The role of the accountant in new product development

Key variables in strategy making
In terms of the barriers to NPD, in my examiner's comments in the September 2003 issue of student accountant, I said that in my opinion, strategy concerned the relationship, explicit or otherwise, between an organisation and its environment and that strategy was determined by decision-making processes within the organisation. The term organisation referred to:

• the resources the organisation had access to
• the structure and systems designed to allocate and control these resources
• the capabilities and competences that resulted from combining these resources, and their value in the creation of products and/or services.

The organisation therefore makes itself a unique configuration or combination of three key variables - environment, organisation and decision-making, thereby deriving some competitive advantage.

Most organisations, whether large or small, private or public, manufacturing or service, profit making or non-profit making, need to introduce new products or services at regular intervals. If we take the world of charity organisations for example, competition between charities for donors has never been more intense. With 'donor fatigue' now common in the developed world, there is a need for charities to develop eye-catching appeals which are more effectively targeted. There is therefore a clear need for strategic management in charity organisations.

In profit making organisations, many myths about NPD exist. One of the most prevalent is that small companies are more innovative than their larger counterparts. Space prevents a fuller discussion of this assumption but I would argue that NPD in a smaller, medium-sized enterprise is often profoundly influenced by its relationship with larger companies.

Partners and strategic alliances (environment)
One key observation of a company's research and development is that innovation is only possible through working with partners and networks which have vital skills and technologies that the company does not. Knowing your own capabilities and competencies, and those owned by others - especially those critical to your NPD process - is a vital strategic insight. Combining different technologies and companies together in new ways to develop new products may be a key skill in the NPD process. My own research into the impact of a management buyout on NPD in smaller businesses points to the positive impact on NPD that support from large customers can have. Once again, the dangers of reaching sweeping generalisations are apparent. For one of the buyout companies I studied, the problems experienced by the few, large customers on which they relied, forced them to develop new products and move into new markets.

3M and Post-it notes (environment, organisation and decision-making)
If one looks at the famous example of Post-it notes, some immediate lessons become apparent. 3M, justifiably, is regarded as one of the world's most innovative companies. It manufactures over 60,000 products, employs 70,000 people, operates in 61 countries and achieves year-on-year growth in sales of 10%. To achieve this growth rate, it sets its business managers the task of ensuring that at least 30% of company sales come from products that are less than four years old. Imagine the pressure that such an objective and culture places on those managers.

Equally important is its 15% rule whereby scientists and engineers working on NPD are able to allocate 15% of their time to projects that do not need formal approval. This creates the necessary freedom of space for new ideas to flourish. Rival companies with tighter control systems are not so innovative - or profitable. The most important barriers to NPD are often to be found inside the organisation, especially a culture that is stifling new thinking and ideas. It may only take one 'no' to reject an NPD proposal. Innovative people and teams often fail and need a management that is not 'destructively critical'. In one author's opinion the rule is not to 'reward success and punish failure' but to 'reward success and failure and punish inaction'. As Thomas Watson, founder of IBM, famously said: 'Success lies on the far side of failure'. Many ideas may need to be tried and rejected before a 'winner' is found. The key is to have a system that encourages the generation of new ideas.

However, 3M's world-famous Post-it notes show how a significant innovation opportunity was nearly missed. Post-it notes were initially viewed as a failure by 3M, the parent organisation. 3M's normal adhesive products are designed to glue things together effectively and permanently. A product which stuck only as long as you wanted it to and could be used repeatedly, did not fit with any of 3M's existing NPD critical success factors. The momentum to commit resources to the product only came after samples of Post-it notes had been sent to the CEOs of America's largest corporations, and their secretaries had demanded further supplies of the new product. Samples had also been sent to the secretaries of 3M's main board directors, with the same result. Involving the customer - be they external or internal - is a key step in proving the viability of a new product or service. Equally important to note is that new products at 3M have to show that they will be able to command traditional 3M profit margins, and there is a exhaustive approval process before large-scale investment into a new venture is made. Despite a positive culture towards innovation, Post-it notes still took ten years to become a significant 3M product.

The role of the finance director
My more recent research into NPD, and the reason for questioning the role of the accountant, stems from the unique access I was given to observe the NPD process in a medium-sized manufacturing company. The finance director had worked in a French multinational company with an active interest in corporate venturing. Immediately prior to joining as finance director, he had worked in a finance capacity within another division of the manufacturing company. The managing director of the company was convinced of the need for a multidisciplinary team to be involved with NPD. Equally necessary was the commitment of senior management to a formal NPD process. In a classic study of the NPD process, Booz, Allen and Hamilton Inc see it involving the following stages:

• exploration - of new ideas which will meet company objectives
• screening - a quick analysis to see which ideas warrant further study
• business analysis - the development of the idea into a more concrete concept including product features and a programme for production, development - moving from the 'idea-on-paper' into a 'product-in-hand', demonstrable and producible
• testing - the commercial experiments necessary to verify earlier business judgements
• commercialisation - launching the product into full-scale production and sales, committing the company's reputation and resources. The launch point is often, particularly in smaller companies, a critical moment as it is the point where the maximum costs have been incurred and no revenue generated.

Small companies often neglect the necessary marketing of the new product, unable or unwilling to meet the cash demands of the marketing spend. Certainly my own case research points to the need for a formal process to move from creativity (the generation of new ideas) to innovation (the commercial exploitation of new ideas). One of my favourite definitions of innovation is 'delivering new value to the customer'.

In the case of the company referred to earlier, the senior management team met once a month to explicitly consider progress on new products and the responsibilities for making things happen. The finance director felt that accountants, with their ability to subject proposals to robust analysis, had an active and positive role to play in resource allocation and in the appraisal of research and development projects with varying degrees of risk. An accountant's realism can balance the naturally optimistic marketeer. Understanding the nature of the company's markets and customers, and the margins and profitability they can and should generate, provides a key input into assessing the viability, timescales and processes involved with NPD projects. The accountant is uniquely positioned to provide these key insights when making NPD decisions.

Using a relevant time-horizon is important. Traditional cost-driven approaches look to make money from day one, but balancing the demand for current profits against the resources required for significant NPD, means a longer time-horizon is a necessity. There are real dangers in imposing a 'one solution fits all' approach. Certainly there is a need to have a clear view of what the break-even volume is and when it will occur. Reaching critical volume levels will determine when cost savings will occur and this may be equally critical for external partners and alliances involved in the project. If the project requires new technology and/or capacity that does not exist within the company then the feasibility of outsourcing, and the consequential changed timescales, leads to a whole new cost and revenue dynamic for the project concerned. The accountant must emphasise the difference between cash and profits and the nature
and risk of the different costs involved in the project.

Critically, the accountant's role changes from the traditionally risk averse (the 'business prevention officer') to that of ensuring profitable opportunities are not missed. This does not mean that the appraisal process is any less rigorous. But the rigour comes from an understanding or knowledge base that really appreciates the NPD process. Understanding the cost drivers and structure and how they are affected by time and volume is critical to making a positive contribution to taking necessary risks. As 3M shows, the attitude towards innovation is significantly affected by the culture of the organisation.

Without this real business understanding there is a danger that the accounting treatments and measures used will favour the known and measurable. For example, preferring capital investment in a new machine (a tangible asset whose life and contribution can be estimated) over a research and development project with unavoidable unknowns. These include the people involved, their ability to work as a team, the need to involve others (including outside consultants) to generate market information materials and technology. The danger of striving to assess and allocate all direct, indirect, overheads, and services costs against a project may quickly deem it financially vulnerable, particularly if current market projections are small.

Accountants - a health warning!
One further criticism of accountants is that by nature (and possibly training) they are happier dealing with the internal cost side of the business rather than the revenue side where there is more uncertainty. Most NPD will have a significant impact on revenues as well as costs. Even familiarity with the cost side is likely to suffer if the senior accountants in the company have little contact with conditions on the factory floor or with customers or suppliers, who might influence their thinking about technological innovation.

Risk perception is argued to be inversely related to familiarity and experience and consequently accountants lacking shop floor or external insights may well perceive technological innovation as more challenging than, say acquisitions which may be just as risky but are much more familiar. The 'traditional' accountant, immersed in their inward-looking discipline and systems, is likely to focus on cost control and risk avoidance rather than actively engaging with suppliers and customers. Some of my own research has confirmed the importance of having a culture and structure which accepts advice and support from outside the organisation, and shows the positive relationship between an outward-facing culture and corporate growth. Clearly, the accountant is a critical member of the senior management team in making this happen.

Team players
Equally clear from my research is the importance of teams in making innovation and growth happen. Others have cited the contribution of multidisciplinary teams to the innovation process. The NPD process can be adversely affected by 'silo' management, where the research and development function is largely divorced from mainstream activities, in particular, sales and marketing. Conscious structures and systems need to be in place to encourage the dialogue. Many companies find that a continued reliance on the product or service to sell itself in the same way, and to the same customers, is at best a recipe for stagnation. New product or service offerings may also need to be sold to internal customers or key stakeholders, who themselves are broader, more creative individuals, actively looking for ways to differentiate their own contribution. For example, new technology, such as electronic data interchange, may automate the simple transactional relationships between the buyer and the seller, but at the same time create the 'space' for the customer to look for other ways in which their suppliers can add value.

Accountants can and must engage in the NPD process - the days of being outside the decision-making team and 'simply analysing the alternatives until only one is left' should be long gone. I referred to 'space' and freedom above as a result of technology, enabling more positive relationships with customers. Equally, the creation of effective management accounting information systems should give accountants a greater opportunity to engage with and contribute to the NPD process. Some of this may involve moving from their traditional comfort zones and into the creative entrepreneurial processes, allowing them to become more significant players in the innovation process. In my experience of observing NPD first hand, the managing director and the finance director are in a unique position. They bring strategic thinking to NPD and are key members of the team shaping the future direction of new products and services.

Adding value
The case study company makes a tear tape that facilitates easy opening of packaging on cigarettes and processed food. The current move to ban cigarette advertising has meant that promotion is increasingly limited to the cigarette pack itself. Consequently, the company has developed a technology, with the involvement of key partners, which allows it to print promotional messages on the tear tapes. In effect they have created a product which gives more value to the customer, and which also has potential as anti-counterfeit and theft-prevention technology.

Implicit in this case example is the need for the accountant to actively engage in the process. The shift in the accountant's perception and role from being an acute analyst of what has happened, to one significantly influencing the shape of the firm's future, is one I am convinced is happening in firms that are growing and competing in global markets.

Conclusions
The accountant has a key role to play in the NPD process, itself a vital strategy area for all organisations. This involves their ability to look forward and not simply backwards.

• Successful innovation requires a formal process through which an idea moves into an innovation. In the December 2003 examination paper, very few candidates were able to describe what such a process might look like.
• Accountants should be key members of a multidisciplinary team created to manage the NPD process.
• Rarely, if ever, does the NPD process operate without involvement from key partners outside the company. These strategic alliances make the process more complex, and change project timescales and costs, but are vital to achieving significant innovation.
• NPD affects all parts of the value chain and system - process innovation may be just as important as new products or services, particularly in industries which are 'mature'. Often, this process innovation affects the way a product or service reaches the customer. Managers in so-called mature industries should be alert to opportunities for new products and services.
• Accountants should be aware of the dangers of preferring those projects or opportunities that are familiar and lend themselves to traditional evaluation and control methods. Research and development may appear more risky but it has more potential for creating competitive advantage.
• Innovations may have to overcome significant cultural barriers. Managers in companies typically prefer to exploit current products and markets rather than explore new opportunities making it difficult to generate the 'space' and resources necessary for new opportunities.
• Many large companies, committed to current technologies, cannot perceive the challenges from new 'disruptive' technologies and ignore the new products or services that emerge. Often radically different products or services have to be located outside of the main business. Large, divisionalised companies with significant corporate headquarters may find it particularly difficult to move into new areas of technology and business.

Overall, the message for accountants is very positive. They have a skill set that is relevant and necessary to the NPD process. Accountants have a duty to actively engage in the process and improve the outcomes by themselves being innovative.

Ralph Bedrock is examiner for Paper 3.5