How useful is estimating Net Present Value as an idea screening tool during the Front End of Innovation?


Idea Management
Net Present Value (NPV) Calculations
Financial Analysis
Wayne Fisher
9 months ago

4 answers


I would be cautious using NPV during innovation. For two main reasons:
1) Often innovation, especially disruptive innovation is about doing something different or differently, there is level of unknown which might be big, so applying method such as NPV might just not be relevant
2) it is a method used in initiative review / prioritisation and Innovation is a different field with different mindset, so using same method as for "classical" initiative can be counterproductive from a mindset change standpoint.
So I prefer to use new means of selection and focus on test & learn.

Fulcran Perier
9 months ago
Agree - Dr. David E. 6 months ago

Well - it cannot stand alone - but it can be a helping hand, if your primary goal with making innovations is financial. If that is not your goal - then why even bother?

Furthermore - NPV is heavily dependant on the cash flow estimation - and as you can imagine with innovation projects, you can more or less define the cash flow as you please - depending on your creativity. Thus, a critical review of the cash flow estimations and prerequisitions is essential before making any decisions.

Jane Thostrup Jagd
9 months ago
One benefit of estimating NPV is the ability to conduct a sensitivity analysis. What are the cash flows that need to be estimated accurately, and which are less critical to understand in early stages of NPD. - Wayne 9 months ago
Agree theoretically = but GI GO - Dr. David E. 6 months ago

I think a NPV calc is premature at this early stage of idea evaluation and vetting. It would be better to use a variety of qualitative and quantitative gates to judge whether an idea is worthy of going to do the next stage of analysis and evaluation. 

Karl R. LaPan
9 months ago
Karl R. LaPan I typically encourage calculating NPV at the early stages of NPD to driving thinking around assumptions. I"m sure a well thought out list of questions could achieve the same endpoint. I facilitated a design workshop yesterday where no one thought to ask the question, "how is competition likely to respond to this product introduction? Turned out to be the #1 killer issue, not NPV. - Wayne 9 months ago
Pro Forma! - Dr. David E. 6 months ago

Hi Wayne, I don't think NPV is especially useful at the early stage of FEI where you are screening ideas for potential investment for all the reasons the other authors have listed above. The NPV estimate is fraught with error because we are making so many assumptions about the cash flows at a point where we may not have every sold this product or service in the market.
You still need a metric to help you make early decisions on where you are going to invest resources.
You could estimate total annual sales (purchase/repurchase) to gauge how big the ideas are for the markets you are considering.
I realize this too can be fraught with error, so some range-finding is useful.
Note that many disruptive products developed for a specific market often find other larger uses once they are in the market.
The more disruptive the innovation is, the harder the financial metrics become.
cheers, John

John Molander, PE
9 months ago
Agree - Dr. David E. 6 months ago

Have some input?