Innovation Imperative Keeping Your Company Relevant

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Innovation imperative Keeping your company relevant

Three-quarters of US private companies are prioritizing innovation, with growth as their top objective. Is your company among them? GYB is published by PwC’s Private Company Services (PCS) practice. Here we discuss the challenges privately owned businesses face and where the opportunities lie, suggesting how you can effectively make the most of both.

Please visit the GYB website at www.pwc.com/gyb for archives and local contacts. Contact our editor at [email protected]. Innovation imperative: Keeping your company relevant Three-quarters of US private companies are prioritizing innovation, with growth as their top objective. Is your company among them?

In today’s world of emerging technologies, markets where an emergent middle class is emerging markets, and emerging consumer giving rise to new consumer demands. demands, companies must emerge too — out Success in those markets increasingly of old molds and into new ones — if they are depends on taking novel approaches, such to survive and thrive. For some companies as reverse innovation,2 and leveraging rapidly that means reinventing themselves. For evolving technologies.3 While such moves others, it’s about seeking innovative ways may appear risky to some private companies, to make their business newly relevant. the alternative is even riskier: standing still while innovative competitors race past. US private companies are keenly aware of this imperative. They don’t view innovation as a “nice to have” but instead see it as a Demographic snapshot: critical means of staying in the game. No Who’s making innovation a priority? wonder that 75% of private-company chief executives we surveyed say they’re making innovation a priority. Within that group, roughly half the companies expect innovation to have a significant impact on the way 87% 1 they do business over the next few years. of private companies that sell abroad As for the one-quarter of private companies that are forgoing innovation, they may come 55% to embrace it yet. Sticking to business as usual of private companies in what remains a slow-growing US economy that sell in the US only can be a distinct disadvantage for non-innovators when up against innovating peers, not to mention up against new, aggressive competitors from outside the United States — all of them vying for US customers.

These are often the same competitors that US private companies face as they seek new Source: Trendsetter Barometer, PwC, December 2011 customers abroad, including in fast-growth

1 Private Company Trendsetter Barometer, PwC, December 2011 (a survey of 226 US private-company chief executives) 2 Reverse innovation involves creating products for markets abroad, test-driving them there, and then adapting those products for home markets. 3 For example, mobile devices are the primary way to reach large consumer populations in places such as India, where first-time users of technology are leapfrogging straight to the latest digital options.

1 Going for growth For instance, 29% of the private companies we surveyed say they plan to co-develop But not necessarily innovations with suppliers to make their going it alone supply chains more flexible — the better to manage risk and respond to new opportunities as supply chains become increasingly Innovation supports a long list of private- complex, particularly in markets abroad.5 company goals. At the top of that list are Here, again, having a reputation for innova- increased profitability, higher revenue, and tion is beneficial, since it eases the way to greater market share. While cost containment finding worthy collaborators. is also among the innovation objectives that private companies hope to meet, it is “Companies mastering external collabora- secondary to growth. tion — including co-development with customers — may end up having higher “Innovation is growth these days,” says growth rates and lower costs,” notes Shelton. Robert Shelton, managing director of the Private-company innovators are well aware Growth and Innovation practice in PwC’s of this, with the majority saying they plan PRTM Management Consulting Group. The to engage customers in developing and proof is in the numbers: Private companies improving their products (e.g., via crowd- that have made innovation a priority are sourcing and other web-enabled methods).6 growing faster than their non-innovating That trend will surely continue as technology peers, forecasting a revenue growth rate of finds ever-better ways of allowing direct 8% over the next year, compared with 5% for consumer input. non-innovators. For companies prioritizing innovation to a “great extent,” the expected growth rate is even higher, at 10%.4 Top business objectives for Companies mastering An emphasis on innovation can also help a private-company innovators external collaboration — company grow its talent base so that the business attracts and retains precisely those 81% including co-development kinds of employees that spawn and sustain Improve earnings/profit margins innovation. Once a company has been with customers — may end 78% recognized as having a high “innovation Increase revenues up having higher growth quotient” in the larger corporate ecosystem, rates and lower costs. innovative workers will be seeking out the 78% company, rather than vice versa. Widen customer base in current markets

Still, doing innovation entirely in-house can be 65% limiting for some companies (even for those Strengthen overall brand via market differentiation with a strong innovation track record and plenty of innovation dollars to spend), which 58% is why a fair number of them are joining forces Improve productivity with partners. “Truly innovative companies 56% know the importance of leveraging external Enter new markets resources,” says Shelton. “The benefits include better quantity and quality of ideas, execu- 52% tion support, access to distribution and sales Reduce costs channels, and lower innovation costs — all of which deliver higher returns on innovation.” Source: Trendsetter Barometer, PwC, December 2011

4 Private Company Trendsetter Barometer, PwC, December 2011 5 Ibid 6 Ibid

Growing your business Innovation is a team sport

While there is no surefire template for exe- Well-defined operational processes may cuting innovation strategy, leading private seem contrary to the free-ranging creativity companies do know that a linear, top-down that’s essential to innovation — which could approach is not the best way to go. Instead, be why many private companies that innovate Innovators forecast higher revenue they favor an integrated cross-departmental do so without any formal approach (55%).* growth rates than their peers approach — one involving the marketing, But the picture changes among private sales, finance, and IT departments, among companies that prioritize innovation to a other key areas of the business. great extent — 59% of them have a formal Projected 12-month growth rate cross-departmental strategy, recognizing its A cross-departmental approach generally importance to putting creative thinking to means that innovation efforts will be better profitable use.* grounded in market considerations and 10% more likely to receive executive buy-in — The importance of a cross-departmental Prioritizing innovation to a great extent as well as be supported by well-defined strategy isn’t necessarily lost on businesses operational processes. that don’t have one. One-quarter of private- company innovators say a chief impediment Such processes include those for identifying to innovation is their lack of a disciplined 8% innovation opportunities, determining where in-house process for driving and executing Prioritizing innovation to any extent in the business innovation is most needed, innovation.* While creating those processes devising an execution strategy, and encourag- from scratch may seem challenging, it could ing employees to propose innovations. be well worth the effort for companies that see innovation as a key path to growth and 5% greater efficiency. Not prioritizing innovation at all * Trendsetter Barometer, PwC, December 2011

Source: Trendsetter Barometer, PwC, December 2011 Innovation’s virtuous circle Innovation begets more innovation Innovator demographics Which private companies are most focused on innovation? The ones who are investing in growth.

Invest in Planned activity Innovation emphasis* innovation Some Great 58% plan to engage customers in 45% 59% developing Increase innovation and improving Generate higher New hiring output via partner revenue as a result of their products investment, better innovation investment talent, and customer 33% 48% collaboration IT 10% 32% R&D

Leverage innovation Use new revenue 28% 51% reputation to to finance more innovation, hire better New products attract partners, new customers, and talent, and adopt new 34% 51% better talent technology Major new capital investments 50% 49% *Percentages show the extent innovation has been prioritized. plan to use innovation to plan to adopt new technologies to Source: Trendsetter Barometer, PwC, December 2011 attract and retain top talent enable innovation

Percentages reflect private companies that are pursuing innovation. Source: Trendsetter Barometer, PwC, December 2011

3 Doing more with less Not far from Silicon Valley, the California wine industry has also been harnessing Turning your business into technology for speed. Social media, in a fast company particular, has proved a fast, expedient, and inexpensive way for winemakers to position products and expand customer For private companies, one of the biggest reach. An early adopter of this approach benefits of technology is the ability to do was Barefoot Wine, a brand acquired by more with less, often to considerable effect. E. & J. Gallo Winery in 2005. Shortly after Don Wen, a partner in PwC’s Private the acquisition, Barefoot started using social Company Services practice, has observed media as a way to get the word out about its this at a number of privately held companies: product. At that time, Barefoot had annual “They identify an aspect of their business sales of 600,000 cases. By 2011, it was that could be more efficient and then wrap selling over 14 million cases a year. 49% technology around it to transform themselves into more agile and faster companies.” That Percentage of private-company Barefoot’s extensive use of social media did doesn’t just mean doing things fast; it can innovators that say they will more than cast a wide publicity net for Gallo’s also mean fast growth. adopt new technologies to new brand — it also helped Gallo learn early on who was buying Barefoot’s wines and why. enable innovation Take the software service industry, for “Through this pioneering use of social media, example. There, a privately held business Gallo was able to accentuate Barefoot’s suc- Source: Trendsetter Barometer, PwC, December 2011 called ServiceSource 7 noticed that many cessful brand characteristics, better appealing large tech companies were achieving less to niche markets and capitalizing on con- than optimal renewal rates on their mainte- sumer tendencies there,” says Bo Parker, a nance, support, and subscription contracts. “We’ve been able to identify managing director in PwC’s Center for Addressing this problem would have Technology and Innovation. consumers’ personal pref- been time-consuming for tech companies, undercutting their main focus of develop- erences, buying triggers, Gallo has applied this approach to its business ing and selling new products. and likely brand loyalty by overall. “We’ve been able to identify consumers’ personal preferences, buying triggers, and ServiceSource proposed an innovative solu- bringing data analytics to likely brand loyalty by bringing data analytics tion: It would wed cloud computing with to bear on the information we mine through bear on the information we big-data management and sophisticated social media and other digital means,” says analytical tools to see which customers were mine through social media Gallo’s CIO Kent Kushar. “These fact-based most likely to renew their contracts — and insights are instrumental in helping us and other digital means.” then target those customers. Through this improve customer experience, create new approach, ServiceSource increased clients’ Kent Kushar products, and drive brand differentiation.” Chief Information Officer renewal rates significantly, in return for a share of the increased profits. E. & J. Gallo Winery Embracing new technologies such as cloud computing (which eliminated the costly and time-consuming investment of building new IT infrastructure) was a crucial compo- nent of ServiceSource’s success, enabling it to devise and implement its system swiftly and economically. That, in turn, allowed the company to deliver its solution to customers at an attractive price.

7 ServiceSource has since gone public, making its initial public offering in 2011.

Growing your business Technology-enabled innovation that focuses Innovative spending on customers is hardly endemic to Northern Private companies are getting more out of their innovation dollars California — it’s an approach that’s character- istic of many private companies, regardless of where they’re located. Wen notes, however, that private companies generally like to be 32% 66% a few steps behind their public counterparts plan to get by plan to increase when it comes to buying new technology, on their current their innovation innovation spending preferring not to put their capital at risk that spending way. In most cases, they don’t have to wait long for new technology to mature into something they’re comfortable investing in. “Where private companies do want to be first 79% 18% movers,” says Wen, “is with their custom- of these companies plan a sizable say they’re getting increase ers — first in delivering quality and solving the same value from problems. To do that, they need to under- innovation at the stand the voice of the customer. A large part same or lower level of innovation for private companies really of spending comes down to precisely that.” Source: Trendsetter Barometer, PwC, December 2011

Mapping the metrics How do you measure the success of your innovation?

Private companies gauge the success of their innovation efforts based on how well those efforts contribute to the following areas.

Metrics

Customer Market Earnings/ Revenue Increased Brand strength/ Reduced Employee recruit- satisfaction expansion profits growth productivity recognition operational costs ment/retentioin

79% 72% 69% 68% 47% 45% 44% 32%

Source: Trendsetter Barometer, PwC, December 2011

5 Funding innovation Some businesses are more innovative than they’re getting (tax) credit for

Innovation and experimentation are not the on a timely tax return or may be claimed on exclusive domains of science and high tech- an amended return for a previous year, under nology. Likewise, neither are tax credits for applicable statutes of limitations. research and experimentation (R&E). Any company that is either creating new products, What’s involved: Gather information on services, and processes or improving them is current-year R&E/R&D activities. Document quite likely engaged in some form of research wages, supply costs, and contracted research and experimentation — also referred to as expenses generated by those activities. research and development (R&D) — mean- Companies will need to bear in mind that ing they could qualify for an R&E tax credit. “incremental spending” is the total spending over a base amount. The base amount for the “In short, you don’t have to be discovering regular research credit is either the greater new engineering principles or novel technolo- of a calculated historical base amount or 50% gies to be eligible for an R&E tax credit,” says of the company’s current-year spending on Mark Stevens, a tax partner in PwC’s Private qualified research. The base amount for the Company Services practice. “However, to alternative simplified research credit is 50% qualify, a company generally will need to of the average of qualified expenses over the exhibit some fundamental reliance on prin- prior three taxable years. ciples of the biological, physical, engineering, or computer sciences somewhere in its process Limitation: A business has to be profitable and of experimentation and development.” taxable to use the credit in a current year. The good news: Unused credits can be carried The ABCs of R&E tax credits forward to future years. An R&E tax credit is an incremental research expenditure credit. There are two federal Missed opportunities credits* — the regular research credit and PwC’s R&E tax credit team has found that many the alternative simplified credit. The regular companies are unaware of their eligibility for research credit is 20% of a qualified amount an R&E tax credit or significantly understate of incremental spending. The alternative their qualified research expenditures. simplified credit is 14% of a qualified amount of incremental spending. Most states (40) have One way to determine whether your company credits that can be added to the federal credits. might be undertaking activities that qualify for an R&E tax credit is to look at your How to claim: Research credits are claimed personnel. Do you employ people (including on a federal or state income tax return. If contractors) who have a scientific or techno- your company is an S corporation or part- logical background, such as engineers, nership, the credit may be claimed on the computer programmers, chemists, biologists, partner’s or shareholder’s individual tax or physicists? “If your company is relying return. In general, the credits may be filed on such workers to apply their scientific or

* The federal credit officially expired at the beginning of the year, but Congress can reinstate it retroactively, as it has done nine times before.

Growing your business technological knowledge in the development Similarly, routine activities a manufacturer or improvement of products, services and must undertake to comply with government processes, it may qualify for an R&E tax standards do not qualify as R&E. However, credit,” says Stevens. if regulatory compliance means that the company must change its manufacturing Many companies in the following industries processes, then the research and develop- take advantage of federal and state research ment activities underlying the process credits: aerospace and defense, automotive, changes could meet the definition of R&E chemical, food and beverage, forestry and for tax-credit purposes. paper products, manufacturing, oil and gas, pharmaceutical, and high technology. Getting started If you think your company is eligible for an What’s eligible? What’s not? R&E tax credit, here’s what you should do: Eligible activities ——Conduct a feasibility or benchmarking Research activities that fundamentally rely analysis of your company’s operations to on principles of the physical, biological, determine their eligibility for the credit computer, or engineering sciences may qualify for an R&E credit. Such activities ——Estimate what the credit might be include the following: ——Gather enough information to establish ——Development of new products/services eligibility for the credit ——Process improvements “Because the credit is against the amount of taxes owed, the taxpayer has the burden of ——Product improvements proving entitlement to the credit,” emphasizes ——Certain environmental and regulatory Stevens. “Documentation is critical.” compliance activities A company will need to furnish work papers that support their credit calculations. The Ineligible activities initial burden of doing this should ease once a ——Research conducted outside the company institutionalizes processes for iden- United States tifying R&E activities and for compiling the necessary documentation. For most qualifying ——Routine data collection businesses, the benefits far outweigh the costs. ——Routine quality-control testing ——Adaptation of existing business components Many companies are unaware A good rule of thumb when assessing of their eligibility for an R&E tax eligibility for an R&E tax credit is to look at a product and the accompanying credit or significantly understate process(es) separately. For instance, a their qualified research cosmetic change to a product does not in expenditures. itself qualify for an R&E credit. However, if you have to revise your manufacturing process in order to make the cosmetic change, the research involved in determining how to make the process modi- fication might qualify for the credit.

7 Balancing act “Companies that are looking to grow more Most companies will aggressively will have a strong core of break- Does your innovation through innovations in their portfolio,” notes pursue some combination portfolio contain the Shelton. “But even high-growth companies of incremental and break- will innovate incrementally in some ways, right mix? such as when they make continual yet small through innovations. upgrades to operations, products, or services. Companies that are most successful at inno- So it’s not simply the case that one type of vation tend to approach it as they would a company is always bold in its innovation and portfolio of investments, striking the right another is always incremental. In reality, most balance between bold innovations and companies will pursue some combination of Bold incremental ones. incremental and breakthrough innovations innovation that senior executives deem appropriate for Admittedly, when one thinks of innovation, their company’s particular market situation the word bold tends to come to mind more and level of risk tolerance.” readily than the adjective incremental, often 64% accompanied by a mental image of people in Indeed, the market situation for a particular of private-company lab coats bent over scientifically or technologi- industry can force otherwise bold innovators innovators plan to cally challenging research. Take the privately to resort to incremental changes for the time develop new held BioBehavioral Diagnostics Company being. “We have to bear in mind that the larger products and (BioBDx), which describes its mission as economy is a collection of microeconomies,” services* providing “tools for the diagnosis and man- says Parker. “Some companies are exposed to agement of neurological and psychiatric parts of the economy that are still contracting, conditions, leading to a transformation of which can severely constrain their cash flow behavioral medicine.” 8 A couple of years back, and ability to invest.” Meanwhile other the company devised a tool to help doctors companies are exposed to faster-growing objectively diagnose attention deficit hyperac- microeconomies, such as the resurgent tivity disorder by measuring a person’s motion automaker sector, where there’s renewed and analyzing shifts in his/her attention. One spending on innovations like electric and Incremental innovation might point to this tool as a quintessential hybrid cars. example of bold innovation. Ultimately, the portfolio balance between Incremental innovation, on the other hand, incremental and breakthrough innovations 78% emphasizes smaller improvements over will depend on a company’s growth objectives. of private-company riskier innovations. These often involve The higher the company’s targeted growth innovators plan to tweaking products or processes. Tweaking rate, the higher the percentage of break- improve current is the very thing BioBDx did after introduc- through innovations the company will need to products and ing its diagnostic tool — roughly a year later pursue, risk appetite permitting. Incremental services* the company unveiled a portable version. innovations, meanwhile, help protect market share and margins of existing products and While incremental changes may be small, the services, and in that way complement a rewards can be large. And they can just as company’s breakthrough innovations. easily be low-tech as high-tech: “A client of ours who’s a distributor cut back consider- ably on costs simply by reconfiguring its *Source: Trendsetter Barometer, PwC, December 2011 storage space, changing the way trucks load products, and using different machinery and racking systems to stack inventory,” notes Wen. The key is to pursue bold and incremental innovations in the right combination.

8 http://www.biobdx.com/wp-content/uploads/2011/03/12132010-YoungStartUp.pdf

Growing your business Taking innovation Facing the future to the next level Companies for which innovation is a high priority are looking beyond the here and now, setting their sights on long-term corporate strategy and future markets Finding your future growth engine Innovation emphasis Prioritizing innovation Prioritizing innovation Private companies will need to up their inno- to some extent to a great extent vation game if they want to extract enduring Innovation goal value from their innovation efforts. To do Set long-term this, they will need to think beyond quick corporate strategy* wins. Where does the company see itself 10 30% 40% years from now? What will be the growth engine that keeps the company relevant and Create new continues to propel it forward? Is the com- markets pany’s current business model up to the task? 22% 55%

Too few companies are looking that far *Including adopting new business models ahead. This may be dangerously short- Source: Trendsetter Barometer, PwC, December 2011 sighted in a business landscape that’s expected to evolve dramatically over the next few decades. Technological advances will change how companies do business, it — means that companies are not only ——Set organic growth targets based on an while the increasing importance of emerg- changing their technologies but are also optimal mix of breakthrough and incre- ing markets will change where that business actually changing the way they do business mental innovation, then choose the levers is done (as well as the nature of the services and whom they do it with,” says Shelton. for carrying out your innovation strategy and products sold). (e.g., technology).

Unlike their public counterparts, private Conclusion ——Determine the roles that internal and companies are not constrained by quarterly external partners should play in the reporting requirements, and so they may Regardless of whether they’re looking to grow company’s innovation efforts, as well be under less immediate pressure to show their business via new service offerings or as the right amount of R&D spend. seeking cost containment through process a return on investment in bold innovation ——Foster a company-wide culture of innova- efficiencies, leading private companies know efforts. This gives them more room to tion. While company leaders should set that innovation needs to be at the heart of maneuver and take risks, which is critical the tone, successful innovation is ulti- these efforts. Here are core considerations to sustaining a culture of innovation at mately a team effort. a company. they keep in mind while pursuing their innovation goals: ——Incentivize innovation. People work Indeed, more than one-third of private com- hard for what they’re measured by panies that prioritize innovation are doing ——Tie innovation strategy directly to your and rewarded for. company’s business goals, including so with long-term corporate strategy in mind. ——Be sure your company’s innovation long-term corporate strategy. That number is even higher among innova- strategy adequately reflects the tion leaders (i.e., private companies that ——How you spend is more important than business’s risk tolerance. prioritize innovation to “a great extent”): what you spend. Develop an operating Forty percent say their innovation efforts model that delivers the right mix of inno- may result in entirely new business models. vation to meet your company’s goals. Fifty-five percent say they plan to use innovation to create new markets for novel products ——How you innovate determines what you and services that are still in the idea or develop- innovate. Trying to drive breakthrough ment stage, along with new modes of bring- innovations with a process designed ing those products and services to market. primarily to develop and commercialize “Finding new ways to deliver the business incremental innovations is unlikely to model — and, certainly, new ways to finance yield positive results.

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MorMoree infinformationormation WWantant toto llearnearn moremore aboutabout prprivate-companyivate-company inno innovation?vation? Please Please contact contact someone someone on on t hethe PwCPwC team,team, includincluding:ing:

DonDon WWenen BoBo P Parkerarker PPartnerartner ManagingManaging Dir Directorector PrivatPrivatee ComCompanypany SerServicesvices CentCenterer for for T Technologyechnology and and Inno Innovationvation (4(415)15) 498-8265498-8265 (408)(408) 8 817-573317-5733 [email protected]@us.pwc.com [email protected]@us.pwc.com

MarMarkk SStevenstevens RRobertobert Shel Sheltonton PPartnerartner ManagingManaging Dir Directorector PrivatPrivatee ComCompanypany SerServicesvices GrGrowthowth and and Inno Innovationvation pr practiceactice (2(216)16) 8875-351275-3512 (408)(408) 8 817-425117-4251 [email protected]@us.pwc.com [email protected]@us.pwc.com

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