure and leveraging lessons for future success. This approach encourages Google to view failures as valuable learning experiences that contribute to their overall innovation journey.

“Postmortems are just as important as the upfront testing,” Breon said. “What did we predict would happen and what did happen? And what was the difference? You want to instill a culture that no one’s getting blamed for this. We wanted to be open and honest. We’re all in this together. I know that sounds super obvious, but it goes a long way.”

Many companies integrate their R&D resources into separate divisions. At Caterpillar, where Olsen worked before becoming a professor, each business group had teams dedicated to product advancement. This way the people working on the innovation are intimately familiar with the core business and products.

“It really depends on how the company is structured,” Olson said. “There was a smaller department within the engine division, for example, that was looking at new product development. So, they might have connections with other divisions or departments, but there wasn’t a division solely for product innovations.”

A Big Challenge for a Small Business

Innovative financing presents unique challenges for small and medium sized businesses (SMBs). The goal for small and medium-sized businesses should be delivering at a high level first, then laying out a plan for new products and services.

“Be able to deliver bottom-line results in a balanced way,” Petratis said. “If you do that well, it allows time to invest in the future.”

To reduce risk, smaller businesses can leverage collaborative partnerships and networks – perhaps with larger companies, or investors – to access resources and expertise. Tap into incubators, accelerators and industry associations to create those networks.

Financing innovation is multifaceted and challenging, but  it’s an integral part of business growth. By fostering an innovation-driven culture, strategically allocating resources, embracing agility, mitigating risks and prioritizing long-term investments, organizations can position themselves to seize opportunities.

Petratis puts it simply, “The lifeblood of businesses is profitable growth. And if you’re not placing some bets on the table on the innovation that’s driving today, you will miss those growth opportunities and potentially be lapped.”