How Much Should You Budget for Product Innovation?
You don’t have to spend a lot to find success, but you also can’t spend your way to a good product.
“How much should I spend?”
This is one of the most frequently asked questions among our clients as they chart a productization strategy for the first time. Budgets are, of course, dependent on the type of product you are looking to launch and your organization’s existing resources and capacity to concept, build, launch, and market it effectively. The good news is that research on innovation shows no relationship between the amount of money spent on innovation and returns on innovation investment. In fact, while we often believe that more time, money, or talent will help us innovate more successfully, innovation flourishes within challenging, but appropriately-prescribed constraints. The bottom line: Budgets of all sizes can see many products successfully from development to launch (and beyond).
At Vecteris, we tend to recommend leaning into the least expensive option that will bring a viable—if not perfect—product to market. This ‘crawl, walk, run’ approach to funding works particularly well alongside a healthy mindset acknowledging that what matters more than the budget itself is how effectively the budget is managed.
Here are the most important considerations to bear in mind when creating new product innovation budgets:
- Fund new product innovation independently of existing projects.
- Focus near-term measures of success on growth, not profitability.
- Anticipate follow-up investments upfront.
Fund Product Innovation Independently of Existing Projects
Many services companies make the mistake of only funding product development when the product can be sold to a single client as part of an engagement—which can make it very hard to assess broader market appetite for the product and make it difficult to scale. The solution to this problem is to fund product innovation from existing cash flow, investing in the creation of well-researched and tested products that solve an urgent and expensive need that many customers have, not just one customer.
The Numbers: In my experience, the most successful organizations start by allocating 2-3 percent of net income to product idea generation, market exploration, and assessment. This budget is used to uncover market needs, test potential product ideas, and estimate the business case for developing and bringing new products to market. After good ideas are identified and business cases are built, a product innovation budget should grow to include product development, launch and ongoing improvement of products. This secondary infusion of resources can range anywhere from five to thirty percent of revenue, depending on the types of products built.
It is possible to begin investing in product innovation both quickly and inexpensively. For example, Empower Media, an advertising and media planning agency, began its productization journey by creating the Empower Explorer Program. Explorers were 3-person teams of employees who spent 6 months finding opportunities to productize their agency services. In return, they received a small stipend of $3,000 on top of their salaries. The Explorer program was a great way to kick off new product innovation at Empower without significant up-front investment. Since the Explorer Program launched, investment has grown substantially to include development resources, a Chief Product Officer, and a Product Innovation Council focused exclusively on allocating investments across the innovation pipeline. The key takeaway: Empower found success because the organization was prepared to fund its innovation separately from existing client projects.
Measure Success in Growth, Not Profitability
To ensure that new products receive sufficient resources, it’s important to evaluate their success using different, growth-oriented metrics than those used to assess the performance of the core business. Very few new products, especially technology-enabled products, will have positive gross margins in the first year. Focus instead on measures that demonstrate market appetite to solve the problem the product addresses: for example, number of customers in year one, revenue growth in year two, and then, gross margins in year three. It is also helpful to include more strategic measures like market share, revenue visibility and lifetime customer value. These benchmarks can indicate strong potential for revenue growth while products continue to be tested and refined.
Anticipate Follow-Up Investment
Companies that want to grow by productizing should set aside reserve investment funds that will allow them to continue to develop, refine and improve the product once it starts to gain traction. This is similar to how venture capitalists think of investments in stages. A good venture capitalist will only make the first investment if the capital is available for a second infusion of funds.
The Numbers: In addition to the funds allocated for initial product exploration, development, and launch, we recommend planning for an additional boost of 10-20% of product revenue to support the development of new features. If an organization does not already have a Product Manager on staff, we also recommend making this hire at this stage. The PM is essential for overseeing customer usage data and analysis, guiding product functionality, directing the marketing strategy, and other duties accompanying a launched and evolving product.
If you haven’t anticipated a second round of investment, there are ways to free up resources for product evolution. We recently worked with one organization who had invested in creating a strong productization strategy, designing, developing, and launching its first subscription-based product. They quickly grew the product to several million dollars in Annual Recurring Revenue. But while they had also invested in the development resources to maintain the product, they did not have dedicated budget allocated to continue to evolve the features. At this stage they needed a dedicated Product Manager or General Manager to continue to capture and translate customer needs and dedicated technical resources to develop new features. Fortunately, they were able to take advantage of favorable debt terms to fund a year’s worth of a General Manager and a small development team devoted to new feature creation. Other ways to free up resources include reducing returns to shareholders, taking on new investors through debt or equity, partially funding development through engagements that include products, and partnering. And reducing custom client work is another useful option that is frequently overlooked.
This approach to new product investment ensures that budgets are designed to support the various stages of a product’s maturity so that organizations can nimbly respond to customer feedback. Assessing a product’s growth with holistic metrics--and a little patience--leaves room for product managers and designers to continue to pursue iterative testing and design with less pressure for immediate profit. Budgets should account for the fact that an initial launch will not be perfect, and that continued testing and tweaking in response to customers’ feedback is necessary for creating a successful product long-term. To thrive, organizations should design and manage budgets that scaffold the operational and cultural shifts required for a flourishing product journey.
Not sure how to craft your product innovation budget? We can help.