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NPV doesn’t work for risky, high-potential projects. Here’s a better approach.
This article was co-authored with Claus Hirzmann of Strategic Finance
“Never test the depth of the river with both feet.” Ironically, this is the very behavior that plagues many of the innovations that ended up in Rita’s “flops file.” From Disney’s Star Wars Hotel to Google’s Stadia to Anheuser-Busch-Keurig’s DrinkWorks and more, these projects all feature massive up-front investment and detailed years-long plans. There’s a smarter way to allocate resources to big bold things.
Innovation and Net Present Value calculations — two mistakes
The net present value (NPV) decision rule is widely adopted and often applied to decisions with respect to investing in innovative new ventures. The rule simply suggests that one project cash flows in and cash flows out for a given initiative over some period of time, then discount back to the present to account for the cost of capital. This is more than highly problematic for new ventures. There are many reasons why.
Ventures are uncertain, so the idea that you can predict cash flows over the lifetime of a project is absurd. NPV further assumes that beginning a project means you will carry it forward to its conclusion. That may not be the case — in fact it will…
