Innovation accounting is a key element of the lean startup. Using the ‘measure’ and ‘learn’ of the Build/Measure/Learn, innovation accounting enables entrepreneurs and teams to create useful metrics that offer insight into user engagement, product-market fit, and scalability.
“There’s no accounting for taste,” but for digital product development, there is accounting for innovation.
After all, a startup business environment is all about innovation and creativity, whether you’re in a startup or corporate startup.
So we need some way to hold teams accountable. Considering that a startup is a new venture, there are no existing metrics or data or past performance statistics to use as a baseline.
Eric Ries defines innovation accounting as “a way of evaluating progress when all the metrics typically used in an established company (revenue, customers, ROI, market share) are effectively zero.”
In other words, a business developing a new product is surrounded by apparent ambiguity (how do you measure ‘opportunity’?). Here, innovation accounting creates a structure to measure progress and success.
What is ‘innovation accounting’?
The lean startup approach bases on five basic principles:
- Entrepreneurs are everywhere
- Entrepreneurship is management
- Validated learning
- Innovation accounting
Key to lean startup is validated learning, both the product and the client’s business. Innovation accounting is a structured way of measuring progress.
Traditional metrics, such as ROI or market share, are ill-suited to the startup. Ries emphasizes that the use of such measures only encourages exaggeration – either of the initial business plan or the predicted returns – in order to secure funding for the project.
During the product development stage, is market share a concern? Yes, it’s important to know your target user, and yes, it’s a long-term goal to capture as many of those users as possible… but while you’re still building and testing your minimum viable product, the number of users is no indicator of success or failure; the product simply isn’t at that stage yet.
So, how does innovation accounting look like?
The 3 levels of innovation accounting
Metrics and measuring performance is often tricky and three consecutive dashboards should be used for each product, each building on the last with further information and data.
Innovation Accounting 1 – Customer Focus
Key is to start with metrics that are easy to track and relate to activities that are part of the product development. Lean startup is all about understanding the needs of users, so the first level is customer focus.
Examples might be:
- Customer discussions per week
- Customer feedback per week
- Conversion rates
- Per Customer Revenue
The purpose is to keep development closely aligned with user needs and feedback.
Innovation Accounting 2 – ‘Leap of Faith Assumptions’
The assumptions you’re making about the product and the market from the beginning are a leap of faith.
The lean startup acknowledges that it’s impossible to start building anything new without assumptions. Measuring the truth of those assumptions is part of the second level of innovation accounting metrics.
There are two types of leap of faith assumptions:
- value assumptions about the value users will derive from the product
- growth assumptions about how new users will find your product
Testing these assumptions through prototyping, MVPs and validated learning that guide the product’s development path is at the heart of the lean startup methodology.
Suggested value metrics to test for positive user behavior are:
- Rate of repeat purchases
- Retention rates
- Willingness to pay a premium price
- Referral rates
The recommended growth metrics are looking for indications of sustainable growth:
- Word of mouth referrals
- Ability to reinvest revenue from one customer and into a new customer acquisition
- Ability to recruit new customers as a side effect of normal usage
The focus is to clarify the product’s market fit and readiness for scaling in that market.
Innovation Accounting 3 – ‘Net Present Value’
Net Present Value is a reality check. It tells you what a future product is worth now. Innovation accounting NPV is based on the long-term drivers of your product’s future performance (and value); for example:
- Number of website visitors
- Percentage of visitors that become users
- Percentage of users that choose to pay for the product
- Average price paid by each user
Level three shifts the focus to the product’s financial performance.
Hold the product team accountable
Act on the data you have. Is the product team performing to plan? What progress is being made, and in what direction? Is the product development still aligned to identified user needs?
Summary of innovation accounting
Innovation accounting is one of the five basic principles of the lean startup.
It addresses the fact that a startup has no real data history or market traction, innovation accounting involves choosing key metrics that enable you to track and measure what really matters.