Spend your budget wisely

This blog analyses 'The Capitalist's Dilemma' by Clayton M. Christensen and Derek van Bever from the June 2014 edition of the Harvard Business Review. It examines the disappointing way in which investment in innovation has failed to take off in the U.S. This is not to say that there is no innovation at all but the potential for it to be culturally pervasive across a wider spectrum is still there and there are a number of reasons why it hasn't happened.


Assessing risk

Traditionally, managers have been afraid to change because they see change as a risky investment. This will always be the case as long as assessing risk is performed in the same way. The problem is that we traditionally look at risk from an insurers mindset which assumes risks are only "high" or "low". Instead they should be looked at as either "good" or "bad". Even in business, the do nothing approach has an associated risk with it so managers may as well embrace risk and be in control.


Innovation types

Assuming that risk is acceptable, there are a number of ways that innovation can be fostered. These are Performance, Efficiency and Market Creating.

Performance innovation looks at substituting poor performing or older products for new ones. Efficiency innovation is all about creating a new business model to sell old products that lead to increased productivity or reducing jobs to free up capital. Finally, Market creating innovation transforms the product or organisations to create new marketplaces or new types of customers (Apple and iPhones for example).

The last of these is quite an significant one and revolves around 2 key features.

1. Enabling technology that drives down costs as volume grows
2. It is a new business model allowing the innovator to reach people who weren't customers because they couldn't afford a type of the original product - eg affordable cars or affordable computers
• Companies that do this tend to need more staff leading to employment growth
• The need to combine innovations in other markets brings about a culture that fosters partnership growth also leading to better outcomes for organisations and employees

There is a basic equation postulated here that goes like this:

Technology that drives down costs 

+ 

Ambition to eradicate non consumption 

= 

A revolutionary effect 

Products that no one has thought of before have the potential to change the marketplace.

Can we be too efficient?

In short, yes. The Efficiency innovation is a good example. For the most part, it's focus is traditionally on eliminating jobs rather than generating them. It is mainly because it is based on the assumption that corporate performance should be based on the efficient use of capital. 

This leads to an unwillingness to spend because it sees debt as a problem. The saying that you've got to spend money to make money rings true. Companies like Coca Cola Amatil run up large amounts of debt. The debt part should not be the problem that organisations focus solely on solving. The creation of revenue and wealth should be given equal if not higher importance. There is no debt problem if you make enough money.

So where did this focus come from? Historically it's come from the idea that capital is scarce and costly. This means the best thing to do is to maximise the amount of profit per capital and various ratios that measure this. The problem with these ratios of x/y is that emphasis is put on controlling the denominator a lot more than increasing the numerator. 

Despite estimates from Bain & Co that capital is in abundance, there is still hesitation from organisations to be attracted to market creation innovations because they put capital costs on the balance sheet. Efficiency innovations look to take costs off the Income statement and can be seen as a more positive thing with most innovation strategies bearing fruit after years 5-10.

Organisations should not just look at serving the needs of current customers but also the potential needs of their future customers. Companies that can see this and be first to market will be more prosperous than others.

Would you like fries with that spreadsheet?

In this article, Christensen and van Beever see spreadsheets as the fast food of strategic decision making. Just like fast food, spreadsheets have the potential to create an unhealthy society by creating an over-reliance on tasty things.

The tasty bites from spreadsheet come in the form of metrics. When these were first created, analysts were able to gain power and leverage in businesses because they could tell CEO's all about their company leading to the 'orthodoxies of new finance'. From metrics, analysts and traders could short-sell company stocks and eventually control the markets these companies compete in.

The tyranny of metrics has the potential to focus on them too earnestly that it withers away ambition. There is a need to be careful not to outsource managerial judgement because there is always the unknown factor in any strategic decision. The key to all of this is to never start an investment conversation with a spreadsheet. Keep the idea alive and fan the flames a bit more. There is a definite need for metrics but at the right time and the right place.


Thesis pieces

Christensen and van Bever postulate that reform is needed in order to change the landscape and offer up 3 forms of this.

• The need to assess investments in new ways. Simply put the metrics used in the past such as return on net assets or earnings per share, have led to investments that squeeze costs and non cash assets. This means that investment to create jobs and growth falls behind efficiency innovations and doing nothing.

• Capital needs to be spent not hoarded for a rainy day. Growth only comes out of outlays of capital and successful companies have proven it is fine to spend in order to improve. We see this in the market place often where companies spend time on a product refresh that sees them come back stronger than before, think Samsung for example.

• Need to look at new ways to manage scarce and costly resources. Time is quite an unheralded resource however if it is prioritized then investments that make the most of a persons time can lead to thought-provoking innovations. For example, if Time is factor that needs to be enhanced then companies can look to innovate via automation or outsourcing of non-essential activities.

Conclusion

The article raises some thought provoking questions and leads to lessons that are applicable here in Australia for government innovation and policy making especially as it relates to ICT strategy at both Federal and State levels. Despite the overall negative perception of the budget by the Australian public, for some government agencies the outcomes look potentially bright whilst others remain cautious. A key theme repeated at various events has been the need for government agencies to focus on productivity especially in terms of how to get the most out of their budget. Some see that they are limited by lower staff resources and reduced budgets. Despite this, in order to survive and be relevant, it is important to spend on capital but to assess the risk and the type of new innovation they offer in a smarter way.

The main take away here is to not just accept things should be done in certain ways because that's how it has always been. Rather organisations need to be cautious of accepting traditional approaches to solving new age problems. Additionally, there is no solving of problems or creation and fostering of innovation without capital investment. It might not be the spark the lights the fire but it is indeed the fuel that keeps it going.