SETTING Top Tier Innovation GOALS FOR CPG INNOVATION: The Vitality Index
In today's fast-paced and ever-evolving business world, innovation has become more critical than ever. To stay ahead of the competition and drive growth, CPG companies need to continually innovate and develop new products and services. However, measuring the effectiveness of innovation has been a significant challenge for many companies. McKinsey's Vitality Index offers a solution to this problem by tracking the share of sales coming from all innovation.
The Vitality Index is a metric developed by McKinsey & Company to measure a company's innovation effectiveness. It tracks the percentage of total corporate sales that come from new products or services launched in the past three years. By tracking this metric, companies can assess the success of their innovation efforts and make informed decisions about future investments. It also aggregates all types of innovation into the equation such as Line Extensions, Expansions, Disruption and Renovation.
We are seeing the McKinsey Vitality Index becoming increasingly popular in the consumer packaged goods (CPG) industry, and within our innovation clients. From our perspective, this is a good yardstick to leverage, because when a company is introducing over 1,000 new products to the market on an annual basis (as some of our clients are), there has to be a way to determine if all of that effort is truly successful, even if 999 of those innovations are just new pack sizes and formats to appeal to individual retailers.
One example of a large CPG putting a stake in the ground for its innovation growth is Kraft-Heinz, which announced in February 2023 plans to grow its baseline revenue with $2 billion in additional sales coming from innovation between 2023 and 2027. With 2022 net sales of approximately $26 billion, this innovation growth goal would result in a vitality rate goal of around 8%.
According to McKinsey, a healthy Vitality Index has a range of possibilities, but that range really depends on the industry being discussed and the manner in which its pursued. For perspective, McKinsey self-describes the Vitality index as “somewhat of a simplistic focus on total revenue. This metric not only fails to differentiate profitable and unprofitable investments but also evaluates all innovation through the same lens, regardless of strategic intent.” They then go on to qualify that “The vitality index is a kind of thermometer: it measures temperature but does not improve health. It can distract companies into shifting volume, effectively cannibalizing existing sales, rather than driving more valuable and disruptive innovation. Indeed, many companies with a strong vitality index—as much as 20 percent of sales from products launched in the past three years—are not growing their top lines.”
Luckily, we can attest that Kraft's goal of $2 billion in sales from innovation representing around an 8% vitality rate is not too far off from other clients we have seen pursuing this metric as their innovation yardstick. And if more than one major CPG is pursuing a vitality innovation target in the high single digits, then it is highly likely that a Vitality index in the high single digits is a good indication of an industry standard that can be used by other larger more established CPGs as well.
Overall, we do believe that the Vitality Index offers a valuable tool for large CPG companies looking to assess the effectiveness of their innovation efforts. By tracking the share of sales coming from new products and services, companies can make informed decisions about future investments and ensure they are staying ahead of the competition. While it may feel very challenging to think about how to measure one’s total innovation efforts in the context of an overall multi-brand, multi-category innovation growth strategy, it doesn’t necessarily need to be. McKinsey does have a very clear and compelling recommendation that starts with an internal assessment of the overall organization’s capabilities and practices by asking these nine key questions:
“Do current innovation efforts empower sustainable, profitable portfolio growth?
Do we use an analytical, data-driven framework to choose where to innovate?
Do we develop innovation systematically, based on consumer-led and analytical insights?
Are we able to accurately predict the size of innovation and sources of volume?
Do we pursue a balanced mix of innovations with distinct roles to meet specific strategic goals?
Do we set metrics and targets by type of innovation based on objectives and portfolio roles?
Are we able to accurately measure innovation incrementality?
Do we measure the impact of innovation to understand if it is margin accretive to the portfolio?
Does our organizational structure use a disciplined process to measure and manage innovation?”
In both our and McKinsey’s experience, “nearly every CPG company can stand to make meaningful improvements in one or more of these areas” in order to improve their innovation opportunities. We firmly believe that a strong Vitality Index is what top-tier CPG organizations are most likely pursuing, and with a clear innovation goal linked to overall revenue, it can really help to focus and prioritize the innovation efforts that need to be pursued for ongoing corporate health.
Reference: https://www.mckinsey.com/industries/consumer-packaged-goods/our-insights/will-innovation-finally-add-up-for-consumer-goods-companies