Creating Employee Networks That Deliver Open Innovation Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Creating Employee Networks That Deliver Open Innovation case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Creating Employee Networks That Deliver Open Innovation case study is a Harvard Business School (HBR) case study written by Eoin Whelan, Salvatore Parise, Jasper de Valk, Rick Aalbers. The Creating Employee Networks That Deliver Open Innovation (referred as “Innovation Brokers” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Leadership.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Creating Employee Networks That Deliver Open Innovation Case Study

This is an MIT Sloan Management Review article. Companies such as Procter & Gamble, Cisco Systems, Genzyme, General Electric and Intel are often credited with having attained market leadership through open innovation strategies. By tapping into and exploiting the technological knowledge that resided beyond their own R&D structures, these companies outmaneuvered rivals. But while other organizations try to follow their example, this research shows that many are failing because they neglect to ensure that the outside ideas reach the people best equipped to exploit them. R&D leaders need to think not only about combing the outside world for new and potentially applicable ideas but also about how to ensure that those ideas receive serious consideration. By understanding the roles of two types of innovation brokers -"idea scouts" and "idea connectors"-in the open innovation process, and by utilizing their talents effectively, managers can preside over major improvements in the conversion of external knowledge into successful outcomes. The authors provide numerous examples, pointing out that success at open innovation depends on the presence of both types of innovation brokers. But despite these innovation brokers'importance to the organization, the people who wound up as idea scouts and connectors often came as a complete surprise to management. Innovation is too important to be left to chance, however. If innovation brokers do not exist, management is obliged to "invent" them -i.e., recruit the right people to perform these valuable roles.

Case Authors : Eoin Whelan, Salvatore Parise, Jasper de Valk, Rick Aalbers

Topic : Leadership & Managing People

Related Areas : Leadership

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Calculating Net Present Value (NPV) at 6% for Creating Employee Networks That Deliver Open Innovation Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026018)	-10026018	-	-
Year 1	3447889	-6578129	3447889	0.9434	3252725
Year 2	3978259	-2599870	7426148	0.89	3540636
Year 3	3964701	1364831	11390849	0.8396	3328839
Year 4	3223475	4588306	14614324	0.7921	2553294
TOTAL			14614324		12675495

The Net Present Value at 6% discount rate is 2649477

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Profitability Index
2. Net Present Value
3. Internal Rate of Return
4. Payback Period

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Innovation Brokers have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Innovation Brokers shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Creating Employee Networks That Deliver Open Innovation

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Leadership & Managing People Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Innovation Brokers often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Innovation Brokers needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10026018)	-10026018	-	-
Year 1	3447889	-6578129	3447889	0.8696	2998164
Year 2	3978259	-2599870	7426148	0.7561	3008135
Year 3	3964701	1364831	11390849	0.6575	2606855
Year 4	3223475	4588306	14614324	0.5718	1843032
TOTAL					10456187

The Net NPV after 4 years is 430169

(10456187 - 10026018 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10026018)	-10026018	-	-
Year 1	3447889	-6578129	3447889	0.8333	2873241
Year 2	3978259	-2599870	7426148	0.6944	2762680
Year 3	3964701	1364831	11390849	0.5787	2294387
Year 4	3223475	4588306	14614324	0.4823	1554531
TOTAL					9484839

The Net NPV after 4 years is -541179

At 20% discount rate the NPV is negative (9484839 - 10026018 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Innovation Brokers to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Innovation Brokers has a NPV value higher than Zero then finance managers at Innovation Brokers can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Innovation Brokers, then the stock price of the Innovation Brokers should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Innovation Brokers should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Creating Employee Networks That Deliver Open Innovation

References & Further Readings

Eoin Whelan, Salvatore Parise, Jasper de Valk, Rick Aalbers (2018), "Creating Employee Networks That Deliver Open Innovation Harvard Business Review Case Study. Published by HBR Publications.