Moral Hazard – It's Not Just For Insurance Anymore - Financial Services - United States

Gunnar Larson g at xny.io
Thu Jun 1 10:38:40 PDT 2023


It's an overlooked driver of new product introduction failures.

Somewhere between 50% and 90% of new consumer products launches fail,
depending on the methodology. Regardless of the weighting given to revenue
and profit targets, growth, and other determinants to arrive at the number,
the rate of new product introduction failure in consumer products is
unacceptably high.

It's not hard to find notable examples of new product introduction
failures: Pepsi's Frito-Lay Lemonade Kellogg's Jolly Rancher Pop-Tarts;
Pepsi's Tropicana Essential Pro-Biotics; and Kraft Heinz's Frosted Salad
Dressing. Perhaps some of these products weren't designed to last forever,
but they involve costly changes to formulas and features that go into new
product development (NPD) launches, and downstream activities like
packaging, marketing, and sell-in. Line extensions, while less expensive,
also involve costs in these areas. When sales fall short, there are rightly
questions about why, and who might be held accountable.

Typical explanations include the inherent difficulty in getting innovation
right, ideation that fails to reflect the right set of market, customer,
and consumer insights, failure to live up to the brand promise, and
sub-optimal launch strategies.

Moral hazard is an often overlooked root cause of poor new product
development performance. It occurs when the incentives and responsibilities
for launching new products are not aligned with accountabilities. In our
experience, there are three main drivers of moral hazard:

Incentives that over-emphasize the quantity of NPD projects vs. profit or
probability of success
Sidelining finance and gaming financial hurdles
Ignoring R&D and engineering capacity constraints and overloading
innovation pipelines
Let's unpack each of these.


1. Incentives tied to quantity of new products
In the drive to hit ambitious top-down growth targets, companies often use
innovation as a plug whether or not there's an innovation pipeline in place
to realistically deliver those numbers. This can lead to lots of hastily
conceived projects.

This approach has an array of shortcomings:

The forecast accuracy of NPD is not measured. In our experience, there is
generally a 50% drop in forecast revenue between the time a product is
approved to go into the NPD pipeline (generally 6-18 months before launch)
and the final demand plan forecast (about two months before launch). After
launch, most products underperform even these lowered demand forecasts.

Limited downside for high failure rates. In many companies the hit rate of
new products is not measured and is seldom utilized as a KPI. Those
responsible for innovation are often appraised according to the amount of
overall innovation activity and do not experience a downside when this
activity falls short of forecast results.
Marketing/Sales talent mix and focus skewed toward "glamorous" new product
introduction versus more technical drivers of value.

The skills and activities oriented to new product launches (e.g.,
consumer/customer/marketing research, customer negotiation, product
positioning, promotion strategy and tactics) are often prioritized over
other, perhaps more tedious, drivers of value such as price-pack
architecture, off-invoice deductions, or auditing in-store merchandizing.
But the latter activities are often more critical than new products in
driving brand performance.

2. Sidelining finance and gaming financial hurdles
In many companies, the finance team is not given adequate chance to act as
a check-and-balance in the NPD process. Key contributors to this issue
include:

A minimal role for the chief financial officer (or head of FP&A). The chief
marketing, growth, or innovation officer is often responsible for what goes
into and comes out of the innovation pipeline, with limited opportunity for
the CFO to challenge the underlying assumptions and soundness of business
cases.

Lack of rigor in business cases. To get into the NPD pipeline, a concept
typically needs to meet certain thresholds based on forecast financial
performance. These thresholds could be minimum volumes, revenue or margin
dollars, or some target return on investment. Too often, rather than
discard ideas that do not meet these thresholds, teams work to match their
assumptions to these minimums, not because they believe they can hit these
targets, but to ensure their favored project gets developed and launched.

Stage gates are not effective. It can be difficult to spot teams who are
gaming financial hurdles, as many NPD processes have very low standards of
proof to support business-case assumptions, particularly earlier in the
innovation funnel – and overly rosy assumptions prevail all too often and
do not undergo sufficient financial scrutiny.

3. Lack of prioritization/ignoring R&D and engineering capacity constraints
Overloading the pipeline is a common culprit when innovation fails.
Oftentimes companies load too many projects into the pipeline, leading to
bottlenecks, delays, and poorly executed projects. This leads to products
missing their forecast launch windows (a critical failure in the eyes of
retail customers with specific shelf-reset windows), poorly developed
products that don't deliver the benefits they were intended to, and higher
product costs that drive profitability lower than expected or lead to
pricing at higher rates than initially conceived.

In AlixPartners' experience there are remedies for each of these drivers of
moral hazard:

Re-orient incentives. Define a clear, measurable financial definition of
success (our recommendation: the percentage of new product introductions
that meet their forecasted profit targets), enforce materiality thresholds,
build KPIs around the hit rate of new products, and ensure that the
individuals and teams that have responsibility for conceiving and approving
new product launches are accountable for the results.

Increase financial rigor early in the NPD process. Including the CFO or
other senior finance executives in the process from the outset enhances the
fidelity of financial commitments. Minimum standards of proof to support
business case assumptions (e.g., requiring evidence from prior launches)
can provide the basis for meaningful debates and drive better NPD decisions.

Ruthlessly prioritize NPD projects. Measure the capacity of available R&D,
engineering, testing, and manufacturing resources. Force-rank innovation
projects by importance and do not exceed the number of available R&D and
engineering hours. Ensure focus on the most material and highest-potential
projects and maximize the chances they will be developed on-time and
on-quality.

Successful innovation is inherently difficult and risky – and critical to
success. Addressing the often misunderstood moral hazard issues incumbent
to many current NPD processes can greatly improve the odds of launching new
products that provide meaningful, incremental lift to both revenues and
profits.


https://www.mondaq.com/unitedstates/financial-services/1323792/moral-hazard--its-not-just-for-insurance-anymore
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