Innovation's Effect on Firm Value and Risk

Product/Service InnovationSorescu, A.; Spanjol, J. · 2008Journal of Marketing

Topicsbreakthrough innovation·incremental innovation·firm value·economic rents·firm risk·cpg·tobin's q·abnormal returns

Executives count on new products for growth, yet many doubt that innovation pays. A breakthrough is the first product to bring shoppers a substantial new benefit, through technology, formulation, packaging, positioning, merchandising or a new market. Incremental launches bring no such benefit. Imagine your team splitting a food or household care budget between the two. Which launches earn shareholders more than the normal return investors require for risk?

Investors value CPG firms more in years when they launch more new products, but only breakthroughs that give shoppers a new benefit are associated with returns above a normal return.

Data chart

One breakthrough is associated with far more firm value than one incremental launch

Left: extra share value above the return investors require for risk, per unexpected breakthrough at a typical sample firm, in millions of dollars. Right: the rise in firm value per breakthrough divided by the rise per incremental launch, in times.

Incremental launches show no reliable returns above a normal return.

Both launch types are associated with higher firm value, but only breakthroughs show reliable returns above a normal return.

Table 5, p. 126, and the share-value calculation on p. 129; 153 publicly traded US packaged-goods firms, 1985-2003. The dollar figure assumes internal funding. Exact values: 0.0847% of equity value, about $4.2 million for $4.9 billion of equity; the separate firm-value comparison is .0337 divided by .000751. The 45-times ratio does not compare returns above a normal return.

Data chart

Breakthroughs in formulation, positioning and packaging outnumber technology breakthroughs

Number of breakthrough products in each type of new shopper benefit, among 22,532 products launched by 153 publicly traded US packaged-goods firms from 1985 to 2003. A product can appear in more than one bar.

Formulation, packaging and positioning breakthroughs are linked to returns above a normal return.

Formulation, positioning and packaging breakthroughs far outnumber technology breakthroughs, and each has a reliable link to returns above a normal return.

Table 3, p. 124; dimension tests, p. 125; footnote 14, p. 127. Of 1,567 breakthrough products, 358 belong to multiple types, so the bars do not form shares of one whole. Technology, merchandising and new market each have fewer than 50 products and show no reliable link to firm value or returns above a normal return; small counts may limit the tests.

Action guide

Fund breakthroughs as your source of returns above a normal return.Keep incremental launches in the plan and give breakthroughs their own protected budget.
Count your packaging, formulation and positioning advances as breakthroughs.Judge your pipeline by the new benefit each product gives shoppers, not by whether it uses new technology.
Ask your finance team to report breakthroughs and incremental launches separately.A combined count hides how differently each is linked to firm value, returns above a normal return and risk. Get all three measures before you set your innovation budget.
Present breakthrough risk to your board together with its return.Show the added volatility next to the returns that offset it for shareholders.

Evidence

Investors value CPG firms more in years when they launch more new products, breakthroughs and incremental launches alike. But firm value alone cannot show whether launches earn returns above a normal return.
Per product, a breakthrough is associated with roughly 45 to 50 times as much added firm value as an incremental launch.
Breakthroughs are the only launches with a reliable link to stock returns above a normal return. At a typical sample firm with about $4.9 billion of equity, each unexpected breakthrough is associated with about $4.2 million of share value above a normal return. An unexpected breakthrough is one beyond what the firm's launch history predicts. The figure assumes the firm funds breakthroughs from its own cash.
Breakthroughs are associated with a more volatile stock price, but for shareholders the returns above a normal return offset that risk. The added risk is specific to the firm, not tied to the stock market as a whole. Incremental launches show no reliable link to risk.
About 7% of the 22,532 new products in the data were breakthroughs, and only 48 were technology breakthroughs. Packaging, formulation and positioning breakthroughs are each associated with higher firm value and returns above a normal return. Merchandising, new market and technology breakthroughs were too few to show a reliable link to either.
Each extra breakthrough in a year is associated with a smaller rise in firm value, but firm value keeps rising across the range observed. The rise would stop at about 24 breakthroughs a year, the highest yearly count in the data.

Key takeaway

Only breakthroughs that give shoppers a new benefit are associated with returns above a normal return for shareholders.

Limitations

The evidence covers 153 publicly traded US CPG firms from 1985 to 2003 and measures stock market value, returns and risk, not the profit or sales of individual launches. Positive returns assume the firm funds breakthroughs from its own cash, and whether gains cover outside funding costs is untested.

Source

Sorescu, A., & Spanjol, J. (2008). Innovation's Effect on Firm Value and Risk: Insights from Consumer Packaged Goods. Journal of Marketing, 72(2), 114–132. https://doi.org/10.1509/jmkg.72.2.114.

https://doi.org/10.1509/jmkg.72.2.114

Exact values behind the rounded figures: each breakthrough is associated with a 0.0847% increase in the market value of equity, about $4.2 million for a typical firm with about $4.9 billion of equity; the per-product firm-value ratio is .0337 against .000751; 1,567 of 22,532 products were breakthroughs.