If you have been in business long enough, you know that the hard work of research is sometimes seen as optional or discretionary by some management teams because it’s hard to calculate the true ROI of research. But we’re thinking about this all wrong. Companies should be thinking about research as a way to separate winners from losers, and move the winners to market as quickly as possible at the lowest possible total cost. So let’s flip it around and consider the value of research using an investment framework.
Business spending and investments fall into three broad buckets, which are:
Infrastructure investments that include the costs of standing the business up and keeping it running at a baseline level. This includes the sunk costs of office space, utilities, computers, distribution centers, manufacturing, and support staff. The business cannot run without them, and the ROI cannot be easily calculated because it’s the paid-in capital needed to get the flywheel spinning.
Variable cost investments include all short-term spending to promote the company’s products. ROI calculations work best in these situations because there is a beginning, a middle, and an end to the spending and the program that is being run. The ROI question is: when I spend a dollar, how much will I get back (in the near term)? For example, advertisers and media companies obsessively focus on maximizing ROI by targeting (i.e., MTA), which is amazing but does little to identify promising ideas or address business strategy: it’s simply optimizing ad spend.
Option creating investments are by far the most interesting! These investments are made for marketing research. An “option creating investment” lets me put a little money down on the table to give me the option of owning something later that is worth much more. If I spend money for an “option” but it’s not going to pay off, then I walk away and let the option expire. Alternatively, if I have a winner, I am in the money. If I put $2 million down and I get back $20 million, my ROI is 10x and it’s time to exercise my option. The product moves over to the ROI category, supported by variable cost investments.
The other option is, of course, launching a product that you did not test and watching it fail spectacularly. All you have to be is right. But if you’re wrong and you’re the CEO, you might be looking for a new job!
Here’s a quick example. Let’s say we have 10 ideas, and each one of them costs $5K to test. Half of them move on to an R&D product development phase at $75K each, and these all move on to a product evaluation phase at $15K each. Two of these then move forward to test market at $500K, but only one of them performs well enough for a regional launch costing $2MM. All in (including the losers) I have spent $3.5MM.
The launched product achieves $10MM in Year 1 sales at a gross margin of 60%, or $6MM. My ROI (including the cost of all my losers) is 171%. If I have two winners, my ROI is even better at 343%. And I am not breaking out the cost of research alone, which is much smaller – I am including all of the costs associated with the launch.
Option creating investments can also be made in customer satisfaction research to identify additional ideas to insert into your screening programs. Over the course of time, the amount of money you may spend in research testing will be rounding error compared to the amount of money made by the winners.
Knowing what won’t work is as valuable as knowing what will by researching effectively. Well-designed research will continuously feed successful business performance and yield great ROI!