Image Source: The Startup Way

The Lean Startup spawned a lot of cool slogans, some of which fit nicely on a bumper sticker. Pivot! Minimum Viable Product! And even Steve Blank’s famous Get out of the building! You can even buy t-shirts with these sayings on them.

One of the most important concepts in The Lean Startup, though, doesn’t fit on a sticker or a shirt. It’s not particularly catchy, involves a lot of math, and is about accounting. 

Few things in this world are perceived as more boring than accounting, and people who pick up a book about innovation and startups are usually looking for something a little more exciting. Believe me, if it were possible to accomplish the goal of creating an engine of continuous innovation without accounting reform, I’d be all for it. But, based on my experience, that is impossible.

To truly transform our organizations and our way of working, we need to change our accounting systems, as well. We need to align finance with all the other parts of the company being redesigned to support the discovery and growth of innovative ideas. That’s why I call this new accounting system “Innovation Accounting” (IA).

What is Innovation Accounting (IA)?

Innovation Accounting is a way of evaluating progress when all the metrics typically used in an established company (revenue, customers, ROI, market share) are effectively zero.

• It provides a framework of chained leading indicators, each of which predicts success. Each link in the chain is essential and, when broken, demands immediate attention.

• It’s a focusing device for teams, keeping their attention on the most important assumptions they’ve made about their project.

• It’s a common mathematical vocabulary for negotiating the use of resources among competing functions, divisions, or regions.

• It provides a way to tie long-term growth and R&D into a system that follows a clear process for funding innovation and can be audited for its ability to drive value creation. 

• It enables apples-to-apples comparisons between two or more startups in order to evaluate which is most worthy of continuing investment, providing a way to see a startup or innovation project as a formal financial instrument that has a precise value and reflects a range of future costs and financial outcomes.

IA has three different levels, each of which corresponds to an organizational dashboard that grows more complex with each level.

3 Levels of Innovation Accounting

LEVEL 1

• Uses a simple dashboard of metrics that allows a team to track progress over time at the start of a project.
• Gives a basic sense of what’s working and what’s not.
• For example, if customers won’t even try the product, it doesn’t matter what their repeat purchase rate is.

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LEVEL 2

• Depends on having a thought-out business plan, complete with assumptions about what will happen that can be tested.
• Includes later-stage variables like repeat purchases, bad retention levels, or margin.
• Represents the complete interaction with a customer. 

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LEVEL 3

• When the learning gained from the first two levels of IA is translated into dollars by rerunning the full original business case with each new set of data collected at Levels 1 and 2.

Now let's try it out together!

Exercise: Make a Level 1 Innovation Accounting Dashboard

1. Come up with some initial metrics.

Teams can choose whatever metrics they want, as long as they are simple and actionable. They don’t even need to relate to each other at this point. The idea is simply to start with something manageable, begin looking at numbers over time, and have a plan.

2. If you’re stuck on metrics, ask these four questions, each of which will give rise to a set of metrics designed to answer it.

• Did we do what we said we were going to do?
• Are our people working differently?
• Do customers (internal or external) recognize an improvement?
• Are we unlocking new sources of growth as a company? 

“To truly transform our organizations and our way of working, we need to change our accounting systems, too.”
Eric Ries

Here’s an example of a Level 1 dashboard looking at the first experiment done by a team building a lemonade stand and hoping for hypergrowth through the use of drone delivery and premium ingredients down the road:

3. Use the dashboard to hold your team accountable. Simply ask this question: Which metrics are improving over time?

• For example, a team that’s trying to prove they can charge a price premium for a new product might do an initial version where nobody is willing to buy, so revenue per customer is $0 for the first test.
• A few product revisions later, perhaps revenue has grown to $1.
• This is progress, even if the goal is ultimately $10 or $100.

Innovation Accounting is not only a way for individual teams to report their progress and communicate in financial terms. It’s also extremely useful for seeing how projects, portfolios of projects, or even whole enterprises are changing over time. And, most importantly, it gives the ability to summarize these disparate initiatives using a common vocabulary and accountability framework. 

This post comes from Eric Ries author of the entrepreneurship bible, The Lean Startup. We sat down with Eric in a recent Creative Confidence Series talk to hear his perspective on how to proliferate entrepreneurship throughout larger organizations—which he codifies in his new book, The Startup Way. We loved his thinking on Innovation Accounting, and how to track your organization's progress along the road to building new businesses.

Learn an accessible and actionable process to do the work of innovation, no matter your role or industry through the IDEO U Business Innovation Certificate.