Measuring Software R&D Effectiveness

Introduction

Because of the economic roller-coaster rides over the last decade, and a number of reasons attributable to the market, a number of software services players are investing heavily into engineering research and development services, including HCL. All of these companies are developing a variety of measures of R&D, such as R&D intensity, R&D as a percentage of sales, and so forth.

My thesis

According to me, R&D outcomes – not spend – are the true measures of the value of innovation. You can't simply throw more money at R&D and expect a proportional return on the investment. But the problem is that there are no standardized metrics for innovation.

The three most commonly used means for measuring innovation impact are:

1.       Percent of sales

2.       R&D headcount, and

3.       Number of patents acquired

None of the above measures are owned by R&D. The percent of sales and headcount are cost-driven, and the number of patents does not give you an indication of future value.

According to me, a better way to track innovation impact on the business is to track the revenue and return on investment directly related to innovation. To do this, let us define R&D Index (RI) as the ratio of revenue generated from innovations over the last 12 months as compared with all other existing revenues. This is a revenue view of innovation verses a spend view. For example, assume HCL has four product lines that have a combined return of $100 million in total revenue. Three of these four products have been earning revenue for more than a year. And the fourth was released just under a year ago and contributed $5 million to annual revenues. In this case RI would be 5/100 or 5%. Healthy organizations should strive for RI to be 10-20%, which compounded over time, will result in 100% revenues from new products every five years.

The second and supporting metric called the Innovation ROI, or IROI, accounts for the money invested in developing an innovation. The IROI can be defined as (cumulative before tax profits over N years from innovation-driven products) / (cumulative product expenditures for that same period). This can be further enhanced by discounting both revenue and cost as a function of prevailing and forecasted interest rates. The IROI allows us to compare overall product values independent of their size.

Conclusion

Combining both the RI and the IROI provides a much clearer picture of a company's innovation health. Using these direct measures of innovation, companies can foresee the revenue implications of unfocused R&D years earlier than with traditional measures. To foresee is to be forewarned, a metaphor realized through the RI.

Views expressed above are solely of the author.