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Where should we focus our innovation
efforts?
• Identify the dimensions - the path that the technology has taken over the
past ◦Identify phases or dimensions where different aspects changed
◦Imagine what customers would want if they can have anything - does it suggest anything that you have not considered?
• Map the utility curve for investing in each dimension
◦Estimate the shape of the utility curve with respect to each dimensions identified
◦Estimate where you think you are on the utility curve- which dimension offered the most relative utility? Cost-lines of
moving along the curves? Where will efforts be best deployed?
• Determine your focus - where do we focus on innovation or investment? (importance to buyers, room for improvement, ease of improvement)

Development budget - where should I put my money? Use my people? Open or close projects?
• Most firms face serious constraints in capital and resources to invest in projects
• Firms use capital rationing - setting a fixed R&D Budget and rank other projects to support it
◦R&D budget is usually a % of pervious year's sales - typically determined through industry or historical
benchmarking ◦R&D intensity varies considerably across and within industries
• Large firms can fund internally whereas. new startups have to obtain
external funding ◦Early stage: friends, family, credit cards,
◦Startups may also be able to obtain funding from government grants/loans
◦If idea/management are promising - secure funding from angel investors or venture capitalists
• Cashflow is vanity - true in the short term
• Profitability is reality (long term)
• Opportunity cost of capital - incremental return of investment that a business forgoes when it chooses to use
funds on an internal project vs investing in a marketable security (gov bonds, risk free)
• 3 major decisions
◦Investment decision - investing scarce resources, what makes a good investment?
◦Financing decision - Fundraising, Debt/equity mix
◦Capital allocation decision - how much to reinvest? How much to return to the owners?

Quantitative methods of choosing projects - NPV, IRR

• How much to give back in X years time? What other uses can the company also use to generate the same return?
• What problem are you trying to solve?
• How much money are you going to bring into the company if I choose to invest? (Risk vs Return)
Strengths - concrete financial estimates, explicitly considering time value of money and timing of investment

Weaknesses -May be deceptive, only as accurate as original estimate of cash flows, may fail to capture strategic

importance of the project, returns may not be attractive

Real call options - applied stock option model to non-financial resource investments
• Market price - cost of R&D program
• Strike price - cost of future investment (eg cost to commercialize new technology developed)
• Intrinsic value - returns to the R&D investment
• Options valuable when there is uncertainty in innovation
• However, many innovation projects do not conform to the same capital market assumptions underlying option models
◦May not be able to acquire option at a small price - may need to fully invest to realize if the technology is successful

◦Value of stock option is independent of call holder behavior but value of R&D investment is shaped by firm's

capabilities, complimentary assets and strategies

Qualitative methods of choosing projects - strategic implication to why I should invest

Many factors in the choice to develop projects are extremely difficult/misleading to quantify
Screening questions can be used to assess different dimensions of the project decision

• Role of customer - market, use, compatibility, ease of use, distribution and pricing
• Role of capabilities - existing, competitor's, future capabilities
• Project timing and cost

Aggregate project planning framework - map R&D projects based on the risk level, resource commitment, timing of cash flows
• Advanced R&D projects - cutting edge technologies, often no commercial application
• Breakthrough projects - incorporating revolutionary new technologies into commercial application
• Platform projects - not revolutionary, but fundamental improvement over preceding generations of products
• Derivative projects - incremental improvement + variety in design features

Derivative projects pays off fast, helps

the firm service its short term cash flow needs
Advanced R&D takes a longer time to pay off, but help the firm to position as a technological leader

Q-sort - ranking ideas of different dimensions

• Ideas are put on cards
• For each dimension considered - cards are stacked in order of their performance of that dimension
• Several rounds of sorting and debate are used to achieve consensus of the projects
◦The most senior person should not be the one to speak first!

Combining quantitative and qualitative information

• Conjoint analysis - estimates the relative value individuals place on attributes
of choice ◦Individuals given a card with products/projects with different
features and prices ◦Individuals rate each in terms of desirability/rank them
◦Multiple regression used to assess degree of attributes influencing rating - quantify trade off involved in

providing different features