Moral hazard – it’s not just for insurance anymore

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:               

1. Incentives that over-emphasize the quantity of NPD projects vs. profit or probability of success
2. Sidelining finance and gaming financial hurdles
3. 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.