Creating a new product category

Creating a new category is the aspiration of every enthusiastic entrepreneur. Most business people would love to have a whole category all to themselves. The dream is that if you could be the “only” player in your category, then you could charge whatever you liked and sell an unlimited volume.

In practice, creating a new category is incredibly hard. In fact, it may be the hardest form of branding that any company can undertake. For most companies, it’s hard enough to explain what your product does (and how it’s different to your competitors’). The task of explaining the entire function of a new product category can be too much for many companies to bear.

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Business Model Strategy: One widget at a time

The whole of your business model can be analysed by imagining one widget at a time. Usually, design thinkers and product managers want to wait until a new product is in the market before testing the financial impact that it has had on the business.

Business planning
William Stout Architectural Books, in San Francisco for DMI conference.

I’m proposing that for your new product development projects that you include an accountant in your early team and that as part of the story-telling process you include financial models of how the new product would work for the business.

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Easiest way to value your intellectual property

You might not want to hear this, but if you can’t put a dollar value on the benefit of your design project then you may not have a project at all. You may have a registered trade mark to protect your brand design. Maybe even a patent or design registration to protect your product designs. But how much intellectual property is there really in your business? And how much is it worth?

In previous posts we’ve mentioned accurate but hard ways to value your intellectual property using financial analysis. There is also a fast and easy way of valuing intellectual property. I call this approach Naked Valuation™ because you are going to compare your business to a similar business without your intellectual property.

This technique will help you make the business case for design thinking more easily by quickly providing additional economic evidence that investment in design will increase the value of your business. To get started, ask:

“If I copied all your land, buildings, equipment & machinery, and then employed dozens of well trained but totally inexperienced laborers to do your jobs. Then what can you do today that they couldn’t do?”

The answer may well tell you a lot about where the real intellectual property is in your business.

Asking yourself this question about the comparable “naked” business will often bring up the value of relationships, channels to market, designs, production problems you’ve solved, trade secrets, tweaks to your systems and even deep knowledge by a couple of key staff.

Whether it’s product design, brand design or innovation processes. Each time you invest in design you are going to add value to the assets that are hardest to copy. It may seem easy to replicate intellectual property such as a physical design or a logo but once you realize that the IP is infused into every element of your business its easy to realize how hard it is to replicate.

To perform a Naked Valuation™ on a product instead of a business, simply identify the value of an asset with the trait that you are valuing and compare it to a similar asset without the trait. For example:

  • Coca Cola sells for $2.69 for 1.5 litres at my local store, the private label store brand sells for $1.39 for the same volume. A value on intellectual property of 48% of the total price.
  • A 2009 Lexus ES sells for $41,000 whereas a Toyota Camry from the same manufacturer with the same design sells for $32,000. To be fair the Lexus includes upgrades that if added to the Toyota would cost around $3,000. Even so, the branded premium is still $6,000 or 15% of the total price.
  • A nice New Zealand Sauvignon Blanc will retail for $30 whereas an unbranded “cleanskin” version of the same wine could sell for as little as $10. For a brand and reputation value of 66% of the total price.

There are lots of other reasons for these price differences and the total return on intellectual property is a function of both price and volume. Even so, the insight remains… to get a quick test of the value of a piece of intellectual property, look for the nearest substitute without your intellectual property and compare the economic value of the two.

Top 5 metrics to help you build the case for design

The big consulting firms (McKinsey, Booz Allen and BCG) would all love to get you to use more metrics to analyse innovation. Partly because it allows them to apply their existing left-brain analytical skills to your right-brain creative design challenges. Everyone has their own take on the role of metrics in design. Whatever side you take there is a lack of easy metrics that you can use to quickly explain to your CEO and CFO why design is important to your company’s growth.

Below are the top 5 metrics that you can pick up today to benchmark your business against your competitors. These are not the only metrics but they are the ones that you’ll be able to use to make a strong case for investing in design:

1. Vitality Index

Sales from products created in last 3 years / Total sales

2. Contribution margin

(Sales – Direct costs) / Total sales

3. Return on assets

Net profit before tax / Total assets

4. Brand value

Expected net annual cashflow from your branded products / Your target annual return on investment percentage

5. Return on intellectual property

Total sales / (Market capitalisation – Physical assets)

Warning, these are not measures that you will be using to manage your design process. Later on we’ll cover metrics such as delivery in full on time as specified (DIFOTAS), Return on innovation investment (ROII), Time to market (TTM) and a whole host of activity measures.

Next week we’ll calculate the numbers for these metrics for a couple of example companies so that you can compare your own performance.

Accounting for innovation

It’s surprisingly easy to use accounting to measure the impact of design. In accounting terms, the impact of your design project will be similar to the “economic” impact we discussed last time, but the language you use to articulate the impact will be very different.

From a design perspective, you’ll need to apply some empathy to your use of terminology. It might not be fun, but like driving a car on a windy road, you’ll need to treat your accountant the way they want to be treated. If you’re going to get the best from them.

Accounting gives us a language to measure the results of innovation.

Wherever you are from in the world the technical accounting terms might differ but, your finanical controller, Chief Financial Officer and accountant will be interested in any project that can:

  1. Increase your revenue
  2. Lower your cost of goods sold
  3. Deliver a higher contribution margin (and gross margin)
  4. Lower your overheads from capital costs
  5. Create more earnings before interest in tax (EBIT)
  6. Ensure ongoing positive cash-flow

Each of these areas are important to design and innovation. What you might notice is missing is the word “profit”. This is because in today’s business climate:

Profit is an opinion, cash is a fact.

Designing the business case for a new product is an integral part of bringing something new to life. For an idea to be sustainable it needs to fit into the company’s aspirations, investment profile and business model.

Statistics on design investment

The best defence in your business case for investment in design is the impact of design on the long-term financial value of the business. There are several reputable organisations that have spend quite some time and money to analyse how spending on design creates impact on the bottom line.

Design Innovation Ireland
Design Innovation Ireland has some great stats on business and design.

Interbrand have some fantastic international analysis on the Best Global Brands 2008 and they discuss how to value your brand based on future earnings using:

  1. Forecast financials
  2. Economic analysis
  3. How your brand influences ongoing consumer demand

The Design Council UK found in 2001 that a basket of companies using design grew by around 10% faster than the market. The Danish Design Centre found in 2006 that out of 800 companies (staff from 35-200) those that use design had growth in gross result (gross profit discussed above) of 250% compared with companies that did not.

In 1993 Roy R. and Potter S. (of the Open University in the UK) found in a study called Winning by Design that 94% of projects using design that were implemented achieved a positive net return. On average the payback period was 14.5 months. Interestingly, product design projects took 15.9 months to pay for themselves and graphics/packaging projects took 11.5 months.

The Irish Center for Design Innovation gets design and innovation in a big way and it’s worth pointing your finance team towards them to check out the financial models for assessing an investment in design.

Armed with your economic levers, your accounting impacts, the specific forecasts and some aggregate data to support your assumptions you are now ready to face your CFO.

Business case for design

This post analyses the business case for design using the fundamentals of micro-economics and financial accounting.

Let’s run through how you (as a product development professional) can use the language of economics and finance to articulate the return on investment of design expenditure. In particular, in the areas of brand, product and process. You can also look at how to articulate the business wide impact of incorporating design thinking into your company’s vision, culture and strategy.

We can use a USD$100,000 engagement with an external product design and innovation firm as an example. The aim of this project will be to develop a product that anticipates latent needs, delights end-users and delivers an integrated holistic experience. However before you or your external product designers get to any of that you’ll need to get past your CEO, senior management team, CFO and their corporate finance team. We’ll address the CEO first.

Economic returns from investing in design

The key levers available to your firm’s senior management include the price, quantity, variable costs and fixed costs of your business. To convince the CEO and senior management team of the benefit of the project you’ll want to address the real life impact of the project in each of these areas. You will need to convince them that with the aid of a disciplined approach to NPD and an empathetic approach to design, your project will create a product that:

  1. Commands a higher price because it is differentiated from your competition.
  2. Sells a higher quantity because it provides more utility to the customer.
  3. Can be produced with lower variable cost.
  4. Is designed to allow for lower fixed costs.

Each of these economic levers contributes to the ultimate goal of your CEO which is usually some variation on creating a sustained and differentiated high margin revenue stream.

You will need to have command of the above financial terms and be able to structure your business case accordingly. The attention span of senior management teams is shortening and a good summary (in terms they understand) is important.

The internal finance team will have their own requirements for your project so speaking their language can help increase you chances of getting a project approved.