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10 Jun. 2019 | Comments (0)
In the Signposts of Innovation, a white paper published by The Conference Board in 2017, the authors described innovation as a process that results in the creation and use of new or improved products or services, or production or operating processes that create value.1 My definition for a culture of innovation is the perception of a company that prioritizes the advancement of new ideas that create value across all operations. Both innovation itself and a culture of innovation are precious attributes for any company to nurture and exploit. The question becomes, how do you measure, value, and manage this intangible asset for value creation?
Innovation is one of the most important and valuable characteristics of a company. Unfortunately, there is often a tendency to pigeonhole innovation with specific functions of a company such as R&D, patents granted, engineering, and new product development, which are, as a group, hard to measure, value, and manage. While these are all significant components of innovation, I believe a broader view of a company’s culture of innovation is more encompassing of the health of the company as a whole, and the results will be reflected in financial performance as a whole.
In 2016, Tenet Partners added “culture of innovation” to a list of historical attributes in its CoreBrand Index® quantitative research study, which has been fielded continuously since 1990. The research was conducted among impartial observers targeting160 large public companies. The study found that culture of innovation correlated closely with other descriptive corporate attributes such as overall reputation, perception of management, and investment potential.
The findings were then analyzed with the cash flow multiple (CFM) as the dependent variable, which explains the premium investors are willing to pay for a share of stock over the cash flow of the corporation. The CFM is calculated by dividing the stock price per share by the cash flow per share, which provides a calculation that reflects the premium value of market capitalization. For example, the stock price per share of $20, divided by cash flow per share of $10 = 2:1 CFM. Since estimates of future cash flow are a component of a corporation’s quarterly reports, the CFM has the advantage of being able to project expected returns into the future, which will help a company to evaluate the potential return on investment (ROI) for the spending required for improving the perceptions of the company, which will impact the CFM.
Further analysis of the study examined whether the culture of innovation is more or less predictive of the CFM than the historical attributes collected in the long-running CoreBrand Index research program. The analytics verified and reconfirmed that each of the historical characteristics in the CoreBrand Index (e.g., overall reputation, perception of management, investment potential) contributes a positive effect to the firm’s market value. By adding culture of innovation to the historical attributes, the predictability of the cash flow multiple improved from 64% to 77%. This is not only statistically significant, but also a breakthrough in forecasting the return on investments made in intangible assets like marketing, branding, R&D, new product development, patents, and employee training.
Culture of innovation is a powerful driving force for corporations. The bigger picture, however, is that when the culture of innovation is measured consistently with other descriptive attributes, the results can reliably predict the cash flow multiple. The clear implications are that managers who need to justify and provide accountability for their budgets have a new tool to measure, value, and manage return on investment for intangible assets.