Rebecca Weeks Watson, who teaches Keys to Entrepreneurial Thinking, is a 2001 UVA McIntire graduate specializing in design thinking and problem solving. Watson’s career began in investment banking, but her appetite for risk led her down the path of entrepreneurship. Her course provides students with the necessary skills and mindset to become successful innovators within any role or industry.
Learn more about the importance of accounting to startups and how Watson’s course encourages students to approach risk with an entrepreneurial attitude.
What is innovation accounting, and what does it measure?
Watson defines innovation accounting as a form of measuring progress that prioritizes a startup’s sustainability over short-term profitability. She argues that while traditional accounting is well-suited for large businesses, net income reveals little about the viability of a startup in its early stages.
Innovation accounting is a vital step of the widely adopted Lean Startup methodology. According to the methodology, every action taken by a founder should be tied to designing and measuring experiments that achieve validated learning. Under the Lean Startup methodology, the question entrepreneurs should ask isn’t “Can XYZ product be built?” but rather “Should XYZ product be built?” Innovation accounting provides metrics that can help the founder answer this question.
According to Watson, innovation accounting is best applied in three steps. The first step involves testing a minimum viable product and gathering feedback and data from customers. The second step is to use the baseline metric established by the test of the minimum viable product to take initiatives that will improve that metric. The last step is to gauge the metric’s improvement over time and over initiatives to decide whether the business is something worth pursuing or whether a pivot needs to be made.
Why aren’t traditional accounting metrics suitable for startups?
With traditional double-entry accounting, revenue isn’t recognized until a sale is made. But with innovation accounting, entrepreneurs can gauge their company’s growth and potential for success long before their first sale. If early-stage startup success was measured by profit maximization, most startups would be considered failures. Thus, Watson believes entrepreneurs should focus on gaining information about their customers and the business problem they wish to solve instead of profit maximization. The process of learning, listening, and adjusting helps entrepreneurs build solutions that achieve product market fit, and that fit is what pushes startups down a viable path to profitability. Therefore, innovation accounting metrics are better aligned with the goals of startups than traditional accounting metrics.
The co-founders of Airbnb, which originally started as Airbedandbreakfast, needed to determine if travelers would be comfortable staying in a stranger’s apartment. Their goal was to test and measure customer demand, not to build up a massive supply of inventory (apartments and rooms) in order to maximize immediate revenue. All they needed to create was a simple website with a few apartment room listings in San Francisco and then track metrics such as the number of page views, confirmed bookings, and shares with friends. The resulting data validated their hypothesis that there were people willing to pay less than hotel prices to stay in a stranger’s space.
How are performance and value measured under the innovation accounting model?
Innovation accounting is often used to measure customer interest and engagement. For example, entrepreneurs can track the amount of time users spend with their product and how many aspects of the business they interact with. Watson points out that metrics such as views, clicks, signups, and repeat customers help reveal how engaged customers are with the product. Entrepreneurs can use these engagement metrics to determine whether their business plan is something worth pursuing or if they need to make a pivot, which involves trying to solve the same original problem but with a different solution. If the entrepreneur decides to continue with their plan, the customer feedback may be used to tweak the product or service, perhaps adding new features, thereby allowing for deeper engagement in the future. Entrepreneurs can also use innovation accounting to track growth and retention. Once entrepreneurs are comfortable with the amount of customer engagement, they can use innovation accounting metrics to gather information on growth and retention.
How should startups choose metrics within innovation accounting?
Watson believes entrepreneurs should choose metrics that help them test their riskiest assumption. The riskiest assumption is an entrepreneur’s hypothesis about what users will gain from their product or service that’s better than the customer’s current alternatives. When identifying their riskiest assumption, entrepreneurs hypothesize what’s most important to potential users and consider the faults of existing alternatives. Entrepreneurs test their hypothesis through experimentation, then gather innovation accounting metrics to determine whether their riskiest assumption is validated.
Watson recounts a story of a startup that failed due to a lack of hypothesis testing. Quibi was a short-form streaming platform that invested over a billion dollars into infrastructure and high-profile Hollywood directors, producers, and actors to create content for mobile devices. Their riskiest assumption was that users want short, high-quality shows they can watch on their commute to work or in between activities. Quibi didn’t conduct small experiments to measure the product market fit before exerting massive resources into content creation. If Quibi produced a few shows for just a subset of users, they could have realized their riskiest assumption was wrong. Innovation accounting would’ve helped Quibi gather information about when, where, why, and for how long the shows were being watched.
How can innovation accounting help entrepreneurs improve their chances of long-term success?
Watson believes innovation accounting’s greatest strength is its signaling ability. Innovation accounting metrics can help entrepreneurs identify what to build and what not to build or what to change and what not to change. The worst-case scenario is that an entrepreneur makes guesses about customers’ desires, spends time and money building a product, and hopes their product successfully addresses those desires. The best-case scenario, argues Watson, is that an entrepreneur uses innovation accounting metrics to track their progress along the way, then uses those metrics to improve their business model. This prevents heartache, losses, and failure.
How do angel investors perceive innovation accounting? Is it considered a reliable measure of success?
Watson says innovation accounting metrics are often included in presentations and pitches to investors. These metrics give strong signals about the health of a startup and can indicate big business potential. For example, entrepreneurs will often include metrics related to how much time their product can help their customers save. Investors view time as money, so such metrics can be incredibly appealing. Metrics demonstrating growth potential are also widely used. If early adopters and influencers show they’re interested in the product and can influence others to try it, the product has more growth potential and investor appeal. Additionally, investors look for metrics related to retention, such as what percentage of customers have decided to stay, upgrade, or continue paying for the product or service since the launch.
