David Binetti is a six-time entrepreneur, having served on the founding team of companies ranging from consumer (QFN, later Intuit’s Quicken.com), to industrial (Arch Rock, acquired by Cisco), to government (USA.gov, acquired by the Federal Government), to political (Votizen, acquired by Brigade) — with three stints as Founder/CEO.
Currently, David helps organizations innovate faster with less risk through Innovation Options, a valuation framework he created that gives entrepreneurs a product-friendly yet finance-approved answer to the eternal question:
“What’s the ROI?”
You have a big, fantastic idea that is completely unlike anything anyone has ever considered. You make a plan, and go to finance to get some resources, and they ask you this agonising question. But it’s a brand new product idea – there is no existing data to base that kind of evaluation on! You know that you’ve got to sell a big idea to get the resources you need, so you’d better project huge profits. But the finance team are cynical, so they raise the discount rate for risky projections… and suddenly you find yourself locked in what David calls the Net Present Value (NPV) Death Spiral.
The problem is that – as an innovator – you are exploring conditions of uncertainty. It’s the only way you’re going to get the risk-reward balance you need. But this NPV-based method of revenue prediction under conditions of uncertainty is forcing you to make a critical prediction at the time when you have the least amount of information. It’s a trap for everyone involved.
Finance is bombarded by mutually exclusive requests for resources, and everyone who’s asking is certain that their idea is the most important or the most valuable. But without more detail and data-backed certainty, finance have no idea if you’re going to use those resources effectively or not. It’s completely opaque. The problem is the way we account for value in innovation.
It’s About Option, not Costs
David breaks the product lifecycle down into three key stages, highlighting the key things you have to measure at each stage, and wryly points out that – when you start out with a new product – the only data points you have to measure are costs.
But this is a fallacy – the main thing you have to offer the organisation is not costs, but options for the future. You are creating options for the company to explore, so the new way to account for your activity might be through something called “Innovation Options”.
If we think about innovation as a kind of expensive and uncertain risk we would like control, we can apply our existing tools for managing risk – financial options. Using this mental model, options measure the value of “optionality“, not financial cost, and are not a traditional investment but rather a hedging instrument based on tried-&-test option-pricing models.
Without diving into the maths, David walks through the three inputs you need to create a meaningful model of your investment:
- How much do you intend to spend in the future (Say, what your theoretical Series A investment be)
- What do you think that would be worth if you were wildly successful?
- How frequently are you going to test to see if you are doing well, according to your plan?
There are a few key things to understand about innovation options that make them a powerful tool. First of all, the value of your option adjusts as you iterate, giving you the data and information you need to decide if it’s worth investing or not. Which is another way of saying that this system also measures risk, and the more frequently you iterate, the more you will be able to mitigate the risk of the portfolio!
This creates a “Risk Sigma”, which is a normalised metric, comparable across all your projects, and which enables corporate governance. There are strong benefits for both the innovator and the finance team concerned with corporate governance. This framework also plays to the strengths of what we understand to be good product management – rapid iterations, constant discovery, learning and derisking.
Before he opens the floor to an extensive and detailed Q&A session, David invites everyone to check out innovation-options.com to get a handle on the maths involved, and leaves us with a keen insight when it comes to innovation and the cost of product development:
Accurate bad news is infinitely superior to inaccurate good news.