The motto “cash is king” is nowadays praised more than ever. As companies brace for a still uncertain post-covid world, a key concern for many CEOs and CFOs is to safeguard liquidity and cut costs. Consequently, many firms are hoarding cash. A recent analysis by S&P Global shows that US companies are building record-high cash buffers. For instance, the average cash ratio among S&P 500 companies (which is obtained by dividing total cash by current liabilities) grew 24% in just a few weeks since the pandemic started (it was 13.8% at the end of 2019, and jumped to 17.1% by the end of the first quarter of 2020).
At the same time, there is ample evidence that firms that spur innovation and continue to take risks during hard times outperform more conservative and cost-cutting peers. For example, a recent study by Gartner which uses evidence from the 2008 recession shows that post-recession winners tend to elevate innovation funding as a way to safeguard future growth.
So, what should innovation leaders do to solve this conundrum? Should they be careful and avoid investing in large and cash-demanding innovation projects (a “wait-for-better-days” approach)? Or should they risk large investments in innovation projects with highly uncertain returns?
None of these options seems desirable these days. And that’s where “metered funding” comes into play. It is a great time for firms to consider metered funding as a potential solution that offers the best of both worlds.
What is Metered Funding
Metered funding is more a mindset than a ‘budgeting model’. Its roots tie back to the lean startup movement and it asks firms to see their innovation projects as “internal ventures” and make decisions on funding in an incremental way, as projects mature. This means that early investment decisions are smaller and focused on promoting learning and de-risking, whereas later investment decisions are larger and based on growth prospects. It is basically an application of the popular “funding rounds” approach used by venture capitalists in startup funding to corporate innovation projects. The term was seemingly coined by Eric Ries – the author of the 2011 best-selling book Lean Startup – in his 2017 book The Startup Way. The table below summarizes some of the differences we observe between the traditional funding and the metered funding models.
Benefits of Metered funding
There are several benefits accredited to the metered funding model such as triggering innovation teams to focus on the right questions in the right order (e.g., first focus on learning and validating assumptions and only then focus on growth and scaling), as well as lowering the political burden on the team in their early stages (because values at stake are small either way). As a consequence, a metered funding approach may help promote speed, remain innovative without overinvesting, as well as stimulating an entrepreneurial mindset among teams.
In one of the companies we often work in innovation – a large multinational firm – we have observed the transition from a traditional funding model to a leaner model that is much closer to the “metered funding” approach, and the results are impressive. Some years back, when we started collaborating with them, to request funding for an innovation, teams had to prepare full-fledged cash-flow projections, including NPV and IRR calculations, best- and worst-case scenarios, graphical depiction of the cash flow evolution in the next 10-15 years, and so on. To help innovation teams prepare these financial projections, there were special workshops dedicated to financial literacy, special tools used to make the projections and many hours of work in preparing nice Excel charts and financial projections. The discussions about the right horizon to take, the discount rate to use, etc, were long and often felt unconvincing for such early-stage ideas where uncertainty and many assumptions clearly dominated the complete and solid formulas used in financial models.
Over the years, the company adopted an incremental investment approach. This does not mean that there is a lack of discipline. There are very clear milestones and rules that innovation teams need to meet to be able to move into the next “round”. Yet, the teams’ time is now better spent in tasks that are close to those proposed by the ‘lean startup’ philosophy. Rather than discussing discount rates and cash flow projections, early-stage teams focus on clarifying the hypotheses in which their business case rests and what’s the minimum amount of resources they need to test those hypotheses and validate (or invalidate) their idea. This incremental investment approach also allows for multiple feedback moments, reducing both uncertainty and the resource commitment in the innovation’s early stages. Today, the firm makes leaner and faster investment decisions, tests a significantly higher number of ideas and makes “go or kill” decisions much faster and cheaper than before.
This company is not alone. In an online conversation on innovation held in April 2020, Susana Jurado (a senior innovation executive at Telefonica, the largest telco operator in Spain) describes a very similar experience at Telefonica. According to Jurado, Telefonica adopted the lean startup methodology in 2012 and transitioned to a metered funding approach shortly thereafter. According to Jurado, metered funding “allowed us [Telefonica] to minimize the risk, and we are ensuring that we are investing the minimum resources needed in each moment”. Jurado also recollects that the adoption of metered funding allowed Telefonica “in just 18 months to be much faster than we were before (more than twice faster in our innovation cycles) [which allowed us to] test 45% more ideas than we were capable before, while investing on average 48% less budget in each project”.
In short, metered funding may allow you to test many more ideas with significantly less budget per project. In normal times the best approach is not to cut innovation funding but, instead, to test many more ideas with a similar budget to increase the odds of discovering a “home run” innovation.
Under the current uncertainty, metered funding may allow firms to sustain or even increase their innovation efforts by making smaller commitments today with a promise of increasing the stakes once clear milestones are achieved. In other words, metered funding may be one way to increase your chances of being one of post-covid winners without inflating your innovation budget.